Computer systems used to establish the opening price were overwhelmed by order cancellations and updates during the “biggest IPO cross in the history of mankind,” Nasdaq Chief Executive Officer Robert Greifeld, 54, said yesterday in a conference call with reporters. Nasdaq’s systems fell into a “loop” that kept the second-largest U.S. stock venue operator from opening the shares on time following the $16 billion deal.
While the errors were resolved and Facebook completed its offering, the day was another setback for equity exchanges trying to erase the memory of the botched IPO in March by Bats Global Markets Inc., another bourse owner. Nasdaq’s issues contributed to disappointment among investors as Facebook (FB)’s stock plunged as much as 14 percent today.
“It’s amazing that both Bats and Nasdaq unfortunately failed in an inglorious way,” William Karsh, the former chief operating officer at Direct Edge Holdings LLC, an exchange operator that competes with Nasdaq, said in a telephone interview yesterday. “It proves that technology isn’t infallible. There are so many moving parts that things can go wrong. That’s the lesson we learn.”
SEC Reviewing
The U.S. Securities and Exchange Commission said it will review the trading. Jonathan Thaw, a spokesman for Menlo Park, California-based Facebook, declined to comment.
“This was not our finest hour,” Greifeld said yesterday, a day after Nasdaq’s board convened to discuss the offering. Asked if his job is secure, he said, “I certainly hope so.”
Nasdaq will use an “accommodation pool” that may total $13 million to pay back investors that should have received executions in the opening auction, based on the decisions of a third-party reviewer, Greifeld said. Nasdaq said today in a notice that the Financial Industry Regulatory Authority would be the organization handling the review.
Media reports that brokers may lose $100 million repaying investors whose orders were mishandled are credible, Thomas Joyce, the CEO of Knight Capital Group Inc. (KCG), said today on CNBC.
Under Water
Facebook slumped 11 percent to $34.03 today, slipping below its offering price of $38 after advancing as high as $45 on the day of its debut.
The controversy is a black eye for Greifeld, whose venue won out over the New York Stock Exchange in the battle to list Facebook’s offering. While the market capitalization of NYSE shares is about triple the value of Nasdaq companies, the latter market operator has about twice as many technology companies trading for $1 billion or more, data compiled by Bloomberg show
Problems surfaced on May 18 at 11:11 a.m. New York time after Morgan Stanley (MS), one of the underwriters that sold 421 million shares, completed its role in setting the price for the trade in Nasdaq’s opening auction, Greifeld said.
Nasdaq’s software for IPOs allows investors to cancel or update details of orders until the auction runs. Trade requests received during the 5 milliseconds it took to operate the auction disturbed the process, leading to an imbalance of buys and sells and sending the program into a loop.
Manual Intervention
Exchange officials manually intervened to allow the auction to occur at 11:30 a.m. The IPO software “didn’t work” even after thousands of hours of testing for “a hundred scenarios” aimed at anticipating problems, Greifeld said. “We’re not happy with our performance,” he said on the call.
Volume during the auction amounted to 75.7 million shares, or almost 1 percent of trading during the entire day on all U.S. exchanges, according to data compiled by Bloomberg.
“We saw on a real-time basis, obviously with the pressure of the world upon us, that this was happening,” Greifeld said. “We then manually intercepted this cross,” he said. “That manual intervention said we had to ignore the cancels that came in between the raindrops as we were processing the trade.”
Responding to the malfunction, Nasdaq altered its IPO procedures today. The exchange operator said it will no longer accept “cross-eligible” order modifications after the auction’s final price calculation has begun, according to an e- mailed statement.
Facebook Stake
Nasdaq wound up selling 3 million shares of Facebook because of its intervention, according to two people familiar with the events. A broker was used to unwind the position that had been placed in the exchange’s so-called error account for $10.7 million, the people said. Greifeld mentioned the $10 million proceeds yesterday, though he gave a lower share total.
Nasdaq will ask the SEC for permission to add the money it received to the $3 million available from the exchange, according to its rules, to repay investors that should have received trades, Greifeld said on yesterday’s call.
Orders totaling 30 million shares were submitted into the opening auction between 11:11 a.m. and 11:30 a.m., Greifeld said. About half of them may involve “some level of dispute,” he said. Greifeld said he didn’t think the delay in starting trading affected the price of Facebook shares.
Finra Report
Finra will provide a report to Nasdaq OMX about the total value of all “valid claims,” Nasdaq said today. One of the two people said $13.7 million would be a minimum amount that Nasdaq would pay and that Finra’s review process would take one to three weeks.
Adding to the confusion after the IPO started trading, Nasdaq reported an issue with confirming transactions from the opening auction with the brokerages that placed them. The exchange said in a statement posted to its website at 11:59 a.m. New York time that it was having a problem delivering the messages. An update at about 1:57 p.m. said they had been sent.
Nasdaq said today that trading delays in Zynga Inc. (ZNGA) on May 18 were caused by the Facebook malfunction. The stock was halted twice by marketwide volatility circuit breakers that normally last five minutes. One went for about 50 minutes and another was more than an hour.
‘Bizarre Ways’
“When you have a complex market system that gets overwhelmed, it fails in bizarre ways,” James Angel, a finance professor at Georgetown University in Washington, said in a phone interview on May 18. “If you don’t know whether you got filled, you don’t know your position. If you’re buying you might buy more shares and then suddenly you’ve got twice as many shares as you wanted. It makes it hard to do your risk management and hard for brokers to know how much credit to extend to customers.”
Facebook was originally scheduled to open at 11 a.m. At about 11:07 a.m., a Nasdaq official told market participants on a conference call that the exchange was delaying the opening. Aside from assurances that an update was coming, the phone line went silent until just before the first trade at about 11:30 a.m., according to two people who were on the call and asked not to be identified because the discussions were private.
Buy and sell requests that should have been filled in the opening auction, based on the exchange’s rules, weren’t, while cancellations for other trade requests were ignored, they said. Their employers plan to appeal some of the results they received for orders sent to Nasdaq.
Bid and Offer
Nasdaq began experiencing problems with its bid and offer quotes after the opening auction trade. By 11:31 a.m., the exchange’s highest bid, or price at which market participants were willing to purchase shares, was $42.99, and its lowest offer to sell was $42.50, according to data compiled by Bloomberg. The quotes produced a so-called crossed market, where sellers appear to be asking less than buyers are willing to pay.
Other markets continued trading, usually with a difference of a few cents between their best bid and lowest offer. Nasdaq’s quotes were marked as manual and not electronically accessible, which allowed brokers and other exchanges to ignore the venue’s prices. Its offer price later dropped to $38.01 and remained at that level, almost $4 below the highest bid, until 1:49 p.m., according to data compiled by Bloomberg.
“Clearly investors would hit the ‘don’t like’ button,” Matt McCormick, who helps oversee $6.2 billion at Bahl & Gaynor Inc. in Cincinnati, said in a telephone interview.
The IPO price valued the company at 107 times trailing 12- month earnings, more than all Standard & Poor’s 500 Index stocks except Amazon.com Inc. and Equity Residential. The valuation also made Facebook, co-founded in 2004 by a then-teenage Mark Zuckerberg, the largest company to go public in the U.S.
Customers of London-based Fidessa Group Plc, which helps asset managers track transactions, weren’t receiving confirmation of Facebook trades, according to an e-mailed statement. Michael Cianfrocca, a spokesman for Charles Schwab Corp. in San Francisco, wrote in an e-mail: “There are currently industrywide delays in reporting trade executions. These issues do not appear to be unique to Schwab.”
TD Ameritrade
Uncertainty about whether orders received executions in the opening auction affected some clients of online broker TD Ameritrade Holding Corp., according to Steve Quirk, senior vice president of the trader group at the Omaha, Nebraska-based company. Facebook accounted for 22 percent of equities volume at the firm, he said by e-mail.
Nasdaq shares climbed 3.6 percent to $22.78 today after losing as much as 4.4 percent, the most since October, to $21.99 on May 18. NYSE Euronext (NYX) rose 2.6 percent to $25.26 today.
A total of 582.5 million Facebook shares traded on May 18, or about 6.6 percent of total volume on U.S. exchanges, according to data compiled by Bloomberg.
“I don’t think you’ll see a long-term downturn of volume on Nasdaq,” Karsh said. “Nasdaq will pick up a couple percentage points because it’s the primary listing venue for Facebook.”
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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