United States: SEC Approves IEX's Registration As National Securities Exchange, Updates Automated Trading Interpretation

Last Updated: June 28 2016
Article by Steven D. Lofchie

Most Read Contributor in United States, August 2018

The SEC approved the amended application by the Investor Exchange LLC ("IEX") to register as a national securities exchange. Simultaneously, the SEC updated its interpretation of "automated quotation" in order to require trading centers to "honor" automated securities prices that are subject to small delays, or "speed" bumps, when accessed.

According to the SEC, IEX must satisfy several standard requirements before it can begin to transition its operation to a national securities exchange. Those requirements include the following:

  • entering into an SEC-approved agreement with FINRA, pursuant to Securities Exchange Act Rule 17d-2 ("Rule 17d-2 Agreement"), that permits FINRA to fulfill IEX's regulatory obligations with respect to its common members for specified regulatory and enforcement matters;
  • entering into a final regulatory services agreement that specifies the examination, enforcement, and disciplinary functions that FINRA will provide to IEX in addition to entering into the Rule 17d-2 Agreement;
  • becoming a party to the multiparty Rule 17d-2 agreement concerning the surveillance, investigation and enforcement of common insider trading rules;
  • ensuring the minor rule violation plan that IEX must file under Securities Exchange Act Rule 19d-1(c)(2) is declared effective by the SEC; and
  • joining the Intermarket Surveillance Group.

A distinguishing feature of IEX is its Point-of-Presence ("POP") and "coil" infrastructure (collectively, the "POP/coil delay"), which intentionally delays all incoming messages from users to IEX and all outgoing messages from IEX to users. According to IEX, the infrastructure is designed to "ensure that no market participants can take action on IEX in reaction to changes in market prices before IEX is aware of the same price changes on behalf of all IEX members."

Rule 611 of Regulation NMS (the "Order Protection Rule") protects the best-priced "automated quotations" of certain trading centers by obligating other trading centers generally to honor those quotations by not executing trades at inferior prices. Under Regulation NMS, an "automated quotation" is one that, among other things, can be executed immediately against an incoming immediate-or-cancel order. In light of IEX's POP/coil delay, the SEC updated its interpretation of "immediate" in the context of Regulation NMS to mean "not precluding a de minimis intentional delay"; i.e., a delay that is short enough not to "frustrate the purposes of the Order Protection Rule by impairing fair and efficient access to an exchange's quotations." In this way, the SEC's interpretation would bestow "protected" status to IEX quotations under the Order Protection Rule despite the POP/coil delay.

The SEC noted that it will conduct a study of the effects of intentional access delays on market quality, including asset pricing, within two years of the SEC's interpretation in order to reassess whether further action is appropriate.

Commentary

The questions raised by the SEC's approval of IEX's application are these: (i) how extensively should market rules be standardized, and regulations govern, where a trade is directed or executed, (ii) should investors and brokers be given more freedom to ignore disfavored markets, and (iii) how much latitude should markets have to make their own rules? Perhaps these questions should be answered before everyone is forced to comply with the requirements of Regulation NMS.

A regulatory system that requires participants to waste years obtaining approval for a new exchange with a slightly different mechanism for executing trades is not a system that encourages experimentation, nor does it allow for dynamic responses to market forces.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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