Conflicts of interest in the Facebook IPO?

In the wake of the Facebook IPO the chief underwriter, Morgan Stanley, has been accused of a conflict of interest in alerting some, but not all, potential purchasers of the stock to negative news about the company.  Additionally, the sharp drop (more than 25% from its initial price  as of this writing) of Facebook shares is itself taken as indication of some kind of wrongdoing by the firm.

With respect to the latter issue, a piece in a blog published by The Telegraph argues –  pretty convincingly, I think – that this criticism is unfair: “the Facebook IPO hasn’t been all that great for those who bought shares in it is true. …But that’s not the point. Quite the contrary: that sagging share price is evidence of the huge success of the stock offer. For… the banks were not working for the new investors. They were selling to the new investors. And their gaining a good high price for the shares was exactly what they were supposed to do. Further, there is in fact a conflict of interest at such banks. If an IPO gets away with a good pop ….as the shares rise after issue, then the bank has failed its own customer, the issuer, for it has left money on the table. Money that rightly should be going into the pockets of the issuing company or the previous shareholders. However, making an issue with a good pop increases the business franchise of that issuing bank. It makes the various fund managers, hedge funds and investment managers like them. Be willing to do more business with them and thus increase their longer-term profits. Which is where the conflict comes in: screw the issuing company and be the popular boy on the block, or actually work for your customer, the issuing company, and damage your own longer term prospects?”

And what of the claim of selective disclosure?  According to this report,  the head of the chief industry self-regulatory body (FINRA) said, “The allegations, if true, are a matter of regulatory concern,..”  On the other hand, this analysis  suggested that due to rules that investment banks must follow in IPOs, Morgan Stanley in fact acted properly – although the piece also noted that the rules, which were intended to reduce conflicts of interest in the securities industry,  themselves are unfair.

For readers looking to learn more about this – particularly thorny – legal landscape, here  is a place to start.  But while in any  regulated business (such as financial services) an analysis of conflicts or any other ethics-related issue should generally start with the law, that ought not to be the end of the inquiry.  So, as this story develops, the COI Blog will return to it to see what broader ethical lessons (if any) can be drawn from it.

Finally, for “extra credit,” consider this story from the somewhat parallel universe of commodities regulation about a set of new rules which are also intended to reduce conflicts of interest but which some critics feel will end up having unintended negative consequences (perhaps similar to what happened with Facebook): “To the extent that the rule inhibits the flow of analysis and trade ideas to small investors, it will give an informational trading edge to larger entities…”