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Tricky Issues in the Facebook Lawsuits

Pre-IPO selective disclosure may not even be illegal


Many investors have lost a tidy sum on the Facebook (NASDAQ:FB) IPO. But one group will get rewarded: securities attorneys. Today, three shareholders filed a civil suit against Facebook, Morgan Stanley (NYSE:MS) and the 33 other underwriters. What’s more, the attorney general of Massachusetts has sent a subpoena to Morgan Stanley.

At the heart of these actions is a bombshell story from Reuters. It claims that an analyst from Morgan Stanley, Scott Devitt, came up with lowered revenue and earnings forecasts for Facebook — and provided some investors with those estimates. This was based on information from an executive at Facebook. Those investors may have then sold their shares at the opening of the IPO, when the stock hit $42.

No doubt, this looks extremely distasteful. But is it illegal? Perhaps not. Keep in mind that analysts of the underwriters are not allowed to publish research reports until 40 days after the IPO. That’s according to a long-standing rule — called the “quiet period” — from the Securities & Exchange Commission.

Yes, it’s kind of a dumb regulation. And perhaps it may be changed because of the Facebook debacle.

Unfortunately, it’s also fuzzy as to what analysts can tell investors during the pre-IPO process. This is especially the case when the communications are oral, which appears to be the case with Devitt’s comments to investors.

All in all, the Facebook IPO has been another major hit to investor confidence. The offering attracted a large number of retail investors who have sustained major losses. Now, it looks as if they were kept out of the loop of critical information.

Is this any way to run a sophisticated financial system? In the end, let’s hope regulators find ways to make the IPO process more equitable and implement new rules that provide equal information for all investors.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.

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