Compliance Lessons from Facebook’s IPO Debacle

The world’s most popular social network went public in 2012.

Published by Reuters Complinet

June 2012

It is too early to know whether there was any wrongdoing during preparations for the much-hyped Facebook IPO in May, despite the public outcry. It will be months, and more likely years, before the investigations are over, the lawsuits resolved, and investor angst over whether to still “like” Facebook as an investment are settled. Even so, there is valuable guidance for compliance officers in the events that have taken place so far.

“What is clear is that the Facebook IPO was a complete debacle, with fingers being pointed at the underwriters, NASDAQ and the company itself,” Donna Boehme, principal of Compliance Strategists, a consulting firm in New Providence, NJ, wrote in an email. “What is not yet clear is whether there were any actual violations of securities law. Until all the facts come out, we don’t know whether this is a compliance matter, or whether this is a matter of unintended consequences under existing rules, amplified by technical and PR blunders,” she said.

As the famous (or infamous) former high-flying Wall Street analyst and now blogger Henry Blodgett recently pointed out, lead underwriter Morgan Stanley maintains that it followed all the rules as they currently exist with regard to disclosure of information for the FaceBook IPO. “The problem is that, as Facebook has illustrated, the rules themselves are grossly unfair,” Blodgett wrote in his Business Insider column.

There are of course, always going to be areas that fall outside of the compliance officer’s ability to control, such as the technical glitches that caused Nasdaq to delay the start of trading in Facebook’s case, or the sheer volume that appears to have been a factor in how slowly trades were completed and posted. Class-action shareholder lawsuits are an almost inevitable result of any IPO.

The best defense, observers say, is a good offense. When an event such as a high-profile IPO is likely to come under a public and regulatory microscope, compliance officers need to be extra vigilant, said Kathleen Wailes, senior vice president of Levick Strategic Communications and the chair of Levick’s Financial Communications Practice. If compliance professionals are confident that all regulations have been followed and all compliance issues addressed before the big day, then they’ll be as prepared as possible when (and not if) the fallout comes.

Fueling the flames over Facebook’s issue may, ironically, have been the company’s insistence on making a large number of shares available to retail investors. According to some reports, as much as 25 percent of Facebook’s shares went to these smaller investors – folks who are less familiar with the IPO process and more likely to feel cheated, Blodgett wrote.

Facebook isn’t even the first social media IPO in the past year to experience problems. Groupon went public late last year, and then had to restate its earning as questions surrounding the company’s accounting practices came to light. The company’s shares currently languish at less than a third of their initial offering price.

Too often, young companies rush to market before they’re ready, warns Steve Hobbs, managing director at Protiviti, which helps companies prepare for their IPOs. Maturity is one of the things Hobbs has learned to look out for. Are internal controls in place? Is the company ready for the extra scrutiny that comes with being public? “Make sure you’re ahead of the curve,” he suggests.

“Companies that are most successful demonstrate an understanding and commitment to internal controls over financial reporting (ICFR) well before they are required to by law,” said Sean Turner, managing director of the transaction services group at Morgan Franklin, a consulting firm that advises small companies preparing for IPOs. “This not only helps build investor confidence but also reduces the risk of having to issue financial restatements down the road.”

One of the issues faced by small companies is whether they have or can afford a chief compliance officer or a team of compliance professionals on staff. So it’s important to know who’s handling compliance, and to be certain all parties to the deal are on the same page. A lot of Morgan Franklin’s clients are too small to have full-time compliance officers, Turner said.

“One possible result of the Facebook debacle is that regulators (SEC and FINRA) may feel obligated to clarify the rules governing pre-IPO communications, or write new rules (a common reaction to high profile headlines), but that’s by no means clear,” Boehme wrote.

Turner agrees that the rules which erected a “firewall” between analysts and bankers are confusing. In the light of the Enron collapse, the Sarbanes-Oxley Act required that analysts be independent from bankers, to lessen the appearance of conflicts of interest. The rules have since been relaxed to allow analysts to work with companies to develop estimates and share them with institutional investors and bankers in the course of “road show” events. That information may not be shared with the general public, fanning the flames for those who say the small investor just isn’t getting the same information as everyone else.

“The lesson for investors is that hype and emotion are fleeting and the only reality in the market is price based on earnings,” Boehme wrote.

Compliance officers should be following the resolution of the FaceBook debacle and current practices regarding IPO communications carefully, and ensuring that existing programs are modified to reflect any new rules, practices or risks that result, advises Boehme.

Five lessons for compliance officers from the Facebook IPO:

  1. Be extra-vigilant when an issue is likely to receive additional regulatory and public scrutiny.
  2. Get involved at every step in the process.
  3. Be aware of what all parties to the transaction — lead counsel, underwriters, bankers and the company — are doing to ensure compliance.
  4. Review all communications, written and oral. Know how they will be disseminated, and ensure that all interested parties have them, or have access to them.
  5. Make sure there is time to be adequately prepared for the IPO.

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