Why Facebook is being Sued by Investors

Investors are suing Facebook (FB) for failing to properly disclose company performance information. Specifically, financial analysts were given estimate information and an earnings warning prior to the initial public offering that advised them to lower their ratings for the company per Reuters. However, despite filing a document with the Securities and Exchange Commission indicating the possibility of lowered advertising revenue, the information disclosed to underwriters may have been different. This has raised concerns of negligence, failure to disclose information and possible securities fraud.

The sixth amendment to Facebook’s S-1 registration from filed with the SEC, specifically page 13 of the document, states advertising revenue could be affected by a number of factors. This statement does not indicate what will happen, just what could happen. Furthermore, page 57 of the document says that average advertising prices in Q1, 2012 did not decline due to higher prices in countries around the world offsetting declines in the United States and Canada. This latter statement could lead investors to think that advertising revenue is secure.

If the information disclosed to analysts on May 9, 2012 indicated advertising revenue would decline with more certainty a material difference in disclosure is evident. According to a MarketWatch interview with Anthony Sabino, a law professor at St. John’s University, Facebook is less likely to have committed securities fraud as it is to have been involved with negligence, either directly, or via its underwriters. This negligence is tied to the perceived improper disclosure of information per Sabino.

The State of Massachusetts has already released a subpoena to Morgan Stanley in order to determine the investor disclosure process used by the underwriting firm. According to Global News Wire, the firms filing suits against Facebook include Morgan and Morgan, and the Law Offices of Bernard M. Gross. Business Wire has also reported that Girard Gibbs LLP, and the Former Lousiana Attorney General with Kahn, Swick & Foti, and  Gilman Law LLP are also filing law suits.

In terms of legality, whether investors were given the right information will be decided by courts or out of court via settlements. In a CNBC interview, Henry Blodget, CEO of Business Insider, indicated a strong sentiment against Facebook as having participated in either an “egregious violation,” or an unfair fallback on “ridiculous rules”  that allow private disclosure of verbal estimates. Since public companies are required to disclose specific information to investors, the Securities and Exchange Commission and Financial Regulatory Authority are also investigating this issue per Fox Business.