Regulators miss forest for the trees in Facebook IPO mess

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Investors angry about their losses on Facebook Inc. stock should be thrilled to know that the regulatory hammer is already falling on the Wall Street firms who helped take the company public.

Until, perhaps, they learn the details. Then they might wonder what, exactly, the regulators are thinking.

In this case, it is Massachusetts' top securities regulator, William Galvin, who extracted a settlement and $2-million fine from Citigroup for the alleged actions of two Internet analysts. Citigroup, one of the investment banks that took Facebook public, has fired both of the analysts, according to the Wall Street Journal and other media outlets.

According to the Consent Order Citigroup reached with Mr. Galvin's office, a junior analyst in the company's research department e-mailed two reporters at the TechCrunch blog about a month before Facebook went public.

The junior analyst attached a draft of work by Citigroup's senior internet analyst, which the Massachusetts regulator asserts "contained confidential, nonpublic information of Facebook obtained by Senior Analyst in order to enable [him] to prepare to initiate coverage of Facebook following the IPO."

The e-mail trail Mr. Galvin included in the Consent Order makes clear that the TechCrunch reporters wanted to publish the document. It also shows that they seemingly listened when the junior analyst said no and, experts on Facebook themselves, offered a critique of some of the assumptions in the analysis.

This, per Mr. Galvin's conclusions of law, meant Citigroup "failed to prevent or detect the written disclosure of material, nonpublic research information in the restricted period prior to the Facebook IPO."

Mr. Galvin's rap on the senior analyst is even more specious. He details how a reporter from a French publication, writing a piece on Google Inc. subsidiary YouTube, asked via e-mail if the senior analyst believed if YouTube "has been above" a previously disclosed 2011 revenue estimate, "would be above" a 2012 revenue estimate, and whether it was "largely profitable."

Per the Consent Order: The senior analyst answered, via e-mail, "yes, yes, yes." And then, in a clumsy cover-up, he told Citigroup's communications staff he hadn't responded. When the reporter told the communications staff he had indeed responded, the senior analyst asked the communications staff to say the interview hadn't yet occurred.

And that's pretty much it. (If you want to read the full Consent Order rather than take my word for it, you can read it here.)

The violation, Mr. Galvin's order says, is that Citigroup "has engaged in … unethical or dishonest conduct or practices" in the securities business. It has failed to "observe high standards of commercial honor and just and equitable principles of trade in the conduct of its business."

This? This is the unethical or dishonest conduct that's emblematic of Wall Street's culture?

Mr. Galvin offers no evidence that anyone traded shares of Google or Facebook on the basis of these two conversations with journalists. Despite his assertions, he also offers no evidence that any of the information was material – that it would make a difference in how someone would trade.

The problem here, it seems, isn't that Citigroup's Facebook estimates, derived from its role as an underwriter, were shared with two journalists. It's that Citigroup's analyst supposedly had access to nonpublic Facebook information because his firm was one of the company's underwriters.

The U.S. went through a great deal of trouble trying to minimize, if not eliminate, analyst conflicts resulting from the underwriter relationship. It seems there's more work to be done.

And I'm a journalist, so I'm biased when I say the biggest problem on Wall Street isn't analysts talking to journalists (disclosure: I have a small position in Facebook stock). Instead I think it's the vast network of whispering insiders that makes the market unfair. Aren't there better targets for Mr. Galvin?

READERS: What's more worrying, the conflict of interest of analysts commenting on an IPO their firm is underwriting, or of analysts sharing information with journalists?