The second-biggest U.S. stock-exchange operator said in a statement today that it would pay $13.7 million in cash, with the rest of the money credited through reduced trading costs for members who suffered losses. The Securities and Exchange Commission must approve the plan. Knight Capital Group Inc. (KCG:US), which lost as much as $35 million, said the proposal doesn’t go far enough, and NYSE Euronext (NYX:US) said it will harm competition.
Delays and malfunctions on the Nasdaq Stock Market were the first signs of trouble in the May 18 Facebook IPO that burned (FB:US) investors, cost Wall Street market makers an estimated $120 million and prompted lawsuits against the company, its exchange and the underwriters. The stock (FB:US) is down 29 percent since the $16 billion offering, the biggest ever by a technology company.
“My biggest concern is they took our order, they were responsible for it, and then more than two hours later they came back and said ‘nothing done,’” Packy Jones, chairman of JonesTrading Institutional Services LLC, a Westlake Village, California-based broker, said in a phone interview. “It’s difficult to manage the investment process when you’re doubting your counterparties.”
The program Nasdaq announced would cover three kinds of orders placed during the IPO cross, the process used to open a stock after an offering: sales priced at $42 or less that weren’t executed; purchases priced at $42; and certain types of sell orders that should have participated in the cross and were entered into the market at 1:50 p.m. New York time on the day of the offering, receiving less than $42.
Orders eligible include those submitted before 11:30 a.m. New York time that were disadvantaged by Nasdaq’s technical error and those in which the member firm was uncertain of the outcome of the trade request. Orders that don’t qualify include “losses that are attributed to execution message delays when in fact an outcome was already certain,” Eric Noll, the executive vice president for transaction services at Nasdaq OMX, said in a webcast today.
Nasdaq won’t cover claims from brokers who allowed customers to cancel orders and took the loss themselves, he said.
“Accommodations will not be made available for losses that resulted from affirmative decisions by members, or in cases where members told investors that unconfirmed trades had been executed,” according to Nasdaq OMX’s statement today.
“We have no control or visibility over that relationship,” Noll said. “Those losses that are attributable to that activity are going to be borne by the member firm who made those decisions.”
The exchange operator said it hired International Business Machines Corp. (IBM:US) to review its systems. Nasdaq shares rose 1.7 percent to $22.24 today. Facebook climbed 3.6 percent to $26.81 and reached $26.83 at 5:50 p.m. in New York.
Letting Nasdaq use trading discounts as compensation is unfair because it will compel customers to divert orders to the exchange if they want to be paid back, according to an e-mailed statement from New York-based NYSE Euronext, the biggest operator of American equity venues.
“This is tantamount to forcing the industry to subsidize Nasdaq’s missteps and would establish a harmful precedent that could have far-reaching implications for the markets, investors and the public interest,” the statement said. “We intend to strongly press our views that Nasdaq’s proposal cannot be allowed to permit an unjust and anti-competitive situation.”
Direct Edge Holdings LLC in Jersey City, New Jersey, the fourth-largest U.S. exchange operator, has “significant concerns” with Nasdaq’s remedy and will “aggressively voice them,” spokesman Jim Gorman said in an e-mailed statement.
Knight Capital in Jersey City, New Jersey, estimated in a May 23 government filing that it lost $30 million to $35 million in the IPO. The company is one of the largest wholesalers, a category of market makers that executes orders for individual investors sent to the firm from retail brokers. Such firms may guarantee customers executions in the auctions at the start and end of trading each day at the resulting price, assuming they can manage risks by buying and selling in the market.
“Clearly, we are disappointed that Nasdaq’s compensation fund does not come close to covering reported losses from broker-dealers like Knight who traded Facebook shares on behalf of average investors the day of the IPO, and who suffered losses as a result of Nasdaq’s failures in connection with this IPO,” Knight said in a statement. “Their proposed solution to this problem is simply unacceptable. As previously stated, the company is evaluating all remedies available under law.”
Nasdaq OMX Chief Executive officer Robert Greifeld said in an interview with CNBC today that the payback plan was designed to aid its broker-dealer members in cases where it’s clear they lost money due to errors in the auction process. Nasdaq OMX is not responsible for the decisions of retail and institutional investors who bought and sold through those firms, he said.
“This is clear, it’s clinical, it’s objective, it’s data- based,” Greifeld said. “In terms of generic comment with respect to the psychology of the market, I can’t respond to that. Everybody’s entitled to their own opinion.”
The exchange pressed ahead with Facebook trading on May 18 because its testing didn’t reveal a problem with the IPO cross and the company’s technology department said the system was ready, he said. Continuous trading “worked perfectly” from then to the 4 p.m. close, Greifeld said.
“The technology people had to make some real decisions, and the senior management is not in a position to question the information of that decision,” Greifeld said in the CNBC interview. “It did run at 11:30 a.m. The problem was the confirmation didn’t come out until 1:50 p.m.”
Nasdaq will determine how much to pay most investors and traders by comparing their execution price to $40.626, the volume-weighted average price for Facebook from 1:50 p.m. until 2:20 p.m. on May 18, Noll said. It chose that period because member firms could have made decisions then, after receiving execution reports at 1:50 p.m. from the IPO cross earlier in the day, he said. Losses for orders released into the market at 1:50 p.m. will be compared to the $42 price from the IPO cross, Noll said.
Facebook was sold by underwriters at $38 on May 17. The pricing of the first public transaction, a trade known as the IPO cross, took a half hour longer than Nasdaq OMX planned the next morning. About 30 minutes after that, the market owner (NDAQ:US) reported an issue confirming trades from the opening auction with the brokerages that placed them.
Order updates and cancellations totaling 30 million shares were submitted into the auction as a technical issue was being repaired between 11:11 a.m. and 11:30 a.m. New York time, Greifeld told reporters on May 20. About half may involve “some level of dispute,” he said.
Nasdaq OMX said in a May 21 notice that the 30 million shares didn’t participate in the IPO cross. An error prevented execution reports for the shares that entered the auction, as well as those that were ignored, from being disseminated immediately to brokerages, the company said.
Some orders submitted before 11:30 a.m. received executions at prices different from the $42 IPO cross, causing buyers to pay more and sellers to receive less than they should have, Nasdaq OMX said in another May 21 notice. A portion of those deemed ineligible for the IPO auction were later re-entered into the market by Nasdaq’s systems, the exchange said.
Losses may total $120 million for the four largest U.S. equity wholesalers, or market-makers that execute orders for individual investors supplied from brokers such as TD Ameritrade Holding Corp. and Charles Schwab Corp. (SCHW:US)
Citadel LLC, the Chicago-based investment firm run by Ken Griffin, lost as much as $35 million on Facebook in its market- making unit, according to a person with knowledge of the firm. UBS AG (UBSN) lost about $30 million and Citigroup Inc. (C:US) about $20 million from servicing retail customers through their wholesaling businesses, Dow Jones Newswires reported on May 25.
Nasdaq’s handling of the IPO has led to led to lawsuits and is being examined by the SEC. A review by the regulators that has yet to be completed shows technical failures precipitated the trading issues, not a violation of industry rules, the Wall Street Journal said May 30, citing people familiar with the matter who it didn’t name.
Greifeld acknowledged “poor design” in software put the opening auction that set the price for the first traded shares into a loop that delayed its completion. Executives of the company “believed they had the right solution” as they worked to start trading, Noll said in a statement provided by spokesman Robert Madden on May 22.
SEC officials will examine whether New York-based Nasdaq OMX took enough care setting up and testing the IPO auction, when it became aware of the breakdowns and how much it knew as they were occurring, according to Larry Harris, a professor of finance and business economics at the University of Southern California in Los Angeles and a former SEC chief economist.
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