Citigroup slammed Nasdaq OMX Group Inc's plan to compensate firms harmed by Facebook's botched market debut to the tune of $62 million, saying in a regulatory filing the exchange should be liable for hundreds of millions more, according to a letter seen by Reuters.
Citi said Nasdaq's actions in the May 18 initial public offering amounted to "gross negligence," in the letter to the U.S. Securities and Exchange Commission, which had not yet been made public.
Citi's market-making arm, Automated Trading Desk, lost around $20 million in the May 18 IPO, a source told Reuters in May. That is just a sliver of the upwards of $500 million that market-making firms - which facilitate trades, backing them with their own capital - and brokers lost in the $16 billion IPO.
Liabilities at U.S. exchanges, which have some regulatory duties, are capped in most instances. Nasdaq's cap in most instances is $3 million a month.
But the New York-based exchange should be fully liable for all of the IPO losses, Citi argued, because it was operating in the capacity of a for-profit company during the IPO, and as such it should not have regulatory immunity.
"Nasdaq cannot cloak its actions in immunity because it was acting exclusively as a for-profit business, and not as a market regulator, when it made the grossly negligent business decisions that caused market participants hundreds of millions of dollars of losses," Citigroup said in the letter.
A Nasdaq spokesman declined to comment.
UBS AG has disclosed it lost more than $350 million when the lack of timely order confirmations by Nasdaq caused UBS's internal systems to re-enter orders multiple times. The Swiss bank has threatened legal actions to recover the losses.
The other top retail market makers involved in the IPO Knight Capital Group, which sources have said is leaning toward accepting Nasdaq's plan, and hedge fund Citadel, which is in favor of the plan both lost $30 million-$35 million in the IPO.
DECISION TO MOVE FORWARD
Facebook's eagerly anticipated IPO was initially delayed by 30 minutes due to a technical glitch.
Nasdaq then made the decision to put through a fix to the systems problem and get the stock trading by way of a secondary matching engine that led new orders and changes in orders that came in later to not show up in the opening price. A matching engine pairs bids and offers to complete trades.
Eric Noll, Nasdaq's head of transaction services, later said in a statement earlier that the fix instead led to 2-1/2 hours of uncertainty during which brokers were unable to see the results of their trades.
Citi said in its letter that the decision to move forward with the IPO was a business decision made in haste. Further, it said trading should not have been allowed to continue during the confusion that followed.
THE PROPOSAL
The $62 million all-cash reimbursement plan Nasdaq submitted to the SEC is $22 million larger than originally proposed. The prior plan was made up mostly of trading rebates, which drew loud protests from other exchanges and market makers.
Nasdaq emphasized that it was not obligated to compensate firms for the glitch-ridden IPO, and that it's plan was voluntary. It gave strict parameters as to which types of orders could qualify to be reimbursed, and added that firms that sign on would have to waive their right to sue the exchange.
Comment letters on the proposal to the SEC were due by Wednesday.
Citadel, in a letter available on the SEC's website dated August 21, called for the SEC to approve Nasdaq's proposal.
It said the issue of whether Nasdaq, as a for-profit enterprise, should be afforded liability protections, was one that should be addressed at another time.
"The proposed accommodation standards are objective and fair," Citadel said in the letter.
FACTUAL ERROR
But some broker-dealers argued Nasdaq's reimbursement plan should be broader.
New York-based Triad Securities Corp said in a filing on August 20 it believes "Nasdaq's theory of compensation is based on factual error," and should be increased.
Facebook's shares began trading at 11:30 a.m. on May 18 at an opening price of $42, but many investors did not receive confirmations that their pre-market orders had gone through for hours after. Many buy and sell orders did not actually go out until later in the day, while others, including cancellations, were lost altogether.
At issue in Nasdaq's proposal is the establishment of a benchmark price of $40.527 at which "a reasonably diligent member" could have acted to mitigate losses, the proposal said.
Nasdaq said firms should have realized that some opening orders were not going to be filled when many, but not all orders, were executed at 1:50 p.m. It said firms should have cut losses by selling their positions into the market over the next 45 minutes.
Vandham Securities Corp, based in Woodcliff Lake, New Jersey, also argued in an August 21 filing Nasdaq should more fully compensate its members.
Both Vandham and Triad said Nasdaq was telling its customers after the market closed on the day of the IPO that orders could be sold at an opening price of $42, so firms should not have been expected to take actions to sell their positions and cut their losses.
"Vandham requests that the commission not approve the portion of Nasdaq's proposal that sets a limit on the amount that customer's losses will be reimbursed, but instead recommends that customers be reimbursed for their losses in full," the broker said in its filing.
Nasdaq shares closed down 2.2 percent at $23.19 on Tuesday.
