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Facebook Lawsuit (Like IPO) May Disappoint Investors

Even if the Facebook shareholders suing the social network and its underwriters over the handling of the initial public offering win a settlement, history suggests the payout could be small.

Three investors filed a civil lawsuit in Manhattan federal court Wednesday alleging that the site and the banks handling the deal failed to disclose crucial information prior to the IPO. At issue are changes analysts at underwriters Morgan Stanley and other banks including Goldman Sachs made (but didn’t share) that downgraded their forecasts for Facebook’s revenue growth. The plaintiffs — who are seeking class-action status — could get a payout if they can demonstrate misstatements or omissions in the company’s offering documents, says Charles Whitehead, professor of law at Cornell University’s Law School, and a former Wall Street attorney. “If it’s a plausible claim, this is very likely to get settled,” he says. Facebook and Morgan Stanley both say the lawsuit is without merit.

Such shareholder lawsuits after an IPO aren’t uncommon, experts say, and they often end in a settlement since the plaintiffs and defendants involved prefer to avoid costly ongoing litigation. Such cases were far more prevalent during the dotcom boom, but they are making a comeback, says Dominic Auld, a lawyer at Labaton Sucharow, who prosecutes securities cases. In April, a Groupon shareholder sued the online deal site, alleging, among other things, that the company concealed information from the filings for its November 2011 IPO.

The overall number of securities class-action filings on behalf of investors has risen over the past few years. In 2011, 188 suits were filed, up 7% from 2010 and up 13% from the year before, according to Stanford University’s Securities Class Action Clearinghouse. So far this year, 62 such lawsuits were filed.

But while lawsuits have been on the rise, settlement amounts keep dropping. There were just 65 settlements in 2011, down 24% from 2010, according to Cornerstone Research, an economic and financial consulting firm. And in 2011, the total settlement amount for all securities class-action lawsuits was $1.4 billion, down from $3.1 billion. For context, in 2006 when 89 cases were settled, the total payout was a whopping $17 billion.

The Facebook shareholders face several legal challenges. Under the Securities Act of 1933 and the Securities Exchange Act of 1934, investors can bring a lawsuit against an IPO firm if they suspect there were material untruths or omissions in the company’s prospectus. The analysts’ projections alone aren’t much to stand on, says Whitehead. “The fact that analysts decided to lower revenue projections doesn’t mean the prospectus was inaccurate,” he says. What the plaintiffs will have to prove is that the analysts’ forecast change was based on material information that was omitted from the company’s prospectus, he says. The case could shift even further in the plaintiffs’ favor if they can prove that the underwriters selectively passed on information to some clients but not all, says Auld.

Experts say that Facebook’s high IPO price may have helped get the company into hot water with this lawsuit. While investors can’t win a lawsuit based on an IPO that performed poorly, academic studies suggest that higher IPO prices can lead to more lawsuits. “Underpricing lowers the potential damages that plaintiffs can recover, and thus reduces plaintiffs’ incentives to bring a lawsuit against the firm,” according to 2002 report “Litigation Risk and IPO Underpricing” co-authored by Michelle Lowry, associate professor of finance at Penn State University’s Smeal College of Business. The study goes on to say that class-action lawsuits tend to follow a large drop in the company’s stock price.


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    • This lawsuit may not payout a huge amount of money but it does help shape the environment of having investors being more active and paying attention to what these companies are doing. The reason the recession hurt so many people was partly because people were not paying attention. No matter the payout it shows investors will not lay down anymore to the corporate executives.


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