Exchanges Defend Liability Limits When Systems Malfunction
October 16, 2012
Exchange executives are playing defense.
At a recent industry conference, options executives defended rules granting themselves immunity from prosecution in the event problems with their trading systems cause their members or customers to lose money.
Their assertions follow criticism by brokers of exchange operator Nasdaq OMX Group, for claiming immunity from lawsuits stemming from its botched handling of Facebook’s initial public offering.
“Exchanges should have it,” Boris Ilyevsky, a managing director with the International Securities Exchange’s options exchange unit, said of the rules. “They are not set up as these gigantic organizations funded in such a way to withstand being put out of business in a single day because of a systems malfunction.” Ilyevsky was speaking at a conference in September sponsored by the Futures Industry Association and the Options Industry Council.
All of the exchanges have rules on their books limiting their liability in the event of systems problems. According to a recent Nasdaq filing, the SEC accepts “that it is consistent with the purposes of the [Securities Exchange Act of 1934] for a self-regulatory organization to limit its liability with respect to the use of such facilities by its members” through such rules.
“The notional values of those [options] contracts are in the billions and billions and billion of dollars,” Ed Provost, chief business development officer at the Chicago Board Options Exchange, said at the conference. “It’s just impractical to expect an exchange processor to be responsible for the financial repercussions of a product with that kind of value.”
Still, that’s just what some in the industry believe should happen—at least as far as one particular exchange is concerned.
“The law is clear,” Dan Keegan, global head of cash equities trading at Citigroup, told the Securities and Exchange Commission in a letter in August. “Nasdaq does not enjoy immunity from liability for its misdeeds where it was acting in its capacity as a profit-maximizing, publicly-held corporation.”
Keegan was referring to a 2007 case decided by the United States Court of Appeals for the Eleventh Circuit known as “Weissman v. NASD” that, he says, found that Nasdaq was “not entitled to immunity when it is engaging in ‘non-governmental activities that serve its private business interests.’”
Citi, in that letter to the SEC, called Nasdaq’s mishandling of the Facebook initial public offering “grossly negligent.” The big broker contends it should be “entitled to recover all of its losses attributable to Nasdaq’s gross negligence, not just a very small fraction as is currently the case.”
In its letter, Citi maintains the immunity from lawsuits that exchanges enjoy only extends to those times when the exchanges are acting in a regulatory capacity. It does not apply when they cause harm as a result of poor business decisions.
Citi’s Automated Trading Desk market making unit lost a reported $20 million due to the Facebook fiasco. UBS’ market making unit lost another $356 million. UBS has threatened to sue Nasdaq.
