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Facebook face-off

Flurry of lawsuits, regulatory scrutiny test social network after quick fall in stock price

Facebook’s initial public offering of stock has raised questions about whether some investors were offered a rosier picture than others. Facebook’s initial public offering of stock has raised questions about whether some investors were offered a rosier picture than others. (scott eells/bloomberg news)
By Beth Healy
Globe Staff / May 24, 2012
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The uproar over the handling of Facebook Inc.’s stock launch grew louder Wednesday as lawyers representing investors sued Morgan Stanley and other major Wall Street firms involved in the deal, as well as the Nasdaq Stock Market and Facebook executives.

The flurry of lawsuits and regulatory scrutiny of the highly anticipated initial public offering seemed to come almost on cue after the social networking company’s stock price slumped after it began trading on Friday.

“It was so overly hyped. You have a number of disappointed investors and traders,’’ said David Barbash, a corporate securities lawyer at Posternak Blankstein & Lund in Boston. But if Morgan Stanley tipped off certain large investors to negative news at Facebook while it was out selling the IPO to other investors, the firm will face problems, Barbash said.

“It’s going to be huge headaches for Morgan Stanley, and potential legal liability if it turns out to be correct,’’ he said.

Meanwhile, lawmakers in Washington, at both the Senate Banking Committee and the House Financial Services Committee, said Wednesday that they plan to look into the controversy around the third-biggest IPO of all time. Federal and state regulators, including Massachusetts Secretary of State William F. Galvin, have launched inquiries into the stock offering.

Galvin said his office had received numerous calls from investors complaining about Facebook’s stock decline. Callers were reminded there are no guarantees a stock will rise in value, he said. “People should have been treated fairly and there should not have been any hierarchy in terms of information being given,’’ Galvin said.

The state Securities Division, which Galvin oversees, is investigating what information a Morgan Stanley analyst relied on to lower his revenue estimate for Facebook just days before the IPO, and what the source of that information was. They also are asking whether Morgan Stanley was aware of the analyst’s actions.

According to published reports, Morgan Stanley analyst Scott Devitt cut his estimate for Facebook’s 2012 revenue to $4.85 billion, from more than $5 billion, just ahead of the IPO. He shared the information with a group of hand-picked large investment clients, according to the reports, at the same time the firm was out selling the IPO to other investors and raising its launch price.

A class-action lawsuit filed in New York on Wednesday names Morgan Stanley as well as Facebook’s top executives and other large stock underwriters, including Goldman Sachs & Co. It alleges that only some investors learned of the dimmer take on Facebook’s prospects ahead of the IPO.

Facebook, in a statement, said, ‘We believe the lawsuit is without merit and will defend ourselves vigorously.” The company declined to comment on allegations that one of its executives directed Morgan Stanley to lower the estimate.

Morgan Stanley said in a statement that several firms had lowered their estimates, based on revised material Facebook filed with securities regulators on May 9 that was publicly available — saying that an increase in customers using mobile devices could hurt advertising revenues going forward. Morgan Stanley said it “followed the same procedures for the Facebook offering that it follows for all IPOs.”

Goldman Sachs declined to comment.

People in the securities business say it is highly unusual for an underwriter of a stock offering to lower its estimates while running an IPO.

“I’ve never heard of anybody cutting numbers in the middle of a roadshow,’’ said David Donovan, a former top trader at Fidelity Investments who is now an industry consultant.

Anna Ward, a recent Boston University graduate who received 100 shares of Facebook as a commencement gift, said the drop in the stock was disappointing, not least because this is her first time owning stock. But she expects the shares to rebound over time.

“I’m of the generation that grew up with Facebook, so the stock is symbolic,’’ she said. “I’m going to hang onto my shares for the long term.”

After slumping more than 18 percent since the Facebook IPO, the shares rose 3 percent, to $32, on Wednesday.

Separately, regulators were looking into technology issues at Nasdaq that led to problems with the Facebook IPO. Trading started a half hour later than expected, and there were delays throughout the day. The stock market was the subject of an investor lawsuit filed Tuesday in federal court in New York over its handling of the stock’s opening day of trading.

Fidelity Investments in Boston said “many of our customers have been affected” by trading delays in Facebook on the stock’s first day of trading. The trades have now all been confirmed, said Steve Austin, a spokesman, but Fidelity is assisting regulators who are making inquiries into the Nasdaq issues.

“Fidelity’s senior management has been working with the regulators, market makers, and Nasdaq to represent all of our customers’ trading issues from May 18th, and we will continue to do so until we are confident that Nasdaq has done everything it can to mitigate the impact to our customers,’’ Austin said.

Nasdaq’s chief executive this week blamed software problems for the trading glitches. The stock market did not respond to requests for comment. Morgan Stanley is also reviewing trades and adjusting prices for customers caught in the Nasdaq glitch, Reuters reported.

Beth Healy can be reached at bhealy@globe.com. Erin Ailworth of the Globe Staff contributed to this report.

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