SEC Approves Nasdaq Deal for Facebook IPO But Lawsuits Could Follow

U.S. regulators approved Nasdaq OMX Group’s $62 million compensation plan for firms that lost money in Facebook Inc.’s glitch-ridden market debut, a victory for the exchange operator that also set the stage for potential lawsuits from firms seeking more.

The Nasdaq plan will give retail market makers far less than the $500 million in estimated losses from Facebook’s initial public offering. Nasdaq said in a note to traders on Monday that the U.S. Securities and Exchange Commission approved the plan, and that firms had one week to submit requests for compensation.

A systems failure at Nasdaq on May 18 prevented timely order confirmations for many market participants, leaving them trading in the dark in the midst of the leading online social network’s long-awaited initial public offering.

UBS AG has pegged its losses from the problematic IPO at above $350 million. It said it has already filed an arbitration demand against Nasdaq to fully recover losses due to the exchange’s “gross mishandling the IPO.”

Other market makers that took losses in the botched IPO include units of Citigroup Inc., Knight Capital Group and Citadel LLC.

Citi had opposed Nasdaq’s plan, while Knight supported the plan but did not want to waive its right to sue for compensation. Firms that sign on to the plan must agree not to take legal actions against Nasdaq over the IPO. Citadel has backed the plan.

It was not immediately clear if any other firms planned to take legal action to try to recover their full losses. Knight, Citi and Citadel declined to comment.

REGULATORY IMMUNITY

The SEC’s written decision said that while several letters to the regulator had expressed concern that approval of the compensation plan could affect pending litigation against Nasdaq, the ruling concerned only whether the compensation plan was consistent with existing regulation.

The regulator said it was “expressing no view as to whether Nasdaq or any other person may have violated the federal securities laws or any other laws, any rule or regulation … in connection with the Facebook IPO.”

At stake is the extent to which U.S. stock exchanges, which match hundreds of billions of dollars of transactions daily, can be held liable for technical glitches in an environment dominated by lightning-fast automated trading.

Liabilities at U.S. exchanges, which have some regulatory duties, are capped when the exchanges are performing those duties. Nasdaq’s cap for technical glitches in most instances is $3 million a month.

If Nasdaq had to make whole all the brokers that lost money in the IPO, it might bankrupt the exchange, which could end up driving more trading onto less transparent venues, such as dark pools, said Tamar Frankel, a Boston University professor who teaches securities law, corporate governance, and legal ethics.

The SEC said the question of whether Nasdaq should be able to claim regulatory immunity in this case was outside of the scope of the regulator’s consideration.

Separately, the SEC is investigating Nasdaq’s role in the botched IPO. A source previously said the two sides are in talks to possibly settle the probe.

VOLUNTARY PLAN

Nasdaq has maintained that it is not obligated to compensate firms for losses, and that its plan is voluntary. It has given strict guidance on which types of orders will qualify to be reimbursed.

Nasdaq spokesman Joe Christinat said now that the SEC has approved the plan, the Financial Industry Regulatory Authority can promptly begin processing claims for restitution.

UBS called Nasdaq’s proposal “inadequate and insufficient,” and said in a statement the SEC’s approval of the plan does not change its opinion.

Citi had also asked the SEC to not approve Nasdaq’s plan, arguing in a letter that Nasdaq “was acting exclusively as a for-profit business, and not as a market regulator, when it made the grossly negligent business decisions that caused market participants hundreds of millions of dollars of losses.”

Knight, which in August had its own technical glitch that cost it $461 million and nearly bankrupted the company, said in a letter that month to the SEC it supported Nasdaq’s efforts but that the condition of having to waive the right to sue would “set a harmful precedent.”

Shares of Nasdaq, which has completed 50 IPOs since the Facebook IPO, were down 0.6 percent at $32.16 on Monday afternoon.