Morgan Stanley case exposes Facebook to similar challenges

Class Action

William Galvin, the Secretary of the Commonwealth of Massachusetts, said he didn’t have the authority to determine whether Facebook executives acted improperly.

“The broader issue is the fairness of the marketplace for investors,” Galvin said in an interview this week.

The details emerging from the consent order may also add ammunition to dozens of class actions, which a judge ordered to be consolidated earlier this month. The testimony disclosed by Massachusetts could be used by prosecutors attempting to make a case that Facebook and Morgan Stanley misled investors, said Erik Gordon, a clinical assistant professor at the University of Michigan’s Stephen M. Ross School of Business.

“The real liability for Facebook and Morgan Stanley is yet to come,” said Gordon.

If Facebook omitted material facts in its prospectus, known as an S-1, it could be found in violation of Section 11 or Section 12 of the Securities Act of 1933, Diamond said.

‘Scariest Thing’

While it told potential investors that mobile usage could adversely affect revenue, the revelation that it gave a select group of analysts specific numbers on how that trend would affect sales over the full year could be considered a material omission, he said.

A violation of Section 11 could result in a fine or injunctive relief, or it could force the company to return proceeds of its IPO to shareholders, Diamond said.

“A material misstatement or omission in an S-1 is the scariest thing in the world,” Gordon said. “It’s going to hinge on whether the disclosures made in the S-1 were sufficient to give reasonable investors as accurate a view as reasonably possible.”

One of the earliest signs that Facebook’s growth wouldn’t reach the rosiest projections surfaced on May 7, the day the roadshow began, according to testimony cited in the settlement. That evening, Facebook Chief Financial Officer David Ebersman informed Grimes that Facebook’s second-quarter revenue would likely be lower than previously estimated.

Less Confident

Ebersman had told analysts at an April 16 briefing at Facebook’s headquarters that sales would be $1.1 billion to $1.2 billion.

Now, Ebersman was telling Grimes that he was less confident about those numbers because user growth on mobile devices was outpacing advertising gains. Ebersman also said it was unlikely that Facebook would reach $5 billion in sales for the year, as he’d told analysts.

Grimes relayed that information to a Morgan Stanley capital markets banker, according to Massachusetts.

The next day, May 8, as the roadshow moved from New York to Boston and Baltimore, Facebook was predicting quarterly sales at the low end of its $1.1 billion to $1.2 billion range and sales 3 percent to 3.5 percent below the full-year estimate.

Grimes said in testimony that he advised Ebersman to update analysts on the numbers. To avoid the appearance of incomplete disclosure, he recommended updating the prospectus again to show investors the trend.

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