The Underwriters Weren't The Only Ones Stabilizing Facebook When It Opened

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There is much to ponder about Nasdaq's slow-moving plans to compensate the people it screwed by taking its time confirming trades on the day Facebook opened.* Here's a fun thing I didn't quite understand, from Reuters:

Nasdaq's liabilities for a trading glitch are limited through regulation and a contract with its customers to $3 million per month. The exchange has applied to the SEC to increase the amount to $13.7 million to include a gain of $10.7 million it made from the Facebook IPO through the sale of so-called "phantom shares" it was left holding in the IPO.

So, that's kind of odd? Somehow Nasdaq got fake shares worth $10.7mm, and when it realized it had these fake shares, it was like "huh, interesting, we don't really need these" and sold them to investors and will put the money toward compensation? That seems ... unlikely. For context here is May 18; the blank spot on the left is where Nasdaq was embarrassing itself:

The New York Post has perhaps a more comprehensible explanation combined, of course, with a whiff of scandal:

Sources tell The Post that the Securities and Exchange Commission is probing to see how the exchange operator run by CEO Bob Greifeld made a $10.7 million profit while trading off the social media company’s shares.

Nasdaq bought and sold so-called “orphaned” shares during the early period of trading in order to facilitate trading of the stock as technical glitches created a logjam in the early frenzied moments of trading on May 18.

Good probe, SEC! Let's try to do a really quick and dirty reconstruction here. This all imaginary but my imagination goes like this:
(1) At and around the open, with the stock at around $42, there were more buyers than sellers.
(2) "More buyers than sellers" is mostly a punch line,** since prices clear markets, but they don't clear markets in the special case when the market operator gets wrong how many buyers and sellers there were. So there were actually more buyers than sellers in the sense that sellers thought they sold X shares and buyers thought they bought X + Y shares, Y > 0.
(3) So who sold the Y shares?
(4) Nasdaq, I guess?
(5) Where did it get these shares?
(6) From its imagination, I guess? It didn't own any shares, and probably didn't have a locate to borrow them, making this a naked short. So good work looking into that SEC. (Actually the Post thinks that the SEC thinks that the problem was front-running, which, maybe also!)
(7) When it realized it had just imagined up some shares, Nasdaq ... bought them back?
(8) At, let's say, less than $42, since the stock never really retook its 11:30am heights.
(9) Round numbers if it did its selling at $42 and its buying at $38, its $10.7mm profit was around Y = 2.7mm shares, or a little over two-thirds of one percent of the float; this is more or less a minimum since the stock rarely went above $42 and was mostly well above $38.

I don't know; I'm open to better explanations of this, so if you have one let the class know. But if this is right, it suggests that, just as Facebook's underwriters were short 60-odd million shares and bought in that short to prop up the price on its opening day, Facebook's exchange also got more or less accidentally short 3-ish million shares or so, and bought in that short too. Which probably had the effect of stabilizing trading, providing liquidity to buyers to tamp down the initial pop, and then providing liquidity to sellers to prop up the later decline.

But not enough to keep the stock up - and, just like the underwriters, Facebook's exchange profited nicely on the stock's dive. Unlike the underwriters, though, Nasdaq was at risk on its short: the underwriters had the greenshoe option to buy any shares they sold back from the company at $38; Nasdaq, which seems to have sold its shares by accident, had no such option. If the numbers above are right - and they're not! - then a Facebook pop to, say, $50 would have left the underwriters unharmed but lost Nasdaq $20-30mm or so. Good thing for Nasdaq that it traded like crap.

Nasdaq Weighs Fee Discount as Facebook Compensation [WSJ]
Nasdaq to Make Facebook Compensation Announcement [Reuters]
Feds probing Nasdaq’s $10.7M FB profit [NYP]

* For instance, from the Journal:

Nasdaq OMX's plan to pay back brokers has been slowed by thorny regulatory questions centered on exchanges' ability to compensate customers who lose money as a result of faulty technology, according to people familiar with the matter.

The questions have also raised concerns among rival stock-exchange operators, including NYSE Euronext NYX and BATS Global Markets, wary of any regulatory precedent that could be set by Nasdaq in the matter and further steps Nasdaq may take to repair relations with some of its biggest customers, according to people familiar with the matter.

I bet! As someone who used to sell tax-and-securities-law-sensitive products, I found this tidbit strangely wonderful. Like, if you're, say, Nasdaq, or NYSE, you are often not entirely broken up to be able to say to clients "Yes, we would love to give you your money back, but you see, it's illegal. Strange, right? It's very complicated, 'thorny' even, but there it is. Sorry!" But it's somewhat unusual for (1) Nasdaq to say "y'know what, it may be illegal to give you your money back, but we're doing it anyway!" and (2) Nasdaq's competitors to say "no, no, Nasdaq, please, keep your money." I don't know, just sort of fun and awkward. Anyway.

** In the form:

CEO: Why is our stock going down?
Banker: More buyers than sellers?

Oh how we'd laugh.

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