More Details Emerge On Communications Between Facebook, SEC Prior To IPO

The name Barbara C. Jacobs may not ring a bell for most readers, but the name of the assistant director for corporation finance at the Securities and Exchange Commission is definitely a familiar one in the offices of Facebook Chief Financial Officer David Ebersman and Fenwick & West, the social network’s law firm, as she and her staff were responsible for vetting the company’s initial public offering filing.

Bloomberg published a detailed post chronicling the back-and-forth between the two sides prior to Facebook’s May 18 IPO.

We previously reported, via CNET, on Jacobs’ concerns over how Facebook’s skyrocketing total of mobile users would affect its revenue prospects. Jacobs wrote to Ebersman Feb. 28:

Your statement that users “could decide” to increasingly access your products primarily through mobile devices appears to contradict the first part of this risk factor. Further, assuming that the trend toward mobile continues and your mobile monetization efforts are unsuccessful, ensure that your disclosure fully addresses the potential consequences to your revenue and financial results, rather than just stating that they “may be negatively affected.”

Please provide a more detailed discussion of the key challenges you are facing. For example, discuss how you plan to address the challenges associated with increased user access to and engagement with Facebook through your mobile products, where you do not currently directly generate meaningful revenue, particularly to the extent that mobile engagement is substituted for engagement with Facebook on personal computers. For guidance, refer to Section III.A of SEC Release No. 33-8350.

Facebook addressed the SEC’s concerns in a revision to its S-1, filed May 9:

We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users increasing more rapidly than the increase in the number of ads delivered. If users increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.

The Bloomberg post, written by Linda Sandler, Brian Womack, and Douglas MacMillan, detailed several other exchanges between the SEC and Facebook, including:

  • Facebook dropped a reference to Nielsen research touting the effectiveness of ads linked to users’ friends after Jacobs ordered the social network to either produce the study and obtain consent from Nielsen to use the data, or remove the mention of it.
  • Facebook initially said game developer Zynga accounted for 12 percent of its 2011 revenue, but after the SEC raised some questions about that figure, Fenwick & West’s Jeffrey Vetter revised the number to 19 percent — 12 percent from processing fees for virtual goods, and 7 percent from ads on pages generated by Zynga’s applications.
  • The SEC also required Facebook to include a warning about possible user attrition due to Zynga: “Zynga may choose to try to migrate users from existing Facebook-integrated games to other websites or platforms. Our financial results may be adversely affected.”
  • After Vetter declined to provide a figure for revenue generated per user, saying that the social network preferred to look at “overall growth in users” and “overall revenue in evaluating the business,” the SEC performed the calculations itself, and they were included by Facebook in its April 23 S-1 revision. The SEC found that average revenue per monthly active user fell to $1.21 in the first quarter of 2012 from $1.38 in the fourth quarter of 2011.

Bloomberg also shared several criticisms of Facebook’s IPO process, including:

Wedbush Securities Managing Director Michael Pachter:

They were given the benefit of the doubt when they went public that they were ready for primetime. They still haven’t proved that they are.

IPOdesktop.com President Francis Gaskins:

It has been clear from the beginning that the insiders were bailing, given that they sold $10 billion of shares and continued to sell as the lock-up period expired. They clearly knew that the company’s best growth rate was behind them and the stock was overvalued.

University of Chicago Booth School of Business Finance Professor Luigi Zingales:

When you have a significant change in your forecasts, it’s good business practice to postpone the IPO so that the market has more time to understand what’s going on.

The fact that some institutional investors got access to a company’s information that was not available to ordinary investors creates the perception that there are two sets of rules and increases the mistrust in the market.

University of Michigan Ross School of Business Professor Erik Gordon:

Before the underwriters were even selected, hysteria about this stock was already out of control.

Class V Group Principal Lise Buyer:

Perhaps management should have seen that the party was getting out of hand, and should have understood that the hangover would be wicked.

Dartmouth College Tuck School of Business Professor Paul Argenti:

There should be more public appearances by the CEO. There should be ongoing media-relations activities that help give confidence to investors. I don’t see any of that going on. I see the exact opposite. It’s amateurish.

Readers: What was Facebook’s most glaring error throughout its IPO process?

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