June 22, 2016

The IEX Machete

We humans don’t like change.

We become accustomed to uncomfortable shoes, kinks in the neck each morning, the monotony of sameness. Were we recorded we’d likely be surprised to hear ourselves making excuses for why what we don’t like must continue. The USA’s Declaration of Independence lamented how people are disposed to suffer ills rather than change them.

The rise of IEX, the Investors Exchange, embodies that ethos. Late last Friday the enterprising folks canonized by Michael Lewis in his book Flash Boys won longsuffering reward when the Securities and Exchange Commission granted the alternative trading system status as a US stock exchange able to host listings.

We’ve become disposed to suffer ills. It’s been 45 years since companies wanting to list shares publicly with a US national stock market had more than two choices (OTC Markets Group and NYSE MKT, I’m not slighting either of you here). That’s remarkable in a country that prides itself on entrepreneurialism and innovation, and testament to both the byzantine form the market has taken and the entrenched nature of the competition.

Comments on IEX’s exchange application are supportive save for vitriol from would-be peers reminiscent of the invective and condescension of some activist investors (think Icahn and Ackman).

Contrast with the behavior of golfing professionals at last weekend’s US Open. Dustin Johnson won his first major despite a controversial penalty, and his fellow competitors rallied behind him despite what we could call “losing market-share.”  Contender Bubba Watson on CNBC’s Squawk Box said he was with fans shouting “Dus-tin! Dus-tin!”

That’s mature professionalism. By contrast, IEX joins the green jackets of the stock-exchange business to derogations from peers. They’ve lobbied for every penalty stroke.

We mean no offense to the incumbents. But it’s embarrassing. Our stock market obsessed with speed and crammed with arbitrage and mostly inhospitable to the active “long-only” (few now are purely long) investors companies spend all their time and resources courting is meaningfully a product of legacy exchanges. We’ve been sold a bill of goods.

The Duopoly is loath to admit IEX or share the power they’ve exercised over the listing process. Why? If innovation and choice are byproducts of free markets, incumbent opposition should raise eyebrows (kudos to the SEC for reinforcing the mechanism of a free and open market that exists for issuers and investors). They’ve chosen easy regulatory monopoly instead, and it’s made them arrogant.

Without restraint through competition and transparency, the market has become a tangle of vines smothering differentiation between companies and promoting arbitrage over investment. The proof is in plunging ranks of public companies, confusion everywhere about what’s setting prices (we’ve cured that malady by the way), and a general migration of stock-prices toward means without regard to fundamentals (those who blame regulation I get it, but the market itself is the problem).

We’ve lost sight of original purpose. So welcome to the jungle, IEX.  We could use a sharp machete.

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