Facebook IPO Insider Trading: A Misread Notion or A Serious Issue?

Facebook went public and being the biggest social network and the biggest tech IPO in the history, the news aren’t quieting down. If you have any knowledge on IPO’s and stock trading in general, you’ve probably heard of the term insider trading, a form of illegal trading of stocks by individuals that have access to non-public information.

Well, in the biggest IPO of the year, it seems that some strange stuff happened there. Some information leaked only to a selected few, leaving the public in despair now that Facebook’s shares are down. So, what really happened in the Facebook IPO?

Is Social Really Worth It?

Many business analysts agree that social media is (still) just a hype and everything built on it will burst like a bubble. Now that Facebook is a public company and it is valued at over $100 billion, those claims seem to be true; social media is probably at its peak, going down from now on. Targeted advertising you say? It may work for some, but the others would disagree – General Motors decided to stop advertising on Facebook, claiming that paid ads on Facebook have very little or no impact of consumers, Wall Street Journal reports:

On May 15, The Wall Street Journal reported that General Motors Co. planned to stop advertising with Facebook after deciding that paid ads on the site have little impact on consumers’ car purchases. The move fueled questions about whether Facebook’s business prospects could support its valuation.

But that’s just the tip of the iceberg – if you’re a Facebook shareholder, you’re probably pretty disappointed with the prices during the week. Unfortunately, you’re about to be even more angry.

The Big Fish Eat the Little Fish

In the middle of the IPO roadshow (nb. a roadshow is a presentation by an issuer of securities to potential buyers, intended to create interest in the securities) bankers cut their forecasts for the company, Business Insider writes. It seems that Facebook’s lead underwriters Morgan Stanley, JP Morgan and Golman Sachs suddenly cut their earnings forecasts at the same time. This is a major problem for the public, because it is obvious that they’ve had some information which wasn’t pass on to the public.

Earnings forecasts are material information, especially when they are prepared by analysts who have had privileged access to company management. As lead underwriters on the IPO, these analysts would have had much better information about the company than anyone else.
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In other words, during the marketing of the Facebook IPO, investors who did not hear about these underwriter estimate cuts were placed at a meaningful and unfair information disadvantage. They did not know what a lot of other investors knew, and they suffered for it.

Selective dissemination of this sort could be a direct violation of securities laws. Irrespective of its legality, it is also grossly unfair.

That’s not very nice, isn’t it? But what was the information the underwriters had and the public didn’t?

Panic Attack?

What actually happened is that some Facebook executive told the underwriters to cut their estimates. David Ebersman, Facebook CFO decided to boost up the number of Facebook shares by 25%, but that wasn’t the only problem – Facebook practically announced that its second quarter falls short of analysts’ estimates; of course, only the underwriters knew this. Business Insider has the quote from the updated IPO prospectus, filed on May 9th:

Based upon our experience in the second quarter of 2012 to date, the trend we saw in the first quarter of DAUs increasing more rapidly than the increase in number of ads delivered has continued. We believe this trend is driven in part by increased usage of Facebook on mobile devices where we have only recently begun showing an immaterial number of sponsored stories in News Feed, and in part due to certain pages having fewer ads per page as a result of product decisions.

Hence their estimate cuts; they knew that Facebook will have a bad Q2 and that the stock prices will drop. Unfortunately, individual investors didn’t get that information and were put in a bad position. Many of them invested a lot of money (relatively) into Facebook shares and are now in a huge loss.

What do you think will happen next with the Facebook as a public company? Will it burst?