Facebook Shareholders Sue Mark Zuckerberg for Insider Trading and Failure to Disclose Material Information

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Investors who bought stock in Facebook are upset, leading them to do what upset investors do best: file a lawsuit against the person and/or company that allegedly wronged them. In this case, the person is CEO of Facebook Mark Zuckerberg and the company is Facebook (along with a few banks that helped with the Facebook IPO), and the wrongdoing alleged is insider trading, and failure to disclose relevant information (i.e., that Facebook was not worth as much as the IPO price suggested). Not long ago, Zuckerberg and his brainchild Facebook were widely admired and praised. He was the king of technology – a Harvard dropout turned billionaire – but uneasy lies the head that wears a crown. Now Zuckerberg, having officially been sued for insider trading in the U.S. District Court in Manhattan, has lost much of his esteem.

So, what is this lawsuit all about, and is it of merit? First, the lawsuit itself is being filed by a group of Facebook shareholders, making it a class-action lawsuit. Essentially, the plaintiffs claim that the stock offered to investors during Facebook’s IPO was dramatically overpriced, and that Facebook and the banks that helped set up the IPO were aware of this fact. They were aware of the overvaluation because in the days leading up to the IPO, Facebook’s revenue forecast wwas severely reduced. All of this would have been more or less fine (ethically speaking) if the entire investment community were made aware of this reduction; however, the lawsuit alleges that only a select group of insiders (including Zuckerberg) and preferred investors were in fact privy to this adjusted forecast.

As a consequence, this fortunate group of shareholders and potential investors were able to act on “inside information” that was not disclosed to the public. For example, the lawsuit alleges that Zuckerberg, aware his company was valued unjustifiably high (because of the reduced revenue forecast), unloaded around a billion dollars worth of stock in an effort to cash out before the share prices inevitably dropped. Of course, Zuckerberg’s financial gain is another investor’s loss, and hence the class-action lawsuit. To the extent that these charges of insider trading may be true, the lawsuit would be justified.

Why has Facebook’s value dropped so much since the IPO anyway? After all, if the value of Facebook stock wouldn’t have started to slide since the IPO, there probably wouldn’t be much investor outrage. First, the company was overvalued to begin with (for reasons of company revenue – past, present, and future), so it is only natural that the price of Facebook stock has dropped. However, investing in Facebook was widely seen as an investment in extraordinary potential, so even if Facebook’s current revenue didn’t justify its high valuation, its potential to make revenue did. But this is exactly Facebook’s problem: it is not clear how Facebook will continue to increase its revenue, especially since so many users now interact with Facebook primarily on mobile devices. Facebook’s revenue is derived from advertising, and theoretically there is money to be made in mobile advertising, but this is largely uncharted territory. In any case, people who use Facebook on their phones are not using the website as much, and this cuts into the website’s ability to generate revenue.

All we know at present is that investors are unhappy, lawsuits have been filed, and Facebook doesn’t look nearly as invincible as it once did. We’ll see how it all pans out.

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