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The players in the IPO process

In order to better understand the conflicts of interest that
can arise, the following is a summary of all the players in
the IPO process and their various objectives.
The Issuing Firms:
In this case it is facebook. It is generally trying to get
the highest prices for its shares.
The Underwriter:
This is role is usually preformed by an investment bank
or a syndicate of investment banks.
Their role is to solicit interest and promote the offering,
to purchase any shares that can not be sold to the
public, and to support the price after listing
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The players in the IPO process

The Underwriter:
Underwriting can be very lucrative for investment banks as
they take about 7% of the issue in fees.
It is important to note that investment banks have many
divisions. In the case of an IPO, an investment banks
analysts are also supposed to be independent from its IPO
underwriters. They should advise to clients independently
regarding the fair valuation of a stock.
The Institutional Investors
These are fund managers and professional investors with
whom investment banks have a close relationship.
Investment banks rely on institutional investors to take up
most of the IPO issue (and thus reduce their risk of
underwriting)
Institutional and other investors can often achieve large
profits by participating in IPOs as on average, there is
usually a very large first day return (e.g. 20%), known as
IPO under-pricing.

The players in the IPO process

Retail Investors
These are mum and dad investors who apply for IPO
stocks through a public application process. They have
no inside connections with investment banks.

Some basic facts about facebook

Initially planned to sell about 340 million shares @ $28-$35 i.e.
around $12 billion proceeds
This placed the companys valuation at around $90 billion
dollars.
In response to very strong investor demand, increased its
indicative stock price range to $34-$38 per share.
This placed Facebooks valuation at $100-$120 billion.
This will make Facebook the third-largest initial share sale in
U.S. history after Visa Inc and General Motors.
The next biggest internet IPO was Google at around $1.5 billion
Facebooks valuation was based on a 25x multiple over current
sales and 55x times multiple of earnings!
Its clear the market was pricing significant growth
opportunities
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Growth Opportunities
At a market value of $100 billion, investors are estimating
that each person with a Facebook page is worth roughly
$110. But thats based on the potential profits not what
Facebook is making off them now. Just before the IPO
Facebook generated $4 worth of sales for the company.

The IPO
The issue was managed by 33 underwriters (investment banks)!
Halfway through the road-show all of the shares available for
offer had been pre-committed to be sold.
To get an allocation of facebook IPO stock you had to have an
established relationship with a stock broker or institutional
investor (i.e. wealthy individuals or investors)
Almost no small retail investors(those that had no access) had
been able to access the IPO stock
Not even all investment banks or stock broker and their clients
(i.e. funds, high net work individuals etc.) were able to get
access to Facebook IPO stock.
There was enormous hype around this IPO, with some
predicting the price would reach over $100 on the first day of
trade.
The media acted like it was certainty that there would be a
significant and large 1st day return on the stock.
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The IPO
But days before the IPO, the underwriting banks warned large
investment firms and fund managers about Facebook's
dimming revenue prospects
Armed with this information many investment managers
slashed the number of shares they intended to buy, just
before the IPO
Some fund managers did not buy into the IPO at all.
The final IPO issue price that cleared all of the demand on the
stock was $38.00
In the first few days after the stock was issued the price
dropped by 16 percent.
After all of the fund managers pulled out of the offering,
retail investors ended up receiving 25 percent of the offering,
which is quite high for such a high profile IPO.
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Glossary of Terms

SEC
The U.S. Securities and Exchange Commission (SEC) is an agency of the
United States federal government. It holds primary responsibility for
enforcing the federal securities laws and regulating the securities
industry, the nation's stock and options exchanges, and other activities
and organizations, including the electronic securities markets in the
United States. In Australia, the government agency with similar
responsibilities is Australian Securities and Investments Commission
(ASIC).

FINRA
In the United States, the Financial Industry Regulatory Authority, Inc.
(FINRA) is a private corporation that acts as a self-regulatory
organization (SRO). FINRA is the successor to the National Association
of Securities Dealers, Inc. (NASD) and the member regulation,
enforcement and arbitration operations of the New York Stock
Exchange. It is a self-regulatory organization, a non-governmental
organization that performs financial regulation of member brokerage
firms and exchange markets.
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Glossary of Terms

Reg FD
Regulation Fair Disclosure, also commonly referred to as Regulation FD
or Reg FD, is a regulation that was promulgated by the U.S. Securities
and Exchange Commission (SEC) in August 2000. The rule mandates
that all publicly traded companies must disclose material information
to all investors at the same time.

SEC S-1 Form

The S-1 form is an SEC filing (a formal document submitted to the SEC)
that must be lodged by companies planning on going public to register
their securities with the SEC in accordance with the Securities
Exchange Act of 1933, which aims to ensure all important information
is disclosed about the securities. It contains basic business and
financial information. Amendments to the form can be made as
material information arises or delays are caused by market conditions.

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Glossary of Terms

Massachusetts Securities Division (MSD)

The primary role of the MSD is investor protection. The overall goal is
ensure free and competitive securities markets to increase investor
confidence, encourage the formation of capital and support the
creation of new jobs in Massachusetts. Different states will have
different security divisions with separate laws and regulations that
must be followed.

Professional Conduct Program (PCP)

CFA Institute upholds the Code of Ethics and Standards of Professional
Conduct, exam rules and regulations, and Bylaws to protect the
integrity of its membership, designations, and examination programs.
The Professional Conduct Program administers the disciplinary process
for the CFA Institute, which includes monitoring compliance,
investigating allegations, conducting disciplinary proceedings, and
imposing sanctions if necessary.
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Glossary of Terms

IPO Roadshow
This represents a presentation by the issuer to potential buyers. The
management of the company looking to complete an IPO travels
around multiple cities to give presentations to analysts, fund managers
and all potential investors. Not only do such presentations provide
excitement and interest in the IPO, but is often critical to the success
of the IPO process.

Wall Street / Main Street Investors

Whilst Wall Street refers to major/global financial institutions,
institutional investors and major corporations, Main Street investors is
the term given to individuals, retail investors and small/independent
investment companies. As such, there is usually a significant
knowledge gap between the two parties.
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Case Study Discussion Questions

Relate this case to the CFA Code of Ethics.

What were the probable misrepresentations and/or omissions of facts
in the amended S-1 filing?
Did the lead underwriters violate Fair Dealing with regards to the
conveyance of updated revenue forecasts? If yes, how so?

Consider the lawsuit, Morgan Stanley v. Uma M. Swaminathan, stated in

the case study.
In what way/s did Vanguard potentially fail in its fiduciary
responsibilities toward Swaminathan?

A US judge stated that internal calculations and projections are not

material facts that are required to be disclosed in a registration
statement.
Discuss the potential repercussions to future IPOs in light of this ruling.
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