The revelation that Facebook gave specific estimates to bank analysts and not to the public revives questions about whether the company was sufficiently forthcoming ahead of the IPO, said Stephen Diamond, an associate professor at Santa Clara University School of Law.

“By providing that information to just a subset of potential investors, in essence they have denied other investors access to material information,” Diamond said. The Securities and Exchange Commission “should have pushed much harder to find out whether there was quantifiable data available or not,” he added.

Facebook has not been accused by regulators of wrongdoing. Michael Buckley, a spokesman for the Menlo Park, California- based company, declined to comment. The SEC had no immediate comment. New York-based Morgan Stanley did not admit or deny Galvin's claims in settling.

The settlement offers fresh insight into a widely anticipated IPO that turned into a debacle for the company and Morgan Stanley. Facebook shares have tumbled 27 percent since they started trading for $38 on May 18, to $27.71 as of the close yesterday. The company capitalized on its popularity among consumers by raising the price and number of shares sold to retail investors, who weren't privy to the private conversations or revenue estimates.

Class Action

William Galvin, the Secretary of the Commonwealth of Massachusetts, said he didn't have the authority to determine whether Facebook executives acted improperly.

“The broader issue is the fairness of the marketplace for investors,” Galvin said in an interview this week.

The details emerging from the consent order may also add ammunition to dozens of class actions, which a judge ordered to be consolidated earlier this month. The testimony disclosed by Massachusetts could be used by prosecutors attempting to make a case that Facebook and Morgan Stanley misled investors, said Erik Gordon, a clinical assistant professor at the University of Michigan's Stephen M. Ross School of Business.

“The real liability for Facebook and Morgan Stanley is yet to come,” said Gordon.

If Facebook omitted material facts in its prospectus, known as an S-1, it could be found in violation of Section 11 or Section 12 of the Securities Act of 1933, Diamond said.

While it told potential investors that mobile usage could adversely affect revenue, the revelation that it gave a select group of analysts specific numbers on how that trend would affect sales over the full year could be considered a material omission, he said.

A violation of Section 11 could result in a fine or injunctive relief, or it could force the company to return proceeds of its IPO to shareholders, Diamond said.

“A material misstatement or omission in an S-1 is the scariest thing in the world,” Gordon said. “It's going to hinge on whether the disclosures made in the S-1 were sufficient to give reasonable investors as accurate a view as reasonably possible.”

One of the earliest signs that Facebook's growth wouldn't reach the rosiest projections surfaced on May 7, the day the roadshow began, according to testimony cited in the settlement. That evening, Facebook Chief Financial Officer David Ebersman informed Grimes that Facebook's second-quarter revenue would likely be lower than previously estimated.

Ebersman had told analysts at an April 16 briefing at Facebook's headquarters that sales would be $1.1 billion to $1.2 billion.

Now, Ebersman was telling Grimes that he was less confident about those numbers because user growth on mobile devices was outpacing advertising gains. Ebersman also said it was unlikely that Facebook would reach $5 billion in sales for the year, as he'd told analysts.

Grimes relayed that information to a Morgan Stanley capital markets banker, according to Massachusetts.

The next day, May 8, as the roadshow moved from New York to Boston and Baltimore, Facebook was predicting quarterly sales at the low end of its $1.1 billion to $1.2 billion range and sales 3 percent to 3.5 percent below the full-year estimate.

Grimes said in testimony that he advised Ebersman to update analysts on the numbers. To avoid the appearance of incomplete disclosure, he recommended updating the prospectus again to show investors the trend.

Treasurer Calls

At 8:10 p.m. that evening, Facebook's management held a conference call with Grimes, capital markets bankers and counsel from Facebook and Morgan Stanley. Grimes testified that he was with the treasurer on the call. Facebook, with input from Morgan Stanley, decided to update the filing.

On May 9, as the roadshow moved to Philadelphia, Ebersman informed Facebook's board by e-mail that the prospectus was being refiled. He also said the company was forecasting second- quarter revenue of $1.14 billion, while analysts were predicting $1.18 billion.

Grimes and Facebook's then-treasurer, Cipora Herman, stayed at a Philadelphia hotel that evening to make calls to analysts. In preparation, they rehearsed the calls, with Grimes playing the role of the analyst.

After the S-1 was filed, Herman would call an analyst every fifteen minutes and read the script, which said that the social network's second-quarter sales would be at the lower end of the $1.1 billion to $1.2 billion range.

Grimes said that while the analyst calls were being made, he was “far down the hall” so he wouldn't hear anything.

“I took extra precaution to do that, and sat on the floor,” he testified.

The first call was to Morgan Stanley, followed by JPMorgan Chase & Co., Goldman Sachs Group Inc., and Citigroup Inc. Seven additional calls were made by 8:30 p.m. Grimes and the treasurer then joined the roadshow team in New York. On May 10 and May 15, the treasurer made calls to the remaining eight analysts.

Under the 2003 consent decree, Morgan Stanley had pledged to stop investment bankers from influencing analysts.

Galvin, citing the script and Grimes' involvement, faulted Morgan Stanley for dishonesty, ethics violations and failing to supervise employees.

When asked later in testimony whether the treasurer had a script, Grimes said he didn't remember. Yet, Facebook provided the Massachusetts securities division with a script that was handwritten by Grimes.

Low End

“You can decide what you want to do with your estimates,” he wrote. “Our long term conviction is unchanged, but in the near term we see these trends continuing, hence our being at the low end of the” $1.1 billion to $1.2 billion range, the script said.

Facebook filed its sixth amended prospectus at 5:03 p.m., and within minutes the treasurer called bankers at Goldman Sachs and JPMorgan, with Grimes in the room.

No revenue projection numbers were provided in the May 9 filing, and the company only discussed the trend for the second quarter, not the rest of the year.

After the calls, all three analysts from the lead banks reduced their estimates to the lower end of the $1.1 billion to $1.2 billion range. Morgan Stanley's analyst lowered his to $1.11 billion from $1.18 billion.

The treasurer added to the script that the trends would remain over the next six to nine months, resulting in sales for the year of 3 percent to 3.5 percent below the $5 billion target.

Morgan Stanley's analyst lowered his estimate by 3 percent to $4.85 billion from $5 billion.

Despite these lowered estimates, on May 15 the price range for the IPO was increased and the next day the number of shares in the offering was bolstered. On May 17, the pricing committee decided to offer shares at $38 a piece, the high end of the increased range.

Herman, who held finance roles at Facebook for five years, left the company in October to take a job as CFO of the San Francisco 49ers football team. Prior to joining Facebook, she was treasurer at Yahoo! Inc.

Bob Lange, a spokesman for the the San Francisco 49ers, declined to make Herman available for comment.

Professor Diamond said the SEC could have been more vigilant as it scrutinized Facebook's IPO prospectus.

The SEC had asked Facebook for more disclosure about the impact of mobile users on revenue during a two-and-a-half-month volley of messages, which were published after the IPO on the agency's website. While it succeeded in getting Facebook to reveal more details about its business, it did not ask the company to estimate how mobile usage may affect its forecast for lower revenue in 2012, the messages show.

“The SEC bears some responsibility here, too,” Diamond said. “That's a question I think Congress ought to ask. Why didn't the SEC wake up and smell that something was going on here?”

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