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SEC slams NASDAQ with $10m fine for Facebook IPOcalypse

Regulator lambasts 'mind boggling' failures that led to busted IPO

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NASDAQ is forking over $10m to the Securities and Exchange Commission as penance for its poorly executed Facebook IPO.

The fine was levied against the exchange for the Facebook IPOcalypse, which saw punters at first unable to buy shares in Zuck & Co's data farm social network, and then able to buy but only at unreliable prices.

"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," the SEC's co-director of its division of enforcement, George Canellos, thundered in a statement.

On the day of the Facebook IPO – May 18, 2012 – NASDAQ repeatedly delayed the start of trading. When trading did begin, problems with buy, sell, and cancelation orders meant some trades hung around for two hours – an eon in terms of a hotly anticipated IPO.

The problems were so great that NASDAQ failed to match buy and sell orders to create an average price for Facebook shares for the first 20 minutes. When it did manage to match them (complete "the cross," in stock market terms) and commence trading, it left out tens of thousands of orders, which the SEC says were "stuck" due to a weird software loop in NASDAQ's exchange software.

"This time discrepancy caused more than 38,000 marketable Facebook orders placed between 11:11am and 11:30:09am to not be included" the SEC said. "Approximately 8,000 of those orders were entered into the market at 11:30am, when continuous trading commenced, and the remaining 30,000 were 'stuck' orders."

NASDAQ eventually dumped 13,000 of these "stuck" orders back into the stock market at 1:49pm on the day (the rest were canceled), and in so doing, drove down the price of Facebook's shares by 93 cents between 1:50pm and 1:51pm because many of the 13,000 orders were selling large quantities of shares.

Failing to include trading orders that were lodged by punters is, we observe, something of a misstep for one of the world's largest stock exchanges – as is then including them in a giant batch that rapidly distorts the share price. NASDAQ executives were aware of this and briefly considered halting trading of Facebook in a executive teleconference code-named "Code Blue," but they thought better of it.

One reason for the trading problems could have been shoddy testing. In the run-up to the hotly anticipated IPO, NASDAQ created a test security named ZWZZT that traders could place dummy orders into. ZWZZT was limited to 40,000 orders, compared with the 496,000 orders that Facebook experienced on its first day of trading.

"I can summarize what went wrong in two words: inadequate testing," Eric Hunsader, founder of stock market analysis firm Nanex, tells El Reg. "I'm not talking about rigorous testing, moderate testing, bare minimum testing – I'm talking about even less than the bare minimum ... it boggles the mind."

No mention was made in SEC materials of whether NASDAQ had tested the system used to calculate the average price (the cross), but Hunsader contends that if they did any testing they would have spotted the problems.

The SEC fine is just another lash in the months of punishment that NASDAQ has been subjected to after the botched IPO. The exchange has already brutally slashed its CEO's end-of-year bonus by over half a million dollars and is preparing to pay out some of its $62m compensation pot to traders affected by the problems.

Citi is planning to file a claim to claw back some of the $20m in lost in the debacle, though the exchange got a reprieve in February when a judge denied a motion to move a class action suite against it to the New York Supreme Court.

Although $10m is the largest ever fine levied against an exchange, we're sure NASDAQ can take the cracking of this whip: NASDAQ OMX reported a net income of $349m in 2012. ®

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