The software error that derailed the initial public offering of Bats Global Markets Inc. (BATS), where 11 percent of all U.S. stock trading occurs, rattled investors concerned about the growing complexity of financial markets.
Joe Ratterman, the chief executive officer, canceled the March 23 IPO after a computer malfunction kept Bats from trading on its own platform and forced a halt in Apple Inc. (AAPL), the world’s biggest company by market value. Transactions in Apple and trades for more than 1 million Bats shares were later canceled.
While engineers at the third-largest U.S. exchange owner reacted in seconds to restore order, the failed debut highlighted concerns about electronic exchanges at a time when regulation of financial markets is increasing after the worst crisis since the Great Depression. New venues have helped cut the proportion of shares changing hands on the New York Stock Exchange and Nasdaq Stock Market in the corporations they list to less than 26 percent from at least 80 percent in 1997.
“The electronic market operates very efficiently and it can accommodate many more trades than a human-only market, but I think what happened Friday shows that you still need boots on the ground,” Walter “Bucky” Hellwig, who helps manage $17 billion at BB&T Wealth Management in Birmingham, Alabama, said in a phone interview yesterday. “That it was corrected quickly helped. But the fact that it happened at all makes people just stand back.”
Ratterman, 45, is facing the biggest crisis of his career after the IPO was pulled, denying a payday for Wall Street firms such as Bank of America Corp. (BAC) and Deutsche Bank AG that own stakes in Lenexa, Kansas-based Bats, which was founded by a high-frequency trader in 2005. The IPO was managed by three of Bats’s owners, Morgan Stanley, Citigroup Inc. and Credit Suisse Group AG. Banks on the IPO will lose $7.1 million in fees because of the withdrawal, data compiled by Bloomberg show.
The rapid drop to 0.02 cent from $16 in Bats (BATS) just as it started changing hands on March 23 reminded investors of the so- called “flash crash” in May 2010, a much larger breakdown. Bats’s board, which hasn’t discussed any leadership changes, will meet this week to consider options and it’s yet to be determined if another IPO will be attempted, Ratterman said in a Bloomberg television interview today.
Yet to Recover
U.S. markets have yet to recover from the subprime mortgage crisis and financial meltdown that began in 2007. The Standard & Poor’s 500 Index, which has more than doubled from its bottom three years ago, remains 12 percent below its peak. Regulators are still putting in place checks on Wall Street, including the so-called Volcker rule designed to keep banks from taking risks with depositors’ money.
The S&P 500 rose 1.2 percent to 1,414 at 2:59 p.m. in New York today as Bats’s share of U.S. equity trading slipped below its one-month average. Its two exchanges handled 10.73 percent of U.S. volume as of 2:30 p.m. New York time, according to data compiled by Bloomberg Between Feb. 27 and March 22, the average was 11.57 percent.
Bats priced 6.3 million shares 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 as a result of the error related to the auction process. By 11:14 a.m., more than 1 million shares had traded.
Apple Circuit Breaker
Compounding the confusion, a single transaction for 100 shares executed on a Bats venue briefly sent Apple, which has a market value of $555.7 billion, down more than 9 percent, setting off a circuit breaker that halted 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, were later voided.
“There are going to be isolated events at the different market centers over time,” Ratterman said in a March 24 interview. “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.”
BZX Exchange, its main market, was accessible to users 99.94 percent of the time last year, according to a regulatory filing. BYX Exchange, its second market, was available 99.998 percent of the time, the company said. The main market processed an average of about 29,000 order messages per second.
The U.S. Securities and Exchange Commission is in discussions with Bats to determine the cause of the incident and review the steps the company is taking to remedy the issues, according to SEC spokesman John Nester. To Andrew Ross, a partner at New York-based proprietary trader First New York Securities LLC, technical problems that affect trading are becoming routine.
“Situations like this happen so frequently that I almost ignored it on Friday, which is a testament to the issue of these technological failures,” Ross said in a phone interview yesterday. “People who trade every day realize that these kinds of errors happen. But it looks awful for Bats, given that they’re an exchange that claims to have technological prowess as a platform for high-frequency trading.”
Daniel Hawke, 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. Regulators are weighing the benefits of electronic markets and exchange competition, which sped up executions and cut commissions for individuals, against technology concerns linked to faster trading and connections between venues.
About 11 percent of American share volume occurs on venues run by Bats, which called itself “a technology company at our core” in the IPO prospectus. Its founder, Dave Cummings, 43, sent an e-mail to traders yesterday saying that while Bats should suspend employee bonuses, the incident was no reason to dismantle the equities market structure.
“This was a freak one-time event,” Cummings wrote. “The Bats matching engine has literally matched billions of orders without problems. However, the code to open an IPO is new. It has been tested in the lab, but until this week not in real- world production.”
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 in the mid-2000s. The company was initially built to service brokers and high- frequency firms, which make trading decisions in milliseconds. Those companies include Tradebot Systems Inc., whose chairman is Cummings, and Getco LLC, both of which have stakes in Bats.
Almost half of the 6.3 million Class A shares that were being offered were from the estate of Lehman Brothers Holdings Inc., 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 (DBK) and Instinet Inc. The failure of the deal voided the payment.
Ratterman wrote to customers and traders in a letter dated yesterday, explaining the technical issues, apologizing for the breakdown and pledging to do better in future.
‘Shouldn’t Have Failed’
“We take pride in our technology, and Friday’s failure to perform as expected has no excuses,” Ratterman wrote. “In addition to several months of our own internal testing, we thoroughly tested this new auction functionality with trading participants for many weeks prior to Friday. It shouldn’t have failed, but it did, and the timing couldn’t have been worse.”
The malfunctions are focusing investor attention on the structure of U.S. markets, 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 so-called dark pools, which unlike exchanges don’t display quotes publicly. 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 held a conference call with its underwriters before the opening auction process began at 10:30 a.m. New York time on March 23 that lasted into the afternoon. The software error became obvious “immediately following the auction” when the transaction didn’t appear on public feeds and quotations weren’t processed, Ratterman said. Engineers rushed to diagnose the problem and developers fixed the code once the error was identified, he said.
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 breakdown 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 and oversaw 650 people as chief technology officer at Bridge Information Systems Inc. before joining Tradebot in 2004. “It was a little disappointing personally, but we were more focused on the functioning of the system.”
Ratterman, who was among the 12 employees Cummings brought over from Tradebot when he started Bats, became CEO in 2007.
Decision to Cancel
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. Bats also discussed withdrawing the IPO with board members on the pricing committee. Scrapping the deal reflected its responsibility as a self-regulatory organization to maintain fair and orderly trading, he said.
“I don’t think you can stop the progress of moving things toward computer trading, because that’s where it’s going and most of the time it works really well,” Rod Smyth, the Richmond, Virginia-based chief investment strategist of Riverfront Investment Group, which manages $3 billion, said in a telephone interview yesterday. “But clearly we’ve seen a couple times where computers do things that no human would do.”
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