Do IPO Road Shows Violate Regulation FD?

Have you heard? Facebook is going public!!! And it’s starting what is known in the trade as a Road Show on May 7th. But it seems to me that Road Shows violate a rule that prevents companies from giving out inside information to select investors, known as Regulation FD.

Whether or not Facebook CEO, Mark Zuckerberg, participates in its Road Show, there will be executives from Facebook traveling to Boston, San Francisco, Chicago, Baltimore and possibly Los Angeles. And during those visits, they will meet with big institutional investors, such as Fidelity, Vanguard, and T. Rowe Price, to present information designed to generate interest in buying Facebook shares.

This brings us to Regulation FD. On August 15, 2000, the SEC adopted Regulation FD to “address the selective disclosure of information by publicly traded companies and other issuers,” according to the Securities and Exchange Commission.

Regulation FD requires issuers of securities to disclose “material nonpublic information to certain individuals or entities—generally, securities market professionals, such as stock analysts, or holders of the issuer’s securities who may well trade on the basis of the information—the issuer must make public disclosure of that information.”

So to comply with Regulation FD, Facebook will make a video of its Road Show presentations available in real-time on the Internet so all potential Facebook investors can hear and see what its executives are saying. This will include the PowerPoint presentation, the questions from investors, and the answers of those executives.

Absent that complete disclosure in real-time to the world, those lucky people invited to the Facebook Road Show are, at a minimum, getting their hands on priceless, inside information that determines whether they put in an order for those shares, and if so, how many they request.

And while we’re at it, Regulation FD will also require disclosure of the names of the investors, the number of shares they order, and the number that they are actually allowed to buy.

After all, those orders are also priceless inside information. How so? If, say, Fidelity, declines to place an order for the shares, that decision would be a powerful vote of no confidence in Facebook that would alert public investors to an opportunity to profit by selling Facebook shares short. Similarly, if Fidelity placed a huge buy order for the shares, that would signal its confidence in the potential for Facebook to exceed expectations.

So Facebook will comply with Regulation FD by supplying all this information to the public in real-time, right? Wrong! According to Cravath, Swaine and Moore, IPO issuers, like Facebook, are exempt from Regulation FD “because the issuer is not yet a reporting issuer.” To be fair, Facebook has included avideo of Mark Zuckerberg  and other executives talking about the company — but it’s missing that critical ingredient of investor Q&A.

This means that the SEC does not require Facebook to disclose what it discusses at its Road Show. And it makes absolutely no sense to me — particularly when you consider the amount of wealth creation that is at stake here.

For example, let’s say that Facebook builds up so much demand for the shares that it ends up selling them at the top of its range — $35 a share. And let’s suppose that all the demand flowing from that hype — including what Facebook discusses in its Road Show presentations — propels those shares to $75 by the end of its first trading day — yielding a first-day market capitalization of $205 billion. That 114% increase would amount to $109 billion in wealth creation for Facebook shareholders.

And why is Facebook not a reporting issuer? If you look at the SEC’s web site, Faceook has been issuing reports on its financial condition for months. And Facebook shares have been trading on secondary markets for the last few years. So Facebook is reporting and it’s an issuer.

Of course, a former SEC commissioner told me that issuing on private markets doesn’t count — only after a company is traded on say, the NASDAQ, is it subject to Regulation FD.

Moreover, even if those lawyers are right, when it comes to the biggest step function in value creation for shareholders, the IPO, a company is exempt from full disclosure. This begs the question, why not just dispense with Regulation FD altogether since it doesn’t apply at a time when such disclosure would be most valuable?

I think the spirit of Regulation FD should require a real-time video stream of all IPO Road Show presentations. And I am hoping someone above my pay grade can explain why the letter of the law allows companies like Facebook — that ironically enough prospers through full disclosure in realtime of its users’ personal lives — to bypass Regulation FD for a process that could transfer over $100 billion in wealth.

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Posted in: Facebook,IPO,Market,Nasdaq