The technology industry often frowns on government regulation as an unnecessary hindrance to the entrepreneurial spirit. But a team of Securities and Exchange Commission attorneys charged with keeping Facebook honest before it went public demonstrated the importance of regulators.
Facebook vs. The SEC
Facebook and the SEC fought for two and a half months before the company's bungled initial public offering, often over information Facebook executives were hesitant to disclose to the public, according to Bloomberg, which dissected a dozen letters published by the SEC after the IPO.
For example, the claims challenged by the SEC included a Nielsen study that showed the effectiveness of ads linked to Facebook users' friends. When Facebook couldn't produce the study, the reference had to be dropped.
One area Facebook seemed intent on glossing over was its failure to maximize ad revenue from the growing number of mobile users. While more than half of the company's 845 million users accessed the site through mobile devices, the amount of ad revenue the company was making per user was falling. The SEC forced Facebook to disclose the problem eight days before the May 17 IPO, giving potential investors the strongest signal yet that the company's revenue growth might not meet expectations.
Other important information demanded by the SEC team led by Barbara Jacobs, assistant director for corporation finance, included slowing revenue growth and its dependence on game-maker Zynga, which was having its own problems keeping the revenue engine running.
There's much more to the Bloomberg piece, which I recommend. For people wondering why the SEC does not release such correspondences in real time before the IPO, it's because the commission believes it would be unfair to publish its questions before companies have a chance to respond. The SEC routinely releases the information no sooner than 20 business days after the IPO.
Still, "It's sad that these kinds of letters are released after the IPO," said Timothy Loughran, professor of finance at the University of Notre Dame. "I understand the SEC's concern about doing real time stuff, but I think a lot of investors probably wouldn't have purchased the (Facebook) stock, if some of the obvious problems had been pointed out to them."
Regulators Doing Their Job
An important lesson from Facebook's IPO imbroglio is what can happen when regulators actually do their job. Jacobs deserves credit for leading a team that carefully scrutinized Facebook's disclosures and refused to give in when facts were missing or misstated. Without that confrontation, potential investors would have had only a rosy picture painted by a company with serious issues and solutions that remained a work in progress at best.
The SEC was so aggressive with Facebook's IPO because of its $100 billion size and the unusually high number of people interested in buying the stock. In general, individuals, or "retail investors," lack the resources of more sophisticated institutional investors, Loughran said. "Clearly, the SEC can add value by helping point out some potential problems or trying to get them to articulate some risks that are obvious."
Looking Out For Small Investors
Even with the SEC working hard behind the scenes, of course, many Facebook investors claim they still got the shaft.
Following discussions about ad revenue growth with Facebook management, the IPO underwriters' analysts lowered their earnings forecasts and told their largest investors. Retail investors were left in the dark. Those who bet on Facebook watched the value of the stock plummet. Today, the stock is worth roughly half of its initial price of $38.
Investors have sued, and Facebook will eventually have to answer their allegations in a New York federal court. In the meantime, the many messages between the SEC and Facebook show how much less information investors would have had without the commission.
Not having regulators watch out for small investors would likely lead to less investment being available to companies that go public. "There seems to be a perception that big players get information and small retail players are cut out of the deal. They're not allowed to sit at the table," Loughran said. "It's a dangerous precedent, because then the retail investors will say, 'I don't want to play this game anymore.'"
When The SEC Drops The Ball
The SEC has sometimes failed in its duty to protect average investors. Critics have often asked where was the commission during the housing bubble that nearly brought down the U.S. banking system when it burst in 2008. The SEC failed to ask the right questions then and the nation paid with the loss of millions of jobs and the worst recession since the Great Depression of the 1930s.
The team in charge of watching the Facebook IPO may have been an anomaly and the toughness and skepticism of its leader Jacobs a rarity within the commission. For the sake of small investors in future IPOs, we can only hope that isn't the case.
Facebook image courtesy of Shutterstock.