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Change Generation

The Startup Stock Exchange Fighting The Scourge Of High-Frequency Trading

If IEX wins approval from regulators, it could make stock trading more fair for ordinary investors.

The Startup Stock Exchange Fighting The Scourge Of High-Frequency Trading

The company uses a tiny "speed bump" to slow everyone down to the same speed.

Top Photos: McIek, A Luna Blue via Shutterstock

Brad Katsuyama believes that Wall Street is rigged against ordinary investors. So he founded IEX, a startup that's hoping to become the newest stock exchange to become approved by the SEC.

Katsuyama—idolized in Michael Lewis's 2014 book Flash Boys—is trying to solve one of the problems of the market today: whoever has the best technology to buy or sell stock faster than anyone else through automated high-speed trading.

If you flip on the financial news on CNBC, you'll still see traders running around on an exchange floor. But nothing actually happens there anymore—the action is invisible, happening at speeds faster than humans can comprehend, in data warehouses in New Jersey. And since technology introduced the challenge of fairness, IEX is trying to also use technology to level the playing field.

The company uses a tiny "speed bump"—350 millionths of a second—to slow everyone on its exchange down to the same speed. If someone wants to buy or sell stock, someone else's computer can't detect that early and drive the price up or down.

"It's one-1000th of the speed of you blinking your eye," says Katsuyama. "So it's totally irrelevant to a pension fund or a mutual fund, but it's critical to certain high speed traders, and they don't like it very much."

Some argue that IEX is unfair to high-frequency traders. Others say the SEC should take on the problems of high-speed trading themselves; after Flash Boys came out, the agency quickly fined the New York Stock Exchange millions for giving high-frequency traders an edge. But Katsuyama doesn't think regulation is the best answer.

"We felt like a regulatory solution would be this broad, overarching change that could actually have a lot of unintended consequences. Whereas IEX is more of a precision solution to a precision problem. There are some forms of high frequency trading that are bad for the market. And we're trying to eliminate that. I think a market-based solution has a much better chance of solving that than broad sweeping regulations."

IEX started running a private exchange (aka, a "dark pool") in 2013 and has steadily grown since. But now it's battling to join the list of the 12 registered stock exchanges in the U.S. Much of the rest of Wall Street is fighting against its entry; not just most high-speed traders, but the stock exchanges themselves.

"Stock exchanges like the New York Stock Exchange and Nasdaq, who used to make the majority of their money in trading—charging a fee to the buyer and a fee to the seller—now make only a small fraction of the money through trading," says Katsuyama. "They actually make much much more money from selling high-speed data and high-speed technology that is primarily used by the high-speed traders."

The SEC is due to make in decision in the coming weeks and has received more public comments on IEX than for all other stock exchanges—combined—in the history of the United States. Almost all are positive, like a teachers' retirement fund in Texas that wrote to say that IEX is saving beneficiaries millions of dollars.

"To think that a solution that's providing that value to the everyday person during their retirement could be denied the ability to compete alongside other exchanges—I think that that would be a tough pill to swallow, if that is the outcome," says Katsuyama. "We're fighting for the approval."

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