UBS Facing Battle on Facebook After Nasdaq Set Aside Cash

Nasdaq OMX Group Inc.’s creation of a $62 million pool to pay brokers that lost money in Facebook Inc.’s public debut shows how far apart the exchange owner is from UBS AG on who is to blame for losses in the botched deal.

Switzerland’s biggest bank said yesterday that its second-quarter profit fell 58 percent in part because of losses that exceeded $350 million in the May 18 initial public offering. UBS is among brokers including Knight Capital Group Inc. that have said they’ll seek compensation after a design flaw in Nasdaq’s computers delayed orders and confirmations just as the shares were about to start changing hands.

UBS promised legal action to get back more than five times as much money as Nasdaq has set aside. In proposing to revamp and enlarge the restitution fund on July 20, Nasdaq said it was seeking a reasonable way to compensate firms for which its “system difficulties caused objective, discernible harm,” according to a regulatory filing.

“I don’t see them getting anywhere close to covering this type of number,” Jillian Miller, an Atlanta-based exchange analyst at BMO Capital Markets, said in a phone interview. “Nasdaq was fairly clear on their conference call that they saw their proposal as a relatively final document. It’ll probably go forward as it is now, with Nasdaq keeping its proposal and UBS trying to sue them.”

Definitive Statement

Nasdaq OMX’s plan to repay member firms represents the company’s “definitive statement” on restitution and no more reserves are planned, Chief Executive Officer Robert Greifeld, 55, said on a July 25 call with analysts. It must get approval by the U.S. Securities and Exchange Commission after a period of public comment before it goes into effect.

Joseph Christinat, a Nasdaq OMX spokesman, declined to comment on Zurich-based UBS’s statement. Karina Byrne, a UBS spokeswoman based in New York, declined to comment beyond the bank’s earnings release.

Delays and malfunctions on the Nasdaq Stock Market were the first signs of trouble in the Facebook IPO that burned investors and prompted lawsuits against the company, its exchange and the underwriters. The stock has fallen more than 40 percent from the price set by underwriters. It slipped 6.2 percent to $21.71 yesterday in New York.

Greifeld acknowledged in May that “poor design” in software put the opening auction that set the price for the first traded shares into a loop that delayed its completion. Nasdaq expanded the plan to compensate member firms after its June 6 proposal to pay out $40 million mostly through discounted trading fees was criticized by brokerages and exchanges.

Botched IPO

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 place at 11:30 a.m. New York time the next morning, a half hour later than Nasdaq planned. About 30 minutes after that, the market owner reported a delay confirming trades from the opening auction with the brokers that placed orders.

The transaction reports, normally distributed immediately, were sent at 1:50 p.m., leaving market makers, brokers and their customers uncertain about whether orders submitted into Nasdaq’s opening cross had been executed. Traders and individuals couldn’t sell to limit losses until they received the reports and knew how many shares they held.

The Swiss bank entered multiple customer orders after “operational failures” at Nasdaq prohibited pre-market requests to buy from being confirmed for “several hours,” according to its statement. After Nasdaq filled all the entered orders, UBS was left holding “far more” shares than clients had asked for, the lender said.

Multiple Failures

“UBS’s loss resulted from Nasdaq’s multiple failures to carry out its obligations, including both opening the Facebook stock for trading and not halting trading in the stock during the day,” the bank said. The bank’s shares lost 5.9 percent to

10.29 francs yesterday.

Assessing responsibility is harder because some firms compounded problems by continuing to place orders for the stock, Larry Harris, a professor of finance and business economics at the University of Southern California in Los Angeles and a former SEC chief economist, said in a phone interview July 20.

“Nasdaq is responsible for creating circumstances in which people made mistakes,” he said. “On the other hand, people made mistakes because they behaved foolishly.”


Another securities firm expected to seek recompense is Knight. The Jersey City, New Jersey-based broker and market-making firm reported second-quarter earnings July 18 that fell 79 percent, including a $35.4 million loss related to the Facebook IPO. Citadel LLC, the Chicago-based investment firm run by Ken Griffin, lost as much as $35 million in its market-making unit, according to a person with knowledge of the firm.

Nasdaq said getting money would be conditioned on the broker agreeing to release Nasdaq of claims for losses related to the Facebook IPO.

In working out the compensation pool, Nasdaq has cited legal protections afforded to exchange operators to shield them from liability when they act in their role as self-regulatory organizations. The exchange has “substantial legal and factual defenses to any litigation” that could result from the Facebook IPO, Greifeld said on July 25.

The exchange’s liability will depend on whether it was acting in the SRO role as it made decisions on the first day of trading, John Coffee, a Columbia University law professor, said in a phone interview.

Nasdaq Decisions

“To the extent you can characterize the decision-making by Nasdaq to have been regulatory in character, they are safe from litigation,” Coffee said. “To the extent it looks like they just blundered, fouled up and couldn’t execute, that is not a regulatory decision and there could be professional liability, though it probably will have to be asserted in arbitration.”

The cap on Nasdaq’s liability stemming from specific technology errors and malfunctions it causes is $3 million, according to the exchange’s rules. Nasdaq raised the limit last year for certain types of errors from $500,000 after a malfunction in April with its automated quotation system led to losses by market makers. Greifeld said in a conference call in July 2011 that the April mishap was the first such error in his eight years leading the company and he didn’t expect another for the next eight.

Curbs on liability were developed to keep the member-firm owners of an exchange from having to pay another broker for losses caused by technical breakdowns, according to George T. Simon, a partner at Foley & Lardner LLP and former associate director in the SEC’s division of market regulation. Simon helped restructure the national equities market after the 1975 Securities Acts Amendments, which overhauled rules for exchanges and trading to spur competition and increase price transparency.


U.S. courts have upheld the immunity of exchanges and associations of securities dealers for actions related to self-regulatory responsibilities such as monitoring the compliance of brokers with laws and running their markets. Cases brought against the New York Stock Exchange and the National Association of Securities Dealers Inc., which created Nasdaq in 1971, preserved that protection in recent decades.

Brokers suing Nasdaq OMX are subject to contracts for trading on the exchange that limit the venue’s liability, said Andrew Stoltmann, a securities lawyer in Chicago who has represented investors in cases alleging securities fraud.

Sergio P. Ermotti, UBS’s chief executive officer, was asked in a conference call with analysts yesterday whether a bank as large as UBS should have been smart enough to avoid the mishaps with the Facebook IPO.

“I’ll leave it up to you to describe if this is stupidity,” he said. “But I can only tell you that we feel that this was a big mishandling by Nasdaq and not a fault of UBS.”