Crowdfunding Loses its Appeal after the Facebook IPO

As Facebook’s shares continue to slump, recriminations over its busted IPO continue with no end in sight.  It might also prompt fresh concern about the JOBS Act, which loosens the rules on capital raising.

Regulators and plaintiffs’ attorneys are circling Facebook and its advisors.  Bankers, company officials, early stage investors and Nasdaq are all coming in for criticism. Even the glassy eyed retail investor is being blamed for assuming Facebook was a risk free way to be a hedge-fund titan for a day and make a quick killing.

But here’s the thing: For all the finger pointing, it’s likely that the Facebook and its bankers complied with the IPO rules. Yes, Facebook’s disclosures weren’t all that clear, and the underwriting banks’ analysts kept their earnings downgrades away from the public, but all this was acceptable under the rules.

The rules are set to change, and in ways that don’t favor retail investors.  So if small investors are feeling burned Facebook, just wait until bankers start crowdfunding growth companies under the provisions of the new JOBS Act.

Under the law, enacted just weeks ago, companies with under $1 billion in revenue will be able to tap the public markets without many of the restrictions that govern IPOs today. They’ll be exempt from disclosure and corporate governance requirements. Small companies will also be able to crowdsource their funding – soliciting investors via the Internet – without filing a registration statement. The information disadvantage for retail investors looks likely to grow worse under the new law.

Many of the protections put in place in 2003 after the collapse of high flying tech companies are also eliminated. (Ironically, the JOBS Act would permit underwriters to publish research on companies before an IPO, which some have argued would have been useful for retail investors eyeing a flyer on Facebook.)

The SEC is not very enthusiastic about the JOBS Act, and it has begun to gather public comments as it develops rules to implement the law. Facebook’s disappointed shareholders should be writing to Mary Schapiro.

 

Disclosure is an Attitude

I recently had lunch with a senior executive from a big accounting firm who complained about the criticism his firm was facing over audits it conducted at big companies that later were found to have big problems.

In all these cases, the executive said, there was a “well established body of accounting practice” that permitted the company to forestall disclosure or keep certain items off the balance sheet or bury an important fact in a fine-print footnote.

As it turned out, the things these companies obscured were pretty important to investors.  Once the off-balance-sheet liabilities were known, the company’s valuation tumbled, executives were fired and lawsuits and recriminations ensued – for the board and its auditor.

The accountants’ defense that “we were just following the rules” just doesn’t fly.  For one thing, the so-called “rules” on disclosure don’t exist.  The SEC does not provide a strict threshold for disclosure, choosing instead to let companies determine what should be released.  The burden is, appropriately, on the company’s board to make the right judgment, consistent with its fiduciary obligation to shareholders.

More than that, auditors ought to stand up as professionals and insist on disclosure when important issues are involved.  Sadly, there are few examples when they’ve done so.

It’s not all the fault of the auditors.  Ultimately, it’s up to the board.  Disclosure isn’t a matter of meeting a test or ticking a box.  Disclosure is an attitude.  A company decides it is going to keep investors informed or not.

Disclosure failures have been at the heart of spectacular corporate failures, from Enron nearly a decade ago, to Lehman Brothers in 2008, and it’s again in focus in the aftermath of Facebook’s bungled IPO.  There, Facebook filed a revised prospectus with a vague statement about user growth was outpacing advertising – an oblique way of saying its revenue growth was slowing.

Did the SEC filing by Facebook meet the legal requirement to disclose a material fact? Probably. (Although that question seems headed for the courts.) Was the statement sufficient to inform investors about the true state of Facebook’s profit outlook?  No, it wasn’t.

The adequacy of J.P. Morgan’s disclosures has also been questioned following its $2 billion trading loss from a complex hedging strategy.

Ultimately, the decision to make a disclosure comes down to management and the board and whether they want to state the facts openly or hide behind obscure accounting practices.

I know in which company I’d want to invest.

I’m Starting to Worry about Goldman Sachs

The outlines of Goldman’s new public relations strategy are becoming clearer.  It involves more television appearances by CEO Lloyd Blankfein, investments in trendy green-tech companies and a new twitter account, unveiled at yesterday’s annual shareholder meeting.

It is part of an effort to create a “more open and friendly” firm, according to news reports.

Lloyd Blankfein in a Zuckerberg-style hoodie surely is next on the agenda.

This looks a little like the time your uncle tried to look cool by wearing skinny jeans.  He was still the same fat guy, just a lot more uncomfortable.  And that’s the risk for Goldman or any other company that tries on a new style without really changing.  The new image will be superficial and short-lived.

Unless Goldman addresses tough issues like executive compensation, business conflicts and financial disclosure, perceptions about the firm won’t really change.  Achieving a lasting shift in public perception takes a lot of work, and it starts with making real changes in the institution itself.  If it were as simple as television interviews and tweets, no firm on Wall Street would have an image problem.

There’s another risk at play here, too.  I suspect that clients don’t really want Goldman to change too much.  For clients, anything that distracts the firm’s management from its core focus is bad.  Making markets, clinching merger deals and raising capital are things Goldman does very, very well, and clients keep returning for more. Goldman’s franchise remains strong, despite the endless negative media coverage the firm has suffered these past few years.  So perhaps Goldman shouldn’t stray too far from the image that has made it so successful.

 

The Facebook IPO Trainwreck

No one is covering themselves in glory in the aftermath of the Facebook IPO.

Lead underwriter Morgan Stanley is battling allegations that it priced the deal too richly.

Facebook insiders are being called greedy for the last-minute increase in the number of shares they sold in the offering.

Facebook’s management is being criticized for signaling analysts to lower their revenue estimates just days before the deal priced – a move that could be a violation of securities laws.  It also appears some institutional investors were informed of the analysts’ downgrade but retail investors were not.

If all that wasn’t enough, Nasdaq has endured a barrage of complaints for breakdowns in its system on the first day of trading that left investors in the dark about the status of their orders.

Predictably, regulators are launching investigations, legislators are scheduling hearings and plaintiff attorneys are filing lawsuits.

This is hardly the place Facebook wanted to be after completing its IPO.  Nor is it encouraging to other firms that are thinking about going public.

Morgan Stanley is clearly in the hot seat. The firm issued a statement late Tuesday defending its actions, but it is standing on narrow ground, asserting that its procedures were “in compliance with all applicable regulations” and that it handled Facebook in the same manner as every IPO.   That’s not enormously reassuring but it may be all it can say right now as it gathers the facts.

Nasdaq also has a lot to answer for.  Its systems are meant to handle high transaction volumes, and its people are expected to test and monitor the infrastructure to prevent these kinds of problems.  It’s not reassuring to hear Nasdaq executives admit they underestimated the scale of the technical problems.  Nasdaq needs to give guidance quickly on how it will address investor losses and repair the weaknesses in its systems.

Even if Facebook shares recover, the events of the past few days will linger in the minds of investors.  It’s too early to know if it will lead to changes in the IPO book-building process, which hasn’t changed much in the past half-century.  If it does, Facebook in its own way will disrupt Wall Street, just as it upended the media and technology sector.

Advice for Eduardo Saverin

Here is some advice for Eduardo Saverin and misunderstood billionaires everywhere: Just. Be. Quiet.

Stung by criticism that he relinquished his U.S. citizenship to evade tax on his fortune, Mr. Saverin gave an interview to the New York Times.  He no doubt believed that a sit-down with a Times reporter to “set the record straight” would reverse the impression that he is lucky, greedy and aimless.  It did not.

He comes across as, well, lost:

Of all the founders, Mr. Saverin has had perhaps the greatest difficulty figuring out how to build on what is likely a once-in-a-lifetime experience.

On the tax issue, Mr. Saverin essentially confirms reports that he wanted to avoid paying U.S. tax by giving up his citizenship and establishing residence in Singapore.  He also awkwardly tries to explain how he has been spending his time and money since leaving Facebook:

What has gotten attention, though, is his billionaire playboy lifestyle in glittering Singapore. Thanks to the interconnected world Mr. Saverin helped to create, the Internet is full of people sharing photos and stories of him embraced by statuesque women and drinking expensive Champagne. “It’s a misperception, especially the playboy,” he said. “I do have a Bentley. I do go out. I’d rather not go into personal details.”

Oh, and that movie was all wrong about him, too:

He also said the depiction of him in the movie “The Social Network” was distorted. “It was more art than documentary,” he said. As to his purported betrayal by Mark Zuckerberg, chief executive of Facebook, the dramatic core of the movie, Mr. Saverin said: “There was no burning there. Mark is a phenomenal guy.”

Mr. Saverin is not alone in having a misplaced belief in his own persuasive powers.

Corporate chieftains, hedge-fund titans and technology wizards often believe that with enough time, coffee and charm, a reporter can be persuaded to take a sympathetic view of their plight.  If it’s People magazine, maybe; but not The New York Times.

The better course for Mr. Saverin would be to do something useful – start another wildly successful company or give a bundle to charity or support a cause he feels passionate about.  All of that is much tougher than a press interview, of course.

The lesson is, until you change the facts, don’t expect a different story.  Until then, please suffer a little adverse press coverage quietly and in the comfort of your enormous yacht.

 

 

 

What’s Next for the FX Lawsuits Against State Street and Bank of New York?

Although it didn’t make the headlines last week, State Street suffered a setback in its long-running legal dispute over the fees it charges clients for foreign exchange services when a District Court judge in Boston denied its motion to dismiss the suit.

State pension funds in Arkansas and California have sued State Street, alleging that they were for years systematically overcharged by the bank for foreign exchange transactions.

State Street has not set aside a reserve against potential claims in these cases, according to a regulatory filing, and its public statements indicate it will contest the lawsuits.  It also has said that the outcome of these suits could have a “material adverse effect” on its future financial results.

This issue also dogs Bank of New York Mellon Corp., which is facing similar suits from state pension funds in Virginia and Florida.  It reported a decline in first-quarter foreign exchange revenue of 21% versus a year ago, and in January settled with federal prosecutors, agreeing to amend its marketing material by eliminating the reference to providing “best execution” in foreign exchange.

Both banks are in a very tough spot.  The outcome of a court trial is risky and would present sensitive bank documents for everyone to see.  There are bound to be embarrassing emails and other material that the banks would not want revealed.  Bank of New York in particular could face some very juicy evidence gathered by a whistle-blower.

But a settlement is also difficult without opening the door to further claims from clients or regulators, who, as State Street notes in its 10-K, are already taking a look at the matter:

“Since the commencement of the litigation in California, attorneys general and other governmental authorities from a number of jurisdictions, as well as U.S. Attorney’s offices, the U.S. Department of Labor and the Securities and Exchange Commission, have requested information or issued subpoenas in connection with inquiries into the pricing of our foreign exchange services.  We continue to respond to such inquires and subpoenas.”

For both banks, the best way to end the litigation – and the uncertainty it creates for its clients and shareholders – is to reach a global settlement that addresses changes in business practices and monetary restitution.  That will take leadership by their CEOs, but the alternative is months, perhaps years, of costly legal skirmishes in courtrooms around the country, while clients take their business elsewhere.

An aggressive settlement strategy, coupled with a credible communication plan, could bring this unpleasant story to a close.