Facebook Inc.'s initial public offering has triggeredallegations the social network and banks led by Morgan Stanleyselectively disclosed crucial information to investors. Securitieslaw experts say it's not clear the firms did anything wrong.

At issue is whether Facebook gave non-public, materialinformation to analysts that was then shared with select investorsin the form of lower earnings projections. The answer lies in theevidence uncovered and the interpretation of Regulation FD, a U.S.Securities Exchange and Commission rule that requires publicdisclosure of important information.

“This is a gray area,” Tamar Frankel, a professor at BostonUniversity School of Law, said in a telephone interview. “There area zillion rules, but there isn't a rule that addresses preciselythis.”

Facebook amended its IPO filing on May 9, about a week beforethe $16 billion sale, to say growth in advertising had failed tokeep up with user gains. It then contacted more than 20 analysts,including those at underwriters Morgan Stanley, Goldman Sachs GroupInc. and JPMorgan Chase & Co., to guide them toward the lowerend of its second-quarter sales estimate, according to a personwith knowledge of the matter.

A day after that filing, the analysts called up some investorclients to communicate their revised estimates for sales andprofit, said people with knowledge of the process.

Facebook's stock has dropped 16 percent since the initial sharesale, spurring shareholder suits from New York to California. Theyallege that Facebook and its underwriters misled investors byfailing to disclose the figures to a wider audience. Information ismaterial if it would probably affect a company's share price, ifknown.

Burden of Proof

The Menlo Park, California-based company didn't give theanalysts any materially different information than the updatedprospectus, said a person close to the company. It's standard for acompany to provide guidance to analysts ahead of an offering, thatperson said. Larry Yu, a spokesman for Facebook, declined tocomment.

Any lawsuit will have to prove that the information Facebook andits bankers gave investors was material, or important, said JeffreyManns, professor of banking and securities law at George WashingtonUniversity.

“It might have been better for Facebook had they made morespecific disclosures and made them publicly, because rather than astory of public outrage and disgust, the expectations might havebeen a bit more tempered in a healthy way,” said Manns. “Facebookwouldn't have this shadow of potential securities litigationhanging over their head.”

Morgan Stanley analysts cut their 2012 profit estimate forFacebook to 48 cents a share from 51 cents, said two of the people,who asked not to be identified because the process was private.They also cut their 2013 profit projection to 83 cents a share from88 cents, they said. Investors received the new figures by phone asunderwriters weren't permitted to publish anything about Facebookduring the marketing period, according to the people.

While the communication of the estimates may have been selectivedisclosure, investors may only have a case if they can prove thefiling omitted crucial information, John Coffee, a ColumbiaUniversity law professor, said in an e-mail.

“This is a good example of the shortfall of Regulation FD, whichshould embarrass the SEC,” he said.

While analysts cut their estimates, Facebook and itsunderwriters raised both the price range and the number of shareson offer. Facebook sold shares at $38 apiece in its IPO. The stockhovered close to that price in its trading debut as Morgan Stanleybought the stock to stabilize it, people familiar with the mattersaid at the time. The stock later fell as low as $30.94 on May22.

Running for Exits

“If it turns out that the vast majority of investors who ran forthe exits right off the bat, ran for the exits because they knewsomething, that's clearly material,” said Dominic Auld, a lawyer atLabaton Sucharow, a New York-based law firm specializing insecurities litigation on behalf of shareholders. He said he'scurrently not representing anyone with a suit in connection withthe IPO.

Morgan Stanley's procedures in the offering are in compliancewith all regulations, Pen Pendleton, a spokesman for the NewYork-based firm, said in a statement this week. The bank said itsent the revised prospectus to all institutional and retail clientsand that the revised analyst estimates were taken into account inthe initial share sale's pricing. He declined to comment beyond thestatement.

Investors have lost more than $2.5 billion since the offeringlast week, according to a complaint filed yesterday in Manhattanfederal court. Among those named as defendants in the suit areFacebook, CEO Mark Zuckerberg, Chief Financial Officer DavidEbersman, Morgan Stanley and other underwriters.

“The fact that underwriters took down their earnings estimatesis material information,” said Sam Rudman, a partner at RobbinsGeller Rudman & Dowd LLP, whose firm is handling the New Yorkshareholder suit. “There isn't any investor in Facebook thatwouldn't have wanted to know that.”

Facebook said in the May 9 filing that its revenue may benegatively affected by users accessing the site on mobile devicesrather than personal computers since the company's ability to makemoney off mobile users is “unproven.”

If the analysts' revisions were based on the public disclosures,banks wouldn't have needed to disclose them to all participants,said Boston University School of Law's Frankel. If the revisionswere based on inside information that other investors didn't have,“that may create a problem.”
SEC spokesman John Nester declined to comment on Facebook'sdisclosures.

“Until we unwind the facts and circumstances surrounding thissituation, it is inappropriate to speculate about what potentialviolations may have occurred,” said a spokesperson for theFinancial Industry Regulatory Authority, a financial industrywatchdog.

The size and prominence of Facebook's IPO may have made it moreof a target for shareholder suits, regardless of the facts at hand,said Dennis Kelly, chairman of government investigations and whitecollar crime at Burns & Levinson. The size may also increasethe threshold for disclosure, he said.

“Materiality is a moving target, it depends on a number ofmoving factors,” said Kelly. “It's first a decision for a judge andultimately a jury.”

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