[ by Larry Goldfarb ] An estimated 400 firms lost almost a billion dollars on the Facebook IPO due to technical issues associated with NASDAQ – which, when boiled down, confronted market makers with 3 very significant trade processing issues:

• A delay in Facebook's opening left trades involving millions of shares unconfirmed for hours;
• Traders were forced to guess their positions and place additional orders based on those estimates;
• Nasdaq delivered the results of the trading Friday afternoon or later; many firms were caught off guard and scrambled to reposition.

We've all heard or read about how much the four biggest market makers lost - UBS lost $350 million, Citigroup $20 million, Knight Capital Group $35 million, Citadel $35 million.  There are countless other market makers who incurred losses - some in the millions. Actions By Brokers, Investors Against Nasdaq. Last week, Nasdaq proposed a $40 million compensation plan involving cash payments and discounted trading fees, but several brokers saddled with losses due to Nasdaq's technology problems said the offer didn't go far enough.  Some, including Knight and UBS AG, are now considering filing lawsuits against the exchange. Two groups of individual investors have already filed class-action lawsuits against Nasdaq, seeking compensation for losses on Facebook trades, arguing that the exchange's technology shortcomings were "foreseeable" and that Nasdaq was negligent in its handling of the hugely anticipated IPO.

Note to Readers. You might find this related story that we posted to our site today, Friday: Greifeld, Nasdaq: Misplaced Defiance Against Member Firms.  It's also in Behind the News, and expresses our concern and disappointment at the rift that threatens the very foundations of the Nasdaq stock exchange - i.e., how do you operate an exchange without market makers?

'Public Utility'. According to John Coffee, a professor at Columbia University, "What you're talking about is essentially a failure of a public utility."  In order to sue a utility, the 'damaged' parties need to show negligence - i.e., Nasdaq failed to exercise a reasonable degree of care. Yet, the question of whether 'damaged' brokers can successfully recover losses from Nasdaq would also depend on how a court interprets Nasdaq's role in the Facebook IPO and aftermarket.  For example, should a court determine that Nasdaq was serving at the time as a quasi-governmental authority, then it would be more difficult for member firms to win and collect.  U.S. exchanges are designated as so-called self-regulatory organizations, or SROs, with power to supervise trading, halt stocks and enforce rules.

"Exchanges have limited immunity if they're performing a government function, but if they're performing a business function, they may be subject to lawsuits," said Howard Schiffman, a partner with Schulte Roth & Zabel and a former trial attorney for the SEC.  "The plaintiffs here will say that Nasdaq is acting as a for-profit business when it's executing trades, and the defendants will say this is part of their regulatory duties."

The issues for Nasdaq to consider in these potential suits are far from straightforward.  For example, as a business that is actively trying to encourage firms to list with or move their listings to the exchange, Nasdaq must be very careful not to alienate these brokers --  since the brokers hurt by Nasdaq are often the same ones that advise clients as to where they list.   [WSJ, 6/15/12]