Nasdaq goes nuclear on the SEC

Nasdaq just went nuclear.

In a letter to the US Securities and Exchange Commission, Nasdaq's law firm, Gibson Dunn, said that the SEC could be sued if it approves IEX's application to become an exchange.

IEX, the upstart trading venue made famous by Michael Lewis' book "Flash Boys," filed with the SEC in September to become a stock exchange, kicking off a heated debate of the merits of its application.

The debate has at times gotten ugly, with IEX and the New York Stock Exchange in particular trading barbs.

For its part, the SEC has delayed its decision on the application until mid-June.

At issue is the IEX speed bump, which the venue says levels the playing field between high-speed traders and the rest of the field.

But IEX's rivals have questioned whether the speed bump is consistent with Regulation National Market System, the rule which governs stock exchanges. It requires that a public exchange's response to an incoming order be "immediate."

The SEC has hinted that the 350-microsecond delay built in to the IEX system could be permissible, as it is under one millisecond. Nasdaq disagrees.

Here is the Gibson Dunn letter:

This supplemental letter explains our view that the Commission's proposed Interpretation of the term "immediate" as permitting an intentional delay of less than one millisecond would conflict with the plain language of Regulation NMS, with the requirements of reasoned decision-making under the Administrative Procedure Act ("APA"), and with the Commission's statutory duty to consider the effect of its actions on efficiency, competition, and capital formation.

Here are the references to judicial scrutiny:

To be sure, courts often afford deference to an agency's interpretation of its own regulations, including to reinterpretations of existing provisions. But that deference is hardly boundless and would not shield the proposed Interpretation from judicial scrutiny. Deference to an agency's interpretation of a regulation is not warranted unless "the language of the regulation is ambiguous."

And:

In addition, the proposed Interpretation would be unlikely to survive judicial scrutiny because this de facto rewriting of Rule 600(b)(3) would impermissibly circumvent the Commission's statutory obligation to consider whether changes to Regulation NMS are justified on the basis of cost-benefit considerations.

And here is the closing paragraph:

For all of these reasons, Nasdaq urges the Commission not to depart from its existing interpretation of Regulation NMS by authorizing artificially delayed response times for protected quotations, and further submits that the Commission lacks the authority to approve IEX's application and to treat its intentionally delayed quotations as protected.

IEX responded to the Nasdaq letter in an emailed statement. John Ramsay, chief market policy officer at IEX, said:

The incumbent exchanges have lost the debate on the merits and Nasdaq's latest salvo is more saber rattling in an effort to stave off competition at all costs.

This isn't the first time that Nasdaq has spoken out about IEX.