Twitter Bankers Kept Important Information From the Public

Twitter's IPO motto may be "less Facebook, more LinkedIn." But it's repeating a crucial mistake that, in Facebook's case, led to class action lawsuits for selective disclosure. Only this time, it's Goldman Sachs instead of Morgan Stanley.

Analysts who work for Goldman Sachs and other banks underwriting the IPO, "have been privately telling select investors that Twitter's revenue may not increase as fast as expected," says Fortune.

The underwriters' analysts are predicting 55% growth next year. The rest of the Street is estimating 80%. For the following year, it's 32% vs. 58%. That's a huge difference for a company like Twitter that is not yet profitable and being judged mostly on its ability to grow.

According to the Wall Street Journal, which broke the news of this "information gap," analyst in the know are restrained by SEC rules, but still sharing the intelligence with their clients:

But the analysts who are widely understood on Wall Street to have the best view of the company's future prospects, thanks to their access to executives, haven't published their views, in accordance with securities rules that limit what information underwriters and companies can divulge during and after stock offerings. Instead, the information has been passed on in discussions with the firm's clients.

That has left an information gap for many smaller investors, many of whom are relying on the published works of analysts such as [Morning Star analyst Rick Summer] and Robert Peck at brokerage SunTrust Robinson Humphrey Inc., who is calling for revenue growth to be 69% in 2015.

"There's an unfortunate disparity in the effort companies make to educate institutional investors and…educating the rest of the investing public," said Vinny Jindal, chief executive of Stockr Inc., an online social network for individual investors.

Before its IPO, Facebook had to reckon with a similar cut in revenue projections because of the rapid shift to mobile devices, where advertising has been less lucrative than on desktops. Here's how Facebook's chief financial officer David Ebersman handled it, says the Atlantic:

On the first day of what may have been the most watched IPO roadshow in memory, Ebersman confessed to Morgan Stanley that Facebook had cut revenue projections — a nearly unprecedented last-minute correction in an IPO of its scale. Even if the changes were small, statistically, in IPO showbiz statistics run second to momentum, and nothing kills momentum like a poorly timed downward revision.

Facebook and Morgan Stanley knew they had to make a public disclosure. But what to disclose? The law requires companies to share all information that would likely influence an investor's decision to buy stock. Plus, Morgan Stanley's research team was still advising clients based on figures that Facebook now considered wrong. With less than a week before the IPO, they came up with a solution that they thought would spare Facebook a modicum of embarrassment — but would have fateful consequences for Morgan Stanley and investors:

• First, Facebook would file an amendment to its public birth certificate, the S-1, to include information about mobile usage cutting into revenue.

Second, the company would call research analysts with much more specific information about the company's weakening projections.

That decision eventually led Morgan Stanley to pay $5 million to Massachusetts for its role in Facebook's selective disclosure. The social network and its underwriters "are still facing class action suits related to the deal," notes Fortune. The "murky" rules around what analysts can do during an IPO naturally fall in the favor of Wall Street clients over the little guy on Main Street:

But the key difference between the analysts who work for the underwriters and those who do not is that the former group gets access to Twitter's executives. That's what creates the problem.

Companies are generally not allowed to tell one group of investors one thing, and not tell everyone else the same. In fact, in the run-up to an IPO, corporate executives aren't supposed to speak publicly to anyone. It's called the quiet period. Nonetheless, while they are not talking publicly, the SEC does allow corporate executives to meet with potential investors. Once again, these meetings are generally restricted to the Wall Street firm's top paying clients. Those are the rules, even if they aren't fair.

Those private meetings with top-paying clients are allowed, as long as the research isn't published. That's where the grey area comes in, explains Fortune:

However, [analysts who work for underwriters] are not allowed to tell them how they will eventually rate a company's stock, or hint at what that rating will be. For some, revenue projections cross the line.

"You are not allowed to front-run your own rating," says Michael Pachter, an analyst at Wedbush Securities, who follows social media companies, and began covering Facebook before it went public. He has decided not to put out revenue projections on Twitter, though Wedbush is not one of Twitter's underwriters. "You might feel a revenue projection falls into the grey area, but my firm's opinion is it's off-limits."

Twitter took advantage of a provision in the JOBS Act to file a "secret IPO" partly to avoid having to do amend its filings in public and alarming manner, the way Facebook had to days before its IPO. But there's another section of the JOBS Act that could close that information gap between Wall Street and the pitiable noob on Main Street. No one seemed as interested in that provision, says Fortune:

The JOBS Act specifically allows analysts to pick up coverage of a company before it goes IPO, even if they work for one of the underwriters. That would remove the information divide, because once an analyst picks up coverage they have to publish their research for everyone to see. That could be why none of the big Wall Street firms have taken advantage of this provision in the JOBS Act.

"The Wall Street firms have a monopoly on information in the IPO process, and they're trying to hold on to it," says Bill Hambrecht of WR Hambrecht, an underwriting firm pushing for a more open IPO process.

Like we said, this IPO is not for you, kids.

[Image via Getty]