Citigroup Inc., whose market-making unit suffered millions of dollars of losses trading Facebook Inc. in its public debut, urged U.S. regulators to reject Nasdaq OMX Group Inc.’s proposal to make up for its errors.
The third-biggest U.S. bank said New York-based Nasdaq OMX’s claims that its liability should be limited by immunity afforded to exchanges is unsupported by legal precedent. Decisions made by the second-largest U.S. equity trading venue in the May 18 initial public offering were aimed at protecting its profits rather than member firms, the company said.
Citigroup’s assertions, contained in a 17-page letter to the Securities and Exchange Commission, came one day after rival market-maker Citadel LLC said Nasdaq OMX’s proposal should be approved. The New York-based bank said its losses exceed its portion of the pool proposed by Nasdaq OMX last month, which would compensate Wall Street firms that lost money after a design flaw in its computers delayed Facebook’s open and left traders confused about how many shares they owned.
“Market participants suffered hundreds of millions of dollars of losses as a result of Nasdaq’s profit-driven conduct prior to and during the Facebook IPO, not as a result of protected regulatory activity by Nasdaq, or routine system failures,” Citigroup wrote. “Nasdaq should not be permitted to hide behind regulatory immunity.”
Joseph Christinat, a Nasdaq OMX spokesman, declined to comment.
The opposition is another sign Nasdaq’s responsibility will be determined in court rather than by regulators. UBS AG, Switzerland’s largest bank, said last month that it is examining legal options after losing as much as $350 million in the IPO.
Citigroup, Chicago-based Citadel, UBS in Zurich and Knight Capital Group Inc. in Jersey City, New Jersey, operate equity wholesaling groups, brokers that execute orders for individual investors sent by securities firms such as Charles Schwab Corp., TD Ameritrade Holding Corp. and Fidelity Investments.
Nasdaq OMX last month increased its planned payout to brokers that lost money trading Facebook to $62 million from $40 million in cash and credit. The decision was made despite protections it possesses as a so-called self-regulatory organization, Nasdaq Stock Market said. The cap on Nasdaq’s liability stemming from technology errors it causes is $3 million, according to the exchange’s rules.
Delays and malfunctions on Nasdaq were the first signs of trouble in the Facebook IPO, which prompted lawsuits against the company, its exchange and the underwriters. At yesterday’s close of $19.44, Facebook was down 49 percent from the $38 price set by underwriters on May 17.
The pricing of the first public transaction on May 18, a trade known as the IPO cross, took a half hour longer than Nasdaq planned because of technical malfunctions. In May, Nasdaq OMX Chief Executive Officer Robert Greifeld acknowledged “poor design” in software put the opening auction into a loop that delayed its completion.
Citigroup said Nasdaq should have halted the IPO when it realized the auction process wasn’t working as planned. Instead, the exchange encouraged firms to continue submitting orders and updates, “adding new pricing information for the system to digest at a time when it was having difficulty with the information received as of 11:05 a.m.,” the bank said.
“In a hasty, high-risk move, Nasdaq unilaterally gambled that its systems would function properly, despite the issues that it was beginning to experience at the time,” Citigroup wrote. “Nasdaq’s failure to notify market makers like Citi of what was going on behind the scenes is inexcusable.”
Nasdaq told market makers “to make their clients whole, with assurances that they would be reimbursed for client accommodations that were made at Nasdaq’s direction,” Citigroup said.
Citadel, run by Ken Griffin, lost as much as $35 million in trading related to the offering in its market-making unit, according to a person with knowledge of the firm. Knight lost $35.4 million in Facebook trading, it said on July 18.
Citigroup disputed the formula Nasdaq said it would use to determine how much to reimburse firms, saying the benchmark price selected for determining the level of losses should reflect trading before noon on May 21.
Nasdaq told the SEC it would determine how much to pay by comparing firms’ executions for Facebook to the average price, weighted by the number of shares traded, from 1:50 p.m. to 2:35 p.m. on May 18. That price was about $40.53, Nasdaq said. The average price Citigroup suggested was $34.36, based on data compiled by Bloomberg.
Citigroup’s opinions were echoed in a letter dated Aug. 22 sent to the SEC by the Securities Industry and Financial Markets Association, a Wall Street trade group. Sifma, as the organization is known, warned regulators against the precedents that might be set from a decision affirming that Nasdaq OMX’s actions on May 18 fell under exchange protections.
“Sifma does not believe that Nasdaq is entitled to regulatory immunity in connection with the Facebook IPO, because Nasdaq was acting as a for-profit market participant, not in its capacity as a self-regulatory organization,” the group wrote. “We note that Nasdaq received the Facebook listing, and its attendant listing fees, after a hard-fought competition with the New York Stock Exchange to gain Facebook’s listings business.”
Curbs on exchange liability were developed to keep member- firm owners, who used to own the exchanges, from having to pay another broker for losses caused by technical breakdowns. Nasdaq OMX, a publicly traded company, makes money from fees levied on firms that trade on its systems and use its technology infrastructure. It also makes money from the sale of quotation and trade data and from payments by companies that go public or maintain listings under its auspices.
“The hundreds of millions of dollars of losses suffered by market participants in connection with the Facebook IPO resulted from a series of hasty, self-interested and high-risk business decisions by Nasdaq, which did not take full account of the negative downstream effects,” Citigroup said. “Nothing about these profit-driven actions reflects a concern for the integrity of the market or otherwise suggests that Nasdaq was acting in a regulatory capacity.”
Brokers are concerned that exchanges have too much leeway to avoid culpability for trading mishaps that are their own fault, T.R. Lazo, Sifma’s managing director and associate general counsel, said in a telephone interview yesterday.
“Broker-dealers take on a lot of liability and they question why exchanges, given their capacity as for-profit market participants, essentially have a regulatory liability protection,” Lazo said. “This is a good time to take a look at those rules and the purpose they serve and whether they ought to be changed.”
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