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Bloomberg News
Facebook’s initial public offering in May was a media event in New York. Not only did it not meet expectations, but it also has raised legal challenges.

Legal fallout of IPO looms for Facebook

Social-networking company’s bank punished for sharing inside details

– Facebook, the world’s largest social-networking company, could be exposed to legal challenges surrounding its initial public offering similar to those faced by Morgan Stanley, according to legal experts.

In the first regulatory claims to flow from the May 17 IPO, Massachusetts officials said this month Morgan Stanley will pay $5 million for letting its investment bankers provide research analysts with specific revenue information that was not disclosed by Facebook to the general public.

That broke a decade-old rule enacted after the dot-com crash that blocks bankers from influencing analysts, Massachusetts said.

The state’s settlement with Morgan Stanley includes for the first time details of the closed-door conversations between Morgan Stanley and Facebook before the IPO, including testimony from Michael Grimes, who led the deal for the bank.

According to the consent order, Grimes wrote a script for Facebook’s then-treasurer to read to analysts that detailed Facebook’s lowered revenue estimates.

Grimes “did everything but make the phone calls himself,” an SEC regulator said in a statement.

The revelation that Facebook gave specific estimates to bank analysts and not to the public revives questions about whether the company was sufficiently forthcoming ahead of the IPO, said Stephen Diamond, an associate professor at Santa Clara University School of Law.

“By providing that information to just a subset of potential investors, in essence they have denied other investors access to material information,” Diamond said. The Securities and Exchange Commission “should have pushed much harder to find out whether there was quantifiable data available or not,” he added.

Both Facebook and the SEC had no comment.

The settlement offers fresh insight into a widely anticipated IPO that turned into a debacle for the company and Morgan Stanley. Facebook shares have tumbled 27 percent since they started trading for $38 on May 18.

The company capitalized on its popularity among consumers by raising the price and number of shares sold to retail investors, who weren’t privy to the private conversations or revenue estimates.

William Galvin, 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.

The details emerging from the consent order may also add ammunition to dozens of class action lawsuits, 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, an 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,” Gordon said.

If Facebook omitted material facts in its prospectus, it could be found in violation of federal law that could force the company to return proceeds of its IPO to shareholders, Diamond said.