There's irony here. A site famous for making private information public is being sued for keeping public information private.
After Mark Zuckerberg rang the NASDAQ opening bell, the dollar signs in the eyes of small investors quickly vanished as glitches abounded and anxiety spread. When the dust finally settled, optimism was nowhere to be found and pessimism once again stigmatized the financial market.
The Facebook disclosure scandal is about how big investment firms like Morgan Stanley and other IPO underwriters passed on insider information to their biggest clients about Facebook's potentially weak quarter, but failed to tell their financial advisors and individual clients. Therefore, certain entities knew the initial IPO price was too high and others didn't. It can then be reasoned that this had a direct effect on the stock's plummet, because when people find out a company isn't doing well they usually dump the stock.
As Henry Blodget, the CEO and Editor-in-Chief of Business Insider wrote, "At best, this selective disclosure of the estimate cut is grossly unfair to investors who bought Facebook stock on the IPO (or at any time since) and didn't know about it. At worst, it's a violation of securities laws." (See story.)
What Facebook and Morgan Stanley did was unfair, but was it illegal? As you'd expect, Facebook and Morgan Stanley say no. In fact, they say they were actually following the rules.
It all goes back to the 1990s and the dot-com boom. Back then, part of an analyst's job was to help take companies public, which meant, as Blodget writes, "evaluating IPO candidates, pitching IPO candidates, positioning IPOs, marketing IPOs, and then providing research on IPOs after the companies went public." At some firms, analysts were even paid directly for banking deals.
On its face, this seemed to be a conflict of interests. But hey, that was how the game was played. After the dot-com market crashed, New York Attorney General Eliot Spitzer investigated and realized that this conflict of interests resulted in analysts being very hesitant or downright against downgrading stocks for fear of hurting a firm's banking business. Spitzer's investigation led to the creation of a much-needed wall between research and banking. The investigation also declared that underwriter research analysts would not be allowed to publish any research on an IPO, or publish anything in print, until 40 days after the deal. Yet during this 40-day quiet period, underwriter research analysts were still allowed to do three things:
- Talk to company management about the business
- Generate estimates for IPO companies with management's help
- Discuss these estimates and their opinions verbally with big institutional investors
So, before we go accusing analysts of playing favorites, note that there was simply no vehicle for them to relate this information to the general public as they were not allowed to publish anything in print for 40 days as the Spitzer rule stated in 2002. Therein lies the rub and the irony. As we all know, there are other ways in 2012 to relay information to the public without paper. One website in particular comes to mind.
The Facebook/Morgan Stanley IPO debacle was likely not illegal but definitely not fair, and that's because the rules themselves are not fair. If no action — litigation or otherwise — is taken, then there is no impetus for the rules to change. So while the lawsuits may or may not prove to be lucrative for the plaintiffs, they will play a part in amending the status quo so this debacle will become an anomaly and no longer the rule.
