Skip to main content

Beware, investors: Facebook was just a warning

By David Wessels, Special to CNN
updated 7:06 PM EDT, Thu May 24, 2012
Main Street investors in Facebook lost more than $600 million based on the closing price of $32 on Wednesday..
Main Street investors in Facebook lost more than $600 million based on the closing price of $32 on Wednesday..
STORY HIGHLIGHTS
  • Investors are suing Facebook about withholding information on the company's IPO
  • David Wessels: Small investors like you and me lose out
  • He says the new JOBS Act will in fact roll back protections for investors
  • Wessels: Facebook was just a warning; future IPOs are more risky

Editor's note: David Wessels, an adjunct assistant professor of finance at the Wharton Business School, is a co-author of "Valuation: Measuring and Managing the Value of Companies."

(CNN) -- Facebook's IPO was all the rage Friday. Retail investors -- people like you, me and our neighbors -- flocked to the offering in hopes of returning to those glory days when a dramatic rise in stock price was a given.

But, alas, like so many recent IPOs, Facebook languished near its offering price on its first day and dropped on subsequent days of trading.

It could have been worse.

Disgruntled investors had ample opportunity to sell Friday afternoon once technical issues at Nasdaq were resolved. Those who chose to sell did so at a profit.

David Wessels
David Wessels

Investors in some other IPOs never have the chance to recoup what they put in. For example, PetroLogistics, a company that owns the world's largest propane processing plant, began trading below its offering price in early May. Nearly a month later, the stock still trades below what original investors paid.

So if profits aren't guaranteed, why the uproar over Facebook's IPO? Because an analyst at Morgan Stanley, the investment bank which set the offering price, released a report lowering the financial forecast for the company just before the offering. Angry stockholders allege the report was released only to a select circle of institutional investors, who then headed for the door. Consequently, most investors were left to shoulder the loss.

Why is Facebook being sued?
CNN Explains: IPOs

If this feels unfair to you, you're not alone. After all, why should you have to lose out?

After the dot-com crash, WorldCom and Enron, Congress included provisions in the much maligned Sarbanes-Oxley legislation to address potential conflicts of interest. Among other things, the bill led to a so-called "Chinese Wall" separating communication between investment bank research analysts and underwriters.

However last month a bipartisan bill, innocuously named the JOBS Act, rolled back these and other investor protections for companies with less than $1 billion in revenue, deemed emerging growth companies. Once again, research analysts can communicate directly with management and if desired share favorable (or unfavorable) reports.

Under these new rules it is only a matter of time before an enterprising young analyst crosses the line and writes an ethically questionable report.

Prior to Sarbanes-Oxley, researchers at Cornell and Dartmouth universities found that analysts affiliated with the underwriting bank issued buy ratings to prop up dropping stocks, only to watch the stocks drop further after the buy rating was issued. This was in direct contrast to reports written by unaffiliated analysts, where stocks rose following a buy rating. The differences in performance were staggering.

For markets to function effectively, investors need to trust the information reported by companies, and research analysts need to be able to act independently. Investors should remember that any stock can lose value no matter how much hype surrounds the company, and that research analysts have many bosses -- not just the small investors on the streets.

Congress must create a level playing field such that every investor has a fair shake, not just those who have special access. Facebook was just a warning. The real risk lies in the countless other IPOs less likely to receive so much scrutiny and spotlight.

Follow us on Twitter @CNNOpinion

Join us on Facebook/CNNOpinion

The opinions expressed in this commentary are solely those of David Wessels.

ADVERTISEMENT
Part of complete coverage on
updated 11:39 AM EDT, Thu October 30, 2014
Mike Downey says the Giants and the Royals both lived through long title droughts. What teams are waiting for a win?
updated 2:32 PM EDT, Thu October 30, 2014
Mel Robbins says if a man wants to talk to a woman on the street, he should follow 3 basic rules.
updated 5:03 PM EDT, Wed October 29, 2014
Peter Bergen and David Sterman say more terrorism plots are disrupted by families than by NSA surveillance.
updated 5:25 PM EDT, Wed October 29, 2014
Time magazine has clearly kicked up a hornet's nest with its downright insulting cover headlined "Rotten Apples," says Donna Brazile.
updated 4:55 PM EDT, Wed October 29, 2014
Leroy Chiao says the failure of the launch is painful but won't stop the trend toward commercializing space.
updated 7:45 AM EDT, Wed October 29, 2014
Timothy Stanley: Though Jeb Bush has something to offer, another Bush-Clinton race would be a step backward.
updated 8:37 AM EDT, Tue October 28, 2014
Errol Louis says forced to choose between narrow political advantage and the public good, the governors showed they are willing to take the easy way out over Ebola.
updated 2:03 PM EDT, Mon October 27, 2014
Eric Liu says with our family and friends and neighbors, each one of us must decide what kind of civilization we expect in the United States. It's our responsibility to set tone and standards, with our laws and norms
updated 7:45 AM EDT, Mon October 27, 2014
Sally Kohn says the UNC report highlights how some colleges exploit student athletes while offering little in return
updated 3:04 PM EDT, Sun October 26, 2014
Terrorists don't represent Islam, but Muslims must step up efforts to counter some of the bigotry within the world of Islam, says Fareed Zakaria
updated 9:02 AM EDT, Fri October 24, 2014
Scott Yates says extending Daylight Saving Time could save energy, reduce heart attacks and get you more sleep
updated 8:32 PM EDT, Sun October 26, 2014
Reza Aslan says the interplay between beliefs and actions is a lot more complicated than critics of Islam portray
updated 7:19 AM EDT, Mon October 27, 2014
Julian Zelizer says control of the Senate will be decided by a few close contests
updated 8:12 AM EDT, Fri October 24, 2014
The response of some U.S. institutions that should know better to Ebola has been anything but inspiring, writes Idris Ayodeji Bello.
updated 9:12 AM EDT, Tue October 21, 2014
Sigrid Fry-Revere says the National Organ Transplant Act has caused more Americans to die waiting for an organ than died in both World Wars, Korea, Vietnam, Afghanistan and Iraq
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT