Facebook IPO debacle triggers legal debate over disclosure

May 24 (Bloomberg) -- Facebook Inc.’s initial public offering has triggered allegations the social network and banks led by Morgan Stanley selectively disclosed crucial information to investors. Securities law experts say it’s not clear the firms did anything wrong.

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

“This is a gray area,” Tamar Frankel, a professor at Boston University School of Law, said in a telephone interview. “There are a zillion rules, but there isn’t a rule that addresses precisely this.”

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

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

Facebook’s stock has dropped 16 percent since the initial share sale, spurring shareholder suits from New York to California. They allege that Facebook and its underwriters misled investors by failing to disclose the figures to a wider audience. Information is material if it would probably affect a company’s share price, if known. The stock rose 2.9 percent to $32.93 at 9:32 a.m. in New York today.

Burden of Proof

The Menlo Park, California-based company didn’t give the analysts any materially different information than the updated prospectus, said a person close to the company. It’s standard for a company to provide guidance to analysts ahead of an offering, that person said. Larry Yu, a spokesman for Facebook, declined to comment.

Any lawsuit will have to prove that the information Facebook and its bankers gave investors was material, or important, said Jeffrey Manns, professor of banking and securities law at George Washington University.

“It might have been better for Facebook had they made more specific disclosures and made them publicly, because rather than a story of public outrage and disgust, the expectations might have been a bit more tempered in a healthy way,” said Manns. “Facebook wouldn’t have this shadow of potential securities litigation hanging over their head.”

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