Nasdaq's £26m compensation for Facebook IPO glitches draws harsh criticism

The boards of the Nasdaq OMX Group and the Nasdaq Stock Market are seeking review by the Securities and Exchange Commission (SEC) to compensate brokerages with $40 million (£25.7 million) for losses incurred during last month’s problematic Facebook IPO.

The IPO was riddled with technical problems, which led to a delay of 30 minutes. The problem stemmed from Nasdaq’s IPO Cross, a pre-IPO auction process that the exchange put in place in 2006 that allows traders to place orders and agree on an IPO price before the stock is officially launched, which couldn’t handle the trading demand.

This led to a number of brokerages suffering financial losses after losing out on half an hour of trading and not receiving up-to-date information.

Nasdaq recently revealed that it had earmarked $13.7 million (£8.8 million) for compensation, but this fell short of estimated losses of more than $100 million (£64.2 million).

Nasdaq has now said that it will add to its $13.7 million compensation by offering brokerages reduced trading costs, to bring compensation fees up to $40 million.

“After consideration [and] in keeping with Nasdaq’s customer focus, the Nasdaq OMX group board approved a voluntary accommodations fund of approximately $40 million,” said Nasdaq in a statement to investors.

“Under the proposal, the details of which are subject to SEC review, approximately $13.7 million would be paid in cash to member firms. The balance would be credited to members to reduce trading costs, with all benefits expected to be achieved within six months for the vast majority of firms.”

It also revealed that it has selected IBM to conduct a review of the current state of processes for designing, developing, testing, deploying and operating market systems.

Setting a harmful precedent

Compensation will be paid to financial firms that experienced problems with three kinds of orders that were placed during the IPO cross:

• Sells priced at $42 or less that did not execute
• Sells priced at $42 or less that executed at an inferior price
• Buys priced at $42 that were executed in the cross but not immediately confirmed

Facebook’s initial IPO was priced at $38 a share, but this leapt up to $45 in the first few hours after trading, and has since declined up to 30 percent.

However, Nasdaq’s compensation plans have not been well received within the financial industry. Knight Capital, one of Wall Street’s largest trading firms that suffered losses during the IPO debacle, has blasted the compensation as paltry and has hinted that it might take legal action, according to the LA Times.

Furthermore, operating rival New York Stock Exchange (NYSE) has released a statement claiming that if SEC were to approve the plans that this would result in unfair practice and equates to the industry subsidising Nasdaq’s mistakes.

“We believe it would be wholly inconsistent with fair practice and an undue burden on competition to allow Nasdaq to use pricing and other machination as a guise for fairly compensating those impacted by the Facebook IPO issues," said NYSE.

“Such a tactic would potentially strongly incentivise customers to divert order flow to Nasdaq in order to receive compensation to which they are entitled, and allow Nasdaq to reap benefit from market share gains they would not have otherwise received.”

NYSE believes that this would establish a “harmful precedent that could have far reaching implications for the markets, investors and the public interest”.

Egg on their face

Rik Turner, senior financial services analyst at Ovum, told Computerworld UK that he was inclined to agree with Knight Capital and NYSE, and suggested that the increased compensation was probably still not enough.

He said: “I suspect $40 million is peanuts compared to the potential earnings on that first day when trading was delayed. It is also questionable whether discounting on trading fees is anti-competitive.”

“I think NYSE is right, there is an argument to be made here. Presumably if NYSE feels that they have a sufficient argument they will take it to court, especially given the highly litigious nature of US business. It will be interesting to see whether or not the courts will agree with them.”

Turner also suggested that Nasdaq may face longer-term consequences for the failed IPO, where companies may think twice about launching an IPO on its exchange.

“Nasdaq’s systems proved to be not up to scratch when it was faced with a really major IPO. Nasdaq could start losing business from their very important primary market, that is, the IPO market, to NYSE. That would be a major loss of additional business to them,” he said.

He added: “If you have seen what’s happened with the Facebook IPO and you think that your share, whenever you go public, may trigger a similar amount of interest and generate serious traffic in the first few days of trading, you are probably going to want to guarantee it’s on a place that can handle that kind of traffic.”

“With Nasdaq having shown that it’s not fit for purpose, egg is all over its face. People may well be thinking the other alternative is NYSE.”

Copyright © 2012 IDG Communications, Inc.

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