Facebook Sued Over IPO Scandal With Morgan Stanley

Where’s the dislike button when you need it?  Facebook definitely needs it this week after a disastrous past five days.  Shares of Facebook ended at $38 on its first day of trading, exactly where they started.  So much for the usual IPO pop.  Then on Monday to start the week, shares were down 13% early in the trading day, followed by another sharp drop in share price yesterday.

Of course, none of that is nearly as significant as the bombshell story that Reuters journalist Alistair Barr dropped yesterday.  According to Barr, Morgan Stanley, the head underwriter for Facebook’s IPO, cut future revenue estimates for Facebook based on a tip from Facebook financial executives while the company was on its media tour in the days preceding its first trading day.  According to financial analysts, this type of revision so close to an IPO is very uncommon.

The big issue here, however, is that Morgan Stanley allegedly only disclosed their forecast to insiders, leaving retail investors holding the bucket, as financial people say.  According to the report, Morgan Stanley cut Facebook’s future revenue estimates before Facebook increased its initial share price from $34 to $38 per share, as well as increased the total number of shares available by 25%, all of which were done to meet retail investor demand.  Thus, Morgan Stanley allegedly pulled this move to tip insiders off to sell their shares on the first day of trading, knowing that they would be bought up by eager retail investors looking to invest in Facebook.

Selective disclosures are illegal based on the New Deal era 1934 Securities Act.  According to the above report, Morgan Stanley’s selective disclosure would violate Rule10b-5 of the 1934 law, which prohibits the use of any “device, scheme, or artifice to defraud”.  By simultaneously tipping off insiders to sell their shares while pumping up retail investor demand for Facebook, Morgan Stanley would likely be found in violation of the law.

And the bad news for Facebook and Morgan Stanley is far from over.  Today, Facebook shareholders filed a class action lawsuit against both companies for the above grievances.  The law firm leading the suit is Robbins Geller, which happens to be the same firm that successfully won a $7 billion judgment against Enron several years back.  The suit claims that financial information in Facebook’s May 9th disclosure “were untrue statements of material fact”, citing two news reports, including the Reuters report linked above.

Class action lawsuits against public companies rarely are successful, but perhaps this instance will be more positive for Facebook shareholders already looking at losses of 16% from the initial $38 price in just the 4th day of trading.

But hey, it actually could be worse.  Shares of Facebook actually went up today, finishing the day at exactly $32 per share, a gain of 3.23% from the opening price.