Watchdogs Warn Off Facebook Flash Crashers

NEW YORK ( TheStreet) -- Facebook's initial public offering is trading bait that regulators are warning Wall Street not to manipulate in a way that could jeopardize the high-profile deal.

Traders on Facebook's exchange-of-choice -- Nasdaq OMX ( NDAQ) -- received an email Wednesday warning that any unusual activity in an IPO would violate Nasdaq rules and federal securities laws.

" Members are reminded that they must comply with all applicable regulations, including FINRA 5131 and prohibitions against manipulative trading behavior," according to the email alert from Nasdaq.

FINRA 5131 is a rule that prohibits traders from an assortment of shady practices, including investment banks "spinning" underpriced IPO shares to clients in return for business or traders flooding an IPO with underpriced market orders that could force a halt on trading.

Nasdaq also announced in the email that it plans to continue several "IPO testing" programs on Wednesday in order to make sure computer systems could handle different stress scenarios for an IPO. The exchange said it would send out quotes on a placeholder security with the ticker symbol "ZWZZT" at 12:45 p.m. Thursday.

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Regulatory paranoia is at a peak as Facebook prepares to launch its multi-billion dollar IPO Friday and exchange professionals are making sure the IPO goes off without a hitch.

"It's not clear what the market reaction will be and nobody wants another BATS IPO fiasco," said James Angle, a professor at Georgetown's McDonough School of Business. "There will be a lot of attention to the opening."

Trading glitches at the high-speed electronic exchange on March 23 forced BATS to withdraw its much-anticipated IPO. The same glitch also caused a brief, but dramatic, drop in Apple ( APPL) shares.

Angle added that while a complete failure of the Facebook IPO on a BATS level is unlikely, there are numerous other ways the stock can face problems, especially given the pre-trading interest in the stock.

"What if volume collapses the system or if the single-stock circuit breakers kicks in? Nobody knows how many will be lined up to buy the shares," Angle said. "As with any IPO the first couple minutes is a wild ride as everybody tries to find right price."

Facebook will not face the main enemy of an IPO -- liquidity -- because of the huge amount of investor interest. But the rush to buy shares in the aftermarket could also cause significant issues, said Jamie Selway, managing director of broker ITG.

"In terms of stability, I don't think it's much of concern. There is a lot of liquidity there," said Selway. "The main concern is stress testing the system from a buying perspective. They will likely have more orders on the cross in the opening trade than they ever had before."

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Despite the size of the Facebook offering diluting high frequency and algorithmic trading firms from hurting the IPO, and regulators keeping a close watch, that doesn't mean some won't try, added Eric Scott Hunsader of market software consulting firm Nanex.

" Nasdaq will tell everybody to behave and I don't think the price will get hurt, but there are really no controls," Hunsader said. "We'll see. The market's been boring, and this is something new."

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