May 29, 2013 was a bad day at the office for The Nasdaq Stock Market, LLC as it agreed to pay a $10 million fine to settle allegations arising from the troubled May 18, 2012 Facebook IPO. This payment was announced by the SEC in a press release which was highly critical of Nasdaq management and its role in this IPO. This was the largest fine ever assessed against an exchange. This fine was a clear message to the securities exchanges to focus on their systems and processes and ensure that they are ready to successfully run transactions like the Facebook IPO.
The SEC also issued an Administrative Order that describes the Facebook IPO and Nasdaq’s mistakes and securities law violations in detail. The Order also describes several instances where Nasdaq violated its own policies during the IPO. It is clear from this Order that the SEC is angry about the problems with the Facebook IPO and that it holds Nasdaq management responsible. The SEC is very concerned with future offerings and the ability of exchanges to manage them as the size, velocity and complexity of the offerings continues to increase. The SEC confirms that it is the responsibility of an exchange’s management to anticipate the problems that occur in these offerings and to have systems in place that can handle them. It is no longer sufficient to blame these problems on “technical glitches”, especially when so much money and credibility are at stake. The Order also censured Nasdaq and its affiliate, Nasdaq Execution Services, LLC. Matt Phillips has a nice summary of these Facebook IPO problems and the SEC Order on his blog.
The Nasdaq’s actions before and during the Facebook IPO have been roundly criticized by commentators and industry experts and now by the SEC. Nasdaq management conducted system tests prior to the Facebook IPO, but the extent of these tests was woefully inadequate. They conducted tests using 40,000 orders, but almost 500,000 orders were waiting when the Nasdaq opened trading in Facebook stock. This huge volume of advance orders and the continuing high volume of orders quickly overwhelmed the exchange’s systems. In response to these numbers and panicked calls and emails from brokers (who apparently had no idea of how many shares they had purchased or their actual exposure), Nasdaq management held a “Code Blue” emergency call and made a few software adjustments which they thought would fix the problems. These adjustments did not work, however, and brokers continued to panic. Nasdaq management finally discovered that about 30,000 Facebook orders that had been placed earlier in the day had never been executed. Many of these shares were then sold into the open market, which depressed the stock price until brokers stepped in to help support it. Facebook shares were priced at $38.00 at the start of the IPO but closed that day at $38.23. This was a major disappointment, and the stock price has significantly retreated from that level. Facebook’s most recent price was $23.76 per share, a 37.5% decline from its opening IPO price.
The problems with Facebook’s IPO also impacted the trading of Zynga shares on the day of the Facebook IPO. Related systems problems caused 365 orders for trades of Zynga shares to not occur in compliance with timing requirements.
This record settlement compounds Nasdaq’s woes from the Facebook IPO. Nasdaq has reportedly already paid $62 million to brokerage firms to cover their losses from the IPO. UBS, however, contends that it lost $365 million due to the Nasdaq’s problems with the IPO, and it is currently in arbitration with Nasdaq regarding these losses. The final result of this arbitration is uncertain, but Nasdaq will likely be paying a hefty amount to UBS to resolve this matter.
One Nasdaq action that stands out during the IPO process was its establishment of a large short position on about 3 million Facebook shares. Nasdaq apparently made a $10.8 million profit when it covered this short position. The SEC focused on this and stated in its Order that this action violated Nasdaq’s policies. Whether this amount was in some way associated with the fine amount is unknown, but this certainly casts Nasdaq in a further negative light in connection with this offering.
Nasdaq responded to this settlement and the associated fine by issuing an open letter on May 29. In this letter Robert Greifeld, Nasdaq’s CEO, acknowledges that mistakes were made but takes a positive and forward looking approach by listing several initiatives that Nasdaq has undertaken to ensure that future offerings do not encounter these problems. The letter was not as strong as I anticipated. It focused on Nasdaq’s successful record of prior IPOs, which seems somewhat irrelevant in this case due to the unprecedented nature of the Facebook offering. Nasdaq management should have been ready for this situation given the huge amount of public hype and hysteria that led up to this IPO.
The substantial problems that the Facebook IPO experienced have deeper negative implications for the technology industry and the stock exchanges. Investors clearly did not overwhelmingly embrace the Facebook IPO, but the results may have been better without these Nasdaq problems. Technology companies constantly struggle to prove that they are real “grown up” businesses, and a successful IPO by a landmark tech company like Facebook would have really helped to further establish this credibility. Additionally, questions clearly persist regarding the ability of the stock exchanges to handle transactions like the Facebook IPO. Nasdaq’s open letter did not inspire me, but at least they are aware of the problems that they face and they appear to be trying to correct them. We will have to wait until the next big high profile IPO to see how well these problems have been identified and fixed.
The problems with the Facebook IPO and the substantial SEC fine should be a clear warning to all participants in the securities offering process that they need to step up their games. Large securities offerings with an enormous amount of publicity and hype are going to continue to occur, and the exchanges need to be ready to handle them. If new systems, processes and procedures are required, then make them happen. Above all, be prepared for these situations. It’s clearly not acceptable to react on the fly. It’s also clear that the SEC is focused on this area and that it will not hesitate to impose substantial fines and penalties in these situations.