The tragedy of Facebook
"How do I buy a stock?"
That was the subject line of an email passed along to me the morning of Facebook's (NAS: FB) IPO. It was from a friend of a friend, wondering how to buy a stock because she was looking to sink $40,000 -- her entire life savings, previously set aside for a down payment on a house -- toward the Facebook IPO.
At the time, the question looked purely naive. With Facebook's plummeting share price, I now see it less for its naiveté and more for its tragedy. I didn't know the person well enough to advise directly against this move, so I simply ignored the email. I deeply regret that decision now.
Sadly, she wasn't the only one asking that same question. It was being asked by millions of investors across America. For the first time ever a company was IPOing that personally touched the lives of almost every American.
Facebook is a cultural phenomenon. Hundreds of millions of users feel a deep emotional connection to the service; many wanted to buy shares for that singular reason. Others wanted in for fear of missing the investing opportunity of the decade. They didn't want to miss out on the next Google.
Never before were the stakes this high -- for investors to embrace the idea of buying stocks and investing, for the investment industry to create awareness around how to invest in a country where half of people save nothing.
But everybody – all of those who bought in – got robbed by Wall Street.
Welcome to Wall Street. Muppets welcome
"Whatever positive impression [American investors] had of the IPO market and the stock market in general was just torched to the ground."
Long before its IPO, the myth of Facebook's unstoppable rise was born. The company had effectively traded for years on opaque second markets where it changed hands at exorbitant prices despite little to no financial information on the company being publicly available. The reports of Facebook's booming valuation on these markets fed the belief that ravenous demand for Facebook was inevitable heading into its IPO.
However, troubling signs reportedly started to emerge around Facebook just days before its IPO. Conveniently, these details were hidden from the public.
This estimate cut for the VIP club only
As the story goes, midway through the customary "road shows," during which companies give presentations to large institutional investors to promote their IPOs, the group of investment banks bringing Facebook public saw their analysts cut estimates of the company's future sales.
Cutting sales estimates mid-road-show has been described as "unprecedented" in and of itself. But here's the thing: The banks themselves didn't spread the word far and wide. They didn't give anything close to fair access to the information.
Instead they used the information to curry favour from their best clients. As Reuters reports, information was "selectively disclosed". That situation might be more acceptable if the cuts were the result of good research from each bank's analysts -- but that wasn't the case. Reports from Business Insider reveal that the bank's analysts cut estimates because a Facebook executive told them to!
If the press reports are to be believed, in a nutshell Facebook signalled that its growth was worse than expected. Instead of spreading the word to individual investors, the Wall Street underwriters selling Facebook pursued a strategy of raising the offering price and targeting more shares for the individual investors – who remained in the dark. Wall Street was taking Main Street America for a ride.
Now, to be fair, in its S-1 Facebook did disclose that mobile was weighing on growth. However, nobody knew the extent to which that was the case – a fact it appears Facebook executives revealed to its underwriters... who, again, selectively disclosed the information.
Like every facet of Facebook's IPO, the process served to enrich the best clients of the big Wall Street banks while individual investors were left out in the cold. The whole process was grossly unethical – at best – and a huge injustice to any client without an account in the billions of dollars.
However, as will continue being illuminated from Facebook's IPO process, such practices, full of conflicts as they are, are tolerated on Wall Street for a simple reason.
Countdown to doomsday, the IPO begins
On May 18, the day of the IPO, ominous signs were present early in the day. Trading in the company's shares didn't even start on time thanks to technology problems on the Nasdaq that persisted throughout Facebook's first day. Once trading began, Facebook opened near $45, a huge pop over the $38 offering price.
However, that victory would prove short-lived. Within 30 minutes of trading, Facebook had plummeted back down near its offering price. The idea of Facebook's IPO going negative represented a huge PR disaster to lead underwriter Morgan Stanley, so the company began buying up tons of Facebook shares, providing "support" that led the stock to bounce back.
Perversely, while Morgan Stanley was supporting the Facebook IPO from disaster, according to 'The Wall Street Journal' underwriters Goldman Sachs (NYSE: GS) and JPMorgan (NYSE: JPM) were lending out shares to be sold short, an action that provided additional selling pressure on Facebook's shares. Many of those short-sellers were likely acting on the knowledge of Facebook estimates that were reduced downward just days earlier – again, information that was only selectively disseminated and wasn't known by the average individual investor racing to buy Facebook shares.
Morgan Stanley didn't lend shares to short.
Like a pack of wolves attacking its weakest, the Wall Street banks were taking opposite positions. As Yale School of Management professor Daylian Cain told 'The Wall Street Journal': "It's hard to navigate [conflicts of interest] when there are millions of dollars at stake."
There's that "profits above all else" mantra again.
The house always wins
Naturally, like most investors, I was naive enough to think that Morgan Stanley buying billions worth of Facebook's stock – which would plummet in the following days – would result in a loss. But I forgot one key fact: The house always wins.
Morgan Stanley was in charge of an overallotment of Facebook shares used to aid the "stabilisation" process – keeping Facebook from plummeting too far. However, by selling more shares into the market (through the overallotment) than it owned, Morgan Stanley had the net effect of profiting from Facebook's fall. Once again, 'The Wall Street Journal' was on the case and detailed how underwriters notched about $100 million from trading Facebook even as its shares plunged earlier this week.
Heads, Wall Street wins; tails, you lose
The system is effectively set up so underwriters win no matter what. The early individual investors who had Facebook stock pushed on them by their advisors from the likes of Morgan Stanley Smith Barney – they weren't so lucky. As the IPO increasingly looked ready to crumble and more shares were offered, the investment banks used their army of advisors – the ones charging clients a 1% fee to keep their cash in a money market fund that yields 0.2% – to pawn off shares. Bloomberg has reported that retail investors are sitting on more than $630 million in losses.
Most brokers likely had no idea they were eagerly filling requests for Facebook shares as institutional clients with better access to information ran away from the offering. In many ways, these brokers are individuals like me and you. The problem is they were mere pawns to their larger bank's game, but harmful pawns nonetheless.
And so the plan was complete. Wall Street had managed to take Facebook public at an elevated price, effectively shorted the shares and made a profit, and then pawned off the shares on an unsuspecting public who gobbled up Facebook as a "can't-miss investment". The illusion of easy money was created, only to see Wall Street rob Americans who had a huge information disadvantage.
And you paid them a lot for that service. For your sake, I hope you feel used right now.
It's not that every IPO needs to pop. That's not the point at all. And it's not that people shouldn't take personal responsibility for their own poor decision to buy a risky stock.
The broader point is that Wall Street has created a system that uses individual investors and at the same time is rigged against them. While Wall Street might look at several of the practices above and shrug them off as "business as usual", these are the sort of self-serving actions filled with conflicts of interest that don't treat the vast majority of their clients with a modicum of respect. No wonder there are record-low levels of trust in the financial industry.
It's time for investors around the world to do better.
Forget the Alamo; remember the Facebook IPO, and then fire your broker
As ugly as Facebook's IPO has been, I hope investors use this as an opportunity to learn that we don't need to be captive to Wall Street anymore. There is a better way forward.
My greatest fear is that people will read about this saga and simply blow it off. If the average saver can't read a brokerage statement to gauge whether their advisor is charging them exorbitant fees to underperform the market, how are they supposed to understand the damage Wall Street wrought on them with the Facebook IPO?
Instead of breaking the will of a generation, as Mark Cuban believes the Facebook IPO has, I hope a better glimpse into Wall Street's machinery empowers a generation of investors to say "I can do this without Wall Street's games" and put an end to advisors with out-of-control, self-serving fees pushing investments not in their clients' best interests. Learn how to invest on your own, and fight back against getting taken advantage of. Take control of your financial freedom.
It's time for a change.
- Sorry Facebook investors: it's mostly your fault
- Bank refund for Facebook investors
- Why I wouldn't touch Facebook with a barge pole