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Facebook Fallout: Morgan Stanley May Face Legal Liability, Attorney Says

Aaron Task
Editor in Chief
Daily Ticker

As the dust settles on Facebook's botched IPO, a lot of fingers are being pointed, regulators are investigating and at least one class action lawsuit has been filed against Morgan Stanley and Facebook.

"There are issues that we need to look at specifically with respect to Facebook," SEC Chair Mary Schapiro told reporters Tuesday after testifying before the Senate Banking Committee.

The handling of Facebook's IPO is "a matter of regulatory concern," said Rick Ketchum of the Financial Industry Regulatory Authority, Wall Street's self-regulatory agency (yes, they have one).

In addition, the top securities regulator in Massachusetts has subpoenaed Morgan Stanley amid reports that the securities firm, who was the lead underwriter on the IPO, selectively disclosed material information about Facebook right before the offering.

"There's a real chance Morgan Stanley will have legal liability," says Andrew Stoltmann, a securities attorney and principal at Stoltmann Law Offices in Chicago. "Other underwriters might as well. We will see as regulatory investigations expand who else might be liable."

According to Stoltmann, Morgan Stanley would be in violation of the 1934 Securities Act if the company -- as had been widely reported -- cut its earnings forecasts in the middle of the roadshow after receiving material information from Facebook, but only told select clients. (See: Facebook Bankers Secretly Cut Facebook's Revenue Estimates In Middle Of IPO Roadshow)

Rule 10b-5 of the 1934 Act prohibits the use of any "device, scheme, or artifice to defraud," and creates liability for any misstatement or omission of a material fact, or one that investors would think was important to their decision to buy or sell the stock, as explained on Cornell University Law School's Web site.

As lead underwriter of the IPO, Morgan Stanley's "duties are heightened" as it pertains to material disclosures, according to Stoltmann. "It's a little early to say definitely where there's been any violation but certainly at first blush" it appears there has.

A Morgan Stanley publicist told Reuters that the firm "followed the same procedures for the Facebook offering that it follows for all IPOs. These procedures are in compliance with all applicable regulations."

Morgan Stanley "will likely point its finger at Nasdaq," Stoltmann speculates. At least one investor has sued Nasdaq OMX, Bloomberg reports, claiming the exchange "badly mishandled" the offering. (See: "Crisis Meltdown" at Nasdaq Mars Facebook IPO)

As for Facebook, it would appear to have violated Reg FD. The 2000 law makes it illegal for publicly traded companies to selectively disclose material information, as Facebook executives (likely CFO David Ebersman) are alleged to have done.

That said, because Facebook was not yet a publicly traded company at the time, it's unclear whether Reg FD applies, Stoltmann adds.

Investors who feel they have a case can join the class action lawsuit, although those typically take years to resolve and "usually lead to a really small settlement," according to Stoltmann.

However, if a broker recommended Facebook shares to you and you sustained losses -- as anyone who bought the IPO has to date -- Stoltmann says you can file an arbitration claim against the broker, the brokerage firm and Morgan Stanley as well.

In the end, the Facebook IPO cost investors millions of dollars and further damaged confidence in the market but, rest assured, the lawyers will get paid.

More Facebook coverage:

So, Now That Everyone Has Sobered Up, What Is Facebook Actually Worth?

Facebook IPO Latest Blow to Investor Confidence

Facebook Effect: How The Social Network Changed the World

Facebook Crashes Through IPO Price But That Doesn't Make It a 'Failure'

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com