As regulators scrutinize Facebook's problem-plagued stock market debut, they may have to confront areas of securities law that do not always clearly spell out what industry analysts are allowed to tell clients about companies on the verge of going public.
Facebook and the Wall Street banks that underwrote its $16 billion initial public offering are facing questions about how and why stock analysts decided to cut their financial forecasts on the company ahead of the IPO.
An Internet analyst at lead underwriter Morgan Stanley told clients days before the offering that he had reduced his revenue projections - information that some other investors may not have received, Reuters reported Tuesday.
JPMorgan Chase and Goldman Sachs , which were underwriters on the deal as well, also revised their estimates during Facebook's IPO road show, according to sources familiar with the situation.
The Massachusetts Secretary of the Commonwealth said late Tuesday that his office had issued a subpoena to Morgan Stanley related to the communications involving the analyst. The Financial Industry Regulatory Authority also said it plans to look at the matter, while the chairman of the U.S. Securities and Exchange Commission said the agency will examine unspecified issues stemming from Facebook's IPO.
Morgan Stanley said late Tuesday that its procedures for the social media company's IPO were "in compliance with all applicable regulations."
Several rules and regulations could be relevant in any investigation into whether analysts violated disclosure rules, given their banks' access to confidential information from Facebook in the IPO process.
Another important area of inquiry could be whether analysts chose only favored clients to share their forecast revisions with - although such selective treatment may not be prohibited. But even if the conduct does not cross the line legally, it could damage a firm's reputation in the eyes of retail clients who feel left out.
The timing of the Morgan Stanley analyst's forecast revision surprised some investors, who said it may have contributed to the weak performance of Facebook shares. It has also raised questions about access to information and whether federal securities laws were violated.
So-called "gun jumping" rules set out by the SEC, for example, regulate the communications that can be made about an issuer outside its prospectus.
Generally, information disseminated cannot be inconsistent with what is provided in the prospectus, said Adam Pritchard, a securities law professor at the University of Michigan and a former SEC enforcement attorney.
But Pritchard added that there is an exception for oral communications.
"That's the big exception to the gun-jumping rules," he said.
When public companies selectively disclose information, they can run afoul of a rule known as Regulation Fair Disclosure, which requires that material information be disclosed to investors at the same time. But that rule would not apply to information that Facebook provided to its underwriters before it went public, according to securities law experts.
Another set of rules that could be relevant address the communications made by the underwriters. One rule prohibits an analyst who works at the firm underwriting the offering from issuing a report on a company before it goes public.
The Morgan Stanley analyst, Scott Devitt, gave his revision to major clients of the firm in at least one conference call, though it's unclear if his revised view was also spread more widely. Devitt did not return a phone message seeking comment.
An oral communication by an analyst may not violate the rule on prohibited research reports, said Jill Fisch, a professor at the University of Pennsylvania Law School.
"If the analyst is just cautioning a customer on what the disclosure means or what's in the prospectus, I'm not sure that is technically inconsistent with the rule," she said.
Provisions of a 2003 settlement that regulators reached with investment banks could also come into play. Major Wall Street banks agreed to reforms after they were accused of using their research units to hype initial public offerings that analysts privately held in low regard.
Under that settlement, the banks agreed to take steps to ensure the independence of their research units. They agreed, for example, to prohibit analysts from participating in road shows and other efforts to solicit investment banking business.
If an analyst were found to be working with the investment bankers taking a company public, that could be a violation of the settlement, said Thomas Gorman, a partner at the law firm Dorsey & Whitney and author of the SEC Actions blog.
He suggested that Wall Street's history with IPOs shows that these offerings can be rife with conflicts for banks.
"Morgan Stanley's researchers should not be opining on the IPO at the same time they are acting as lead underwriters," he said.