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Facebook shareholders just filed a class action suit against Facebook and Morgan Stanley.The firm handling the suit is Robbins Geller, which won $7 billion from Enron bankers.
They are suing over the allegation that analysts at Facebook’s IPO underwriters cut their estimates for the company in the middle of the IPO roadshow—and only told institutional investors about this change, not everyone interested in buying Facebook stock.
The suing lawyers argue that this information did not find its way into Facebook’s prospectus, which meant the prospectus “contained untrue statements of material facts.”
Last night, we reported that one of the underwriter’s analysts said he was told by a Facebook financial executive to cut his estimates.
Here is the meat of the complaint:
20. The Registration Statement and Prospectus contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading and were not prepared in accordance with the rules and regulations governing their preparation.
21. With regard to the Company’s expectations for the second quarter of 2012, the Registration Statement and Prospectus stated, in pertinent part, as follows:
Based upon our experience in the second quarter of 2012 to date, the trend we saw in the first quarter of [daily active users] increasing more rapidly than the increase in number of ads delivered has continued. We believe this trend is driven in part by increased usage of facebook on mobile devices where we have only recently begun showing an immaterial number of sponsored stories in News Feed, and in part due to certain pages having fewer ads per page as a result of product decisions.
22. In describing the risks related to Facebook’s business and industry, the Registration Statement purported to warn that the Company’s revenues could be negatively affected by the rate of growth in mobile users of its site or app. The Registration Statement and Prospectus stated in pertinent part as follows:
Growth in use of Facebook through our mobile products, where our ability to monetise is unproven, as a substitute for use on personal computers may negatively affect our revenue and financial results.
We had 488 million [monthly active users] who used facebook mobile products in March 2012. While most of our mobile users also access Facebook through personal computers, we anticipate that the rate of growth in mobile usage will exceed the growth in usage through personal computers for the foreseeable future, in part due to our focus on developing mobile products to encourage mobile usage of Facebook. We have historically not shown ads to users accessing Facebook through mobile apps or our mobile website. In March 2012, we began to include sponsored stories in users’ mobile News Feeds. However, we do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered. If users increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.
23. The Registration Statement and Prospectus also purported to warn investors that the Company’s revenues from advertising could be adversely affected by, among other things, the “increased user access to and engagement with facebook” through mobile devices. In that regard, the Registration Statement and Prospectus stated, in pertinent part, as follows:
We generate a substantial majority of our revenue from advertising. The loss of advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our business.
The substantial majority of our revenue is currently generated from third parties advertising on facebook. In 2009, 2010, and 2011 and the first quarter of 2011 and 2012, advertising accounted for 98%, 95%, 85%, 87%, and 82%, respectively, of our revenue. As is common in the industry, our advertisers typically do not have long-term advertising commitments with us. Many of our advertisers spend only a relatively small portion of their overall advertising budget with us. In addition, advertisers may view some of our products, such as sponsored stories and ads with social context, as experimental and unproven. Advertisers will not continue to do business with us, or they will reduce the prices they are willing to pay to advertise with us, if we do not deliver ads and other commercial content in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. Our advertising revenue could be adversely affected by a number of other factors, including:
- decreases in user engagement, including time spent on facebook;
- increased user access to and engagement with facebook through our mobile products, where we do not currently directly generate meaningful revenue, particularly to the extent that mobile engagement is substituted for engagement with Facebook on personal computers where we monetise usage by displaying ads and other commercial content;
- product changes or inventory management decisions we may make that reduce the size, frequency, or relative prominence of ads and other commercial content displayed on facebook;
- our inability to improve our analytics and measurement solutions that demonstrate the value of our ads and other commercial content;
- decisions by advertisers to use our free products, such as facebook Pages, instead of advertising on Facebook;
- loss of advertising market share to our competitors;
- adverse legal developments relating to advertising, including legislative and regulatory developments and developments in litigation;
- adverse media reports or other negative publicity involving us, our Platform developers, or other companies in our industry;
- our inability to create new products that sustain or increase the value of our ads and other commercial content;
- the degree to which users opt out of social ads or otherwise limit the potential audience of commercial content;
- changes in the way online advertising is priced;
- the impact of new technologies that could block or obscure the display of our ads and other commercial content; and
- the impact of macroeconomic conditions and conditions in the advertising industry in general.
- The occurrence of any of these or other factors could result in a reduction in demand for our ads and other commercial content, which may reduce the prices we receive for our ads and other commercial content, or cause advertisers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results.
24. The statements referenced above in ¶¶ 21-23 were untrue statements of material fact. The true facts at the time of the IPO were that Facebook was then experiencing a severe and pronounced reduction in revenue growth due to an increase of users of its Facebook app or website through mobile devices rather than a traditional PC such that the Company told the Underwriter Defendants to materially lower their revenue forecasts for 2012. And, defendants failed to disclose that during the roadshow conducted in connection with the IPO, certain of the Underwriter Defendants reduced their second quarter and full year 2012 performance estimates for Facebook, which revisions were material information which was not shared with all Facebook investors, but rather, was selectively disclosed by defendants to certain preferred investors and omitted from the Registration Statement and/or Prospectus.
25. On May 19, 2012, in an article entitled “Morgan Stanley Was A Control-Freak On Facebook IPO – And It May Have Royally Screwed Itself,” Reuters reported that “Facebook . . . altered its guidance for research earnings last week, during the road show, a rare and disruptive move.”
26. On May 22, 2012, in an article entitled “Insight: Morgan Stanley cut Facebook estimates just before IPO,” Reuters reported that that Facebook’s lead underwriters, Morgan Stanley, JP Morgan and Goldman Sachs, all cut their earnings forecasts for the Company in the middle of the IPO roadshow and that only a handful of preferred investor clients were told the news of the reduction. In that regard, the article stated, in pertinent part, as follows:
In the run-up to Facebook’s $16 billion IPO, Morgan Stanley, the lead underwriter on the deal, unexpectedly delivered some negative news to major clients: The bank’s consumer Internet analyst, Scott Devitt, was reducing his revenue forecasts for the company.
The sudden caution very close to the huge initial public offering, and while an investor roadshow was underway, was a big shock to some, said two investors who were advised of the revised forecast.
They say it may have contributed to the weak performance of Facebook shares, which sank on Monday – their second day of trading – to end 10 per cent below the IPO price. The $38 per share IPO price valued Facebook at $104 billion.
The change in Morgan Stanley’s estimates came on the heels of Facebook’s filing of an amended prospectus with the U.S. Securities and Exchange Commission (SEC), in which the company expressed caution about revenue growth due to a rapid shift by users to mobile devices. Mobile advertising to date is less lucrative than advertising on a desktop.
“This was done during the roadshow – I’ve never seen that before in 10 years,” said a source at a mutual fund firm who was among those called by Morgan Stanley.
JPMorgan Chase and Goldman Sachs, which were also major underwriters on the IPO but had lesser roles than Morgan Stanley, also revised their estimates in response to Facebook’s May 9 SEC filing, according to sources familiar with the situation.
Morgan Stanley declined to comment and Devitt did not return a phone message seeking comment. JPMorgan and Goldman both declined to comment.
Typically, the underwriter of an IPO wants to paint as positive a picture as possible for prospective investors. Investment bank analysts, on the other hand, are required to operate independently of the bankers and salesmen who are marketing stocks – that was stipulated in a settlement by major banks with regulators following a scandal over tainted stock research during the dotcom boom.
The people familiar with the revised Morgan Stanley projections said Devitt cut his revenue estimate for the current second quarter significantly, and also cut his full-year 2012 revenue forecast. Devitt’s precise estimates could not be immediately verified.
“That deceleration freaked a lot of people out,” said one of the investors.
Scott Sweet, senior managing partner at the research firm IPO Boutique, said he was also aware of the reduced estimates.
“They definitely lowered their numbers and there was some concern about that,” he said. “My biggest hedge fund client told me they lowered their numbers right around mid-roadshow.”
That client, he said, still bought the issue but “flipped his IPO allocation and went short on the first day.”
Sweet said analysts at firms that are not underwriting IPOs often change forecasts at such times. However, he said it is unusual for analysts at lead underwriters to make such changes so close to the IPO.
“That would be very, very unusual for a book runner to do that,” he said.
The lower revenue projection came shortly before the IPO was priced at $38 a share, the high end of an already upwardly revised projected range of $34-$38, and before Facebook increased the number of shares being sold by 25 per cent.
The much-anticipated IPO has performed far below expectations, with the shares barely staying above the $38 offer price on their Friday debut and then plunging on Monday.
Companies do not make their own financial forecasts prior to an IPO, and underwriters are generally barred from issuing recommendations on the stock until 40 days after it begins trading. Analysts often rely on guidance from the company in building their forecasts, but companies doing IPOs are not permitted to give out material information that is not available to all investors.
Institutions and major clients generally enjoy quick access to investment bank research, while retail clients in many cases only get it later. It is unclear whether Morgan Stanley only told its top clients about the revised view or spread the word more broadly. The firm declined to comment when asked who was told about the research.
“It’s very rare to cut forecasts in the middle of the IPO process,” said an official with a hedge fund firm who received a call from Morgan Stanley about the revision.
27. As of the date of the filing of this complaint, the 421 million shares of Facebook common stock sold in the IPO are trading at approximately $31 per share, or $7 per share below the price where plaintiffs and the Class purchased $16 billion worth of Facebook stock while defendants pocketed billions of dollars. Plaintiffs and the Class have suffered losses of more than $2.5 billion since the IPO.
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