Facebook Goes Public: The Tumultuous IPO Process

Is Facebook a force that will define a generation? Or is it a transient manifestation of the bigger social media revolution – springing from the demand to connect using the latest technologies?  While Facebook’s cultural impact raises such philosophical questions, its business model and recent IPO have raised legal questions that are likely going to take just as long to answer.

Throughout Facebook’s history, it has sought to balance its social and corporate missions. In a letter to prospective investors during the IPO process, Mark Zuckerberg remarked that Facebook was built “to accomplish a social mission” of creating a more connected world. Arguably, Facebook has fared well in its social mission. Through the power of networking, Facebook has helped connect diverse populations, crossing geographical, ethnic, and cultural boundaries. In some cases, Facebook even has helped facilitate revolutions. Not surprisingly, Facebook also is in a position to foretell where Internet usage is trending. Through placing certain advertisers in users’ newsfeeds, Facebook has shown the ability to increase traffic to advertisers three-fold.

Facebook, however, is a corporation. Its business model involves inviting more subscribers through “people they may know” and selling virtual advertising space and virtual goods/services to its members.  Facebook recently went public, listing on the NASDAQ. The process was not so much a growth design but rather a strategic move to comply with U.S. securities law.

Facebook first came close to falling into the SEC’s net in 2011 when Goldman Sachs used a special purpose vehicle (“SPV”) to allow its clients to invest $1.5 billion in the company. The transaction spurred debate on possible enforcement action against Goldman and Facebook for violating the Securities Exchange Act of 1934, a provision of which requires SEC registration for companies with more than 500 investors. To get around this limitation, Goldman created an SPV as an intermediary between investors and Facebook. Investors invested in the SPV that owned shares of Facebook, but not Facebook directly.

Facebook’s recent IPO again raised the ire of the SEC, but this time, complaints also came from investors. Dismal performance of the stock aside, Facebook and underwriters for the recent IPO face class-action lawsuits for alleged material misstatements in the prospectus and selective disclosure.

It is alleged that Facebook failed to disclose the known risk that increased use of mobile devices could cause a significant reduction in revenue. An executive released this information to the underwriter, who later passed this information only to big-ticket clients. The information, however, was not initially included in Facebook’s prospectus. Consequently, the information reached individual retail investors much later when the prospectus was amended. It is also alleged that the amendment was vague, leaving investors guessing how the increase in mobile access would affect revenue.

Facebook recently filed to consolidate all pending lawsuits in a single court for pre-trail management purposes. Facebook also seems to have used its response to shift blame to NASDAQ and its trading glitches. Facebook and the underwriters have admitted to making the alleged analysts calls. However, Facebook maintains that such calls were in compliance with SEC regulations.

There is also concern with the way Facebook conducted its “road show,” in which Facebook gave presentations to select institutional investors.  Regulation FD mandates that a company disclose instances when it provides non-public information to investors. Thus, to comply with Regulation FD, Facebook made available video of its road show presentations.  However, some are concerned that the videos did not go far enough because the question and answer sessions from the road shows were excluded. Facebook, for its part, maintains that such additional disclosures were not required.

In addition to the various lawsuits, Facebook’s IPO also has spurred calls for regulatory reform. The Senate Banking Committee looked at whether the IPO process works for retail investors, while the House Financial Services Committee held a hearing focused on whether U.S. stock markets are reliable.