In the Matter of the NASDAQ Stock Market, LLC and NASDAQ Execution Services, LLC, SEC Admin. Proc. No. 3-15339.  On May 29, 2013, the SEC announced it filed a settled administrative proceeding against NASDAQ related to poor systems and decision-making during the Facebook IPO.  According to the SEC’s Order, there was a design limitation in NASDAQ’s system to match IPO buy and sell orders that caused problems with the the Facebook IPO.  Several members of NASDAQ’s leadership decided not to delay the start of secondary market trading in Facebook believing they had addressed the system limitation by making small changes to computer code.  However, NASDAQ management did not really comprehend the problem and the decision to initiate trading before fully understanding the situation led to more problems.  As a result, more than 30,000 Facebook orders remained stuck in NASDAQ’s system for more than two hours when they should have been promptly executed or cancelled.

The matching of buy and sell orders in an IPO is called “the cross.”  According to the SEC’s Order, the problems encountered during the Facebook IPO caused the cross to fall 19 minutes behind the orders received by NASDAQ.  NASDAQ was aware of a difference between the final pricing and volume totals and the actual totals on NASDAQ’s internal systems.  This discrepancy revealed that there was still a problem and that orders were not being handled properly.  Yet, NASDAQ did not address this issue.  NASDAQ also violated its rules by taking a short position in Facebook in an unauthorized error account.  NASDAQ then covered the short position and made more than $10 million in profits.  The SEC’s order also charges NASDAQ’s affiliated third party broker-dealer NASDAQ Execution Services (NES) with failing to maintain sufficient net capital reserves on the day of the Facebook IPO as a result of NASDAQ’s own Facebook trading through the unauthorized error account.

In separate incidents unrelated to the Facebook IPO, the SEC’s order also charges NASDAQ with violations of Regulation NMS and Regulation SHO based on its failure to appropriately monitor and enforce compliance with price-test restrictions in October 2011 and August 2012.

The SEC’s order finds that NASDAQ violated Section 19(g)(1) of the Exchange Act by not complying with several of its own rules, and that NES violated Section 15(c)(3) of the Exchange Act and Rule 15c3-1 thereunder by failing to maintain sufficient net capital reserves on May 18, 2012.  NASDAQ also violated Rule 201(b) of Regulation SHO during and violated Rule 611 of Regulation NMS.  NASDAQ and NES agreed to a settlement without admitting or denying the SEC’s findings. The order censures NASDAQ and NES, imposes a $10 million penalty on NASDAQ, and requires both NASDAQ and NES to cease and desist from committing or causing these violations and any future violations. The order also requires NASDAQ and NES to complete numerous undertakings.