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Judy Greenwald

Facebook IPO problems teach tough lessons

June 3, 2012

Facebook IPO

Litigation and regulatory investigations of various problems with Facebook's initial public offering of stock may add momentum to a trend of hardening D&O rates.


While Facebook Inc.'s well-publicized problems with its initial public offering are in many ways unique, companies should take heed of some lessons from the company's experience, say observers.

The lessons include exercising caution in determining the amount raised and in disseminating nonpublic information to firms' investment bankers.

Menlo Park, Calif.-based Facebook Inc. went public on May 18, selling 421 million shares to the public at $38 a share, giving it a total value of more than $16 billion. There were glitches, though, in the trading process at NASDAQ. Furthermore, and more significantly, since the initial sale the stock has decreased by $10.28, closing at $27.72 on Friday.

According to one reported estimate, as of Thursday, the company was worth $26 billion less than it was just two weeks previously.

The situation has led to at least two purported class action lawsuits filed against Facebook and its investment bankers, including one in U.S. District Court in New York and another in state court in California, as well as investigations by regulators.

Meanwhile, Facebook has $10 million of primary coverage with Houston-based HCC Insurance Holdings Inc., according to market sources, although it is likely to have a tower totaling perhaps $300 million, with many other insurers involved.

Experts say at least the primary layer is likely to be eaten up by defense costs, even if Facebook is ultimately not held liable. Doug Busker, HCC's director of investor relations, said HCC does not comment on any individual policyholders. A Facebook spokesman could not be reached.

Although some 23 pages of Facebook's IPO prospectus were devoted to outlining risk factors, Brian Roffe Profit Sharing Plan et al. vs. Facebook Inc. et al.—the lawsuit filed in New York—alleges that the company made misleading statements and omitted material facts.

The suit also states that defendants failed to disclose during the IPO's road show that certain underwriters reduced their performance estimates for the company and only “selectively disclosed” this information to “certain preferred investors.” The charges in the state suit, Darryl Lazar et al. vs. Facebook Inc., are similar.

Plaintiffs attorney Michael E. Criden of Criden & Love P.A. in South Miami, Fla., who is soliciting plaintiffs for a lawsuit against NASDAQ and is considering filing one against Facebook, said the company issued shares that raised more than three times the original $5 billion offering planned.

“They either overestimated the appetite for the stock, or they didn't care, and they just wanted to clear out a lot of selling shares from inside the company,” he said.

Ty Sagalow, president of New York-based Innovation Insurance Group Inc., said Facebook, which “started a whole new paradigm in social interaction,” is an example of disruptive innovation, which is “a good thing for society” but creates a “rocky road” in pricing an IPO.

Kevin LaCroix, executive vp at OakBridge Insurance Services L.L.C. in Beachwood, Ohio, said the eleventh-hour increase in the number of shares and its pricing at the top of the suggested range, raised questions.

Jay R. Ritter, a professor of finance at the University of Florida in Gainesville, said “From an investor's point of view, what went wrong, of course, is the stock price has dropped after the IPO, which happens especially for a company as difficult to value as Facebook, where the company is growing rapidly but there's a huge amount of uncertainty about how fast future revenues and profits will grow.”

Mr. LaCroix noted, however, that “the offering was a success” in that the company was able to maximize it.

“It's probably a bigger issue for those companies sort of waiting in the wings, hoping to ride Facebook's coattails, and take advantage of a marketplace that was assumed to be more receptive to investing in tech IPOs,” Mr. LaCroix added.

Some observers say Facebook may have done little, if anything, wrong. Some of the information the company is charged with not disclosing, including problems with Facebook's mobile applications accessibility, was public knowledge, said Joseph Monteleone, a New York-based partner with the Tressler L.L.P. law firm.

Daniel I. Goldberg, a partner with law firm Reed Smith L.L.P. in New York, said problems emerge whenever the spotlight is on an IPO. “I don't think there's anything more wrong or more different” here than has been the case with other IPOs, he said.

The case is likely to be settled, said Perry S. Granof, Glencoe, Ill.-based of counsel to law firm Williams Kastner. “Even if plaintiffs' case is flimsy, the amount of damages is so significant that nobody's going to take a chance on litigating this case in court.”

But the Facebook litigation will add momentum to an already hardening directors and officers liability insurance market, said Peter R. Taffae, a D&O expert at Los Angeles-based wholesale brokerage Executive Perils Inc. “A lot of D&O treaties come up July 1, and the timing of this is pretty bad because the insurers already are starting to talk about increases,” he said.

There are lessons to be learned from the Facebook IPO, including the need to be conservative in the size of an IPO and exceedingly cautious in the information relayed to others, say observers.

Some commentators have said the share increase caused a classic supply-and-demand problem, said Mr. LaCroix. You “can't stuff in more product than there is demand,” he said.

Richard J. Bortnick, a member of law firm Cozen O'Connor in Philadelphia, said, “If you believe what plaintiffs alleged, Facebook did not widely disseminate its reduced earnings projections. The whole premise of transparency and open trading is (that) everybody knows the same thing and is playing on a level playing field.”

Some observers are concerned the Facebook IPO will lead to revisions of the Jumpstart Our Business Startups, or JOBS, Act, which was signed into law by President Barack Obama in April and is intended to reduce the number of regulations required to issue an IPO.

 



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