A Financial Disservice of Epic Proportions

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There is no doubt that Morgan Stanley (NYS: MS) , Goldman Sachs (NYS: GS) , JP Morgan Chase (NYS: JPM) , and the Merrill Lynch arm of Bank of America (NYS: BAC) are in the soup right now, facing investigations and lawsuits regarding the Facebook (NAS: FB) IPO flap. Despite the problems these banks have experienced during and after the financial crisis, you would think that handling something like a company's initial public offering would be a no-brainer. Was the slip-up borne of ignorance, or greed? Right now, it's looking a lot like the latter.

According to Henry Blodget, who has been picking through the detritus to determine what happened, the story has decidedly unsavory undertones. It seems that, a couple of days after Facebook's IPO roadshow began, the four underwriters cut their earnings estimates for FB after noticing some prospectus changes made by the social media colossus. The wording wasn't crystal clear, but seemed to infer a disconnect between acquiring new users and seeing a commensurate increase in revenues. The three lead banks, as well as B of A, apparently took this to mean that Facebook wasn't doing as well as everyone thought.

The banks then told their clients of the estimate cuts, and therein lies the rub. Was it legal to tell some investors, but not all? A class action lawsuit filed in New York purports that it was not, and a slew of regulators like the Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Massachusetts Secretary of the Commonwealth are gearing up to examine the facts of the case.


Another issue revolves around Facebook's involvement in this scandal. Did the underwriters decide on their own that the disclosure was indicative of future financial problems, or did Facebook tell them so, and direct the banks to trim their estimates? Blodget thinks the latter, and it does make sense, particularly since this action is so far from usual as to be practically unheard of. So far, however, Facebook is mum on the subject.

Fool's take
It will take some time for all of the facts to come to light, and an avalanche of written words will no doubt bury us all with explanations, analyses, and postulations. It's hard to believe that, even with all the official attention being paid to how the banks behaved, there will be any permanent damage done to their bottom lines -- which, according to the Wall Street Journal, have been enriched handsomely by this affair. I could be wrong, though; the recent brouhaha over JP Morgan's trading fiasco has once again lit a fire under the anti-big bank and pro-regulation camps, so maybe a few select heads will have to roll, just to wrap this mess up tidily. No matter what the resolution, it seems evident that these banks did a disservice to scores of investors, and possibly to Facebook's image.

For Facebook, much will depend, I think, on whether or not it was culpable. If it can be painted as a victim of sorts, then this additional attention may benefit them. If it is found to have told the underwriters to cut their estimates, the company's image may be tarnished for downplaying their revenue problems until the last minute, despite the fact that the banks should have known better, whether Facebook told them to or not.

As for investors who subscribed to the "first day, stay away," school of thought, I'll bet they're feeling pretty smug right now. By the time the next tech IPO rolls around, I predict there will be a lot more of them.

But Facebook's not the only growth stock out there. You can read about a company that our Foolish experts consider multi-bagger potential by reading this free report right now.

At the time this article was published Fool contributorAmanda Alixowns no shares in the companies mentioned above.The Motley Fool owns shares of JPMorgan Chase and Bank of America.Motley Fool newsletter serviceshave recommended buying shares of The Goldman Sachs Group. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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