Facebook and its bankers are engulfed in complaints related to the initial public offering of the company’s stock. The IPO has been a disaster, with Facebook shares almost immediately collapsing below their original $38 offering price. (At the closing bell today, they were trading at $32.)
The mess got worse on Tuesday, when Reuters reported that analysts for Facebook’s underwriter banks apparently lowered their future-revenue estimates for Facebook, and told some investors—but not all. So as the smart money was warned off the offering, the dumb money was rushing into the deal.
That would seem bad enough, but some reports say that even as Facebook apparently was guiding down future-revenue estimates, the company and its underwriters were raising the price of the offering and adding extra shares. In fact, a bunch of inside investors (who may or may not have been privy to the negative forecast) decided to increase the number of shares they were willing to sell.
Regulators are investigating, and investors are filing lawsuits. But guess what? Even if Facebook and its bankers did everything they’re accused of doing, it’s likely that they didn’t break any laws, says Adam Pritchard, a professor of securities law at University of Michigan Law School and a former SEC attorney. “In terms of legal consequences, I would not see anything that would suggest they are vulnerable,” Pritchard says.
Here are some points to consider from Pritchard:
1. There’s a law called Regulation Fair Disclosure that requires public companies to disclose information to all investors at the same time. But there’s a catch: the law applies to public companies, Pritchard points out, and this stuff all happened before Facebook went public.
2. It’s true that a company preparing for an IPO is not supposed to give out information that differs from what’s in its official prospectus. But here again, there’s a catch: oral communications don’t count, Pritchard says. So as long as Facebook and its bankers shared bad news over the phone or in person, rather than via email and in writing, they’re off the hook. “If you reduce the information to writing, then that’s considered a prospectus, and prospectuses are tightly regulated during the waiting period before an IPO,” he says. “But oral offers are not prospectuses. So you have a lot more latitude with what you can say.”
3. A 2003 law prohibits research analysts at underwriting banks from participating in IPO roadshows or helping their colleagues in the underwriting department sell shares in IPOs. But those analysts, of course, must build financial models for new companies. So they are allowed to talk to the company. And they are allowed to tell investment clients about their projections, Pritchard says.
Even if the reports are true that analysts at Morgan Stanley, Goldman Sachs, and JPMorgan Chase lowered their numbers on Facebook and told some of their clients about it, that’s perfectly legal, Pritchard says, as long as the analysts did this on their own, rather than alongside the underwriters who were selling the deal. “Analysts can talk to investors and so can underwriters; they just can’t be in the same room at the same time,” he says.
4. What about Facebook’s role in all this? A report from Business Insider editor Henry Blodget (a former Wall Street analyst) said that the analysts were advised to lower their projections by “a Facebook executive who knew the business was weak.”
Even if that’s true, Pritchard says, there’s no problem, since company executives talk to analysts all the time. Also, even if these conversations took place, they happened before the IPO, when Facebook was still a private company.
5. And what about Facebook’s private investors, including two board members who decided last week to sell more shares than they’d originally planned? If they were privy to inside information about revenues looking weak, is that a problem? No, says Pritchard, because insider trading involves information that’s not public, but this information was shared with analysts, who shared it with clients.
(Both board members declined to comment yesterday.)
The only fallout, Pritchard says, could be that Morgan Stanley will suffer damage to its reputation for having botched a big IPO and priced the deal in such a way that shares immediately fell after the stock began trading. “Underwriters don’t like to sell offerings that fall below their IPO price. They like to give a little bonus to their institutional investors. So next time Morgan Stanley calls, they might not get a call back,” he says.
6. As for Facebook, it’s looking pretty good. They raised money at $38 per share, which was quite a coup.
Nevertheless, Michael Arrington, a securities lawyer turned blogger turned angel investor, suggests that Facebook is setting up its chief financial officer, David Ebersman, to take a fall for the problems.
Arrington points to a story in The Wall Street Journal that cites unnamed people “familiar with the matter.” The story puts responsibility on Ebersman and deflects it away from Facebook cofounder and CEO Mark Zuckerberg and COO Sheryl Sandberg, saying that Zuckerberg delegated the IPO to Ebersman, and that Sandberg recused herself from the IPO talks because she has a personal friendship with Michael Grimes, who oversaw the deal at Morgan Stanley.
7. Will any of this lead to more reforms of Wall Street like there were after the dotcom crash a decade ago? Probably not, Pritchard says. In fact, he says the only lesson anyone should take from the Facebook IPO is simply this: “The problem is small guys thinking they are going to get rich investing in IPOs. They’re not. They are going to get taken. They should stop investing in IPOs. They are bad investments. There is a lot of evidence showing that you’re better off putting your money into an index fund than into an IPO.”
Bottom line: Facebook and its bankers sold the stock for the best possible price, and if you’re one of the suckers, too bad. Chalk it up as an expensive lesson.
