June 29, 2012 / By JENNY STRASBURG And JACOB BUNGE/ WSJ
Nasdaq OMX Group Inc. NDAQ +1.11% may be forced by securities regulators to upgrade its trading systems in the wake of last month's glitch-ridden stock sale by Facebook Inc. FB -2.70%
The Securities and Exchange Commission is investigating what caused the mishaps that plagued the Nasdaq Stock Market during Facebook shares' debut on May 18 and the effects on brokers and investors who lost money.
As part of the deepening inquiry, regulators are weighing demanding that Nasdaq agree to revamp its processes for developing, changing, testing and implementing the computer code used in initial public offerings and other exchange functions, according to people familiar with the investigation. The SEC hasn't decided yet whether to take any enforcement action against the company.
A regulatory request to improve its systems would be a rebuke for Nasdaq, a company that has long cultivated an image as a leader in exchange technology. It also could add to the exchange's costs.
The SEC review comes as the exchange group prepares to submit to the SEC its plan, expected next week, for compensating brokers who claim losses on trades it failed to execute properly, and helps keep the spotlight trained on Nasdaq's performance during one of the most hotly anticipated IPOs in years and on its chief executive, Robert Greifeld.
Nasdaq's emergence as an all-electronic trading forum helped transform the exchange industry, and its reputation for cutting-edge systems has attracted the stock listings of generations of Silicon Valley's best-known technology companies. Facebook was supposed to burnish that reputation.
Nasdaq said this month that it had hired International Business Machines Corp. IBM -0.83% to review its technology systems. The exchange group's executives are also reviewing its management structure, focusing on the operations and technology areas overseen by Anna Ewing, said people familiar with discussions inside Nasdaq. Some executives said her responsibilities, which include overseeing Nasdaq's own trading technology as well as products it sells to brokers, would be too broad for any manager.
Nasdaq's board, which includes Mr. Greifeld, first discussed potential ways to restructure its operations and technology unit, including possibly replacing Ms. Ewing as the supervisor over both areas, more than four weeks ago, said one person with direct knowledge of the discussions.
Ms. Ewing declined to comment. She was made vice president over operations and technology in 2005.
Nasdaq officials intend to discuss their plans, including any management and personnel moves, with the SEC within the next few weeks, two people with knowledge of the matter said.
Mr. Greifeld said in a June 6 interview that the Facebook offering forced Nasdaq to grapple with complex questions about how its pre-IPO testing had failed. Asked whether any Nasdaq executives would lose their jobs, he said the company was "not ruling out any actions."
In a speech just last weekend, Mr. Greifeld said exchange executives placed too much credence on assurances from its technology group. He didn't name Ms. Ewing. "We did not have enough business judgment in the process," he said.
Confidence in Nasdaq's handling of the Facebook IPO began to unravel even before the social-networking company's shares opened, as the exchange group's systems stumbled into an automated loop as it lined up orders, delaying the opening of trading by half an hour.
After trading started, Nasdaq failed to send order confirmations to brokers for almost three hours, leaving investors big and small in the dark about the size and value of their positions.
As the industry's primary regulator, the SEC has the power to order licensed exchanges to address shortcomings to their systems and internal controls. In October 2011, the agency sanctioned electronic stock-exchange operator Direct Edge Holdings LLC for mistakes it blamed for millions of dollars in trading losses.
The SEC said Direct Edge had violated transaction rules and its own guidelines when it fixed erroneous trades stemming from its "untested computer code." The firm had also improperly intervened in its trading systems, the SEC said.
Direct Edge said it planned "significant" investments in technology and staff.
On Wednesday, a senior SEC official said the agency was studying whether high-profile trading mishaps attributed to "glitches" could in fact be traced to failures by exchange or trading-firm programmers to design systems robust enough to handle a flood of orders or other unusual scenario.
"A trading problem may indeed be technological, but that does not mean it is merely technical," Daniel Hawke, head of the SEC's market-abuse unit, said during a speech.
Retaining IBM to review Nasdaq's practices and then beefing up its technology could double the exchange company's spending on system maintenance and upgrades over the next few quarters, according to Matthew Heinz, analyst for Stifel Nicolaus & Co. He estimated Nasdaq now spends about $10 million a quarter on technology upkeep.
Nasdaq has not set limits on how much it might spend to revamp its technology, said a person with direct knowledge of discussions.
Mr. Greifeld is known as a cost-cutter who has argued against big travel budgets and fought replacing worn-out office furniture, say people who've worked with him. But he has at times shown a willingness to invest, driving Nasdaq's 2008 acquisition of Nordic exchange group OMX.
In April, Mr. Greifeld outlined plans to cut an additional $50 million in costs this year.
"If volumes continue to be weak, we will continue to focus on the things that we can control, most importantly costs," Mr. Greifeld told analysts.