SEC digs into Facebook’s IPO

Regulator probing Nasdaq’s and other exchanges’ breakdowns

A message on Nasdaq’s video facade in New York’s Times Square welcomed Facebook on May 18, the first day of the company’s initial public offering.
A message on Nasdaq’s video facade in New York’s Times Square welcomed Facebook on May 18, the first day of the company’s initial public offering.

— The Securities and Exchange Commission is investigating the Nasdaq stock exchange and its role in the troubled initial public offering of Facebook, according to people briefed on the inquiry.

Regulators are examining whether Nasdaq failed to properly test its trading systems, which broke down during the IPO, and whether the exchange violated rules when it rewrote computer code to jump-start trading.

Nasdaq has blamed flawed computers and “technical errors” for Facebook’s botched debut last month.

The Facebook investigation comes after a broader inquiry into trading breakdowns and other problems at the nation’s largest exchanges, including two previously undisclosed cases involving Nasdaq’s archrival, the New York Stock Exchange, the people said.

The agency’s enforcement unit, which has opened more than a dozen related cases, is examining whether exchanges lack adequate controls and favor select investors.

“If exchanges have technical problems, that slows capital formation and erodes the confidence” of investors in the market, said Sen. Jack Reed, D-R.I., who held a hearing this week on the initial public offering process.

While none of the exchanges has been accused of any wrongdoing and the SEC may never take enforcement action, the investigations represent a significant shift. Traditionally, the agency has been relatively cozy with the industry, which is increasingly under pressure to produce profits since the exchanges became publicly traded companies.

Along with the threat of enforcement cases, the SEC has introduced several measures to improve the safety of the markets. For example, the agency has approved proposals that would help limit volatility in specific stocks, including circuit breakers that would halt trading.

“Cases against exchanges are few and far between, and inevitably a big deal,” said Stephen Crimmins, a partner at the law firm K&L Gates and a former enforcement official at the SEC.

Facebook’s initial public offering highlights the problems facing exchanges — and how regulators are finding their responses lacking.

On May 18, its first day of trading, Facebook got off to a rocky start. Nasdaq delayed the start of trading and later flooded the market with shares, adding to investor trepidation.

Nasdaq’s lack of communication — and at times, lack of contrition — aggravated the situation, according to documents and executives, bankers and regulators. On a May 31 call with the SEC chairman, Mary Schapiro, and other officials, Nasdaq’s chief executive expressed confusion about the SEC’s aggressive approach.

“We’re regulators, too,” said the chief executive, Robert Greifeld, adding “we’re all in this together.”

The Facebook debacle comes after a flurry of trading breakdowns. In March, BATS Global Markets canceled its own IPO, after its systems faltered. Nasdaq last year halted trading in dozens of stocks amid technical problems.

Such experiences echo the so-called flash crash. On May 6, 2010, the Dow Jones industrial average plummeted more than 700 points in minutes, before recovering shortly thereafter.

In nearly every case, companies blamed technical malfunctions. But regulators say some breakdowns may point to more fundamental issues.

The SEC is also examining whether some exchanges give undue priority to high-frequency trading firms and big institutional investors through its order types and data disclosure.

The New York Stock Exchange is among the most prominent players facing scrutiny from regulators, who have opened two investigations into the Big Board, according to people briefed on the matter who spoke on the condition of anonymity because the cases are not public.

The SEC, the people said, is examining whether the New York exchange violated technical rules by distributing in-depth stock data to paying clients faster than the public received general information. The issue was first discovered in the rubble of the flash crash.

The exchange declined to comment. But people close to the exchange have attributed the problem to unintended technical shortcomings.

The SEC, which has penalized the Direct Edge exchange for having “weak internal controls,” is also pursuing the Chicago Board Options Exchange for not properly policing the markets.

In February, BATS Global Markets acknowledged receiving a request from the SEC.

The agency, a person briefed on the matter said, is examining whether any collaboration between BATS and high-frequency trading firms could hinder competition.

Facebook shares rose $1.21, or 3.8 percent, to close at $33.05.

Business, Pages 23 on 06/23/2012

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