May 17 (Bloomberg) -- Facebook Inc.’s initial public offering will be the biggest test of a rule introduced in 2011 to protect investors and curb volatility on the first day a company trades.
The Financial Industry Regulatory Authority reminded more than 4,400 member firms on May 15 that they shouldn’t accept buy requests known as market orders until trading begins. Such transactions are authorizations to purchase at the best available price, as opposed to limit orders that require investors to specify a minimum or maximum.
Facebook plans to sell shares tonight in a deal that may value the firm at as much as $104.2 billion, the most ever for an IPO. Finra’s notice about market orders follows malfunctions that disrupted the debuts of Bats Global Markets Inc. in March and Splunk Inc. in April, and comes as Facebook’s listing venue, Nasdaq Stock Market, conducts tests of its computers and customers’ systems before the IPO auction.
“Since the visibility and the size of the float is so significantly larger than Bats and Splunk, there probably won’t be an issue as size and demand will help neutralize any distribution and market-making problems,” Larry Tabb, chief executive officer of Tabb Group LLC, said in an e-mail. “While the chance of a problem is very small, if there is a problem it will have huge ramifications, not just reflecting poorly on Nasdaq but on U.S. exchanges, the U.S. capital formation process and basically the functioning of the U.S. markets.”
The Finra rule follows curbs and new trading requirements implemented by exchanges and regulators after the so-called flash crash on May 6, 2010, when the Dow Jones Industrial Average plunged 9.2 percent before recovering. In addition to introducing circuit breakers, which pause trading in stocks and exchanged-traded funds when prices move 10 percent in five minutes, market makers must quote within a certain price range. New rules were also implemented to guide exchanges’ decisions about when to void errant transactions.
Facebook, which is offering 421.2 million shares, may see trading volume of about 1 billion tomorrow, based on first-day activity at companies such as Google Inc., LinkedIn Corp., Zynga Inc. and Yelp Inc., Tabb said. U.S. equities traded a daily average of 6.77 billion shares this year through yesterday, according to data compiled by Bloomberg.
The Finra ban on market orders before trading begins was instituted because shares are more volatile when there’s no “established public trading history,” the organization said.
The prohibition went into effect in September, two months after Zillow Inc.’s debut, in which the company ranged between $32.50 and $60 on its first day. Underwriters for the Seattle- based provider of real-estate data sold stock for $20 on July 19. The next day, it opened at $60, dropped to $50 within six seconds, and ended at $35.77, according to data compiled by Bloomberg.
“Given the absence of an established trading market, the potential exists for a wide variance between the public offering price of a new issue and the price at which trading on the secondary market commences,” Finra said on May 15. “As a result, investors who place market orders for an IPO may find their orders filled at prices beyond their reasonable expectations, and such transactions may further contribute to the unconstrained increase in the price of a new issue in the secondary market.”