Small investors face an uphill battle with a lawsuit against Facebook and its investment banks, complaining that crucial information was concealed ahead of the companys initial public offering last week, according to legal experts.
Adam Pritchard, a securities law professor at the University of Michigan law school, says that investors must prove that Facebook made a material misstatement in its prospectus in addition to claiming that more information was passed to institutional clients than to retail investors.
You have to be able to show something in the registration statement thats misleading, Pritchard says. That strikes me as a pretty steep challenge for the plaintiffs attorneys based on what we know so far.
Facebook closed at $32 a share Wednesday, down from the $38 offering price last week, but a gain of $1 on the day. The approximately $2 billion in market capitalization that has been lost since the IPO makes it a tempting target for legal maneuvers.
The lawsuit, filed in U.S. district court in Manhattan Wednesday, charges the defendants with failing to disclose a severe and pronounced reduction in revenue estimates for Facebook that were passed to the underwriters by the company.
The company disclosed in a regulatory filing on May 9 that it faced a number of challenges to its growth prospects, including the fact that an increasing number of consumers accessed the website on mobile devices, from which it earned less revenue for ads. The question is whether that information is essentially what was passed to investment banks.
Elizabeth Nowicki, an associate law professor at Tulane University, says that if the information passed to institutional investors was so important, then that nonpublic information made the prospectus materially misleading because it didnt include that information.
But Michigans Pritchard says that the requirement to equally share information about a company, known as regulation FD, for fair disclosure, only applies to public companies and Facebook was a private firm until its IPO last Friday. Regulation FD also has an exception for disclosures made in connection with public offerings.
The argument that its a regulation FD problem is pretty thin on two grounds, Pritchard says.
There is no requirement in the law that companies disclose revenue forecasts in their IPO prospectus. Indeed, Pritchard says to do so would be foolhardy because it would invite lawsuits if the forecasts prove to be wrong.
There is also no requirement for a company to give the same information to retail investors that it gives to its investment banks, Pritchard says. If retail investors think they do, they are delusional, he says.
Nowicki says the Facebook situation reminds her of what happened in the Internet boom a decade ago.
The bigger issue in my mind is that it smells bad, Nowicki says. This whole situation smacks of 1999 where you had big IPOs with tech companies that had crazy valuations. Nobody complained because they made money on the first day, but now were seeing volatility in the downward direction and nobody likes that.