NYSE Criticizes Nasdaq’s Facebook Compensation Plan
The second-biggest U.S. stock-exchange operator said yesterday that it would pay $13.7 million in cash, with the rest of the money credited through lower trading fees for members who took losses. That step was criticized by the New York Stock Exchange owner, which said it compels customers to trade on Nasdaq to get refunds. The Securities and Exchange Commission must approve Nasdaq’s plan before it can be implemented.
“This is tantamount to forcing the industry to subsidize Nasdaq’s missteps and would establish a harmful precedent,” NYSE Euronext said in an e-mailed statement. “We intend to strongly press our views that Nasdaq’s proposal cannot be allowed to permit an unjust and anti-competitive situation.”
Delays and malfunctions on the Nasdaq Stock Market were the first signs of trouble in the May 18 Facebook IPO that burned investors, cost Wall Street market makers an estimated $120 million and prompted lawsuits against the company, its exchange and the underwriters. The stock is down 29 percent since the $16 billion offering, the biggest ever by a technology company.
Knight Capital Group Inc. in Jersey City, New Jersey, estimated in a May 23 government filing that it lost as much as $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.
“Clearly, we are disappointed that Nasdaq’s compensation fund does not come close to covering reported losses from broker-dealers like Knight,” the company 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.”
Executives of Bats Global Markets Inc. and Direct Edge Holdings Inc., the biggest U.S. equity market operators after NYSE and Nasdaq, said today at a conference sponsored by Sandler O’Neill & Partners LP in New York that they also objected to Nasdaq’s plan and would oppose it.
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. that were disadvantaged by Nasdaq’s technical errors 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 yesterday.
Nasdaq won’t cover claims from brokers who allowed customers to cancel orders and took the loss themselves, he said. Losses from “affirmative decisions by members” or in cases where members told investors that unconfirmed trades had been executed won’t be eligible, the company said.
“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.”
Nasdaq OMX Chief Executive officer Robert Greifeld said in an interview with CNBC yesterday 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 isn’t responsible for the decisions of retail and institutional investors and isn’t trying to take anyone’s business with its compensation plan, he said.
“We cut fees and the people will get the reduced fees,” he said. “They don’t have to give us any more market share. Our market share could be constant or decline and people will still get paid,” he said. “We are offering this to our customers that transact with us every day. They do not have to give us one incremental share for them to earn this payment.”
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.
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, 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 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)
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) 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.
“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.”
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