The Securities and Exchange Commission (SEC) has fined Nasdaq’s parent company Nasdaq OMX $10 million, the largest-ever fine levied against an exchange, due to violations in company policy and securities law during the Facebook initial public offering (IPO) last May, one of the largest in history. Nasdaq's failure to properly prepare for the offering caused 30,000 Facebook stock orders to essentially get stuck due to trading traffic greater than the system's capacity, leaving many investors trading blind, not knowing how much stock they had and how much it was worth.
The problem began when Nasdaq ran tests before the IPO, per regulations, to ensure that the system could support the increased traffic of such a large public offering. However, the simulation used only 40,000 orders, while on 11 a.m. on the morning of the IPO the system received a massive, but not unexpected, deluge of 496,000 orders.
Here Nasdaq first violated market rules by being poorly prepared for the launch. Although Nasdaq CEO Robert Greifeld told the SEC Nasdaq "conducted more than a hundred IPOs using the same or similarly designed systems, without incident" prior to the IPO of Facebook, the SEC believed that Nasdaq recklessly undertested their system. Nasdaq, the SEC continued, failed to ensure that their systems and contingency plans were strong enough to handle the IPO without disruption. The overwhelmed system, however, was unable to properly process the data and in turn determine the stock's correct opening price.
That same day, May 18, Nasdaq management convened a "Code Blue" conference call to discuss their next step. Despite doubts from CEO Robert Greifeld who wrote, "Should you stop trading for some period of time so we can all catch up and actually understand our exposure?", they decide to proceed by changing a few lines of code and switching to an untested backup system, hoping that the fix would stick. Resuming trading without fully understanding the root of the problem, the SEC says, was a violation of several Nasdaq and SEC rules governing the price/time priority for executing trade orders.
When the IPO launched the system failed, and Greifeld was immediately inundated with calls and email from brokers, including one who wrote that "we are all trading blind."
"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," says George S. Canellos, co-director of the SEC’s Division of Enforcement.
In addition to faulty systems, and the decision to keep the trading live despite no understanding of the root of the problem, the SEC also found that Nasdaq violated its own rules by maintaining a short position on the Facebook stock in an unauthorized account.
Although Nasdaq OMX denies any wrongdoing, it has issued an apology to investors and agreed to pay $62 million for money lost due to the flawed IPO. Further, Greifeld announced that Nasdaq has created a new team of engineers dedicated to monitoring daily system performances, as well as a new quality assurance office, both overseen by the new positions of chief information officer and global head of market systems.
While many blamed Nasdaq for the Facebook stock's early trouble, the stock has never risen back to its opening price of $42.05, instead hitting a low of $17.57 in October and recovering to its current level around $23, indicating that the stock's woes have outlasted the IPO chaos.