UPDATE: Citadel Backs Nasdaq on Payback for Facebook IPO Losses

--Citadel urges approval of Nasdaq OMX plan to compensate Facebook IPO losses

--Citadel traded $3.8 billion worth of Facebook stock May 18, incurred losses

--Current Nasdaq OMX rules not designed for large-scale market problems, says Citadel

(Updates with additional comments from Citadel letter, further background.)

 
   By Jacob Bunge 
 

Citadel LLC urged U.S. regulators to approve a controversial plan by Nasdaq OMX Group Inc. (NDAQ) to make good on some losses sustained by trading firms in the stock market debut of Facebook Inc. (FB).

The $62 million proposal, which Nasdaq OMX retooled last month following outcry from brokers and rival exchanges, is "objective and fair," according to a letter submitted Tuesday by Citadel to the Securities and Exchange Commission.

Citadel, known for its hedge funds, ranks among the biggest handlers of stock and options orders flowing out of retail brokerage firms. Such wholesale market-makers, which trade on some individual investors' orders and pass others on to rival firms or exchanges, were among the hardest hit by the glitch-ridden debut of Facebook shares May 18.

On an average day, Citadel estimates that it accounts for about 10% of all trading in U.S. listed stocks, and more than 20% of the volume in domestic stock options.

Citadel lost $30 million to $35 million trading the newly minted shares, according to persons with knowledge of the transactions. Rival Knight Capital Group Inc. (KCG) disclosed that it lost $35.4 million, while banking group UBS AG (UBS) lost more than $350 million.

The Chicago-based firm's letter on the Nasdaq OMX compensation plan represents Citadel's first public comments on the Facebook IPO. A spokesman for Nasdaq OMX did not respond to a request for comment.

In the letter, Citadel estimated that the firm bought and sold more than $3.8 billion worth of Facebook shares in the process of executing its customers' orders for the hotly anticipated stock, and "incurred losses protecting retail investors from the problems caused by Nasdaq."

Those problems, according to Citadel, were "unprecedented" and current rules governing the exchange's liability for member firm losses driven by exchange system problems were not designed to address such large-scale market events. For that reason, according to Citadel, regulators should approve Nasdaq OMX's new plan.

The parameters Nasdaq OMX set out for paying back $62 million in losses--far from the total amount suffered by Wall Street firms--are "reasonable," according to Citadel. Oversight of the claims process by the Financial Industry Regulatory Authority is a positive, the firm told regulators.

Not all Nasdaq members agreed. Vandham Securities Corp., a broker-dealer and market maker, submitted a separate letter to the SEC Tuesday urging regulators to block the current plan's ceiling on making up losses and require Nasdaq OMX to reimburse its customers "in full."

Should regulators approve Nasdaq OMX's plan, firms like Citadel that suffered losses trading Facebook's shares on May 18 will face a choice. They can agree to accept a portion of the $62 million package, likely healing only a portion of their losses, and in return waive any legal claims on Nasdaq OMX.

Knight, one of the most vocal critics of Nasdaq's mishandling of the Facebook flotation, is expected to support the Nasdaq OMX plan, according to a person familiar with the firm's strategy.

Other participants may pursue legal action against Nasdaq OMX instead of accepting a slice of the payout. UBS, which accused Nasdaq OMX of "gross mishandling" of the Facebook debut, has said it will seek full compensation for its hundreds of millions of dollars in losses through legal channels.

Exchanges hold strong defenses against lawsuits aimed at recouping losses driven by faulty systems, their legal liability limited by their status as regulatory entities.

Citadel in its letter urged regulators to postpone any debate around the extent exchanges, now largely for-profit enterprises, should retain these legal protections, so that such discussions don't delay compensation flowing back to injured firms.

-Write to Jacob Bunge at [e-mail]

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