Facebook IPO faces intense scrutiny

Facebook Inc.'s $16 billion initial public offering is getting less friendly with each passing day.

Morgan Stanley Smith Barney LLC, the lead underwriter, last Tuesday released a statement defending its handling of the May 17 IPO after the Massachusetts Securities Division subpoenaed the investment bank over its communications with clients.

The Securities and Exchange Commission and the brokerage industry's watchdog both said they may review the offering, and buyers of the stock have sued Facebook, The Nasdaq OMX Group Inc. and the underwriters over the sale.

The anticipation that preceded history's biggest technology IPO has been replaced by investor ire, including about whether the offer was priced too high.

“Rather than anything illegal or untoward, the valuation was the truly unfathomable part of what's causing this frenzy,” said Michael Holland, chairman of Holland & Co., an investment firm that oversees more than $4 billion.

LAWSUIT FILED

Morgan Stanley, The Goldman Sachs Group Inc. and JPMorgan Chase & Co. were sued last Wednesday along with other underwriters and Facebook by investors who claimed they were misled in the purchase of the social-network firm's stock.

In a complaint filed in U.S. District Court for the Southern District of New York, the investors said the members of a proposed class action have lost more than $2.5 billion since the initial public offering last week. They claimed Facebook and the banks didn't disclose lower revenue estimates.

Also sued were units of Bank of America Corp. and Barclays PLC, and Facebook's top executives and directors, according to the filing.

Facebook spokesman Andrew Noyes wrote in an e-mail: “We believe the lawsuit is without merit and will defend ourselves vigorously.”

Pen Pendleton, Michael Duvally and Mark Lane, spokesmen for Morgan Stanley, Goldman Sachs and Barclays, respectively, declined to comment. Representatives of JPMorgan and Bank of America didn't return calls seeking comment.

Facebook increased the number of shares being sold in the IPO by 25% two weeks ago to 421.2 million and raised its asking price to a range of $34 to $38, from $28 to $35. It began trading at $38 and by last Thursday had dropped to $33.03.

DECISION MAKERS

Facebook chief financial officer David Ebersman was the point person on the deal, while chief executive Mark Zuckerberg and chief operating officer Sheryl Sandberg weighed in on major decisions, said people with knowledge of the matter, who declined to be identified, as the process was private. Dan Simkowitz, Morgan Stanley's chairman of global capital markets, was one of the main bankers. Michael Grimes, global co-head of technology investment banking, also played a key role.

Morgan Stanley, already taking heat for helping price the IPO, is on regulators' radar because of claims that research analyst Scott Devitt shared negative news about Facebook with institutional investors before the IPO, according to Richard G. Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority Inc.

Those communications may be a “matter of regulatory concern” to both Finra and the SEC, Mr. Ketchum wrote in an e-mail. He wouldn't say whether the commission is probing Morgan Stanley.

The Massachusetts Securities Division last Tuesday subpoenaed Morgan Stanley to learn more about talks between Mr. Devitt and the firm's institutional investors about Facebook's revenue, according to William F. Galvin, secretary of the commonwealth.

“There is a lot of reason to have confidence in our markets and the integrity of how they operate, but there are issues we need to look at specifically with regard to Facebook,” SEC Chairman Mary Schapiro told reporters last Wednesday.

Morgan Stanley said its procedures complied with all regulations. The bank “followed the same procedures for the Facebook offering that it follows for all IPOs,” Mr. Pendleton wrote in an e-mail.

FACEBOOK “SHARED NEWS’

The bank said it sent a copy of a revised prospectus that Facebook filed May 9 to all of its institutional and retail investors. The filing disclosed that Facebook's advertising growth hasn't kept pace with the increase in users.

Mr. Pendleton said that many analysts in the syndicate reduced their earnings estimates to reflect that information, and that those revised views were reflected in the pricing of the IPO.

Bloomberg News, citing two people with knowledge of the matter, reported May 10 that Facebook was telling analysts that sales may not meet their most optimistic projections.

The ill-starred IPO also was marred on its first trading day when Nasdaq's platform was overwhelmed by order cancellations and updates that made the stock market operator unable to finish the auction required to open.

The SEC said it will review the trading.

A Facebook investor sued Nasdaq OMX Group Inc. last Tuesday, also in Manhattan federal court, saying the exchange “badly mishandled” trades in Facebook stock, which resulted in delays and a failure to complete customer orders.

The investor is seeking class-action status for the suit on behalf of investors who lost money because their buy, sell and cancellation orders weren't properly processed.

Robert Madden, a spokesman for The Nasdaq Stock Market Inc., didn't return a call seeking comment on the suit. Ashley Zandy, a spokeswoman for Facebook, declined to comment on the action.

Related Topics: Initial Public Offerings (IPO)