Exchange Tech Under Fire After Facebook IPO Fiasco

Terry Flanagan

With the Facebook initial public offering enduring a shaky start to life, due to an exchange glitch and Morgan Stanley coming under fire for its role as lead banker in the IPO, some market participants are calling for more reliable and robust exchange infrastructure.

“There are definitely limitations to exchange technology as there is with any technology,” said Michael Wong, analyst with financial data provider Morningstar. “That’s why they always upgrade and reach for new frontiers and push the limits. If you look at the volumes of exchange trading and even beyond trading, the volumes of information like tick info and how many times orders are sent out and cancelled due to the rise of high-frequency trading, you have to realize the magnitude and multiples of info flow going across exchanges these days compared to past years.”

Exchange technology has become more robust over the years, to the point where orders are handled in microseconds, or millionths of a second. With high-frequency traders sending a constant barrage of messages, sometimes sending over a hundred orders with only a single fill, with the rest getting cancelled almost immediately after, exchanges have certainly performed adequately considering the strain they are put under.

It was only with the Facebook IPO, which saw an unprecedented and record amount of activity, did some constraints come to the surface.

Market maker and broker-dealer Knight Capital Group revealed that it could suffer losses of up to $35 million because of the technical problems Nasdaq OMX had matching up buy and sell orders to form the opening trade in Facebook shares on May 18, which led to a 20 minute period in which new orders, changes to existing orders and cancellations of orders in the stock were left hanging. Brokers and market makers were not privy to the results of the trades until more than two hours later.

“The failure was Nasdaq’s,” Knight chief executive Tom Joyce said of the IPO’s blunder on a television interview. “This was arguably the worst performance by an exchange on an IPO ever.”

Some estimates peg Wall Street’s total trading losses related to the Nasdaq glitches at about $100 million. Nasdaq plans to pay back at least some of those losses related to the technical errors, but has set only about $13 million to settle those claims.

“The exchanges are doing as much as they can,” said Wong at Morningstar. “Most of the major exchanges like Nasdaq and NYSE Euronext even license their technology to other exchanges, so quite a few venues around the world are running on Nasdaq technology, which for the most part has performed well. Whatever happened with the Facebook IPO happened despite testing and years of nearly flawless execution, so they possibly hit some kind of constraint they weren’t prepared for.”

Market participants have had a mixed reaction to the Facebook IPO and in the days that have followed. Some investors have filed lawsuits against underwriter Morgan Stanley, alleging selective dissemination of analyst forecasts, while others have taken aim at Nasdaq, claiming the exchange’s technology snafu during the Friday IPO left many investors in the dark regarding the status of their orders. Securities and Exchange Commission chairman Mary Schapiro has said that her agency would investigate the issues surrounding the offering as well.

“It continues to erode confidence,” said Joe Saluzzi, partner and co-founder of Themis Trading, an independent agency broker-dealer.

The Facebook mess at Nasdaq comes months after Bats Global Markets, the third largest exchange operator by market share in the U.S., had a critical error on its own IPO, which was to be listed on its own exchange. Once again, it was technology that was blamed for the issue, which were substantial enough for Bats to pull its listing off the table indefinitely. It is now considering listing its stock on Nasdaq or NYSE if it decides to try again.

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