Nasdaq faces years of litigation over Facebook IPO

June 11, 2012 (MSNBC:  Market Day) By Roland Jones

The Nasdaq stock market may have thought it was putting a lid on the debacle over Facebook’s botched IPO when it said last week that it will put up $40 million to compensate clients impacted by the botched public stock offering.

Instead, the Nasdaq may have simply stirred up a hornet’s nest.

Angry investors — from major investment banks to small retail investors — are lining up to condemn Nasdaq for the technical glitches that marred the first day of trading for Facebook’s IPO last month, leading to complaints of slow order confirmations and too many shares offered at too high a price.

According to a report in The Wall Street Journal Monday, investors and financial firms say they lost a collective $500 million on Facebook shares that they didn’t want, were unable to sell as the company’s share price began falling shortly after the IPO, or had to take back from their angry customers.

On Friday, the Journal reported that Swiss bank UBS is considering legal action against the Nasdaq after it lost as much as $350 million because of technical glitches when Facebook went public.

“I think the Nasdaq has a lot to worry about,” said Stuart Meissner, a New York securities industry attorney and former securities regulator.

This was not like the Flash Crash, or the 1987 stock market crash, for which the market couldn’t prepare. It was an IPO and the Nasdaq would have had months to prepare for it, Meissner said.

Meissner said he expects the legal claims against the Nasdaq to go beyond the institutional level to include cases from individual investors who feel they were mistreated by the institutions with which they placed their trades for Facebook shares.

“It’ll be the hot potato effect,” he said. “The customer will blame the banks, and the banks will blame the Nasdaq. This will probably mean litigation for years.”

Adding to the negative press for the Nasdaq, on Monday The Wall Street Journal published a behind-the-scenes report of what happened during Facebook’s public offering on May 18. It included a five-hour period during the trading day when the Nasdaq’s CEO Bob Greifeld was cut off from all communication as he flew from San Francisco to Newark, N.J.

He even missed a call to his office from Securities and Exchange Commission Chairman Mary Schapiro, the paper said.

Last week, major trading industry executives rushed to condemn the Nasdaq’s proposed compensation plan, which will see the Nasdaq pay $13.7 million in cash to member firms affected by the problems associated with the IPO. They argue that the amount on offer doesn’t even begin to compensate them for their trading losses. Some have questioned whether the plan, which is subject to approval by regulators, will ever be permitted.

“It’s underwhelming at best,” Thomas Joyce, a vocal critic of the Nasdaq’s handling of the Facebook offering and chief executive officer of Knight Capital Group, the largest trader of U.S. shares by volume, said. “Nasdaq has got to go back to the drawing board and come up with something else.”

Some $27 million of the $40 million that the Nasdaq has earmarked for compensation will be discounted transaction fees to firms that were affected by the IPO debacle. It’s a plan that the Nasdaq’s rivals say is nothing more than a ploy to drum up more trading business.

Joyce called the plan “too cute by a half.”

“I don’t understand why they think they should get more businesses because of their behavior on the Facebook IPO,” he told CNBC. “Why should a competitor gain a leg up because they screwed up?”

William O’Brien, CEO of Direct Edge, an electronic exchange that is the third largest stock market in the U.S., said the proposal to offer exchanges discount trading fees probably is illegal.

“I don’t think it’s going to be approved by [regulators],” he told CNBC. “I think we’re going to be talking about this for a long time.”

Greifeld said in a CNBC interview last week that his company had been “embarrassed” by the technical problems that occurred during the Facebook IPO, and he apologized to the industry for what happened. But, he added, the exchange had done a thorough study of the trading in Facebook shares to decide on the compensation it should pay.

“The beauty of our market is we have all the data […] so we know exactly what transpired,” he told CNBC, adding that the Nasdaq’s assessment of the losses is based on a two-week, objective analysis.

“It’s clear, it’s clinical, and it’s objective and databased,” he said.

A backlash from major trading companies and others in the securities industry will make it more difficult for the Nasdaq to rebuild the exchange’s tarnished reputation following the Facebook trading debacle.

And it comes at a challenging time for traditional stock exchanges, such as the Nasdaq and the New York Stock Exchange, which are losing their dominance as the traditional providers of trading forums for investors, according to Sebastian Mallaby, the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations.

Mallaby notes that the number of companies listed on U.S. stock exchanges has declined over the past decade. Instead, institutional investors are turning to so-called “grey markets,” such as SecondMarket, where they receive many of the same advantages of stock markets, but with fewer regulatory burdens. Increasingly, mutual funds and other big investors are also opting to invest in private equity, he added.

“The original theory of big stock exchanges having the central position as providers of liquidity has been rendered anachronistic by new technology,” he said.