Facebook Inc. chief executive officer Mark Zuckerberg, and several banks led by Morgan Stanley were sued by shareholders, who claimed the defendants hid the social networking leader’s weakened growth forecasts ahead of its $16-billion initial public offering.
The defendants were accused of concealing from investors during the IPO marketing process “a severe and pronounced reduction” in Facebook revenue growth forecasts, resulting from increased use of its app or website through mobile devices.
The lawsuit was filed in U.S. District Court in Manhattan on Wednesday, according to a law firm for the plaintiffs. A day earlier, a similar lawsuit by a different investor was filed in a California state court, according to a law firm involved in that case.
The New York lawsuit was brought on behalf of Dennis Palkon and Brian Roffe, who said they respectively bought 1,800 and 200 Facebook shares at the IPO price, and Jacob Salzmann, who said he paid more than $123,000 on May 18 for 2,961 shares at an average $41.77 each.
In the New York case, shareholders said research analysts at several underwriters had lowered their business forecasts for Facebook during the IPO process, but that these changes were “selectively disclosed by defendants to certain preferred investors” rather than to the public generally.
“The value of Facebook common stock has declined substantially and plaintiffs and the class have sustained damages as a result,” the complaint said.
Bank of America and Barclays Plc are also defendants in the New York case. Other defendants include Facebook Chief Financial Officer David Ebersman and several directors.
On Wednesday a Democratic aide to the Senate Banking Committee told The Associated Press the panel wants to learn more about the initial public offering. The committee seeks briefings with representatives of Facebook, regulatory agencies and others. The aide spoke on condition of anonymity because the committee's planned inquiry hasn't been publicly announced.
Facebook had urged analysts working for some of the 33 underwriters to lower their revenue 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 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.
Representatives of Facebook and Morgan Stanley did not immediately respond to requests for comment.
Facebook shares fell 18.4 percent from their $38 IPO price in the first three days of trading, reducing the value of stock sold in the IPO by more than $2.9 billion.
The issue of selective disclosure drew the attention of the main regulator of U.S. 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.
Andrew Noyes, a Facebook spokesman, said: “We believe the lawsuit is without merit and will defend ourselves vigorously.”
“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.”
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.
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 Mr. Pritchard added that there is a big exception to these so-called “gun-jumping rules” for oral communications.
"The SEC has since the 1990s broadly condemned the trickling out of material non-public information, which would include that savvy, well-paid analysts are lowering estimates,” said Elizabeth Nowicki, an associate professor at Tulane University Law School and a former SEC lawyer.
Syndicate banks “are on the hook in terms of liability by not making accurate, complete disclosure,” she added. “Selective disclosure of analyst outlook changes is not acceptable.”
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.
“It’s dreadful for the markets,” former SEC Chairman Arthur Levitt said of the IPO and its handling by banks and Nasdaq. “It’s an event with long-lasting negative implications for an industry that can ill afford this kind of blemish, and the last chapter hasn’t been written. Nobody looks good here.”
With a file from The Associated Press