Massachusetts Secretary of the Commonwealth William Galvin last week accused Morgan Stanley of breaking the law as lead underwriter in Facebook Inc.’s initial public offering, triggering a $5 million fine.
What had Morgan Stanley done wrong? The allegations, as written by Galvin’s office, seem to have been crafted with one goal in mind: To make it impossible to answer that question.
Let’s start with the consent order Galvin issued as part of his office’s settlement with Morgan Stanley. The first 92 paragraphs include a description of the securities regulator’s jurisdiction and authority, a list of the relevant parties, and a 16-page statement of facts.
Next is a section called “violations of securities laws,” which lists three counts. Each count says the regulator “restates and incorporates the facts set forth in paragraphs 1-92.” After that, they say “the conduct of respondent, as described above, constitutes a violation,” followed by citations of the state laws, regulations or other provisions Morgan Stanley supposedly breached. The alleged infractions include dishonest or unethical conduct, disobeying a 2003 consent decree on analyst research, and failing to supervise employees.
Which facts constituted which violations? There’s no way to determine that from the order. When I asked Galvin during a phone call, he declined to answer the question. As far as I can tell, even viewed in the worst possible light, none of the conduct described by Galvin was an obvious breach of anything.
Morgan Stanley paid anyway, without admitting or denying Galvin’s allegations. That’s understandable. The fine amounted to 7 percent of its $67 million of fees from the IPO — a classic nuisance settlement. The real crime here seems to be that Facebook’s stock price fell a lot after the company went public in May, which of course isn’t a crime at all.
Here’s the gist of what happened. At an April meeting, according to Galvin’s version of events, Facebook’s chief financial officer, David Ebersman, told research analysts at the company’s underwriters that Facebook’s revenue forecast for the second quarter of 2012 was $1.1 billion to $1.2 billion. For the year, he told them Facebook’s forecast was $5 billion.
These numbers weren’t in Facebook’s February registration statement. Nor, it should be noted, was Facebook required by Securities and Exchange Commission rules to disclose numerical forecasts in its public filings.
The SEC historically has discouraged pre-IPO companies from providing such projections in writing, out of concern that they are unreliable and that companies would be tempted to inflate the numbers to hype their offerings.
In May, after Facebook had begun a roadshow for institutional investors, Morgan Stanley’s top investment banker on the deal, Michael Grimes, learned the company had reduced its revenue estimates. How did he respond? He told the CFO that updating the company’s guidance to the research analysts would be a good idea. Facebook executives agreed.
Grimes helped Facebook’s treasurer at the time, Cipora Herman, rehearse what she would say in phone calls to the analysts. Grimes wrote a script for her.
He also drafted language for an amended registration statement that Facebook filed with the SEC on May 9. The filing contained new information about threats to the social-media company’s revenue growth — a disclosure widely reported in the press at the time.
Facebook’s treasurer called the underwriters’ research analysts, about 20 in all, and provided the revised revenue estimates. Once again, Facebook didn’t include numerical revenue forecasts in its amended SEC filings. The SEC’s rules on selective disclosure, known as Regulation FD, didn’t apply to Facebook before its IPO was completed. Those rules apply only to companies that already are public.
Galvin’s consent order quoted a portion of the 2003 analyst research settlement that said Morgan Stanley investment bankers can’t “seek to influence the contents of a research report or the activities of research personnel for purposes of obtaining or retaining investment banking business.” The order suggested Morgan Stanley had flouted this provision. It’s hard to see how.
Galvin’s order contained no facts suggesting that Grimes’s purpose was to get investment-banking business. Grimes simply wanted Facebook to come clean with the analysts, who previously had been given erroneous numbers.
A news release by Galvin’s office last week said, “While retail investors were left to interpret vague qualitative information” in the registration statement, “syndicate research analysts were given specific numbers in order to revise their revenue estimates.”
This may be true. However, Galvin’s consent order didn’t say it was a violation. Under the SEC’s rules, disclosures of this sort are legal — and to be expected — in the IPO process. Plus, whatever disclosure obligations there may have been, they belonged to Facebook, not Morgan Stanley.
Institutional investors that buy IPO shares from a company’s underwriters normally have access to more information than retail investors who buy in the open market after an IPO is completed. Maybe this isn’t fair. But if Galvin wants to do something about it, he should lobby the SEC or Congress to change the system.
During the phone call with Galvin, I also got the impression he lacked some basic facts. At one point, for example, he said, “They’ve acknowledged a violation of the rules,” referring to Morgan Stanley. Actually, his consent order said Morgan Stanley didn’t admit or deny any violations.
It’s too bad Morgan Stanley’s lawyers didn’t tell Galvin to see them in court.
Weil is a Bloomberg View columnist.