When Facebook Inc. filed its proposal Feb. 1 to go public, ittouted the effectiveness of ads linked to customers' friends,citing research from Nielsen, the audience-counting company.

Barbara Jacobs, an assistant director for corporation finance atthe U.S. Securities and Exchange Commission, was skeptical, as sheand her staff vetted the filing to ensure Facebook had disclosedall material information to investors. The claim appeared to bedrawn from marketing materials, not a Nielsen study, she wrote toChief Financial Officer David Ebersman, 42.

She gave him an ultimatum: Produce the study and provideNielsen's consent for use of the data — or don't use it, she wroteto Ebersman on Feb. 28. Facebook dropped the reference afterinitial resistance.

The incident was part of a two-and-a-half-month volley ofmessages among SEC officials, Ebersman and Facebook's law firmFenwick & West LLP. A dozen letters, published a month afterthe May 17 IPO on the SEC's website, depict a management teamhesitant to disclose information and still guessing at evenrudimentary aspects of its business just weeks before the companyheld the largest-ever technology initial public offering. Many ofthe issues raised by the SEC and now unnerving investors wereforeshadowed in the then-private correspondence between the SEC andFacebook.

“They were given the benefit of the doubt when they went publicthat they were ready for prime time,” said Michael Pachter, amanaging director at Wedbush Securities Inc. “They still haven'tproved that they are.”

The shares dropped as much as 3.6 percent today.

On the most critical issue facing Facebook's future as a publiccompany — whether it could make money from the soaring number ofmobile users, who see fewer ads than other customers – - theletters show executives holding back crucial details until the SECpushed for further disclosure.

Noting that Facebook was counting some mobile users twice,Jacobs wrote on March 22: “Please explain to us how you determinedthat your metrics are not overstated.”

Only eight days before the IPO, on May 9, did Facebook makeclear in a filing that that daily mobile customers were increasingfaster than advertising growth, potentially hurting revenue andprofits. It was the strongest public signal that the IPO could fallshort of its high expectations.

The issue of mobile users is even more relevant today asFacebook, based in Menlo Park, California, announced on Oct. 4 itnow counted one billion users worldwide, up from 845 million at theyear's start. More than half of them, or 600 million, accessFacebook through a mobile device, a number that grew 41 percentthis year.

'Increasingly Skeptical'

“We've been growing increasingly skeptical of some of theirmonetization methods,” Richard Greenfield, an analyst at BTIGResearch, told Bloomberg Television on Oct. 8, referring toFacebook's struggles to get revenue from mobile users. He cut hisrating on the shares to sell.

Facebook went forward pricing the IPO at $38 a share. That was107 times trailing 12-month earnings, making it more expensive than99 percent of all companies in the Standard & Poor's 500 Indexat the time. The SEC has no say in setting IPO prices.

Once called the IPO of the century, Facebook has dropped 45percent through Oct. 5. That's the worst offer-to-date performanceof any U.S. IPO raising at least $1.5 billion since 2007, when MFGlobal Holdings Ltd. went public, according to data compiled byBloomberg.

The shares dropped 3 percent to $19.63 at 9:48 a.m. New Yorktime, the lowest intraday level since Sept. 11.

Ashley Zandy, a spokeswoman for Facebook, declined to commentfor this story.

The losses were acute for retail investors. They were allocatedan unusually high proportion of shares after institutionalinvestors balked. And they didn't get the same flurry of warningcalls from Facebook officials who, days before the IPO, privatelyadvised securities firm analysts to lower earnings and profitestimates — largely on the dearth of revenue from mobile users.

“It has been clear from the beginning that the insiders werebailing given that they sold $10 billion of shares and continued tosell as the lock-up period expired,” said Francis Gaskins,president of IPOdesktop.com, an independent IPO research firm inMarina del Rey, California. “They clearly knew that the company'sbest growth rate was behind them and the stock was overvalued.”

By the time the final amended prospectus was filed May 16, a daybefore the company went public, Facebook had over the weeksincluded the mobile data and many of the material facts the SEC haddemanded.

SEC Correspondence

What investors didn't see until a month after the IPO were theletters that pushed Facebook to disclose in detail such keyfinancial challenges as decelerating revenue growth, user count andits dependence on gaming company Zynga Inc. — all issues that arosein prominence after it became a public company.

Publishing the SEC letters beforehand would be “a better way toget the information to the market than an amended filing,” saidPeter Henning, a former SEC lawyer who teaches at Wayne StateUniversity in Detroit. “The SEC is a better soap box than thefilings.”

Even a summary of points would be helpful for investors, Henningsaid, should the SEC decide that disclosing the letters would exertundue influence over market sentiment.

“As an investor you want all the information you can get, andthat would certainly be one of the pieces,” money manager MichaelHolland, chairman of Holland & Co., said of the correspondence.He chose not to buy Facebook at the IPO because it was moreexpensive than Apple Inc. and Google Inc., he said.

Current SEC policy is to release correspondence no earlier than20 business days after the IPO. The SEC doesn't post correspondence“real time,” said John Nester, a spokesman, because “people couldmisinterpret our questions to companies about their disclosurebefore companies have had opportunities to provide a completepicture.” By law, “a company is responsible for its owndisclosures,” he said.

Luigi Zingales, a finance professor at the University ofChicago's Booth School of Business, said Facebook should havedelayed the IPO after it cut its forecasts. Analysts said the laterevisions were surprising and almost unprecedented.

“When you have a significant change in your forecasts, it's goodbusiness practice to postpone the IPO so that the market has moretime to understand what's going on,” Zingales said.

By the time the letters were published, the stock was cratering,on the way to losing half its $38 IPO price and erasing as much as$49 billion in market capitalization. The stock that sold for $16billion in the IPO was worth $8.6 billion as of Oct. 8, datacompiled by Bloomberg show.

Month's Salary

Ryan Cefalu, a 34-year-old data-systems manager and father oftwo in Baton Rouge, Louisiana, said he bought about $4,000, orabout a month's salary, in Facebook stock and has lost about $2,050on paper.

“The IPO went terribly,” he said. “I expected it to go up for acouple days at least before it went it down. That never happened.It never had a chance to.”

The SEC continues to investigate Facebook's IPO to determinewhether any material information was omitted or misrepresented. TheSEC is conducting an “in-depth review of all the participants” inthe IPO, SEC Chairman Mary Schapiro said in an interview that airedSept. 28 on Bloomberg Television. She declined to elaborate.

The Senate Banking Committee is also looking into the matter,and has held meetings “with a range of involved parties includingFacebook, Nasdaq, Morgan Stanley, and the SEC,” said Sam Gilford,press secretary for the Senate committee, in an e- mailedstatement.

Facebook's eight-year transformation into the largestsocial-networking service is the stuff of legend. Born of marathonlate-night coding sessions by Mark Zuckerberg and his HarvardUniversity schoolmates, Facebook swiftly expanded beyond being asite for college kids into a network linking people from across thecountry, and eventually, the globe.

An IPO loomed as the investor base widened, reflecting insiders'desire to sell. It was also spurred by SEC financial disclosurerequirements for companies that have more than 500 shareholders.All the while, the public caught glimpses of Facebook's potentialvaluation from high-profile private investments — like MicrosoftCorp.'s purchase of a 1.6 percent stake, which gave Facebook a $15billion valuation, or a $1.5 billion private placement managed byGoldman Sachs Group Inc. valuing Facebook at $50 billion.

Stock 'Hysteria'

Facebook trading on secondary market-maker SecondMarket Inc.suggested a market cap of $85 billion in July 2011, seven monthsbefore Facebook disclosed on Feb. 1 that it planned a sharesale.

“Before the underwriters were even selected, hysteria about thisstock was already out of control,” Erik Gordon, a professor at theUniversity of Michigan's Ross School of Business, said in a phoneinterview.

It's not unusual for a company going public to tussle with theSEC over what should be included in its prospectus. Yet Jacobs'sinquiries underscored growing concern within the SEC over the waynewer consumer Web companies account for increasingly large userbases, according to a person with knowledge of the matter.

The regulator is spending more time scouring user-growth metricsand requiring more details, said this person, who asked not to benamed because the SEC's review process is confidential.

Last year the agency pressed Groupon Inc. to abandon anaccounting method that made the then-unprofitable daily couponbusiness look profitable by hiding certain marketing costs, aperson familiar with the matter said at the time. Julie Mossler, aspokeswoman for Chicago-based Groupon, declined to comment.

The official whose name became most closely associated with theprodding of Facebook is the SEC's Jacobs, whose eight-personinformation technologies and services team at the SEC's DisclosureOperations Office was tasked with reviewing the Facebook filingsthat began Feb. 1.

Jacobs, who is 51 in public records, has held various roles atthe SEC since 1989, once proposing rules to let small companiesprice securities on a delayed basis, according to her profile onthe Practising Law Institute's website. She holds law degrees fromthe University of San Francisco and Georgetown Law Center.

Her letters were addressed to Ebersman, who joined Facebook aschief financial officer in 2009 after holding the same title atdrugmaker Genentech Inc. from 2005 until early 2009. A graduate ofBrown University with a degree in economics and internationalrelations, Ebersman replaced Gideon Yu, who left after Facebooksaid it wanted a successor with experience in running a publiccompany.

Zynga Questions

Facebook's responses were signed by Jeffrey Vetter, 46, of theMountain View, California, law firm Fenwick & West. He declinedto comment. Vetter, who joined Fenwick in 1995, has also helpedprepare public offerings for companies including Fusion-io Inc. andJive Software Inc.

By the end of February, the SEC had amassed a list of 92 matterson which it sought further information.

An area of concern: Facebook's reliance on Zynga, which makesthe five most popular games played on Facebook including “TexasHoldEm Poker.” When Zynga missed earnings estimates in July,Facebook's stock tumbled 8.5 percent, underscoring theirinterdependence.

At first Facebook's filing said Zynga accounted for 12 percentof 2011 revenue. After further prodding, Vetter said that Facebooklast year got 19 percent of revenue from Zynga — 12 percent fromprocessing fees of virtual goods and 7 percent from ads on pagesgenerated by Zynga apps.

The SEC also got Facebook to include a warning that Zynga, whichhad recently begun offering games on its own and other websites,could lure Facebook users away, hurting Facebook financially.

“Zynga may choose to try to migrate users from existingFacebook-integrated games to other websites or platforms,” Facebookdisclosed. As a result, “Our financial results may be adverselyaffected,” it said.

Concerns related to Zynga drove JPMorgan Chase & Co. andMorgan Stanley to cut their price targets for Facebook last week.They cited lower expectations for revenue from Facebook's paymentsbusiness after Zynga reduced forecasts.

Dani Dudeck, a spokeswoman for Zynga, declined to comment.

Revenue Details

Jacobs also asked Facebook why it hadn't included data onrevenue generated by each user, a “key” indicator of performance.Vetter dismissed the request on March 7, saying that the companyprefers to look at “overall growth in users” and “overall revenuein evaluating the business.”

Unswayed, the SEC carried out revenue-per-user calculationsitself, which Facebook only then included in a revised filing onApril 23.

The figures showed revenue worldwide from each monthly activeuser declining, to $1.21 in the first quarter from $1.38 in thefourth, a seasonal drop, according to Facebook. They also revealedthat per-user revenue was lower in Asia, at just 53 cents down from56 cents in the fourth quarter.

One of the most contentious issues was Facebook's haltingdisclosure of the number and growth of mobile users of Facebook,where they were located, and how it would derive revenue fromthem.

In its initial filing, known as an S-1, the company said mobileusage of Facebook increased around the world and numbered 425million “monthly active users” in December 2011. It acknowledgedthat it hadn't proven it could “monetize” people using only mobiledevices, where the absence of ads may “negatively affect ourrevenue and financial results.”

Jacobs responded on Feb. 28 by asking for a “more detailed”discussion of these key challenges. If the company's attempts tomonetize those mobile users fail, she wrote, then “ensure” thatyour disclosure addresses the potential consequences to revenue,“rather than just stating that they 'may be negativelyaffected.”'

Vetter filed a revised prospectus on March 7, disclosing thatFacebook's monetization strategy could run up “excessiveexpenses.”

Still, in a letter the same day he resisted Jacobs's effort toreveal the number of users who “primarily access” Facebook throughmobile devices, saying they didn't have a “reliable” count.

Facebook would disclose the number of daily active mobile usersonly “for the staff's reference,” not in its registrationstatement, Vetter wrote. That number showed a big jump, to anestimated 58 million mobile-only Facebook users on Dec. 31, 2011,from 23 million on March 31, 2010.

Mobile-Only

Jacobs asked for the impact on revenue of greater mobile use,only to be told by Vetter that Facebook couldn't “specificallyassess the impact” as those users may also be using personalcomputers to get onto Facebook. When asked how many new users weremobile only, he estimated that 69 million, or 44 percent, of the156 million new users might be mobile- only.

Asked about the geographical breakdown of mobile users, Vettersaid it didn't have a reliable count. For instance, he said, thecompany counted as Canadian many BlackBerry users around the worldbecause the servers are based in Canada.

This prompted Jacobs to question whether Facebook's then-overall user count of 845 million might be wrong as a result of thefuzzy number of mobile users.

Facebook said it believed its data were “reasonably accurate” asoverall data eliminated the multiple counting of mobile users.

On May 9, Facebook released a disclosure to investors cautioningabout the growth in mobile users exceeding growth of ads. It was apivotal admission — and one of the first warnings that drewwidespread attention from analysts and investors.

On that same day, Zuckerberg, Ebersman and Chief OperatingOfficer Sheryl Sandberg were in the midst of the road show to pitchthe stock to investors.

Investor relations staff at Facebook began placing a battery ofcalls to equity analysts with a dour warning: sales for the secondquarter and full year wouldn't likely match its earlier guidance,according to people familiar with the situation.

Analysts adjusted their forecasts down and shared them verballywith their firms' institutional clients, whose demand for the stocksagged as a result, people with knowledge of the matter said on May10. Sharing that information only with institutions isn't unusual,and it's legal as long as they don't do it in writing.

Market 'Mistrust'

Still, said finance professor Zingales, “The fact that someinstitutional investors got access to a company's information thatwas not available to ordinary investors creates the perception thatthere are two sets of rules and increases the mistrust in themarket.”

Despite the cautionary signs, on May 15 Facebook and MorganStanley executives raised the asking price to a range of $34 to $38from $28 to $35. A day later they also increased the number ofshares being sold by 25 percent to 421.2 million. That was aneffort to create a stronger buffer against a price decline inAugust when insiders and early investors were allowed to sell theirstock, said one person familiar with the matter. The lock- upperiod was for only three months, unusually short compared to theaverage six months.

The final pricing decision was worked out in a May 17 conferencecall joined by the highest ranks of Facebook and lead underwriterMorgan Stanley. On the call were Ebersman, Michael Grimes, MorganStanley's global co-head of its technology investment bankinggroup, and Morgan Stanley CEO James Gorman, an unusual appearanceby an investment bank's chief that reflected the importance itascribed to the IPO, people familiar with the matter said May 23.JPMorgan and Goldman Sachs executives joined in too.

They reached consensus on pricing the IPO at the top of the $34to $38 range, as a lower level would have signaled weakness indemand, said one of the people close to the situation.

Contention also arose over the volume of shares that should beset aside for retail customers. Facebook went into the road showwith the intention of shifting more shares than usual to retailinvestors, according to the same person. Goldman Sachs, one of thebanks in the IPO, pushed back against the idea, arguing that it washard to gauge retail demand and that those investors tend to sellquickly at the first sign of a stock's volatility, the personsaid.

Including Users

Yet Facebook wanted the larger retail allocation to let itsusers take part in the IPO, the person said. In the end, 25 percentof the shares sold at the IPO were allocated to retail investors,other people have said. That exceeds the average amount of 15percent.

On the first day the lock-ups expired, Aug. 16, Facebookdeclined 6.3 percent to $19.87. Those shares freed up made up only14 percent of the total 1.91 billion that will eventually beunlocked.

“Perhaps management should have seen that the party was gettingout of hand, and should have understood that the hangover would bewicked,” said Lise Buyer, principal at Class V Group in PortolaValley, California.

There were no headaches for investors who bought equity whileFacebook was still private and were able to sell at the $38 IPOprice. Goldman Sachs sold 24.3 million shares, which raised $924million at the IPO price, doubling its original investment.Greylock Partners made 18 times its initial investment, selling 7.6million shares for $289 million. Microsoft sold 6.6 million shares,which raised $249 million, more than quintupling its initialstake.

Spokesmen for Morgan Stanley, Goldman Sachs and JPMorgandeclined to comment.

Company executives did little to help their cause amongshareholders during Facebook's first months as a newly publiccompany.

After Zuckerberg's presentations for investors during thepre-IPO road show, the CEO went four months with few publicappearances, doing a July 13 interview with Bloomberg News anddefending the company's projections on a July 26 call withanalysts. Apart from contributions to that call, which coveredsecond-quarter results, Ebersman and Sandberg also shied away fromthe limelight.

Silence over the plunging share price and growth prospects didlittle to allay investors' anxiety, said Paul Argenti, a professorat Dartmouth College's Tuck School of Business in Hanover, NewHampshire.

'Amateurish' Approach

“There should be more public appearances by the CEO, thereshould be ongoing media relations activities that help giveconfidence to investors,” Argenti said. “I don't see any of thatgoing on. I see the exact opposite. It's amateurish.”

Zuckerberg returned to the public eye in a Sept. 11 on- stageinterview at the TechCrunch Disrupt conference in San Francisco. Heacknowledged that the company had made missteps in executing amobile strategy. Based on the amount of time users spend on mobile,he said, the company should eventually make “a lot more money” viawireless devices than through desktops.

Since May, the company has rolled out new advertising servicesfor its mobile versions. That includes an offering that lets gamemakers on its service target users to download their applicationson smartphones.

Facebook stock has reversed part of the losses suffered sincethe IPO, climbing 14 percent to $20.23 yesterday since hitting arecord low of $17.73 on Sept. 4.

Yet the shares will probably come under more pressure startingin mid-October, when holders of more than a billion shares, many ofthem employees, will be permitted to sell.

At $20 a share, Facebook trades at 42 times estimated 2012profit, still more than twice Google's price of less than 18 timesprofit.

Among more than 40 lawsuits related to Facebook's offering, someinvestors blame their losses on trading errors by Nasdaq, whereFacebook is listed. Others claim company managers didn't discloserevised revenue forecasts in the days before the stock started totrade publicly on May 18, or they didn't warn that a surge inmobile users would slash revenue.

Facebook has said the suits, which have been consolidated underone judge in federal court in New York, lack merit. If Facebook canprove it disclosed all the risks adequately pre- IPO, the suits maybe an uphill battle for investors.

The IPO proved a harsh lesson to first-time investors like LindaLantz, an online marketer in Granite Bay, California, who bought100 shares in the offering with hopes of Internet riches.

After losing close to $1,500 in the four months since, Lantz hasan appreciation for the difficulty in valuing social mediacompanies with many users and relatively small profits, she said inan interview.

“The problem with Facebook is that it's not a tangible good, andbecause it's not a tangible good, people can't feel and touch it,and it definitely has a huge risk of doing what it did,” Lantzsaid, “and that's to go down.”

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