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Saturday, June 2, 2012

A Free Market ( IPO ) for Fools


The market for IPOs is rigged against the little guys. Or, as an old market adage warns the little guys, "If you can get shares in an IPO, you don't want them." So the usual litigators have lined up to file suits against Facebook, its selling shareholders, and its underwriters.Cases like these need only a group of newbie investor-plaintiffs who lost money. No legal theory is really needed when people have been played for suckers. But there is a theory of the case anyway: Some analysts realized that Facebook's (ticker: FB) revenues weren't up to expectations and made plans to lower their official estimates. Then they spread that word around to some of the big institutional clients that usually scoop up most of the shares in any popular IPO—and they didn't put a warning on everyone else's Facebook wall.

The big guys didn't buy, leaving room for people who paid no attention to skeptical stories in Barron's to pick up Facebook shares at the offering price.There is one similarity between a highly regulated market and a free market: In both, a fool and his money are soon parted. The main difference is that in the regulated market, the fool's lawyer shares in the spoils.Even some usually cynical journalists find the IPO a compelling story, since it features bad-guy bankers and their innocent victims.

A columnist for a leading business daily went so far as to suggest last week, "There should be a complete ban on analysts' communications with investors during an IPO to end any suspicion of preferential treatment." He did concede that similar rules have been in force since the 1930s, and strengthened every few years, without much visible effect on a Street that is the world's most efficient rumor machine. No matter. To some idealists, a rule that doesn't work automatically makes the case for a better rule.

Federal rules currently require companies offering shares not to talk up their value—which also prevents them from telling the truth, good or bad, about their prospects if they had a mind to do so. The process of federal registration of securities micro-manages the conveyance of information to investors so meticulously that few investors ever read the resulting legalese. That in turn has led to rules requiring plain language in filings. As yet, there's still no rule requiring investors to read the prospectus.Another rule tells analysts at underwriters that they can't publish reports for an underwritten company for 40 days after an IPO. This seems like a rule that prevents locking the barn door after the horses have escaped, but some people think it sounds good.

For reasons that only a lawyer could love, the U.S. Supreme Court has determined that the First Amendment's protections of free speech and free press do not apply rigorously to certain forms of "commercial speech," such as flogging stocks. This spurious distinction between political speech and commercial speech is every bit as troublesome as the distinction between untainted political speech and that perverted by bushels of money from rich people, corporations and unions. Commercial speech needs its ownCitizens United case to remove government restrictions.There's no doubt that in a land of free markets, stocks would be marketed on late-night television as long as there might be gullible speculators to buy them. Indeed, some such stocks would be baldly fraudulent. That raises only the question, "So what?" Fraud is a crime, but speech in aid of fraud should not be a crime itself.

It's also important to recognize that Facebook's IPO is not a matter of great economic importance, except to the happy selling shareholders and the not-so-happy purchasers of IPO shares. Facebook was not selling shares to advance the U.S. economy; it was selling shares to enrich its founders, early employees and angel investors. Advancing the U.S. economy is a side effect, if it happens at all.

Google (GOOG), Microsoft (MSFT) and Apple (AAPL), to pick three prominent IPOs of the past, advanced the U.S. economy greatly, but their IPOs themselves were not as important as their managers, their strategies and the markets they addressed so creatively. The events of May 2012 will do very little to determine whether Facebook joins their club.



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