Bloomberg News

Bats IPO Scuttled on Potential for Erratic Trading

March 25, 2012

The potential for “uncoordinated and chaotic” trading after bad code corrupted its computers spurred Bats Global Markets Inc. (BATS), the third-biggest U.S. stock exchange operator, to scuttle its initial public offering, according to the company’s chief executive officer.

Joe Ratterman, picked as CEO of the six-year-old stock venue in 2007 after the high-frequency trader who founded Bats left, said in a telephone interview that the board hasn’t discussed leadership changes. While his team in Lenexa, Kansas, responded in seconds when computer errors related to software for the IPO auction derailed its stock and forced a halt in Apple Inc., it wasn’t enough to salvage the public debut.

“It was embarrassing,” Ratterman said. “We feel terrible about it. But the steps that were taken, I believe, were taken at the right pace and the right actions were taken,” he said. “The firm is responsible. We take responsibility. There’s no outside influence here.”

Ratterman, 45, faces the biggest crisis of his career after scrapping the IPO, intended to raise money for the Wall Street firms that guided Bats from a company with 13 employees six years ago into the third-largest American equities exchange. The cancellation emboldened critics of modern market structure, who say the mosaic of more than 50 trading sites that grew up in tandem with electronic trading during the last 15 years has put investors at risk.

‘Isolated Events’

“There are going to be isolated events at the different market centers over time,” Ratterman said. “We’ve had historically very few instances where our systems have gone down, but they have gone down in different ways in the past like every other venue. I don’t think this is anything new as much as it was under a bright spotlight.”

Bats priced 6.3 million shares at $16 on March 22 and was ready to begin trading a day later when one of its computers malfunctioned, triggering events that ended with the IPO’s cancellation. While the company reported its opening transaction for $15.25 a share at 10:45 a.m. New York time on its website, feeds including those sent to Bloomberg LP displayed different prices. At 11:14 a.m., data showed 1.26 million shares had traded, with the lowest at 0.02 cent.

Compounding the confusion, a single trade for 100 shares executed on a Bats venue briefly sent Apple (AAPL) down more than 9 percent to $542.80, setting off a circuit breaker that paused the stock everywhere in the country for five minutes. The shares rebounded and the errant trade at 10:57 a.m., along with all transactions in Bats shares, was canceled.

Wall Street Owners

Bats held a conference call with its underwriters starting before the opening auction process began at 10:30 a.m. that lasted into the afternoon. The glitch became obvious “immediately following the auction” when the transaction didn’t reach public feeds and quotations weren’t processed, Ratterman said. Engineers rushed to diagnose the problem and software developers began to fix the code once the problem was identified.

The $15.25 level generated by the auction, even though it was down 75 cents from the price set by underwriters the night before, was valid because the software glitch didn’t affect the process of establishing it, he said. Bats planned to be the first company to list on its exchange.

“That print, we believe, was a correct price,” said Ratterman, who holds a bachelor’s degree in math and computer science from Central Missouri State University. “It was a little disappointing personally, but we were more focused on the functioning of the system than we were on the value of the print.”

Expanding Exchanges

Pulling the IPO hurt Bats and the brokerage and trading firms who steered it to prominence as a way of holding down fees when the New York Stock Exchange and Nasdaq Stock Market expanded by buying electronic rivals. The company was initially built to service high-frequency firms like Tradebot Systems Inc., whose CEO Dave Cummings founded it. Automated trading firm Getco LLC and Wedbush Inc., owner of an investment bank whose clients include high-speed traders, have equity stakes.

The malfunctions are refocusing scrutiny on market structure in the U.S., where two decades of government regulation have broken the grip of the biggest exchanges and left trading fragmented over dozens of venues, including electronic communications networks and dark pools. Bats, whose name stands for Better Alternative Trading System, expanded in tandem with the automated firms that now dominate the buying and selling of American equities.

“Bats is obviously for-profit and NYSE and Nasdaq are public companies,” said Joseph Saluzzi, a partner at Themis Trading LLC in Chatham, New Jersey, said in a phone interview March 23. “They need to address shareholder wealth first and investor protection second.”

Investigating ‘System Issues’

Bats sent a notice about 10 minutes before the Apple halt saying it was investigating “system issues.” More than three hours after trading closed, the company said in a statement that a computer that matches orders in companies with ticker symbols starting with A to BFZZZ “encountered a software bug related to IPO auctions.” The glitch made existing customer orders for those securities unavailable for trading.

Ratterman said the decision to cancel the offering was made by his executive team in consultation with the syndicate desks of the underwriters. Morgan Stanley (MS), Credit Suisse Group AG and Citigroup Inc. (C), all of which own stakes in the company, managed the offering. Bats also discussed withdrawing the IPO with board members on the pricing committee. Scrapping the deal reflected its responsibility as a so-called self-regulatory organization to maintain fair and orderly trading, he said.

Exchange Obligation

“We had the ability to decide to pull the IPO because we were the issuer,” he said. “But our decision to do so was based off what we thought was potentially going to be a very uncoordinated and chaotic open on the first day of an issue. It was more about our function as an exchange that we made the decision for the trading community and we put our interest in the IPO completely aside.”

Almost half of the 6.3 million Class A shares being offered were from the estate of Lehman Brothers Holdings Inc. (LEHMQ), with another 1.1 million from Getco, according to Bats’s March 21 filing with the Securities and Exchange Commission. Bats also planned to pay a $100 million dividend to shareholders including its 10 main financial company investors such as Bank of America Corp., Deutsche Bank AG and Instinet Inc. The failure of the deal voided the payment.

Ratterman said the company, which operates two trading platforms in the U.S., prepared for the first day of trading by running mock IPO auctions in which its technicians tried to anticipate problems. In a February filing with the SEC, Bats said its BZX Exchange was accessible to users 99.94 percent of the time, while its BYX Exchange, its second market, was available 99.998 percent of the time.

‘Daily Auction Testing’

“There was an amazing amount of testing,” he said. Bats earlier this year had successful debuts for nine exchange-traded funds. “Those tests were happening for three to four weeks leading up to this with daily auction testing. This is an example of an edge scenario -- that despite hundreds and hundreds of tests and code reviews, there was a condition code that had not been seen.”

The exchange operator was trying to raise money for its selling shareholders less than two years after a crash erased $862 billion in less than 20 minutes from U.S. share values, a plunge that critics linked to the fragmented market structure that helped Bats thrive.

An official with the SEC’s enforcement division said last month that the agency is examining trading practices that gained dominance in the past decade amid the shift to automation. Daniel Hawke, head of the market-abuse unit, said the SEC is looking at techniques such as co-location, in which exchanges let traders place computers close to the market to shave time off executions.

SEC Request

Bats itself got a request from the SEC for information on the types of orders its customers use. The inquiry, disclosed in a regulatory filing Feb. 23, sought information about how order types have evolved. Bats said regulators asked for documents “related to the development, modification and use of order types, and our communications with certain market participants,” including some of Bats’s owners.

The company hasn’t commented on the SEC’s request. Once the computer errors emerged on the day of the IPO, Bats was in contact with the commission “within minutes” of the 10:45 a.m. auction and stayed in touch during the day, Ratterman said. His team of programmers and engineers responded in “fantastic fashion” even though trading in the company’s shares never resumed.

“If we were to find wrongdoing or incompetence on the development side as we review this, then clearly we would need to take action. I don’t suspect we’ll find that,” he said.

“If we could go back, we would clearly hope to find the bug in testing before it was found in production.”

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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