Facebook Inc and Morgan Stanley, the lead underwriter of social networking company's IPO, have been sued by shareholders who claim the defendants hid Facebook's weakened growth forecasts ahead of its US$16 billion (NZ$21.28b) initial public offering.
The lawsuit, which also targeted underwriters JPMorgan Chase and Goldman Sachs among others, comes as Facebook and the banks that took it public face many questions about the IPO process, which culminated in a May 18 stock market debut plagued by technical glitches.
Facebook shares fell 18.4 per cent from their US$38 (NZ$50.77) IPO price in the first three trading days. In early afternoon trade on Wednesday, Facebook shares were up 2.5 per cent at US$31.78 (NZ$42.46).
The legal action accused the defendants, including Facebook Chief Executive Mark Zuckerberg, of concealing "a severe and pronounced reduction" in revenue growth forecasts resulting from increased use of Facebook's app or website through mobile devices.
Facebook was also accused in the lawsuit of telling its bank underwriters to "materially lower" forecasts for the company.
"The main underwriters in the middle of the road show reduced their estimates and didn't tell everyone," said Samuel Rudman, a partner at Robbins Geller Rudman & Dowd, which brought the lawsuit. "I don't think any investor in Facebook wouldn't have wanted to know that information."
Andrew Noyes, a Facebook spokesman, said: "We believe the lawsuit is without merit and will defend ourselves vigorously."
Morgan Stanley had no comment. It said on Tuesday that Facebook IPO procedures complied with all applicable regulations, and were the same as in any initial offering.
The lawsuit seeks class-action status, and was filed on Wednesday in the US District Court in Manhattan. It asks for compensatory damages and other remedies.
On Tuesday, law firm Glancy Binkow & Goldberg said it filed its own lawsuit in California state court on behalf of an investor. Nasdaq OMX Group Inc was also sued on Tuesday by an investor who claimed the exchange operator was negligent in handling orders for Facebook shares.
Research analysts at several underwriters lowered their forecasts for Facebook after the Menlo Park, California-based company in a May 9 prospectus cautioned investors about the possible impact of users shifting to mobile platforms.
Facebook makes little revenue from mobile ads, and did not say that changing user behaviour could reduce profit and revenue.
The shareholders said the disclosures about Facebook's business risks were inadequate, and that the company should have told everyone, not just "preferred" investors, that analysts knew those risks and cut their business outlooks accordingly.
Regulators including the US Securities and Exchange Commission, the Financial Industry Regulatory Authority, and Massachusetts Secretary of the Commonwealth William Galvin have begun looking into how the IPO was handled. The US Senate Banking Committee is also reviewing the matter.
"The SEC has since the 1990s broadly condemned the trickling out of material non-public information, which would include that savvy, well-paid analysts are lowering estimates," said Elizabeth Nowicki, an associate professor at Tulane University Law School and a former SEC lawyer.
Syndicate banks "are on the hook in terms of liability by not making accurate, complete disclosure," she added. "Selective disclosure of analyst outlook changes is not acceptable."
BofA, BARCLAYS ALSO SUED
The New York lawsuit was brought on behalf of Dennis Palkon and Brian Roffe, who said they respectively bought 1800 and 200 Facebook shares at the IPO price, and Jacob Salzmann, who said he paid more than US$123,000 (NZ$164,000) on May 18 for 2961 shares at an average US$41.77 (NZ$55.82) each.
Reuters reported this week that four underwriters - Morgan Stanley, Goldman Sachs, JPMorgan and Bank of America - cut their Facebook forecasts after the May 9 prospectus was filed, but that this was not publicly revealed before the IPO.
"If Facebook faced a known and particularly salient risk, boilerplate language would be insufficient," Nowicki said. "If Facebook told underwriters to lower their forecasts, it would certainly be material."
According to people with direct knowledge of the matter, Facebook during its IPO road show advised analysts for underwriters to reduce profit and revenue forecasts, people with direct knowledge of the matter said.
Bank of America and Barclays Plc, are also defendants in the New York case. Other defendants include Facebook Chief Financial Officer David Ebersman and several directors.
Barclays spokesman Mark Lane and Goldman spokesman Michael DuVally declined to comment. Bank of America and JPMorgan did not immediately respond to requests for a comment.
The case is Brian Roffe Profit Sharing Plan et al v. Facebook Inc et al, US District Court, Southern District of New York, No. 12-04801.