SEC Facebook IPO Probe Said to Find No Wrongdoing So Far

Facebook IPO Probe by SEC Said to Find No Material Data Withheld
Just days before the offering, Facebook Inc. officials privately told securities-firm analysts to lower earnings and profit estimates -- largely on the dearth of revenue from mobile users. Photographer: Scott Eells/Bloomberg

The Securities and Exchange Commission, which began probing Facebook Inc.’s May 17 IPO after its stock price plummeted, hasn’t found evidence that the company withheld material information from investors, a person familiar with the matter said.

The SEC, whose investigation is continuing, is still looking at other IPO-related issues, including whether retail investors were harmed by misleading information from brokers or selective disclosures to analysts by the company’s bankers regarding Facebook’s prospects for mobile customers, said the person, who asked not to be identified because the probe is confidential.

Any conclusion by the SEC that Facebook made adequate disclosures of risks prior to its IPO would bolster the company’s defense against civil lawsuits filed by retail customers damaged by the sudden drop in the company’s initial $38 share price, which is about half that value now. During a 2 1/2 month pre-IPO review of Facebook’s filings, the SEC pushed repeatedly for more disclosures, which were made.

“It’s unlikely the SEC will pursue an enforcement action against Facebook based on what they were discussing before the IPO,” said Peter Henning, a former SEC lawyer who teaches at Wayne State University in Detroit. “The SEC would have objected even more strenuously if the company had not complied.”

During the “back-and-forth” process of the pre-IPO review, “Facebook was doing its best to respond to the SEC by disclosing enough information” Henning said.

Facebook Lawyers

Facebook retained the Washington law firm Wilmer Cutler Pickering Hale & Dorr LLP to handle the SEC probe, according to two people with knowledge of the matter. William McLucas, a former SEC enforcement director who heads up the firm’s securities practice, is managing the social-media company’s interactions with the commission, according to the people. Wilmer Cutler had no immediate comment.

Kevin Callahan, an SEC spokesman, declined to comment on the probe, as did Facebook in a statement.

Handling the investor lawsuits for Facebook are Kirkland & Ellis LLP and Willkie Farr & Gallagher LLP, according to court filings. Facebook has said the more than 40 suits, which have been consolidated under one judge in federal court in New York, lack merit.

The SEC is conducting an “in-depth review of all the participants” in the IPO, SEC Chairman Mary Schapiro said in an interview Sept. 28 on Bloomberg Television. The regulator’s initial focus in the probe was whether any material information was omitted from Facebook’s prospectus by the company, whether it shared bad news only with a select group, and whether sales people misrepresented demand for the social network stock to lure small investors.

Stock Drop

The SEC’s decision to investigate the IPO was triggered by the stock drop, not by any allegations of wrongdoing, the first person said. If sales people attached to the underwriting group led by Morgan Stanley were telling wealthy investors to stay away, while encouraging retail investors to buy all the shares they could, that might constitute illegal misrepresentation, the person said.

In the months before the offering, the SEC disclosure team that reviews filings by information technology and services companies, headed by Assistant Director Barbara Jacobs, pushed Facebook to disclose how it planned to make money from mobile customers and how much money it made per user -- $1.21 from each in the first quarter. It also forced Facebook to remove misleading claims about its appeal to advertisers, and raise its estimate of a heavy reliance on game maker Zynga Inc., according to correspondence between the regulator and Facebook posted on the SEC Website.

Ninety-Two Matters

By the end of February, the SEC had amassed a list of 92 matters on which it sought further information. The volley of messages among SEC officials, Chief Financial Officer David Ebersman, and Facebook’s law firm Fenwick & West LLP, resulted in very complete disclosures on key issues before the offering. As a result, the SEC didn’t start the probe with any suspicion of wrongdoing, the person said.

Still, SEC reviews of filings conclude with a reminder to a company that executives remain responsible for ensuring complete disclosure and that the company may be prosecuted later if they fail in that obligation.

Private Guidance

Just days before the offering, Facebook officials privately told securities-firm analysts to lower earnings and profit estimates -- largely on the dearth of revenue from mobile users. A disclosure on May 9 warned investors that users were growing faster than advertising delivered to users.

If Facebook was merely cautioning analysts to read its filings, that was acceptable selective disclosure. If some analysts were told more specifically to consider a particular paragraph or line on, say, page nine of a filing, that might cross the line, the person said.

In lawsuits over the IPO, investors accused Facebook of selective disclosure. The May 9 disclosure was widely reported by the media, so information was publicly available on reduced expectations, even if retail investors didn’t read it.

The rules about what Facebook can tell analysts pre-IPO are broad, under so-called safe harbors of the law that enable companies to discuss regularly released factual information. They can talk freely about data on sales or ads that they’ve previously shared with consultants or reporters; they can also freely describe their business operations without breaking any rules about inside information. They can’t give public forecasts of future performance, though they can talk to underwriters, according to SEC rules.

Probe’s Pace

SEC probes of rule-breaking move more slowly than investigations involving theft of money, where assets are being dissipated, according to the person.

Taking over as the SEC was pilloried for letting bankers run amok and for missing frauds including Bernard Madoff’s multibillion-dollar Ponzi scheme, Schapiro restructured the unit that reviews company disclosures to focus on large financial institutions and to probe for gaps in filings by firms selling shares to the public for the first time. That was the unit that pressed both Groupon Inc. and Facebook to provide investors with more details before their initial public offerings.

The Senate Banking Committee is also looking into the matter, and has held meetings “with a range of involved parties including Facebook, Nasdaq, Morgan Stanley and the SEC,” said Sam Gilford, press secretary for the Senate committee, in an e-mailed statement.

The investor case is In Re: Facebook Inc. IPO Securities and Derivative Litigation, MDL 2389, U.S. Judicial Panel on Multidistrict Litigation (Washington).

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