Nasdaq OMX Group Inc., under scrutiny after shares of Facebook Inc. (Nasdaq: FB) were plagued by delays and mishandled orders on its first day of trading, blamed “poor design” in the software it uses for driving auctions in initial public offerings.
Computer systems used to establish the opening price were overwhelmed by order cancellations and updates as the “biggest IPO cross in the history of mankind” was occurring, Nasdaq Chief Executive Officer Robert Greifeld said Saturday in a conference call with reporters. Nasdaq’s systems fell into a “loop” that prevented the second-largest U.S. stock venue operator from opening the shares on schedule following the $16 billion deal, he said.
While the errors were resolved and Facebook completed its offering, the day was another setback for equity exchanges trying to erase the memory of the botched IPO in March by Bats Global Markets Inc., another bourse owner. Nasdaq’s issues contributed to disappointment among investors as Facebook’s stock closed up 0.6 percent after rising 18 percent earlier.
“It’s amazing that both Bats and Nasdaq unfortunately failed in an inglorious way,” William Karsh, the former chief operating officer at Direct Edge Holdings LLC, an exchange operator that competes with Nasdaq, said in a telephone interview yesterday. “It proves that technology isn’t infallible. There are so many moving parts that things can go wrong. That’s the lesson we learn.”
The U.S. Securities and Exchange Commission said it will review the trading. Jonathan Thaw, a spokesman for Menlo Park, California-based Facebook, declined to comment.
‘Not Our Finest’
“This was not our finest hour,” Greifeld said Saturday, one day after Nasdaq’s board convened to discuss the offering. Asked if his job is secure, he said, “I certainly hope so.”
Nasdaq will use an “accommodation pool” to pay back investors that should have received executions in the opening auction, based on the decisions of a third-party reviewer, Greifeld said. It may total $13 million, he said.
Problems surfaced on May 18 at 11:11 a.m. New York time after Morgan Stanley, one of the underwriters that sold 421 million shares the night before, completed its role setting the price for the trade in Nasdaq’s opening auction, Greifeld said. Nasdaq’s software for IPOs allows investors to cancel or update details of orders until the auction runs. Trade requests received during the 5 milliseconds it took to operate the auction disturbed the process, leading to an imbalance of buys and sells and sending the program into a loop.
Nasdaq officials manually intervened to allow the auction to occur at 11:30 a.m. The IPO software “didn’t work” even after thousands of hours of testing for “a hundred scenarios” aimed at anticipating problems, Greifeld said. “We’re not happy with our performance,” he said on the call yesterday.
Volume during the auction amounted to 75.7 million shares, or almost 1 percent of trading during the entire day on all U.S. exchanges, according to data compiled by Bloomberg.
“We saw on a real-time basis, obviously with the pressure of the world upon us, that this was happening,” Greifeld said. “We then manually intercepted this cross,” he said. “That manual intervention said we had to ignore the cancels that came in between the raindrops as we were processing the trade.”
Nasdaq wound up with 5,000 shares of Facebook because of its intervention, Greifeld said. A broker was used to sell the stock that had been placed in the exchange’s so-called error account for $10 million. Greifeld said he would ask the SEC for permission to add the money to the $3 million available from the exchange, according to its rules, to repay investors that should have received trades.
Orders totaling 30 million shares were submitted into the opening auction between 11:11 a.m. and 11:30 a.m., Greifeld said. About half of them may involve “some level of dispute,” he said. Greifeld said he didn’t think the delay in starting trading affected the price of Facebook shares.
Adding to the day’s confusion, Nasdaq reported an issue after trading began with confirming transactions from the opening auction with the brokerages that placed them. The exchange said in a statement posted to its website at 11:59 a.m. New York time that it was having a problem delivering the messages. An update at about 1:57 p.m. said they had been sent.
“When you have a complex market system that gets overwhelmed, it fails in bizarre ways,” James Angel, a finance professor at Georgetown University in Washington, said in a phone interview on May 18. “If you don’t know whether you got filled, you don’t know your position. If you’re buying you might buy more shares and then suddenly you’ve got twice as many shares as you wanted. It makes it hard to do your risk management and hard for brokers to know how much credit to extend to customers.”
$42 at Auction
Facebook advanced 23 cents to $38.23 after surging as high as $45. It fell as low as the IPO price of $38, which valued the company at $104.2 billion. More than 43 million shares were executed at that level, the second-most changing hands at any price except for $42, the opening auction price, data compiled by Bloomberg show.
Underwriters purchased shares to keep them from falling below $38, people with knowledge of the matter said. The bankers supported the stock amid Nasdaq’s difficulties delivering trade execution messages, said one of the people, who asked not to be identified because the transactions are private.
Facebook was originally scheduled to open at 11 a.m. At about 11:07 a.m., a Nasdaq official told market participants on a conference call that the exchange was delaying the opening. Aside from assurances that an update was coming, the phone line went silent until just before the first trade at about 11:30 a.m., according to two people who were on the call and asked not to be identified because the discussions were private.
Buy and sell requests that should have been filled in the opening auction, based on the exchange’s rules, weren’t, while cancellations for other trade requests were ignored, they said. Their employers plan to appeal some of the results they received for orders sent to Nasdaq.
Nasdaq began experiencing problems with its bid and offer quotes after the opening auction trade. By 11:31 a.m., the exchange’s highest bid, or price at which market participants were willing to purchase shares, was $42.99, and its lowest offer to sell was $42.50, according to data compiled by Bloomberg. The quotes produced a so-called crossed market, where sellers appear to be asking less than buyers are willing to pay.
Other markets continued trading, usually with a difference of a few cents between their best bid and lowest offer. Nasdaq’s quotes were marked as manual and not electronically accessible, which allowed brokers and other exchanges to ignore the venue’s prices. Its offer price later dropped to $38.01 and remained at that level, almost $4 below the highest bid, until 1:49 p.m., according to data compiled by Bloomberg.
“Clearly investors would hit the ‘don’t like’ button,” Matt McCormick, who helps oversee $6.2 billion at Bahl & Gaynor Inc. in Cincinnati, said in a telephone interview.
The IPO price valued the company at 107 times trailing 12- month earnings, more than all Standard & Poor’s 500 Index stocks except Amazon.com Inc. and Equity Residential. The valuation also made Facebook, co-founded in 2004 by a then-teenage Mark Zuckerberg, the largest company to go public in the U.S.
Customers of London-based Fidessa Group Plc, which helps asset managers track transactions, weren’t receiving confirmation of Facebook trades, according to an e-mailed statement. Michael Cianfrocca, a spokesman for Charles Schwab Corp. in San Francisco, wrote in an e-mail: “There are currently industrywide delays in reporting trade executions. These issues do not appear to be unique to Schwab.”
Uncertainty about whether orders received executions in the opening auction affected some clients of online broker TD Ameritrade Holding Corp., according to Steve Quirk, senior vice president of the trader group at the Omaha, Nebraska-based company. Facebook accounted for 22 percent of equities volume at the firm, he said by e-mail.
Clearing broker Pershing LLC told clients yesterday it worked through the weekend to address processing delays for purchases and sales of Facebook shares. The unit of Bank of New York Mellon Corp. expects to deliver trade information to customers’ account by around 7 a.m. on May 21, the broker said in the message.
Nasdaq shares fell 4.4 percent, the most since October, to $21.99 on May 18 following the problems with the IPO. NYSE Euronext, its larger rival, rose 0.3 percent to $24.61.
Facebook shares traded 582.5 million times on May 18, or about 6.6 percent of total volume on U.S. exchanges, according to data compiled by Bloomberg.
“I don’t think you’ll see a long-term downturn of volume on Nasdaq,” Karsh said. “Nasdaq will pick up a couple percentage points because it’s the primary listing venue for Facebook.”