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Facebook, Morgan Stanley, and “Dumb Money”

Posted by Larry Doyle on May 24, 2012 4:01 AM |

For an industry that has ongoing and enormous reputational issues, the manner in which the high profile Facebook underwriting was handled is a clear indication that Wall Street has learned very little over the last few years.

Those in the industry can point to the fact that selective disclosures during an IPO process are not illegal. That is a pathetic statement, but one which far too many will utilize to justify — or I should say, rationalize — horrendous business decisions. The WSJ alludes to this reality in writing, Some Big Firms Got Facebook Warning:

It is one of Wall Street’s best-kept secrets: Securities firms are allowed to selectively confer with favored large investing clients about crucial information as they prepare IPOs.

Wall Street firms, for their part, say they give certain information to big clients because the clients pay for this type of data. It is typical in an IPO for analysts or sales staff to give certain information to clients, they added. But that usually doesn’t apply to small investors.

If anybody was ever looking for evidence that Wall Street utilizes the caste system in dealing with clients, this Facebook underwriting is proof positive. 2300 pages of financial regulatory reform and they missed this? Can you say joke??!! But it is legal so it must be ok, right? Really? I don’t think so.

At any other time, such “selective disclosure” violates federal securities law, which requires companies and Wall Street firms to publicly disseminate any information that could move share prices. Securities law prevents analysts at banks that underwrite large IPOs from issuing research reports to the public until 40 days after the shares begin trading.

Some securities lawyers urge that new rules be put in place to prevent this uneven information flow. “Analysts should not be giving opinions about the IPO at the same time their firms are acting as underwriters. They should not be giving information that’s not in the prospectus to favored clients,” says securities lawyer Jacob Zamansky, who represents investors in securities cases. He isn’t involved in any Facebook cases.

Sharing material information with certain high profile clients only to let other customers and the “dumb money” individuals fend for themselves is quite a way to run a business.

“Dumb money” you say? Yep, dumb money, as referenced by the WSJ:

The lead underwriters, which include Morgan Stanley, Goldman Sachs Group Inc., and J.P. Morgan Chase & Co., set the best price based on demand they saw for the shares last Thursday night when the price was set, say people familiar with the matter.

In this case, some of the demand was coming from what on Wall Street is sometimes called the “dumb money”: individual investors looking for a piece of a company that many use every day to connect with friends and others. In low-profile IPOs, 10% to 15% of shares typically are allocated to individuals. In this case, individuals received roughly 25% of the IPO—big for such a high-profile deal.

I have no idea why individuals would want to play in an IPO that encompasses so much hype. That said, in regard to the “dumb money,” I would ask those on Morgan Stanley’s syndicate desk what they make of the fact that overall volumes across equity exchanges are down approximately 50% over the last three years. Did they factor that reality into their equation in determining just how deep their real book was for this Facebook underwriting?

With the Facebook stock down 16%, lawsuits pending, and the Morgan Stanley franchise value having just taken an enormous hit, I would ask James Gorman and team at Morgan Stanley, “Who is really the dumb money here?”

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • LD


    Facebook IPO lawsuit: How much information should institutional investors share?

    Thursday, May 24, 2012

    Charles K. Whitehead, professor at the Cornell University School of Law and a former Wall Street attorney, comments on the lawsuit leveled against Facebook, Morgan Stanley and other banks that underwrote Facebook’s initial public offering (IPO). The plaintiffs allege that negative information was withheld in the Facebook prospectus.

    He says:

    “Whether or not the Facebook prospectus was materially misleading is an open question for the plaintiffs to prove. What’s not a question is the fact that institutional investors, as part of the sales process, regularly receive information — like the change in projections alleged here — not available to the general public. That may not be such a big deal. After all, most mom-and-pop investors won’t fully comprehend the projections in the first place.

    “What’s more troubling is the signal that the change in projections sent to the institutional market: Namely, that price support for the IPO was likely to be weak and so $38 per share was unlikely to be sustained. That is certainly the kind of information even mom and pop would have understood.”

  • Ron Larson

    I have to go on a rant here. This whole “FB IPO failure” is pure bunk. On the contrary, FB did it right for once.

    All this wining is sour grapes because people weren’t able to steal from the company like other IPO’s have allowed. FB got maximum dollar for their shares, like they were supposed to. Good for them.

    Wall Street, the 24 Financial News media, and the public have forgotten what shares are for. They are to raise capital. Somewhere along the long they forgot that and decided that it was just a way to make massive profits with no work.

    The way IPO’s were “working” in recent history is that a company would underprice their shares. The underwriter would get the right to buy huge block of shares at the dirt cheap price that they would sell to insiders and their best customers. IPO day comes, the stock price rises to market demand, and the insiders sell at a massive profit. The only work they did was know someone at the underwriter.

    The way shares are suppose to work is that you invest a share. The company takes that money and uses it to grow the business. After time, the share is worth more because the company grew, and perhaps it even pays dividends on the share. It takes faith in the company, and time.

    Look at it this way. Lets say you owned a house that you wanted to sell. You hire a real estate agent. The agent convinces you to list the house at $200k. So you sell it at $200. But 2 days later you find out that the agent’s best friend was the buyer, and that buyer then flipped the house for $300k and gave your agent a nice cut of the profit too.

    You, as the seller, would be livid, and would sue for fraud. A company selling shares of itself is no different. If they are convinced to let them selves go for far less than they are worth, then they are doing a disservice to themselves. Management is either incompetent, or in collusion with this scam.

    To me, this “failed” IPO tells me that FB’s management is doing the right thing and did not let Wall Street rip them off like they have done to so many other companies. Those obscene IPO profits that insiders make on IPO’s is stolen money. That is money that belongs to the company, and should be used to buy equipment, hire people, and grow the business.

    Wall Street has managed to craft the IPO laws to force companies to play their game, and sell themselves cheap to insiders. Why don’t companies use public auctions to sell shares? Why does the the company HAVE to set a price? They shouldn’t. They should put up blocks of shares and have buyers bid on them. Let the market decide what they are worth before the company lets a share go.

    I’ll get off my soapbox now.

  • chris

    Why I believe SROIIA is more important to the future of our financial health then is being paid heed. With the recent passage of the JOBS act, and the regulations for crowd funding soon to follow, and given SRO membership is anticipated to be required; An alternative to FINRA must be formed. No one has confidence in the markets. FINRA is at fault and aside from the lack of oversight by the SEC of FINRA, hold them completely accountable. We need a new SRO, and with 600k brokers (a stat I saw published but didn’t confirm) the 200 million needed to fund it, is a drop in the bucket. The opportunity to create a transparent SRO, with real regulation, is at hand. Lets mobilize.

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