Unfriended: Grasping the Class Action Lawsuit of NY Investors Against Facebook and Its Underwriters

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Three New York investors have filed a class action complaint – dated May 23rd – against Facebook and chief executive Mark Zuckerberg, in addition to lead underwriter Morgan Stanley and an array of secondary underwriters (including JPMorgan Chase, Barclays Capital, Goldman Sachs, and Merrill Lynch) claiming that negative information about the social network’s initial public offering was withheld. Monetary damages are to date unspecified. The suit was filed by Robbins Geller, a firm that years ago earned plaintiffs $7 billion in a suit against Enron.

A failure to disclose information unilaterally among all investors could potentially be considered a form of misrepresentation and fraud, as well as a breach of fiduciary duty. For further explanation of these possible charges and more, visit our Investors page.

Particularly interesting and possibly advantageous for the plaintiffs is that Morgan Stanley’s chief analyst Scott Devitt – famed for his accurate, bearish predictions in recent years that Google and Amazon stock would drop – is alleged to have cautioned preferred customers against zealous purchase of Facebook stock. Morgan Stanley controlled both the process of Facebook’s trading and over 38 percent of Facebook shares sold. Devitt’s and other analysts’ revised revenue forecasts were shared via phone calls with institutional investors – but not with retail investors – before public trading of the stock began. These forecasts outlined expectations for how Facebook would fare into the second quarter and throughout 2012. Robbins Geller’s statement against the underwriters thus argues that the prospectus “contained untrue statements of material facts.”

“It appears as though material information was not disclosed,” said the plaintiffs’ lead attorney Robert Weiser. “We believe that the offering was conducted unfairly and it harmed public stockholders.” Facebook itself released an amended prospectus acknowledging the possibility of reduced revenue in light of users visiting the site with increased frequency on ad-free mobile devices.

Under federal law, insiders and forecasters of an IPO are prohibited from issuing earnings forecasts during what’s known as a “quiet period” (or waiting period) , which according to the SEC’s website “extends from the time a company files a registration statement with the SEC until SEC staff declare the registration statement ‘effective.’ During that period, the federal securities laws limit what information a company and related parties can release to the public.”

Numerous problems plagued Facebook’s first day of trading, resulting in losses of roughly $2.5 billion for the small investors. Among them was an alleged underwriting of shares by Morgan Stanley that could potentially be deemed fraudulent in court. Morgan Stanley had allegedly bought around 420 million shares from Facebook, but sold around 480 million shares to the public by short-selling an additional 60 million shares, which if proven in court could be deemed a fraudulent underwriting of the shares.

While a Facebook spokesperson publicly stated that “We believe the lawsuit is without merit and will defend ourselves vigorously,” no other further statements have been made by representatives of the underwriters.

The controversy surrounding Morgan Stanley’s handling of Facebook’s emergence onto the market is a reminder that it is the right of all investors to be granted any publically available information pertaining to the truest value of their portfolio and its components. Selective omission of such information toward certain customers clearly goes against financial practices regulated as law by the SEC. If you or someone you know believes that the treatment of Facebook’s IPO by Morgan Stanley and its fellow underwriters has done harm to their finances, it is within their rights and best interests to contact a legal professional.