Technical errors caused by the Nasdaq stock exchange helped push down Facebook shares in early trading, the social networking giant suggested in a legal filing late Friday, turning what should have been a triumphant moment for Silicon Valley and Wall Street into one of the worst-performing IPOs in U.S. history.
Facebook’s claim about Nasdaq’s performance — contained in a motion to consolidate more than 40 lawsuits over the botched IPO in the Southern District of New York — offers a hint about Facebook’s legal defense, and makes it clear that the company is less than thrilled with the way the exchange handled its duties. Facebook’s motion comes amid an escalating blame-game over the IPO between the company’s bankers, with particular responsibility being laid at the feet of Morgan Stanley tech honcho Michael Grimes, who reportedly insisted that he alone be the “single driver” of the IPO.
If Facebook’s motion is granted — as some experts believe it will be — over 40 lawsuits filed in various federal and state courts will be consolidated in the Southern District of New York, without question the most high-profile venue for financial litigation. (The federal courthouse is just blocks from Wall Street.) That could set up one of the most blockbuster finance trials in years, with intense media interest and coverage. Top executives from Facebook, Nasdaq, and the three lead underwriters, Morgan Stanley, Goldman Sachs, and JPMorgan Chase, could be called to testify.
They’ll face investors angry over a variety of aspects about the IPO, including the fact that trading on the Nasdaq was delayed for 30 minutes, and trades for millions of shares were never confirmed. These problems, Facebook suggests in its motion, spooked investors, causing many to sell, driving the stock price down. Facebook shares traded at about $31 mid-day Monday, down about 20% since the company went public at $38, the largest-ever first-month decline for a billion-dollar IPO of a U.S.-based company, according to Dealogic data cited by The Wall Street Journal. Over $20 billion in shareholder value has evaporated since the offering. In its motion, Facebook clearly lays the blame for the debacle on Nasdaq:
Trading errors caused by Nasdaq throughout the first day of the I.P.O.; the market’s reaction to the uncertainty created by those errors; Nasdaq’s announcement of a claims submission deadline at noon on the second trading day (May 21) that reportedly sparked a selloff of Facebook shares; alleged efforts by one of the lead underwriters to stabilize the share price after Nasdaq’s errors; the public apology and admissions issued by Nasdaq’s C.E.O.; and Nasdaq’s offer of compensation to investors who suffered losses.
Thus, we see the outlines of Facebook’s defense, as described in The New York Times by Peter J. Henning and Steven M. Davidoff, two prominent law professors who focus on white collar crime. “If Facebook can prove that Nasdaq was the reason for the decline in the share value, then the company and its underwriters are off the hook for damages,” the pair wrote Monday in The Times.
Nasdaq’s breakdown is but one source of the flurry of lawsuits, however. Several filings aim directly at Facebook and its underwriters. One set of lawsuits alleges that Facebook’s IPO documents “were negligently prepared and failed to disclose material information about Facebook’s business, operations and prospects.” Specifically, the lawsuits charge that Facebook hid the financial impact of challenges to its mobile advertising business — challenges that would have been material information for prospective Facebook investors. Another set of lawsuits charges that analysts at Facebook’s banks lowered their financial forecasts, which they then “selectively disclosed” to big, favored clients, but didn’t inform the investing public at large.
On this score, predictably, Facebook maintains that it acted appropriately. It says it updated its IPO documents with the SEC to reflect that the number of daily users was increasing faster than the number of ads the company was serving, a change it attributed to its fast-growing mobile user base. Facebook also points out that the revision was widely covered in the press. The investing public, therefore, received adequate disclosure of the mobile weakness, according to Facebook. (Facebook’s update was delivered in dense, relatively-opaque securities-legalese, but may in fact have satisfied the disclosure requirements.)
Newly-released SEC documents show that the regulator was concerned about the transparency of Facebook’s disclosure. In a February 28 letter to Facebook CFO Ebersman, SEC lawyers wrote: “Assuming that the trend towards mobile continues and your mobile monetization efforts are unsuccessful, ensure that your disclosure fully addresses the potential consequences to your revenue and financial results rather than just stating that they ‘may be negatively affected.” In a statement made to Reuters Friday, Facebook said: “We responded to all SEC comments over the course of this correspondence and the SEC declared our registration statement effective on May 17.”
Facing angry investors, and with millions of dollars at stake, it’s clear that all of the participants in Facebook’s IPO are running for cover. Ironically, the only entity that has actually stepped up to take some blame is the Nasdaq market, whose CEO has apologized for the technical errors that plagued the offering. Ultimately, this matter could come to a head at a super-high-profile trial in lower Manhattan. Facebook clearly wants this matter adjudicated as far as possible from its Silicon Valley-stronghold. If the lawsuits are consolidated in the Southern District, investors will get their day in court. But the rest of us may be treated to another, now-familiar spectacle of Wall Street being dragged through the mud over what should have been one of its great triumphs.