Published May 25, 2012
Claims by four of Wall Street's main market makers against Nasdaq over Facebook's botched IPO are likely to exceed $100 million, as they and other traders continue to deal with thousands of problems with customer orders.
A technical glitch delayed the social networking company's market debut by 30 minutes on Friday and many client orders were delayed, giving some investors and traders significant losses as the stock price dropped. The exchange operator is facing lawsuits from investors and threats of legal action from brokers.
Four of the top market makers in the Facebook IPO -- Knight Capital, Citadel Securities, UBS AG and Citi's Automated Trading Desk -- collectively have probably lost more than $100 million from problems arising from the deal, said a senior executive at one of the firms.
Knight and Citadel are each claiming losses of $30 million to $35 million, potentially overwhelming a $13 million fund the exchange set up to deal with potential claims.
Nasdaq also has to contend with the outside prospect that it could lose the Facebook listing entirely after having just obtained it.
Facebook shares ended regular trading on Thursday up 3.2 percent at $33.03, about $5 short of their offering price. Action on the stock, however, has essentially become secondary to the fallout from the IPO -- its price, its size, its execution and questions about selective disclosure of its financial prospects.
Regulators including the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority and Massachusetts Secretary of the Commonwealth William Galvin are now looking into how the IPO was handled. The U.S. Senate Banking Committee is also reviewing the matter.
BROKERS UP IN ARMS
Advisers familiar with the situation said many investors are now finding out, nearly a week after the fact, that their orders were not executed at the prices they thought.
Fidelity, in a statement, said it was working with regulators and market makers on its clients' issues "and we will continue to do so until we are confident that Nasdaq has done everything it can to mitigate the impact to our customers."
Morgan Stanley is also still tending to trade orders placed by brokerage customers on Friday, two people familiar with the situation said. Nasdaq has said all orders were returned by 1:50 p.m. EDT last Friday, but a Morgan Stanley Smith Barney source said it did not get trade information in a "systemic, orderly way.
Late Thursday, the company held a call with its brokers and told them adjustments would be made to thousands of trades so that no limit orders would be filled at more than $43 a share for stock from the IPO day, a person familiar with the call said.
While brokerages may have received confirmation of trades made on Friday, many were still handling customer disputes over what price they received on the trades, officials said.
The question is "who is going to eat the cost" of compensating those investors, said Alan Haft, a financial adviser with California-based Kings Point Capital LLC, which has $200 million in assets.
One prominent plaintiffs lawyer said what happened with Facebook was reminiscent of the dot-com bubble.
"This is just another spin on the same game of unfair treatment of individual investors," said Stanley Bernstein of Bernstein Liebhard. He chaired the plaintiffs' committee in an IPO class-action suit challenging the role of investment banks in more than 300 IPOs between 1998 and 2000. The litigation ended in a $586 million settlement in favor of the plaintiffs.
MARKET MAKERS LOOM
The claims by market makers Knight and Citadel could end up dwarfing some of the brokerage issues, though.
"They are certainly facing the specter of some significant lawsuits if this pool is not enough," a source familiar with Knight's situation said of the Nasdaq claims pool.
Citadel has sent its losses to Nasdaq for potential compensation, a source familiar with the matter said. Citadel's hedge fund was not affected.
The head of trading at Instinet said it still had no idea when Nasdaq would respond to requests for accommodation -- essentially, compensation for the order problems -- or if those requests would be honored.
"Were gonna be looking at a loss on our books" if Nasdaq does not honor the requests, Mark Turner said. "We basically made most of our clients whole because Nasdaq told us to go through the process and file for accommodation. If Nasdaq does not accommodate us we're going to end up taking a loss."
"I don't know that I want to put a dollar amount on that but it's not nearly as significant as Knight's ($30-$35 million)," he said.
Citadel and Knight, as market makers to the Nasdaq, honor their clients' buy, sell and cancellation orders. The orders are supposed to be processed by the exchange within milliseconds, but there was a nearly two-hour delay in processing Facebook orders at the Nasdaq.
During that time, market makers had no idea where their orders stood. And in reality, the price clients bought or sold at was sometimes different than the price they actually got.
For example, Facebook shares began trading with an opening cross price - the first price at which those not in on the IPO could buy or sell - of $42 per share. If an order to sell 10,000 shares at $42 went in at that time, but wasn't filled until later in the day when shares were trading at around $39, a market maker like Citadel or Knight would make up the difference - in this case, at a cost of $30,000.
FEWER PROBLEMS ELSEWHERE
Several analysts who cover exchanges said Nasdaq's legal liability should be limited, though. According to the analysts, securities rules give Nasdaq wide discretion in determining what, if any, compensation it should pay to customers who claim that they suffered losses due to trading execution.
Under exchange rules, Nasdaq's liability regarding client losses from certain trading issues is limited to $3 million a month. Market makers will be arguing that Nasdaq was so grossly negligent that its actions during the IPO opening override the limits, said a source with knowledge of Knight's situation.
Other firms said they did not have similar problems to those of Knight, raising questions about the scope of the losses.
"The problems were where people were trying to cancel orders; we didn't have that," said Peter Boockvar, equity strategist at Miller Tabak & Co in New York. "Because we didn't have a problem doesn't mean there weren't problems."
E*Trade Financial Corp said its market making operations realized losses of "well under a million dollars."
Charles Schwab Corp had a "small number" of the "tens of thousands of clients" who traded Facebook whose issues still have not been resolved, a spokesman said. "Each one requires some analysis to resolve, which can be time consuming."
Shares of Nasdaq fell 1 cent to $21.80 on Thursday. As of Thursday's close the stock was down 5.2 percent from its last close before the Facebook debacle. Over the same period NYSE Euronext is down just 0.1 percent.
The slide in the shares is adding to the pressure on Nasdaq Chief Executive Robert Greifeld, who defended the exchange's performance at its annual meeting last Tuesday.