Investor Confidence Down in Wake of Facebook IPO

Terry Flanagan

Nearly one month after the bungled Facebook initial public offering, rivals and other market participants say that Nasdaq’s handling of the situation has been insufficient.

After a period of prolonged silence following the glitch-ridden Facebook IPO, Nasdaq OMX last week proposed a solution to make amends to its broker-dealer clients, in the form of $40 million in cash and rebates. The proposal is subject to regulatory approval. Rival exchanges have been vocal about their disdain for the plan, which they proclaim would hurt competitive balance.

“What was announced is illegal and a shameless attempt to turn a big investor confidence event into a competitive advantage,” said Bill O’Brien, chief executive of Direct Edge, the fourth largest U.S. equities exchange by market share, during Sandler O’Neill’s Global Exchange and Brokerage Conference in New York last week. “We will contest it in any form we can, although I think it won’t be approved by the SEC.”

Nasdaq said last week that $13.7 million in cash would be paid to its affected member firms and the balance would be credited to members to reduce trading costs, with all benefits expected to be awarded within six months.

“This doesn’t provide closure because of the anti-competitive nature of what was offered,” added O’Brien. “What they provided in terms of trading discounts effectively alters the competitive dynamic in a way that violates U.S. securities law.”

The crux behind rival exchanges’ gripe with the proposed resolution is that it puts brokers in a difficult position, since they have the duty of best execution. O’Brien noted that it would be difficult to know if a broker was routing an order to an exchange because it was the best move for the investor, or if they did so because they had a coupon to cash in at the venue.

“It compounds the investor confidence problems that we’re trying to rectify,” O’Brien said. “Exchanges have the unique responsibility to understand the role they play in investor confidence and how they deal with these events.”

Jamie Selway, managing director and head of liquidity management at agency broker ITG, told the Sandler O’Neill conference: “As a user of Nasdaq on that day, it was surreal the way it was handled. We’re coming up on the one-month anniversary and there has been a lack of communication. It’s hard to envision how it could have been handled more badly, it is sapping investor confidence. We don’t need more events like that to make retail investors feel worse about the equity markets.”

NYSE Euronext chief executive Duncan Niederauer likened Nasdaq’s proposed remedy of trading discounts to oil company BP offering vouchers for discounted gas at their fueling stations following their oil spill in 2010.

“If a similar fate had befallen us that day when we were trying to take a company public, you would have found us to be much more communicative,” Niederauer said in a television interview. “You wouldn’t have trouble finding us. We would have been telling people what we’re going to do about it.”

The technical glitches suffered during the Facebook IPO have been estimated to have cost market makers and broker-dealers $100 million or more in losses. Broker-dealer Knight Capital Group and hedge fund Citadel, both of which are also market makers, revealed in the days following the IPO that they each could suffer losses of up to $35 million because of technical problems at Nasdaq related to the glitch. UBS revealed on Sunday that it may have lost upwards of $350 million, dwarfing previous total estimates, although there has been no official word from the bank.

Nasdaq had trouble matching up buy and sell orders to form the opening trade in Facebook shares, 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.

“Obviously we at Bats went through a similar experience, but when we looked at the problem we were in, we drew a line around it,” said Mark Hemsley, chief executive of Bats Chi-X Europe. “Ultimately we made a clean decision, we went out there and took it on the chin and then moved on.”

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