REVEALED: The Full Story Of How Facebook IPO Buyers Got Screwed

Mark Zuckerberg black and white

The Facebook IPO in May was a disaster.

Hyped up as the must-buy of the decade, the stock faltered as soon as it opened, and the shares then crashed more than 50% over the next few months.

IPO buyers got demolished. Facebook’s reputation took a dive. Lawsuits and recriminations commenced.

The main problem with the IPO was that investors paid way too much for the stock. 

Most of the responsibility for this decision, unfortunately, lies with the investors themselves. No one made anyone pay $38 a share for Facebook.

But some of the fault lies with Facebook, Facebook’s bankers, and some idiotic IPO information-disclosure rules.

During the IPO roadshow, sophisticated institutional investors got important negative information about Facebook that small investors didn’t get. This made the institutions less enthusiastic about Facebook than some less-informed small investors were.

I wrote about the unfairness of this in the wake of the IPO disaster last spring. But now, thanks to an investigation by Massachusetts securities regulators, we have the blow-by-blow details on how small Facebook IPO buyers got screwed.

The Massachusetts “consent decree” tells the behind-the-scenes story of how the negative information about Facebook was shared with some investors and not others. It also shines a light on many aspects of the IPO process that aren’t well understood:

  • The story emphasises just how big an information advantage sophisticated investors have over small investors.
  • It makes a mockery of the fiction that investing is “a level playing field.”

The investigation also reveals that some IPO rules should be changed immediately: All investors should get all relevant information at the same time.

But first, the full story about how Facebook IPO buyers got screwed.

[slideshow]
[slide
permalink=”at-the-beginning-of-an-ipo-company-managers-meet-with-research-analysts-to-teach-them-about-the-business-sometimes-the-company-gives-financial-guidance-the-way-some-public-companies-do-1″
title=”At the beginning of an IPO, company managers meet with research analysts to teach them about the business. Sometimes, the company gives “financial guidance,” the way some public companies do.”
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[slide
permalink=”mark-zuckerberg-did-not-attend-this-meeting-but-facebooks-cfo-david-ebersman-did-2″
title=”Mark Zuckerberg did not attend this meeting, but Facebook’s CFO David Ebersman did.”
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[slide
permalink=”cfo-ebersman-gave-the-analysts-a-very-specific-forecast-for-facebooks-performance-this-forecast-was-never-shared-with-small-investors-3″
title=”CFO Ebersman gave the analysts a very specific forecast for Facebook’s performance. This forecast was never shared with small investors.”
content=””
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[slide
permalink=”the-analysts-used-facebooks-forecast-to-prepare-their-estimates-for-facebooks-performance-these-estimates-were-submitted-to-the-company-for-review-4″
title=”The analysts used Facebook’s forecast to prepare their “estimates” for Facebook’s performance. These estimates were submitted to the company for review.”
content=””
image=”http://static.businessinsider.com/image/50d22f9deab8eacb1f000003″
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[slide
permalink=”importantly-these-estimates-werent-derived-from-independent-analysis-they-were-based-on-the-company-guidance-this-is-clear-from-looking-at-the-estimates-of-the-three-lead-ipo-underwriters-which-were-all-clustered-very-close-to-the-guidance-5″
title=”Importantly, these “estimates” weren’t derived from independent analysis. They were based on the company guidance. This is clear from looking at the estimates of the three lead IPO underwriters, which were all clustered very close to the guidance.”
content=””
image=”http://static.businessinsider.com/image/50d22f9cecad04784900003e”
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[slide
permalink=”no-small-public-market-investors-ever-saw-or-even-knew-about-these-estimates-or-facebooks-guidance-all-the-public-got-was-vague-language-in-the-prospectus-about-risk-factors-6″
title=”No small public-market investors ever saw (or even knew about) these estimates or Facebook’s guidance. All the public got was vague language in the prospectus about risk factors.”
content=””
image=”http://static.businessinsider.com/image/50d22f9b6bb3f79337000009″
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[slide
permalink=”buried-in-the-prospectus-was-a-risk-factor-that-discussed-the-growth-of-facebooks-mobile-usage-and-how-this-might-affect-revenue-7″
title=”Buried in the prospectus was a risk factor that discussed the growth of Facebook’s mobile usage and how this might affect revenue.”
content=””
image=”http://static.businessinsider.com/image/50d22f9a6bb3f77f37000016″
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]
[slide
permalink=”meanwhile-the-analysts-gave-presentations-to-the-banks-salespeople-about-facebook-in-these-presentations-the-analysts-verbally-shared-their-estimates-these-estimates-were-also-given-verbally-to-big-institutional-investors-no-smaller-investors-ever-got-them-8″
title=”Meanwhile, the analysts gave presentations to the banks’ salespeople about Facebook. In these presentations, the analysts VERBALLY shared their estimates. These estimates were also given VERBALLY to big institutional investors. No smaller investors ever got them.”
content=””
image=”http://static.businessinsider.com/image/50d22f9a69beddb26c000023″
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]
[slide
permalink=”on-may-7th-facebook-kicked-off-its-institutional-roadshow-two-weeks-of-face-to-face-meetings-with-big-institutional-investors-9″
title=”On May 7th, Facebook kicked off its institutional “roadshow”–two weeks of face-to-face meetings with big institutional investors.”
content=””
image=”http://static.businessinsider.com/image/50d22f99eab8ea791d00000d”
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[slide
permalink=”that-night-the-trouble-started-facebooks-financial-performance-had-deteriorated-cfo-ebersman-realized-that-the-company-might-not-achieve-the-guidance-he-had-verbally-given-the-analysts-10″
title=”That night, the trouble started. Facebook’s financial performance had deteriorated. CFO Ebersman realised that the company might not achieve the guidance he had verbally given the analysts.”
content=””
image=”http://static.businessinsider.com/image/4fc4d2eceab8ea596600000c”
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]
[slide
permalink=”ebersman-reached-out-to-the-head-banker-at-ipo-underwriter-morgan-stanley-michael-grimes-he-told-grimes-that-facebooks-performance-had-deteriorated-11″
title=”Ebersman reached out to the head banker at IPO underwriter Morgan Stanley, Michael Grimes. He told Grimes that Facebook’s performance had deteriorated.”
content=””
image=”http://static.businessinsider.com/image/50d22f986bb3f7553700000e”
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[slide
permalink=”grimes-is-one-of-the-most-respected-investment-bankers-in-silicon-valley-12″
title=”Grimes is one of the most respected investment bankers in Silicon Valley.”
content=””
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]
[slide
permalink=”grimes-asked-ebersman-why-the-performance-had-deteriorated-so-he-could-come-up-with-a-plan-13″
title=”Grimes asked Ebersman why the performance had deteriorated, so he could come up with a plan.”
content=””
image=”http://static.businessinsider.com/image/50d22f98ecad04dc4d00000b”
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]
[slide
permalink=”then-grimes-called-others-at-morgan-stanley-to-warn-them-that-facebooks-performance-had-deteriorated-14″
title=”Then Grimes called others at Morgan Stanley to warn them that Facebook’s performance had deteriorated.”
content=””
image=”http://static.businessinsider.com/image/50d22f9769bedd6d6a000016″
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]
[slide
permalink=”then-grimes-made-his-recommendation-to-facebook-cfo-ebersman-facebook-should-tell-the-underwriter-analysts-that-its-performance-had-deteriorated-the-next-question-was-how-15″
title=”Then Grimes made his recommendation to Facebook CFO Ebersman: Facebook should tell the underwriter analysts that its performance had deteriorated. The next question was… “how?””
content=””
image=”http://static.businessinsider.com/image/50d22f96ecad04c94b000012″
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]
[slide
permalink=”the-next-day-facebook-executives-met-with-big-institutional-investors-in-boston-and-baltimore-16″
title=”The next day, Facebook executives met with big institutional investors in Boston and Baltimore.”
content=””
image=”http://static.businessinsider.com/image/50d22f966bb3f74835000010″
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]
[slide
permalink=”meanwhile-facebooks-treasurer-cipora-herman-emailed-the-finance-team-to-request-the-financial-models-that-the-analysts-had-submitted-a-couple-of-weeks-earlier-she-wanted-to-see-exactly-what-their-estimates-were-17″
title=”Meanwhile, Facebook’s Treasurer, Cipora Herman, emailed the finance team to request the financial models that the analysts had submitted a couple of weeks earlier. She wanted to see exactly what their estimates were.”
content=””
image=”http://static.businessinsider.com/image/50d22f95ecad047749000026″
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]
[slide
permalink=”facebooks-finance-team-observed-that-the-analysts-estimates-were-very-close-to-the-companys-original-guidance-so-the-question-was-how-to-get-the-analysts-to-quietly-reduce-those-estimates-without-spooking-ipo-buyers-18″
title=”Facebook’s finance team observed that the analysts’ “estimates” were very close to the company’s original guidance. So the question was how to get the analysts to quietly reduce those estimates–without spooking IPO buyers.”
content=””
image=”http://static.businessinsider.com/image/50d22f95ecad048949000020″
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]
[slide
permalink=”this-was-a-sensitive-issue-to-say-the-least-so-the-lawyers-got-involved-19″
title=”This was a sensitive issue, to say the least. So the lawyers got involved.”
content=””
image=”http://static.businessinsider.com/image/50d22f946bb3f7833700000c”
caption=””
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]
[slide
permalink=”grimes-later-testified-about-the-purpose-of-the-call-to-avoid-the-appearance-of-sharing-negative-information-with-only-a-select-group-of-investors-ironically-thats-exactly-what-ended-up-happening-20″
title=”Grimes later testified about the purpose of the call: To avoid the appearance of sharing negative information with only a select group of investors. Ironically, that’s exactly what ended up happening.”
content=””
image=”http://static.businessinsider.com/image/50d22f9369bedd9672000005″
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[slide
permalink=”the-lawyers-recommendation-apparently-was-for-facebook-to-update-the-vague-language-in-the-prospectus-to-include-a-clearer-warning-about-the-possible-impact-of-facebooks-mobile-growth-on-revenue-21″
title=”The lawyers’ recommendation, apparently, was for Facebook to update the vague language in the prospectus to include a clearer warning about the possible impact of Facebook’s mobile growth on revenue.”
content=””
image=”http://static.businessinsider.com/image/50d22f9369bedd687200000a”
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]
[slide
permalink=”meanwhile-ebersman-brought-facebooks-board-up-to-speed-telling-them-exactly-what-was-going-on-22″
title=”Meanwhile, Ebersman brought Facebook’s board up to speed, telling them exactly what was going on.”
content=””
image=”http://static.businessinsider.com/image/50d22f926bb3f7983700000a”
caption=””
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[slide
permalink=”then-it-was-time-to-tell-the-research-analysts-about-facebooks-deteriorating-performance-and-through-them-big-institutional-investors-this-would-be-done-verbally-by-telephone-banker-michael-grimes-and-treasurer-cipora-holed-up-in-a-hotel-in-philadelphia-to-make-the-calls-23″
title=”Then it was time to tell the research analysts about Facebook’s deteriorating performance–and, through them, big institutional investors. This would be done verbally, by telephone. Banker Michael Grimes and Treasurer Cipora holed up in a hotel in Philadelphia to make the calls.”
content=””
image=”http://static.businessinsider.com/image/50d22f9269beddf372000001″
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[slide
permalink=”these-calls-had-to-be-carefully-managed-so-grimes-and-herman-practiced-with-grimes-playing-the-role-of-research-analyst-24″
title=”These calls had to be carefully managed. So Grimes and Herman practiced, with Grimes playing the role of “research analyst.””
content=””
image=”http://static.businessinsider.com/image/50d22f916bb3f79637000004″
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[slide
permalink=”later-grimes-was-asked-under-oath-whether-treasurer-herman-used-a-script-for-the-calls-grimes-said-he-didnt-remember-25″
title=”Later, Grimes was asked under oath whether Treasurer Herman used a “script” for the calls. Grimes said he didn’t remember.”
content=””
image=”http://static.businessinsider.com/image/50d22f90eab8ea2d1d000018″
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[slide
permalink=”under-sub-poena-facebook-would-later-produce-the-script-it-had-been-handwritten-by-michael-grimes-26″
title=”Under sub-poena, Facebook would later produce the script. It had been handwritten by… Michael Grimes.”
content=””
image=”http://static.businessinsider.com/image/50d22f9069bedd167200000e”
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]
[slide
permalink=”the-script-called-for-treasurer-herman-to-explicitly-tell-the-analysts-that-facebooks-performance-would-be-at-the-lower-end-of-its-guidance-range-as-massachusetts-investigators-later-noted-this-script-or-guidance-was-never-shared-with-the-public-27″
title=”The script called for Treasurer Herman to explicitly tell the analysts that Facebook’s performance would be at the “lower end” of its guidance range. As Massachusetts investigators later noted, this script (or guidance) was never shared with the public.”
content=””
image=”http://static.businessinsider.com/image/50d22f8f6bb3f73a35000019″
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[slide
permalink=”importantly-the-script-was-very-explicit-28″
title=”Importantly, the script was VERY explicit.”
content=””
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]
[slide
permalink=”then-at-503pm-facebook-filed-its-amended-prospectus-with-the-sec-the-only-difference-from-the-old-one-was-some-new-vague-cautionary-language-about-traffic-continuing-to-grow-faster-than-revenue-the-prospectus-did-not-include-any-guidance-it-did-not-say-that-facebook-had-cut-its-guidance-it-did-not-say-that-facebooks-performance-had-deteriorated-29″
title=”Then, at 5:03pm, Facebook filed its amended prospectus with the SEC. The only difference from the old one was some new vague cautionary language about traffic continuing to grow faster than revenue. The prospectus did not include any “guidance.” It did not say that Facebook had cut its guidance. It did not say that Facebook’s performance had deteriorated.”
content=””
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caption=””
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[slide
permalink=”then-facebook-treasurer-cipora-herman-started-calling-the-analysts-30″
title=”Then Facebook Treasurer Cipora Herman started calling the analysts.”
content=””
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caption=””
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[slide
permalink=”banker-michael-grimes-stayed-with-her-for-the-first-two-calls-31″
title=”Banker Michael Grimes stayed with her for the first two calls.”
content=””
image=”http://static.businessinsider.com/image/50d22f8e69bedd1c72000011″
caption=””
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]
[slide
permalink=”michael-grimes-later-told-facebook-cfo-ebersman-that-herman-had-done-a-great-job-on-the-calls-32″
title=”Michael Grimes later told Facebook CFO Ebersman that Herman had done a great job on the calls.”
content=””
image=”http://static.businessinsider.com/image/50d22f8deab8ea721d000006″
caption=””
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]
[slide
permalink=”herman-made-a-call-every-15-minutes-talking-with-7-analysts-that-evening-then-she-called-the-other-8-underwriter-analysts-the-following-morning-33″
title=”Herman made a call every 15 minutes, talking with 7 analysts that evening. Then she called the other 8 underwriter analysts the following morning.”
content=””
image=”http://static.businessinsider.com/image/50d22f8d69bedde26a000032″
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]
[slide
permalink=”the-analysts-got-the-message-they-immediately-cut-their-estimates-for-facebooks-performance-to-match-the-new-guidance-34″
title=”The analysts got the message. They immediately cut their “estimates” for Facebook’s performance to match the new guidance.”
content=””
image=”http://static.businessinsider.com/image/50d22f8cecad04a74d000008″
caption=””
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]
[slide
permalink=”specifically-they-cut-their-estimates-for-facebooks-second-quarter-which-wasnt-going-well-35″
title=”Specifically, they cut their estimates for Facebook’s second quarter, which wasn’t going well.”
content=””
image=”http://static.businessinsider.com/image/50d22f8becad04734900001f”
caption=””
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[slide
permalink=”and-they-cut-their-estimates-for-the-full-year-36″
title=”And they cut their “estimates” for the full year.”
content=””
image=”http://static.businessinsider.com/image/50d22f8a69bedd2d6a000019″
caption=””
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]
[slide
permalink=”these-estimate-cuts-were-then-shared-verbally-with-big-institutional-investors-the-public-didnt-find-out-about-them-until-after-the-ipo-had-priced-37″
title=”These estimate cuts were then shared VERBALLY with big institutional investors. The public didn’t find out about them until after the IPO had priced.”
content=””
image=”http://static.businessinsider.com/image/50d22f89eab8ea6f1d00000b”
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]
[slide
permalink=”a-week-later-as-a-result-of-intense-demand-for-shares-facebook-raised-its-ipo-price-and-increased-the-size-of-the-deal-more-facebook-insiders-decided-to-sell-38″
title=”A week later, as a result of intense demand for shares, Facebook raised its IPO price and increased the size of the deal. More Facebook insiders decided to sell.”
content=””
image=”http://static.businessinsider.com/image/50d22f886bb3f73e35000020″
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[slide
permalink=”then-on-may-18th-facebook-went-public-39″
title=”Then, on May 18th, Facebook went public.”
content=””
image=”http://static.businessinsider.com/image/50bfb4336bb3f73361000004″
caption=””
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]
[slide
permalink=”and-not-surprisingly-because-the-business-was-deteriorating-the-stock-quickly-crashed-dropping-by-half-over-the-following-three-months-40″
title=”And, not surprisingly, because the business was deteriorating, the stock quickly crashed, dropping by half over the following three months.”
content=””
image=”http://static.businessinsider.com/image/50d353a969bedd563100002c”
caption=””
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[slide
permalink=”so-thats-the-story-facebooks-financial-performance-deteriorated-during-the-marketing-of-the-ipo-big-institutional-investors-were-told-about-that-verbally-small-investors-were-not-41″
title=”So, that’s the story. Facebook’s financial performance deteriorated during the marketing of the IPO. Big institutional investors were told about that (verbally). Small investors were not.”
content=””
image=”http://static.businessinsider.com/image/50a250076bb3f7e560000034″
caption=””
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[slide
permalink=”facebook-and-morgan-stanley-believe-that-they-followed-the-ipo-rules-in-place-at-the-time-and-they-may-well-have-massachusetts-fined-morgan-stanley-but-didnt-say-what-the-firm-did-wrong-but-it-should-now-be-clear-that-those-rules-are-absurd-42″
title=”Facebook and Morgan Stanley believe that they followed the IPO rules in place at the time–and they may well have. (Massachusetts fined Morgan Stanley but didn’t say what the firm did wrong). But it should now be clear that those rules are absurd.”
content=””
image=”http://static.businessinsider.com/image/4fbceec36bb3f7461000000b”
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]
[slide
permalink=”these-rules-make-a-mockery-of-the-idea-that-investing-is-a-level-playing-field-they-turn-small-investors-into-muppets-43″
title=”These rules make a mockery of the idea that investing is a “level playing field.” They turn small investors into muppets.”
content=””
image=”http://static.businessinsider.com/image/4fb7861becad048c4000000f”
caption=””
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]
[slide
permalink=”these-rules-should-be-changed-immediately-44″
title=”These rules should be changed immediately.”
content=”How To Fix The IPO Rules >
image=”http://static.businessinsider.com/image/50870927ecad048f1e000003″
caption=””
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credit_href=””
]
[/slideshow]