Mad As Hell!

I have been around the technology markets for a really long time, and I have never seen this happen before:

It appears 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 their IPO roadshow.

Worse, if possible, is the fact that the revised earnings forecasts were only passed along to a small group of major (important) investor clients, and not made public.

This is a huge problem.

As you might imagine, the lead underwriters are the most privileged insiders on any deal that is preparing to go public, and they have the best insight into the financial data and associated facts about the health of their client’s business. The earnings forecasts are material information and are prepared by these same analysts employed by the lead underwriters, and as such, are the foundational facts upon which the investing public places their trust. If it turns out that these analysts lied and their employers endorsed these lies, then what does that mean about the system upon which tens of millions of investors have depended for accuracy and integrity?

So, now the apparent truth about Facebook’s lackluster IPO would seem to suggest that news of these estimate cuts dampened interest in the IPO among those who heard about them. (Reuters reported exactly this—that some institutions were “freaked out” by the estimate cuts, as anyone would have been.)

During the road show that was selling (sorry, that’s what it is) the Facebook IPO, investors who didn’t hear about these estimate cuts were placed at a serious and critical information disadvantage. What they didn’t know cost them hundreds of millions of dollars.

Yes. This is a direct violation of securities laws. Privileged information selectively disseminated is a major league no-no. I assume the SEC is on this like, well you know.

What might have actually happened?

One possibility is that the underwriter analysts cut their estimates after a late amendment filing to Facebook’s IPO prospectus, in which a vaguely worded mention that indicated users were growing faster than revenue was a trend, and it appeared to be continuing into the company’s second quarter.

This language freaks out people who are used to reading filing documents, because it could easily have been taken to mean that Facebook’s revenue in the second quarter wasn’t coming in as strong as Facebook had hoped (why else would the language have suddenly been added at the 11th hour?)

Another possibility is that Facebook told the underwriters to cut their estimates—either by directly telling them to, or, more likely, by “suggesting” that the analysts might want to revisit their estimates in light of the new disclosures in the prospectus.

If there was any communication at all between Facebook and its underwriters regarding the analysts’ estimates, Facebook will have to answer for this.

Based on the actual language, it seems highly unlikely to me it would have prompted all three underwriter analysts to immediately cut estimates without some sort of nod and wink from someone who knew how Facebook’s second quarter was progressing. (To get this message from the language, you really have to read between the lines).

At the end of the day, privileged information was known to the lead underwriters and only disclosed to a few, important clients. As a direct result, Facebook’s IPO performed poorly and a lot of investors lost a lot of money, including Mark Zuckerberg, who is $2 Billion lighter today. This practice should be against the law and the lead underwriters should be severely punished. The SEC must regain control of this process and enforce strict oversight rules. The investment community should be outraged. Mary Schapiro should be fired!

Yes, Mary, it’s THAT big.

We’ll soon see how the SEC reacts, and what Congress has to say about all this. Maybe we’ll finally get to see who on Wall Street owns whom in Washington, and what the American people are actually made of.

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About Steve King

iPeopleFINANCE™ Chief Operating Officer. Former CEO of Endymion Systems, Inc. a $36m Information Systems Services company. Co-founder of the Cambridge Systems Group, the creator of ACF2, the leading IBM Mainframe Data Center Security product; acquired by Computer Associates. IBM, seeCommerce, marchFIRST, Connectandsell alumni. UC Berkeley alumni. View all posts by Steve King

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