By David Futrelle
Facebook’s post-IPO meltdown has certainly been bad news for investors who got into the stock at its initial price — or higher. Is it also bad news for the IPO market as a whole?
Facebook isn’t the first dotcom to see its IPO go blooey. Heck, it wasn’t that long ago that we were talking about Groupon’s post-IPO fizzle. But the sheer scale, and the nature, of Facebook’s meltdown has many worrying about the damage it may have done to the IPO market and the stock market in general.
What’s most worrying to investors are the reports that insiders were privy to information about Facebook’s financial worries that the rest of us were somehow expected to infer from some exceedingly vague verbiage added to Facebook’s prospectus before the launch. While what Facebook did may have been perfectly legal — we’ll have to wait for regulators and the courts to decide on that — it has left a distinctly sour taste in many investors’ mouths. If we can’t trust Facebook to, er, share its financial information fairly, who can we trust?
Rolling Stone financial muckraker Matt Taibbi puts it bluntly:
[S]tories like this … hint at a kind of two-tiered market system — in which most of the real action takes place inside an unregulated black-box network of connected insiders who don’t disclose their relationships or their interests, while everyone else, i.e. the regular suckers, live in the more tightly policed world of prospectuses and quarterly reporting and so on.
Why does this matter for anyone other than those unfortunate enough to have bought into the initial Facebook hype? Because markets, ultimately, are based on trust, and trust is based on transparency. We need to know that when big investors put their money into a stock, they are facing the same risks that we are.
That’s why we require public companies to disclose their financials to the public — and why we require companies to give this information to everyone, not just selected insiders. We don’t want insiders to be able to buy into a stock based on good news the company isn’t yet sharing with the public, and we don’t want insiders to be able to sell stock based on bad news before the rest of us get wind of it, which is what seems to have taken place with Facebook on a massive scale.
In a trenchant New Yorker blog post, financial writer John Cassidy argues that the distrust in Wall Street stirred up by the Facebook debacle could sour investors on IPOs for a long time.
[T]he I.P.O. system only works if it preserves a balance between public and private investors. If this balance is upended, and virtually all of the rewards are reserved for insiders, ordinary investors will refuse to play the game. A dearth of I.P.O.s would hurt insiders along with everybody else. More important, a time-tested system of financing companies, which rewards innovation and makes Silicon Valley the envy of the world, would be destroyed.
Other observers, while still worried, have slightly less dire predictions. In the Wall Street Journal, Lynn Cowan notes that Facebook’s inauspicious stock-market debut “could have a ripple effect on everything from IPO valuations to venture-capital funding in the months ahead, especially in anything related to social media.”
Meanwhile, John Fitzgibbon, founder of IPOScoop, tells Fox Business News that in Facebook’s wake, IPO issuers
will have those lead shoes on your feet — this doesn’t mean that game is over, but issuers are going to have to be more realistic with the value of their company. They can’t overprice and let the thing run away with hysteria.
Ironically, bad news for entrepreneurs hoping to make even a fraction of Mark Zuckerberg’s fortune by taking their companies public could actually be good news for investors. With companies afraid to overprice their offerings and then watch their stock fizzle in the midst of a p.r. nightmare like Facebook or Groupon experienced, investors may be able to get in on some good companies on the cheap. “[T]his is a huge plus for the IPO market,” David Menlow of IPOFinancial.com tells CNBC. “Issuers and underwriters alike will overreact with below-average pricings moving forward, and that means value for investors.”
Of course, that requires that investors retain enough faith in the system to put their money into already risky IPOs.
Which leads to the other silver lining of the Facebook debacle: the furor over what looks an awful lot like insider trading could lead to regulatory reforms designed to thwart this kind of favoritism. In many ways, the most appalling thing about the reports of Facebook’s early tip-offs to big investors is that what they did may have been perfectly legal, if morally and ethically dubious. In the Wall Street Journal, Ronald Barusch argues that regulators will have to move to close that loophole. “Look for new regulation where the role of the underwriting firms’ analysts is more formalized and all prospective investors have equal access to it,” he writes.
Let’s hope so.