As a result of Facebook’s initial public offering (IPO) mishap last year, the SEC has charged NASDAQ with securities laws violations resulting from its poor systems and decision-making in handling the IPO and secondary market trading of Facebook shares. In order to settle the SEC’s charges, NASDAQ has agreed to pay a $10 million penalty – the largest ever against an exchange.
Exchanges such as NASDAQ have an obligation to ensure that their systems, processes, and contingency planning are adequate to manage an IPO without disruption to the market. However, despite the anticipation that the Facebook IPO would be among the largest in history, NASDAQ failed to address a design limitation in their system that matched buy and sell orders, causing disruptions to the Facebook IPO. These disruptions then led NASDAQ to make a series of ill-fated decisions that led to the rules violations.
Having thought they had been able to apply a quick-fix to their systems limitation problem, NASDAQ leaders decided not to delay the start of the secondary market trading in Facebook. However, they misunderstood the problem and failed to properly fix it, and as a result caused more than 30,000 Facebook orders to remain stuck in NASDAQ’s system for over two hours after they should have been promptly executed. Additionally, NASDAQ’s Facebook issues caused problems in the trading of Zynga shares, where 365 orders also had failed to be executed. NASDAQ’s decision to initiate trading before fully understanding the problem caused violations of several rules, including NASDAQ’s fundamental rule governing the price/time priority for executing trade orders.
“This action against NASDAQ tells the tale of how poorly designed systems and hasty decision-making not only disrupted one of the largest IPOs in history, but produced serious and pervasive violations of fundamental rules governing our markets,” said George S. Canellos, Co-Director of the SEC’s Division of Enforcement. The SEC hopes that this investigation will set a precedent for not overlooking systems disruptions as mere technical ‘glitches,’ which happens too often in today’s markets.
According to the SEC’s order, NASDAQ further violated its rules when it created a short position in Facebook with an unauthorized error account assuming more than three million shares. NASDAQ is not permitted to do this, and its profit of $10.8 million from the short position was also in violation of its rules.
NASDAQ’s affiliated third party broker-dealer NASDAQ Execution Services (NES) was also charged with failing to maintain sufficient net capital reserves on the day of the Facebook IPO due to NASDAQ’s own Facebook trading through its unauthorized account.
Along with paying its $10 million penalty, NASDAQ has agreed to pay as much as $62 million in an SEC approved plan to help compensate market makers for their estimated $500 million in losses as a result of the botched Facebook IPO.
In a recent letter, NASDAQ CEO Robert Greifield said, “While we prepared extensively for the Facebook initial public offering, the challenges we encountered that day were unprecedented. In the last year, we have carefully reviewed these events. As market leaders, we view our experiences as opportunities to learn and improve.”
Click here to read the full SEC Order against NASDAQ.