ETF Store Insight

Facebook IPO Brings Retail Investor Challenges to Light

May 24th, 2012 by ETF Store Staff

The Facebook IPO on May 18th was highly anticipated and unique.  However, the amount of attention generated by this IPO also brought unwelcomed scrutiny, particularly for the large Wall Street firms that some investors have long felt “gamed” the system against them.  Morgan Stanley, the lead underwriter for the Facebook IPO, is already feeling the brunt of media criticism for its handling of the Facebook IPO.  More importantly, the entire Facebook IPO process has brought to light the many challenges retail investors face in trying to compete against Wall Street’s big investment firms.

Typically, the lead underwriter for an IPO doubles as a cheerleader for the company they’re taking public, complete with overly optimistic earnings forecasts to drive demand.  This is one of the ways they provide “value” and justify their substantial underwriting fees.  In addition, the underwriter will typically make the offering available through their own brokers (who can be quite pushy touting the stock) and even other discount brokerages.  For the Facebook IPO, the resulting investor demand from all of these actions raised the IPO price from the original $28-$35/share range to a lofty $38/share price.  Quite simply, they convinced enough individuals (vs. institutional investors) to buy the IPO so that they could raise the price.

In addition to being a cheerleader for the stock, the underwriter may also play the role of defending (i.e. propping-up) the share price on the day of the IPO.  In Morgan Stanley’s case, they did everything they could to keep the share price above the $38/share IPO price on the first day of trading.  The firm’s traders bought an estimated 30 to 40 million shares at $38/share trying to create a price floor.  Remember, Morgan Stanley has a reputation to uphold (and many more lucrative IPO clients to sell).  The mispricing of an IPO isn’t a bullet point they want on their next sales presentation.  As a side note, the fact that Morgan Stanley could successfully defend the $38/share IPO price doesn’t give a real warm and fuzzy feeling to those individual investors who already feel that the market is manipulated.

Lastly, and possibly most disturbing, is that at the same time Facebook was conducting their investor roadshow to drive demand for their IPO, Morgan Stanley’s own analysts (along with JP Morgan and Goldman Sachs) were cutting revenue forecasts for Facebook.   These lower projections may have only been selectively shared with hedge funds and other institutional investors (who shorted the stock on the first day).  And keep in mind that Morgan Stanley’s own brokers were pushing the stock to their retail clients at the same time they were cutting revenue forecasts.

The moral of this story is that individual investors need to be aware of the stacked deck they are playing against.  As we’ve said many times before, investors must exercise extreme caution when dealing with these larger financial firms and brokers who seem more concerned about their own financial future than yours.  Don’t become Wall Street’s Muppet!  At The ETF Store, we are an independent investment advisor who does not make commissions by pushing stocks like Facebook and we operate as a fiduciary that places our clients’ interests ahead of our own – which is the way it should be.  Additionally, rather than try to combat the big banks and institutional investors on IPOs, our strategy is to focus on building low cost, broad based, highly diversified portfolios for our clients.

To learn more about how to invest with The ETF Store, contact us here and one of our knowledgeable, friendly advisors will contact you at your convenience.