Two top US financial regulators said on Tuesday the issues around the initial public offering of Facebook should be reviewed, putting fresh pressure on the company, its lead underwriter, Morgan Stanley, and the Nasdaq stock exchange.
Facebook shares closed 8.9 per cent lower at US$31, following an 11 per cent plunge on Monday. At that price the company has shed more than US$19 billion in market capitalisation from its US$38-per-share offering price last week.
Reuters reported late Monday that the consumer Internet analyst at lead underwriter Morgan Stanley cut his revenue forecasts for Facebook in the days before the offering, information that was not disclosed to the market before the stock was listed.
Facebook itself had urged analysts working for some of the 33 underwriters to lower their estimates ahead of the IPO, according to four sources with direct knowledge of the conversations that were held during the week prior to the IPO.
“Facebook changed the numbers. They didn’t forecast their business right and they changed their numbers and told analysts,” said another source at one of the underwriters with knowledge of the situation
The company had issued a revised prospectus on May 9 in which it cautioned about the possible negative impact of Facebook users shifting to mobile platforms, but the vague language fell well short of an explicit warning of lower revenues or earnings. Facebook has yet to make much revenue from mobile advertising.
The disclosure of lower forecasts to certain big institutional investors left both Facebook and Morgan Stanley open to accusations of selective disclosure. Many smaller investors who bought Facebook shares in the IPO were left in the dark.
A Facebook spokesman declined to comment.
“Morgan Stanley followed the same procedures for the Facebook offering that it follows for all IPOs,” Morgan Stanley spokesman Pen Pendleton said in a statement. “These procedures are in compliance with all applicable regulations.”
JPMorgan Chase and Goldman Sachs, which were also lead underwriters on the deal, and another underwriter, Bank of America Merrill Lynch, also all revised their estimates during Facebook’s IPO roadshow, according to sources familiar with the situation.
The new estimates showed reductions in revenue and earnings projections for both the second quarter of 2012 and the full year, according to detailed figures reviewed by Reuters.
The issue of selective disclosure drew the attention of the main regulator of US brokerages.
“That’s a matter of regulatory concern to us and I’m sure to the SEC,” said Richard Ketchum, the Financial Industry Regulatory Authority’s chairman and chief executive. “And without saying whether it’s us or the SEC, we will collectively be focusing on it.
Securities and Exchange Commission Chairman Mary Schapiro said investors should be confident in investing, but she conceded there were questions to answer as well.
“I think there is a lot of reason to have confidence in our markets and in the integrity of how they operate, but there are issues that we need to look at specifically with respect to Facebook,” she told reporters as she exited a Senate Banking Committee hearing.
The state of Massachusetts also said it would examine the issues. Secretary of Commonwealth William Galvin issued a subpoena to Morgan Stanley in connection with its analyst’s discussions with investors about Facebook.
A Los Angeles law firm filed a lawsuit seeking class action status against Facebook and its underwriters alleging inadequate disclosure of key information.
The legal issues surrounding the disclosure obligations of a pre-public company and its underwriters are murky, securities lawyers said. Public companies are subject to a rule known as Regulation Fair Disclosure, which requires that material information be disclosed to all investors at the same time.
But that rule would not apply to information that Facebook provided to its underwriters before it went public, according to securities law experts. Underwriters also may not have a legal obligation to disclose their proprietary research to all clients at the same time.
Adam Pritchard, a securities law professor at the University of Michigan and a former SEC enforcement attorney, said that in general, information disseminated pre-IPO cannot be inconsistent with what is provided in the prospectus. But Pritchard added that there is a big exception to these so-called “gun-jumping rules” for oral communications.
Facebook’s guidance to analysts, and the subsequent revised estimates communicated to some investors, were delivered in telephone calls and conference calls rather than emails or written reports, the sources said. The conversations took place shortly after Facebook filed its revised prospectus.
The legal subtleties, though, did little to ease the anger of some investors and brokers who say the Facebook IPO now stands as an ugly example of a system rigged against the little guy.
“Night and day the institutional clients get things that we don’t get,” said a Morgan Stanley Smith Barney adviser who works with retail clients. “It’s a huge issue for the entire industry.”