On August 2, 2012, shares of Facebook, Inc. (“Facebook” or the “Company”) closed at a record low of $20.04, approximately $18 below its initial public offering (“IPO”) price of $38 – a drop of close to 50%. Investors have reacted swiftly to these losses and numerous actions have now been filed around the country by Facebook shareholders.
In this Client Update, we examine the problems with the Facebook IPO and assess the claims that have been asserted by plaintiffs.
Background: The Facebook IPO
On February 1, 2012, Facebook announced its plans to conduct an IPO. On April 23, 2012, Facebook announced that it planned to list its stock on the NASDAQ stock market under the symbol “FB.” On May 3, 2012, Facebook set a price range of $28 to $35 for its shares. The Company and its early investors announced their plan to sell 337.4 million shares, raising $11.8 billion if shares sold at the top of the price range.
On May 7, 2008, Facebook embarked on a “roadshow” in which Facebook executives travelled to key cities to tell potential investors why they should invest in the stock. The first stop on this roadshow was New York. The road show concluded on May 11, 2012 in Palo Alto, California.
On May 15, 2012, Facebook increased its price range for the IPO to $34 to $38 per share. At the high end, the IPO would raise about $12.8 billion and value the company at $104 billion. On May 16, 2012, responding to extraordinary demand, Facebook added another 84 million shares, worth up to $3.2 billion, to the IPO. This increased the number of shares offered in the IPO to a total of approximately 421 million shares. On May 17, 2012, Facebook finally priced its IPO at $38 per share, raising $16 billion and valuing the Company at $104 billion.
On May 18, 2012, Facebook began trading on NASDAQ. More than 500 million shares were traded on the first day. The performance of the stock, however, was lackluster, closing at $38.23. On May 21, 2012, Facebook shares closed below the IPO price of $38, and continued to drop over the next two weeks, declining below $30 for the first time on May 29, 2012.
On July 26, 2012, Facebook’s shares plummeted further after Facebook announced its second quarter results. As widely reported in the financial media, Facebook reported a decline in the growth rate of its advertising revenues, as a result of more users accessing Facebook through their smartphones. On the next day, Facebook stock declined close to 12%, to close at $23.71. Over the next several days, Facebook’s stock price continued to decline, dropping below $20 on August 2, 2012.
Revelations That Facebook Omitted Material Information From Investors
On May 23, 2012, in an article entitled Facebook Advised Analysts To Cut Forecasts Before Float, Reuters reported on conversations that took place between Facebook executives and research analysts during Facebook’s roadshow. The Reuters report was based on interviews with people who had direct knowledge of these conversations. According to Reuters, on or about May 9, 2012, in the lead-up to the IPO, Facebook advised analysts to revise downwards their 2012 revenue and earnings projections for Facebook. This was based on Facebook’s concerns that users of Facebook were increasingly switching from their personal computers to mobile devices to access Facebook. Mobile platforms currently generate less advertising revenue for Facebook than the personal computer platform, and thus pose a significant threat to Facebook’s revenue and earnings growth.
Following Facebook’s warnings, the analysts for lead underwriter Morgan Stanley and at least three other underwriters reduced their forecasts for Facebook’s second-quarter and full year revenue, and communicated this to at least some of their institutional clients.
However, according to the plaintiffs who have commenced claims against Facebook, Facebook never disclosed in its IPO documents (the registration statement and the prospectus) the fact of the conversation with the analysts, or the fact that Facebook had asked the analysts to revise their revenue and earnings projections downwards. According to the plaintiffs, this constituted an omission of a critically material fact.
Subsequent developments lend further support to these plaintiffs’ claims. In the days immediately following its IPO, Facebook blamed the drop in its share price on NASDAQ’s trading problems, and asserted that the failure to disclose the roadshow conversations with analysts had nothing to do with Facebook’s stock performance. However, on July 27, 2012, following its second quarter earnings announcement, Facebook’s share price dropped by nearly 12% as investors reacted to reports by Facebook that its rate of revenue growth had declined due to Facebook users switching to mobile devices. In the following days, Facebook’s stock continued dropping, declining below $20 on August 2, 2012. This sharp reaction to Facebook’s reports of declining revenue growth supports the plaintiffs’ claims because it underscores just how important it would have been to investors, just before the IPO, to know that Facebook had told analysts to revise their revenue and earnings projections to account for the increasing number of mobile phone users.
What Potential Claims Do Investors Have?
There are two main claims that investors can assert, both under the Securities Act of 1933 (the “Securities Act”): (i) a claim for violation of Section 11 of the Securities Act and (ii) a claim for violation of Section 12(a)(2) of the Securities Act.
Section 11 imposes liability in the case of a registration statement that contains an untrue statement of a material fact or omits to state a material fact. A registration statement is a set of documents, including the prospectus that forms part of the registration statement, that a company must file with the U.S. Securities and Exchange Commission before it proceeds with a public offering. Section 11 imposes liability on a broad range of persons involved in preparing the registration statement – including the issuer of the securities (in this case, Facebook), every person who signed the registration statement, every person who was a director of the issuer, and underwriters for the share offering (such as Morgan Stanley).
Section 12(a)(2) imposes liability in the case of a prospectus that contains an untrue statement of a material fact or omits to state a material fact. Section 12(a)(2) imposes liability on any person who offers or sells the security in question.
There are several advantages in bringing claims under Sections 11 and 12(a)(2) of the Securities Act. First, there is no need to establish “scienter” (fraudulent intent) on the part of the defendants. In other words, a plaintiff simply has to allege that there were untrue statements or omissions of material facts, and need not take the extra step to allege that the defendants were trying to deceive anyone. Thus, if there is an untrue statement or an omission of a material fact, “virtually absolute” liability under Section 11 follows. Second, a plaintiff does not need to establish that s/he actually relied on the misleading statements/omissions in purchasing the securities in question. Third, if a violation of Section 12(a)(2) is established, the plaintiff can tender her/his stock back to the defendant issuer. (In this case, any investors who suffered losses on Facebook may tender their shares and get back $38 per share.)
Unsurprisingly, investors who have commenced lawsuits against Facebook are alleging, among other causes of action, violations of Section 11 and 12(a)(2) of the Securities Act. These investors are alleging that Facebook, its directors and officers, and the underwriters for the Facebook IPO failed to disclose, at the time of the IPO, that the Company had told the lead underwriters to reduce their 2012 performance forecasts for Facebook. The plaintiffs allege that the warnings from Facebook were triggered by Facebook experiencing a pronounced reduction in revenue growth due to Facebook users increasingly using mobile devices rather than traditional PCs to access Facebook. According to the plaintiffs, these downward revisions constituted material information which was not shared with all investors, but rather, was selectively disclosed by the defendants to certain preferred investors and omitted from Facebook’s registration statement and prospectus.
Who May Bring Claims?
There are two groups of investors who may bring claims.
First, investors who were allocated stock and thus bought directly in the Facebook IPO would have claims under both Sections 11 and 12(a)(2) of the Securities Act.
Second, investors who were not allocated Facebook stock in its IPO but bought their shares in the “aftermarket” on the day that Facebook listed (May 18, 2012) and the several days afterwards, would also have a claim under Section 11 of the Securities Act. Courts have held that a claim can be brought under Section 11 so long as the securities purchased by the plaintiff can be “traced” back to the allegedly deficient registration statement. See, e.g., DeMaria v. Andersen, 318 F.3d 170, 178 (2d Cir. 2003) (stating that “In a case such as this one, where there has been only one stock offering, any person who acquires the security may sue under § 11, ‘regardless of whether he bought in the initial offering, a week later, or a month after that.’”). In the case of Facebook, the shares that were traded in the aftermarket immediately after Facebook’s IPO are all traceable to Facebook’s registration statement. That is because Facebook’s lock-up provisions prevented Company insiders and employees from selling their stock, so that the only stock that could be traded in the days after Facebook’s IPO was the 421 million shares of stock offered for sale by Facebook under its IPO, which shares are directly traceable to Facebook’s registration statement.
However, investors who purchased their stock in the aftermarket would not have a claim under Section 12(a)(2). An investor can bring a Section 12(a)(2) claim only if s/he bought stock from a defendant who offered or sold the security through a misleading prospectus. The persons liable in a Section 12(a)(2) claim are thus, ordinarily, the issuer and underwriters. Because purchasers in the aftermarket would not be able to establish that they bought their stock from the issuer or underwriter, they cannot bring a claim against these defendants under Section 12(a)(2).
Current Litigation Developments
In just a period of three months, numerous actions have already been filed in federal court in both California and New York. Because so many different actions have been filed, the next steps in the litigation will be for the actions to be consolidated before one federal court, and for an institutional investor or group of institutional investors to then be appointed lead plaintiff to represent the class of all purchasers of Facebook stock. In the meantime, many law firms have announced investigations concerning Facebook’s IPO.
For more information on the Facebook IPO and the contents of this Client Update, or if you bought shares in the IPO or in the aftermarket and would like to learn more about your potential claims, please contact us at firstname.lastname@example.org or on (212) 572-6434.