[Infowarrior] - Some big firms got Facebook warning

[Richard Forno]

Some big firms got Facebook warning

	• by: GINA CHON
	• From: The Wall Street Journal
	• May 24, 2012 5:13PM

http://www.theaustralian.com.au/business/wall-street-journal/some-big-firms-got-facebook-warning/story-fnay3ubk-1226366000196

CAPITAL Research & Management wanted to buy into the Facebook initial public offering. But days before the IPO, an underwriting bank on the deal warned the big investment firm about Facebook's dimming revenue prospects.

The Los Angeles firm, armed with information from a May 11 "roadshow" meeting with underwriters and Facebook, along with similar estimates of its own, slashed the number of shares it intended to buy. The night before trading began, a Capital Research manager told a banker at Morgan Stanley,  the lead underwriter, that the deal's pricing was "ridiculous," according to a person familiar with the situation. Some Capital Research fund managers didn't buy into the IPO at all, say people familiar with the matter.

Jennifer Kohne received no such warning. The 52-year-old retired medical-device salesperson in St. Louis bought 3,000 Facebook shares at $42 through an online brokerage and now sits on losses of $30,000 based on Wednesday's closing price of $32. "We don't get the information that these institutional fund managers are getting," she says. "We're at a disadvantage."

Wall Street firms, for their part, say they give certain information to big clients because the clients pay for this type of data. It is typical in an IPO for analysts or sales staff to give certain information to clients, they added. But that usually doesn't apply to small investors.

At any other time, such "selective disclosure" violates federal securities law, which requires companies and Wall Street firms to publicly disseminate any information that could move share prices. Securities law prevents analysts at banks that underwrite large IPOs from issuing research reports to the public until 40 days after the shares begin trading.

Some securities lawyers urge that new rules be put in place to prevent this uneven information flow. "Analysts should not be giving opinions about the IPO at the same time their firms are acting as underwriters. They should not be giving information that's not in the prospectus to favoured clients," says securities lawyer Jacob Zamansky, who represents investors in securities cases. He isn't involved in any Facebook cases.

Facebook declined to comment. In a statement, Morgan Stanley said it "followed the same procedures for the Facebook offering that it follows for all IPOs. These procedures are in compliance with all applicable regulations."

The Facebook IPO was supposed to be a highlight for the social-media company, lead underwriter Morgan Stanley and the Nasdaq Stock Market.

Instead, the lacklustre deal - Facebook shares have dropped nearly 16 per cent since Friday's launch, though they rose 3.2 per cent on Wednesday - has illustrated that pockets of the financial world remain firmly stacked in favour of the market's biggest players.

The fallout has been quick. State and securities-industry regulators are investigating whether there was anything improper in the investor communications. On Wednesday, some Facebook investors filed suit in Manhattan federal court, alleging that the company and its underwriters failed to properly disclose changes to analysts' forecasts made at the underwriting banks. And a Senate banking panel will examine issues in the Facebook IPO process.

Morgan Stanley said it may adjust prices for trades made during the IPO. The bank said it was reviewing orders by retail brokerage clients on a trade-by-trade basis and will make adjustments if clients paid too much, according to people familiar with the situation.

In a memo sent Wednesday to the nearly 17,200 financial advisers of its Morgan Stanley Smith Barney retail brokerage joint venture, the firm said it expects to make "a number" of price adjustments. The orders in question occurred in Facebook's debut Friday, which was marred by trading glitches by the Nasdaq Stock Market that delayed the start of trading in the social-networking company by 30 minutes.

Clients at Morgan Stanley and other brokerages also were left with orders that were processed improperly. Besides the glitches, a number of investors are angry that Facebook raised the IPO price to $38 a share, even amid declining forecasts for its revenue.

The lead underwriters, which include Morgan Stanley, Goldman Sachs Group Inc  and JP Morgan Chase set the best price based on demand they saw for the shares last Thursday night when the price was set, say people familiar with the matter. Goldman and JP Morgan had limited sway in the Facebook IPO, people familiar with the matter said. Morgan Stanley, Goldman and JP Morgan declined to comment.

In this case, some of the demand was coming from what on Wall Street is sometimes called the "dumb money": individual investors looking for a piece of a company that many use every day to connect with friends and others. In low-profile IPOs, 10 per cent  to 15 per cent of shares typically are allocated to individuals. In this case, individuals received roughly 25 per cent of the IPO - big for such a high-profile deal.

Three days into its roadshow - where Facebook executives and Wall Street underwriters discussed the deal with prospective investors - Facebook released a revised regulatory document about the offering. The document acknowledged user growth for its mobile site hadn't led to an increase in the company's ad revenue.

Facebook said in the filing that the trend of user growth outpacing ads continued into the second quarter. It warned that as more people use Facebook on mobile phones rather than computers, that trend "may negatively affect" results. The revised documents were made available to all investors and written up in media reports.

After filing the updated IPO document, a Facebook executive individually called 21 sell-side research analysts to discuss the contents, as is standard practice, according to people familiar with the matter. Analysts were allowed to ask questions, and following the calls, a majority of them revised their estimates on revenue and earnings, the people said.

Morgan Stanley and the other underwriters sprang into action. In the middle of the roadshow, the banks informed key clients - including large hedge funds, mutual funds and wealthy individuals - of the declining revenue prospects at Facebook. It was a significant red flag.

The Wall Street firms prepared talking points for their salespeople outlining downward revisions on Facebook revenue for the second quarter and full year, people familiar with the matter said. The salespeople scrambled to make as many calls as possible to key clients, reading out the new numbers.

Morgan Stanley said in a statement that a "significant number" of analysts in the IPO syndicate reduced their "earnings views" after Facebook's regulatory disclosure. It said the revised views "were taken into account in the pricing of the IPO."

In any case, the tension was building. In a row of desks on the 4th floor of Morgan Stanley's Times Square headquarters, officials on the company's "syndicate" desk worked the phones, assessing demand from investors to "build a book" - lining up potential buyers to help determine at what price to offer the IPO. Nearby, Morgan Stanley bankers talked with the other investment banks co-managing the deal. As lead manager, Morgan Stanley basically "ran" the books; that is, it helps to decide how many shares are allotted to its clients and how many are to be sold to each underwriter.

Fidelity Investments was among big clients that were told by analysts or bank sales staff of the declining Facebook financial picture, people familiar with the matter say. The nation's third-largest mutual fund firm expressed frustration to Morgan Stanley about Facebook valuations based on the dimming prospects for the company, the people say.

A Fidelity spokesman declined to comment.

Roger Duvendack was one of the many individual investors who were in the dark from his broker. He says he bought 2,000 Facebook shares at 11:30 a.m. on Friday at $42.97 a share, and put his shares up for sale at $45 at 11:33 a.m.

As he saw the shares move down, Mr. Duvendack altered his sale price to $44. After Facebook hit $38 a share that morning, he bought 2,000 more shares at $38.69 just before noon on Friday. He then made several attempts to sell between $41 to $41.40 a share.

But because of Nasdaq's technical glitches, he says, his orders couldn't be executed.

On Tuesday, a senior Nasdaq OMX Group Inc. executive told customers that the exchange would have put the brakes on Facebook's IPO had it known the extent of the technical problems that plagued its systems that day.

Mr Duvendack called his broker, Fidelity, and was told he was having problems because of technical issues at Nasdaq. Eventually on Monday, he says he sold his shares at a loss of nearly $18,000.

A Fidelity spokesman said the company is working with regulators and Nasdaq on behalf of customers who experienced problems.

A senior Nasdaq executive told brokers Tuesday that Nasdaq executives "regret sincerely what happened on Friday," and said that Nasdaq can't assess individual retail customers' losses but is working with brokers that are seeking compensation for those retail clients.

-  Jenny Strasburg,  Anupreeta Das,  Susan Pulliam and Aaron Lucchetti contributed to this article
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