Facebook Outlines Defense in Messy IPO Case

By and Edwin Chan | June 18, 2012

Facebook Inc., facing a raft of lawsuits from investors seeking to recoup losses from its botched IPO, laid out on Friday how cascading Nasdaq trading glitches might have stoked the confusion that marred its May 18 debut.

The No. 1 social network and lead underwriters Morgan Stanley, Goldman Sachs Group Inc and JPMorgan Chase & Co. have filed a motion requesting that dozens of shareholder lawsuits over its $16 billion initial public offering be grouped together in Manhattan federal court.

The filing, while standard in cases with multiple lawsuits, gives a glimpse at how Facebook may choose to structure its defense and represents the social networking company’s first public response to the chaos that engulfed its high-profile debut.

Facebook’s stock leapt 6 percent on Friday to end above $30 for the first time since May 25. It also recorded its biggest single-day gain since it began trading, as a string of recent improvements to its advertising system raised hopes about its prospects. But the eight-year-old company founded by Mark Zuckerberg in his Harvard dorm room has shed a fifth, or $20 billion, of its value from the $38 IPO price.

Despite the downward spiral, many employees made millions with stock awards. On Friday, chief technology officer Bret Taylor – overseer of the social network’s main platform and mobile business – announced he was leaving this summer, becoming the first senior executive to break ranks.

“It’s certainly a negative when so soon after the company has gone public that key people leave,” said Pivotal Research Group analyst Brian Wieser.

But he said such post-IPO departures are not surprising, as executives whose equity shares in the company have vested, cash out and move on.

“It’s not something that you would take as a vote of no-confidence” in the company, Wieser said.

He noted that investors are primarily concerned about Facebook CEO Zuckerberg, Chief Operating Officer Sheryl Sandberg and Chief Financial Officer David Ebersman.

Facebook’s IPO was to have been the culmination of years of breakneck growth for the cultural phenomenon. But it became mired in controversy as more than a dozen shareholder lawsuits accused Facebook and its underwriters of obscuring the company’s weakened growth forecasts ahead of the May 18 stock offering.

Nasdaq OMX Group Inc. has also been sued by investors who claimed the exchange operator was negligent in handling orders for Facebook shares. Nasdaq spokesman Joseph Christinat declined to comment on Friday.

In the motion filed late Thursday, Facebook – the first U.S. company to debut with a market value of more than $100 billion – defended its pre-IPO disclosures on mobile user revenue growth. The motion cited reports that Facebook had told underwriters about lowered revenue forecasts but not amended its prospectus.

Plaintiffs “ignore that what Facebook and the underwriter defendants allegedly did both followed customary practices and did not violate any rules,” according to the motion.


Reuters reported on May 22 that analysts at Morgan Stanley and other top underwriters cut their Facebook estimates just over a week before the IPO and told some institutional investors about the unusual step in conference calls.

A series of filings on Friday revealed that the Securities & Exchange Commission quizzed Facebook about the potential impact of growth in mobile users in the months leading up to the social network’s initial public offering and asked the company to make the risks plainer.

“Assuming that the trend towards mobile continues and your mobile monetization efforts are unsuccessful, ensure that your disclosure fully addresses the potential consequences to your revenue and financial results rather than just stating that they ‘may be negatively affected,'” the SEC wrote in a Feb. 28 letter to Facebook Chief Financial Officer David Ebersman.

In court papers filed late on Thursday before the U.S. Judicial Panel on Multi-District Litigation, Facebook and the banks said the U.S. District Court in Manhattan was the “most appropriate and convenient forum to oversee these coordinated and/or consolidated proceedings.”

Consolidating the many lawsuits leveled at Facebook may help reduce distraction for a company struggling to convince Wall Street it can maintain its growth rates and persuade marketers of the benefits of advertising on a platform with 900 million users.

Internet retailers at a Chicago conference last week voiced worries about a lack of reliable data on the impact of ads on Facebook and many said they were reluctant to switch to paid advertising without that. General Motors upset some investors when it announced days before Facebook’s debut that it saw little reason to pay for ads on the social network.

In the short term, however, Facebook has to fend off accusations it played favorites with disclosures and avoid potentially hefty damages from irate investors who bought into a company valued at 100 times earnings.

Facebook cited on Friday a series of news reports that described how trading errors compounded uncertainty on May 18 after the start of trading in its shares was delayed by about half an hour.

The motion cited lawsuits “alleging that technical problems and other trading-related errors affecting Facebook’s stock – which Nasdaq subsequently admitted – created market uncertainty and caused investor losses.”

IFR, a Thomson Reuters publication, reported on Friday that Nasdaq was still testing for the consequences of a significant change to its IPO procedures the evening before Facebook’s troubled debut.

The change, which made compelling commercial sense for Nasdaq and was introduced just weeks ahead of Facebook’s debut, allowed the exchange to capture orders for IPO securities from 07:00 EST on the first day of trading. The previous system only allowed Nasdaq to capture orders in a 15-minute pre-opening bookbuilding phase.

The fact that the extra time allowed the exchange to gather a greater number of orders that were then fed into the 15-minute bookbuild is significant because Nasdaq acknowledges the volume of trades during that period exposed a software glitch that gummed up IPO trading, IFR reported.

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