Facebook investors seek revenge in court

Some investors bought Facebook (FB) shares with dreams of instant riches, hoping the stock would fund their retirement or pay for their children's college. Those dreams were dashed immediately when the stock opened for trading, and it's been mostly a downhill ride ever since.

What can those burned investors do? Some are just going to suck it up, saying that when you play the stock market, you take a gamble. But others are taking their grievances to court.

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At least two claims in New York and California could become class-action lawsuits against the company, its executives and its underwriters. The lawsuits don't focus on the stock tumble -- although you can be sure they wouldn't exist if the stock had gone the other way.

Instead, the suits claim individual investors missed out on important information about Facebook's finances -- information that privileged Wall Street clients knew about before the IPO began. The investors say the information might have made them think twice about buying the stock. Or maybe they would have done what other in-the-know Facebook buyers did: flipped the shares for a quick profit on the first day.

At the center of the issue is this: Facebook made a change to its regulatory filings about a week before its IPO and warned about the financial challenges in its mobile business (Facebook doesn't show ads to mobile users and therefore makes no money on them). Analysts responded by cutting their revenue forecasts for the company and calling major clients to let them know.

Even worse, some underwriters were helping their clients short the stock, according to The Wall Street Journal. Short sellers bet against a stock by borrowing shares to sell at a high price and then buying them back later at a low price.

So analysts were throwing out these red flags for favorite clients, leading some to back out or change their strategy to flip the shares. But Joe Investor still thought Facebook was a rocket to the moon.

It's unfair. But is it grounds for a lawsuit? The Journal's David Weidner says there were so many early warnings about Facebook's potential that investors should have gotten a clue. There's a sucker born every minute, he says in his column. "Are you really so helpless that you're depending on Morgan Stanley and Goldman to connect that last dot of Facebook's financial picture when 95% of the drawing is visible?"

He's missing the point. Wall Street's favored clients do need Morgan Stanley and Goldman to connect that dot, and they basically got a direct line to Facebook's executives before the IPO. Individual investors don't even get the opportunity. Instead, they're told by people like Weidner to accept what they have and move on.

The biggest impact of the Facebook fiasco may be the potential to change this long-standing practice on Wall Street of analysts secretly giving top investors the heads up before the IPO. Laws do exist to limit this behavior, but the big banks always find a way around them. If regulators are serious about investigating what happened -- and the class-action lawsuits may force that, to some extent -- we may see real change.

But for now, the Muppets have lost another match to Wall Street.