The review of potential technical violations is part of the Securities and Exchange Commission's broader look at how Nasdaq handled its part of the initial public offering, including its decision to proceed with trading despite glitches, these people said. The SEC is also reviewing Nasdaq's communications with market participants, one of those people added.
While the violation of technical exchange rules may be minor compared to larger issues surrounding the IPO, the SEC can sometimes more easily bring enforcement cases against exchanges by using technical rule violations as a hook.
"There are probably numerous rule violations that occurred,” said one of the people familiar with the matter.
A spokeswoman for Nasdaq, part of Nasdaq OMX Group Inc
Federal securities laws require the rules governing exchanges to be transparent and disclosed to the public. A violation can occur if an exchange decides to change it rules or act contrary to its rules without first seeking approval from the SEC.
The SEC has been looking into what happened on May 18 as Nasdaq grappled with problems over Facebook's initial public trading. In an addition to a 30-minute delay in the market debut, there was a 2-1/2 hour period in which many brokers were in the dark about whether their orders translated into trades.
The problems with the Facebook launch, the biggest ever in terms of volume, has been an embarrassment for Nasdaq, which is now facing lawsuits from brokerages that suffered losses that they claim stem from the exchange's technology woes. Four of Wall Street's major market makers expect their losses to be around $115 million. [ID:nL1E8GPGJ9]
Nasdaq has previously said it thought it had fixed all of its problems before proceeding with the IPO.
The decision by Nasdaq not to halt or cancel the market debut, despite its systems problems, is at the center of the SEC's review, these people said.
The agency is also reviewing Nasdaq's problems with its opening cross, or Facebook's first public price; the extent of which it knew about the technology problems; and how it communicated with market participants.
The SEC is not yet done reviewing the matter, and has not made any conclusions about whether there was wrongdoing.
However, there are some similarities emerging between what happened at Nasdaq and what happened with its exchange competitor Direct Edge, which was sanctioned by the SEC in October for rule violations associated with a systems outage.
Like with Nasdaq, a computer code glitch at Direct Edge ultimately led to trading errors and millions of dollars in losses.
To deal with the losses, Direct Edge's affiliated brokerage traded out of the error positions on its customers behalf through its so-called "error account," which the exchange uses to rectify problems.
That action was not allowed by the exchange's rules, and the exchange never sought the SEC's permission.
As a result of the Direct Edge case, exchanges and the SEC have worked together to develop rules that govern how such error accounts can be used.
With Nasdaq, the exchange also resorted to using its error account to trade out of error positions through a third-party broker. There may be a legal distinction between Nasdaq's attempt to fix the error that led to unmatched positions, and Direct Edge's decision to assume positions of customers.
Although Nasdaq filed a rule change with the SEC on May 10 to allow for such an action, the rule has still not been approved.
In addition, the SEC is also likely to look and see if the exchange complied with other technical rules, such as those governing its opening cross, one person said.
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