23 May 2012

Facebook investors sue banks over share flotation

Facebook frenzy turns to fury amid claims banking giants Morgan Stanley, JPMorgan and others tipped off a select number of investors about an analyst’s negative report days before shares traded.

While Morgan Stanley, the lead underwriter on the flotation, says it used the same, legal procedure for Facebook that it uses for all initial public share offerings (IPOs), the US Securities and Exchange Commission said it would examine “issues” regarding Faceook’s $16bn IPO and plummeting share price – an 18.5 per cent drop by the end of Tuesday’s trading.

“It will all come out in the wash because people are going to get sued,” said Jonathan Merriman, chief executive at Merriman Holdings Inc.

In fact, shareholders filed suit in Manhatton on Wednesday against Facebook CEO Mark Zuckerberg and banking giants Morgan Stanley, Goldman Sachs, JPMorgan, Barclays, Bank of America and Facebook’s top executives, Bloomberg reported. Shareholders claim they were misled about growth forecasts, while Facebook and Morgan Stanley deny any wrongdoing. Barclays UK was not immediately able to comment when contacted by Channel 4 News.

“We believe the lawsuit is without merit and will defend ourselves vigorously,” Andrew Noyes, a spokesman for Facebook, said.

Much of the furore centres around whether a select number of investors were called ahead of trading, and whether retail investors – individuals who buy stock for themselves – were buying Facebook at $45 a share, while large institutional investors knew the shares could be overvalued even at the starting price of $38.

“This whole idea of unequal dissemination of information, the institutions heard some chatter the numbers are coming down – obviously retail is not getting that call – so this whole thing just kills the whole idea of the equality of this system and it goes right to the heart of this and I’m sure that’s what the Financial Industry Regulatory Authority (FIRA) and the Securities and Exchange Commission (SEC) are going after,” Mr Merriman said.

Investors de-friend Facebook

FIRA said questions around Facebook are “a matter of regulatory concern” for FIRA and the SEC. Massachusetts’ Secretary of Commonwealth William Galvin issued a subpoena on Tuesday tied to what Morgan Stanley, the lead underwriter, may have been saying to its clients ahead of the IPO.

“Facebook shares will drift lower from here,” predicted Michael Pachter, an analyst at Wedbush Securities, adding “$16bn of shares in one company was too much for the market to absorb on one day.”

Facebook updates its status

The problems began in earnest on 9 May when Facebook updated its prospectus to highlight concerns about users accessing Facebook on mobile phones and how that affects advertising revenue outlook.

Through Morgan Stanley, Facebook informed the SEC of the update and sent a copy to all of the bank’s investors.”The amendment was widely publicised in the press at the time,” Morgan Stanley spokesman Pen Pendleton said in an e-mailed statement. The bank denies any wrongdoing or illegal behaviour.

“A significant number of research analysts in the syndicate who were participating in investor education reduced their earnings views to reflect their estimate of the impact of the new information,” Morgan Stanley continued. “These revised views were taken into account in the pricing of the IPO.”

Facebook IPO frenzy turns to fury amid allegations US banking giant Morgan Stanley tipped a select number of large investors about an analyst's negative report days before shares started trading.

How NASDAQ fits into the timeline

To complicate matters, there were technical problems at tje NASDAQ exchange, delaying the start of Facebook trading on 18 May. The system failed again later in the day when it stopped taking cancellations or orders, leaving many Facebook investors with no idea what positions they held in the midst of confusion around pricing.

But was Facebook overpriced from the start? Facebook and Morgan Stanley raised the number of shares they were selling by 25 per cent days before the IPO to 421m and upped the price from $34 to $38 – the top of the range. Shares closed Tuesday in the US at $31.

Some analysts said that with Facebook’s valuation at 100 times earnings and 26 times revenue there wasn’t much room for the share price to go up. In comparison, a small, private company might be valued at 12-15 times its earnings.

SEC sends Facebook a message

The usual first day spike in share prices didn’t materialise by the end of the trading day on 18 May and Facebook closed near the price as it opened, $38, which may have been helped by Morgan Stanley buying back shares to maintain this price, Reuters said citing unnamed sources. None-the-less, the price began spiralling downward on Monday.

“There are issues we need to look at specifically with regard to Facebook,” SEC Chairwoman Mary Schapiro told reporters in Washington, adding the SEC will review the trading.

Phillip Goldberg, a Maryland investor, sued Nasdaq on Tuesday claiming the exchange mishandled Facebook trading, failing to cancel orders when requested by customers.

Nasdaq Chief Executive Officer Robert Greifeld has said the opening delay “had no apparent impact on the stock price.”