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BATS exchange withdraws IPO after stumbles

By Olivia Oran, Jonathan Spicer, Chuck Mikolajczak and Carrick Mollenkamp

NEW YORK (Reuters) - In a breakdown that resembled a mini version of the 2010 "flash crash," a series of glitches hit the market debut of BATS Global Markets Inc on Friday, causing the company to take the extremely rare step of withdrawing its initial public offering of shares.

The problems caused the shares of exchange operator BATS to plunge from their $16 offering price and briefly trade for less than a penny on Friday morning, creating havoc in the marketplace and again calling into question the stability of high-speed trading.

The glitches, which also prompted a halt in trading of Apple Inc shares, were so severe and so visible, involving BATS' own listing, that some observers said they threatened confidence in the nation's third-largest exchange.

This was the first IPO on the BATS exchange.

"I think some companies might say ‘If they can't handle the IPO of their own stock, how can they handle the IPO of our stock?'," said Dennis Dick, a Detroit-based market structure consultant and trading member at Bright Trading LLC. "There is going to be a confidence issue of listing on BATS."

BATS, an acronym for "Better Alternative Trading System," suspended trading in BATS shares and alerted investors to "system issues" around mid-morning in New York. The exchange, a rival to the New York Stock Exchange and Nasdaq that is based in Kansas City, Mo., later said the problems had been resolved and BATS shares would resume trading at noon.

Late in the day, BATS said trading would not resume, and later said it had decided to unwind its share offering.

Eight hours after the problem started the company blamed a "software bug" for setting off the series of glitches.

"In the wake of today's technical issues, which affected the trading of certain stocks, including that of BATS, we believe withdrawing the IPO is the appropriate action to take for our company and our shareholders," said Joe Ratterman, chief executive officer of BATS Global Markets.

The debacle raised questions for regulators, investors and the underwriters, including Citigroup Inc, Morgan Stanley and Credit Suisse Group, which were listed before the IPO as major shareholders.

Several former or current Credit Suisse bankers serve on BATS' board, according to a BATS regulatory filing. Big shareholders that planned to exit were Getco LLC, a high-frequency trading firm based in Chicago, and Lehman Brothers Holdings Inc.

Unwinding the IPO would mean that the banks and other owners would have to return to investors about $100 million that they gained by selling their stakes in BATS.

Also in play are millions of dollars in fees the banks would have received in fees for doing the underwriting. The episode also could open the door to lawsuits and put BATS' expansion plans on hold.

BATS made a big leap into the European market in December when it completed the $300 million takeover of rival Chi-X Europe. The two exchanges had about a quarter of European share trading on their systems at the time. BATS also was said to be looking for an acquisition in Brazil, as well as planning to create new platforms for other asset classes.

The one positive note about the trading problems was that BATS quickly caught the mistake and halted the problematic trading.

"The public should take comfort that circuit breakers are working as they should after the flash crash," said Holly Stark managing member of Efficient Frontiers, a market structure consulting firm in New York.

Since the May 2010 "flash crash" in which nearly $1 trillion in market value disappeared in minutes, the Securities and Exchange Commission under Chairman Mary Schapiro has pledged to crack down on problems in the high-speed electronic marketplace, which regulators worry has grown unstable and perhaps unfair as high-frequency trading has grown in prominence.

The BATS breakdown could trip up, once again, the march over the last decade toward increasingly automated markets in the United States, Europe and elsewhere.

It is expected to draw even more scrutiny from regulators looking into the soundness of the exchange's servers, trade-matching engines and computer codes, and it could land BATS in legal trouble for withdrawing its IPO after trades were executed in the public marketplace, according to experts.

The SEC regularly visits exchanges and has in the past few months requested detailed information on how orders are routed and executed, according to sources with direct knowledge of the matter.

"As is our practice, SEC staff has been and will continue to be in discussions with BATS to determine the cause and extent of the incident and steps BATS is taking to remedy the situation," said John Nester, and SEC spokesman.

The software bug rendered opening orders for BATS stock inaccessible, the exchange said in a "post-mortem" late on Friday. Once it decided Friday afternoon to withdraw the IPO, the original trade in BATS stock was "torn down." BATS then broke other trades and let all affected parties know about the decision, BATS said.

There is precedent for canceling trades. After the 2010 flash crash, regulators and exchanges agreed to cancel the 20,000 trades that were executed more than 60 percent away from the pre-crash prices of those stocks. The trades were deemed "clearly erroneous," canceling out some big losses - and big profits - for many traders that day.

But BATS' explanation of how it handled the situation came late for those who had agreed to buy shares in the IPO. As BATS officials worked to fix the system breakdown, no one from the exchange publicly explained what had gone wrong. This left institutional investors nervous about their agreement to buy shares, according to people close to the situation.

Increased discomfort among those buyers could have played a role in the decision to cancel the IPO, the sources said.

Founded in 2005, the BATS exchange has captured about 11 percent of U.S. equity market volume and 3 percent of equity options volume and is now the third-largest platform in the U.S., after the NYSE Euronext and Nasdaq OMX .

BATS, headed by 45-year-old Ratterman, was formed by major banks and trading firms looking to break the stranglehold that the NYSE and Nasdaq had on U.S. stock trading, forcing the traditional venues to modernize their technology.

It was started with 13 employees by David Cummings, a computer and electrical engineering graduate of Purdue University. Cummings is the chairman of Tradebot Systems, an electronic trading firm that he founded in a spare bedroom with a $10,000 investment. The growth of Tradebot and BATS had established the Kansas City area as a hotbed for trading technology companies. In 2006, Mr. Cummings told a local Kansas City business newspaper, "Make no mistake, our long-term plan is to be one of the three largest equity markets in the United States."

Friday's market debut would have marked a major next step in the company's evolution.

But the day began badly, when the Wall Street Journal led its front page with a story saying BATS was part of a probe by the SEC into high-frequency trading. Although the investigation had been known for months, the story did little to allay concerns about the BATS exchange.

Then the spectacular trading glitch sparked fears and set tongues wagging on Wall Street.

"The one thing they should have guarded against is the integrity of their platform on the day they went public," said Francis Gaskins, president of IPO research site IPOdesktop.com, in Los Angeles.

As trading began on Friday, BATS stock dipped to $15.25. Then extreme turbulence hit. A slew of bad trades at less than a penny sent the stock plunging. Though the trades were later voided, the plunge unnerved investors.

Around the same time, three Apple trades also went through on the BATS exchange, triggering a circuit breaker that temporarily halted trading of Apple. Those trades ultimately were canceled.

BATS said its installation of software for its IPO triggered a bug just after 10:45 a.m. eastern time that affected all stocks whose ticker symbols began with letters A to BFZZZ—including BATS' own stock. It tried to remove all quotes in the affected stocks but three trades for Apple were executed. By 12:34 pm, the Apple trades were canceled.

By noon, the exchange notified its members that all symbols would be available for trading except for its own shares.

The omission of its own shares was probably the most embarrassing and costly problem for BATS, and ultimately led to its pulling of the IPO, said Larry Tabb, founder of Tabb Group, a markets consulting firm.

"They pulled the IPO because their own symbol was affected," Tabb said. "They couldn't get it to work and it just degraded confidence in their marketplace."

A spokeswoman for the company said she had no immediate explanation for the decision to pull the IPO.

Spokespersons for the IPO underwriters either declined to comment or were not available for comment.

Market participants lost little time criticizing the exchange, and the event lit up the Twittersphere.

"It's just another black eye for the fragmented equity structure," said Joe Saluzzi, co-head of equity trading at Themis Trading in Chatham, New Jersey, and a frequent critic of U.S. equities market structure. "Every day we see things like flash crashes and now IPOs that can't get off the ground." On StockTwits.com, a stock-related Twitter site, commentators took aim at the company. "Man are those investors who participated in the IPO breathing a sigh of relief right now," wrote one.

The glitch on the first day did little to encourage investors. "The last thing you want to do as a listing exchange is mess up your introduction to the public investment world - the IPO," said Jason Weisberg, managing director at Seaport Securities Corp.

(Reporting by Olivia Oran, Carrick Mollenkamp, Charles Mikolajczak, Jed Horowitz, Jonathan Spicer, Jessica Toonkel and John McCrank.; Editing by Alwyn Scott, David Gaffen, Dan Grebler, Leslie Adler and Carol Bishopric)

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