Many Gray Areas in Legal Arguments Over Botched Faceook IPO

May 30, 2012

Facebook’s initial public offering has sparked lawsuits and investigations after a botched trading debut on the Nasdaq stock market delayed the completion of many orders and questions arose about selective disclosures of the company’s financial prospects.

Facebook’s shares closed on Monday at $28.84, leaving investors who bought at the $38 IPO price with losses of 24.1 percent.

U.S. law and regulations on IPOs and disclosure are complex and harbor many gray areas. Following are some of the laws and rules that may play a role in the outcome of this increasingly tangled affair.


A key provision that may be at issue is Section 12 (a)(2) of the U.S. Securities Act of 1933. The section holds liable any person who offers or sells a security by means of a prospectus or oral communication that includes an untrue statement of a material fact or fails to state an essential material fact.

Analysts working for underwriters cut their revenue and earnings forecasts for Facebook following advice from the company, according to people with direct knowledge of the matter.

This could constitute a basis for liability under this provision. It would require establishing that disclosures in the prospectus — which were selectively communicated to some major investors — were rendered misleading as a result of such information being omitted in the documentation that was available to all investors.


The U.S. Securities and Exchange Commission’s Regulation Fair Disclosure, or “Reg FD,” prohibits the selective disclosure of price-sensitive information. It is not likely to be directly applicable in the Facebook case though, as it is not generally applicable to initial public offerings.

However, the SEC has said the Securities Act already accomplishes at least some of the aims of Reg FD. It said the disclosure regime and the civil-liability provisions of the Securities Act already reduce substantially any meaningful opportunity for an issuer to make selective disclosure of material information in connection with an IPO.


Under earlier standards, communication by means other than prospectus, such as road shows and other marketing communications, had been severely restricted ahead of an IPO. Breaching the quiet period was called “jumping the gun.”

However, rules concerning the quiet period were relaxed in 2005 to take account of new methods of communication such as computers, sophisticated financial software, electronic mail, teleconferencing and webcasting. In-person, live road shows are considered to be oral communications not subject to the same universal disclosure requirements as written communications. The SEC took the view that subjecting oral communications to a public disclosure requirement could hamper the capital formation process.

Road shows for IPOs that are not done for a live audience are considered to be “electronic” road shows, or written communications.

All road shows as part of IPOs are, however, subject to the basic Securities Act Section 12(a)(2) material statement liability. Road show presentations should, therefore, not have information that contradicts or goes materially beyond the preliminary prospectus, or contain materially misleading statements or omissions.


Also in 2005, the SEC approved industry rules aimed at raising the wall between a financial company’s investment bankers and its research analysts. The amended rule 2711 of the Financial Industry Regulatory Authority prohibits research analysts from participating in IPO road shows or similar communications in the presence of investment banking department staff.

The rule does allow research analysts to “educate” investors or internal staff in a “fair, balanced, and not misleading way” about an offering, as long as representatives of the issuer or investment banking department are not present.


Nasdaq OMX Group Inc. has been sued by an investor who claimed the exchange operator was negligent in handling orders for Facebook shares, causing losses for investors. The lawsuit, which seeks class-action status, claims that the Nasdaq exchange owed investors a “duty to exercise reasonable care to execute trade orders promptly, accurately and efficiently and to maintain an orderly trading market.” Nasdaq could also face claims from market makers who claim they were misled over whether orders were being completed at a particular time and have subsequently had to compensate clients for resulting losses.

(Reporting by Helen Parry of Compliance Complete, a Thomson Reuters Accelus regulatory information service; Editing by Randall Mikkelsen and Steve Orlofsky)

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