Facebook, One Year Later: What Really Happened in the Biggest IPO Flop Ever

While retail investors clamored for Facebook shares, some large investors were planning a massive short -- essentially betting against the stock's buyers. Scott Sweet, senior managing partner of Tampa-based research firm IPO Boutique, received calls from hedge fund clients saying they heard from research analysts at underwriting banks that Facebook's mobile trend was behind its lowered earnings estimates. One multi-billion dollar hedge fund client told Sweet that he planned to short the stock as a result. (Sweet didn't name the investor due to a confidentiality agreement he has with clients.)

"The consensus among hedge funds on the West Coast was to short the stock on day one," said one institutional investor at a medium-sized hedge fund specializing in technology stocks. "The call we received from JP Morgan about earnings being lighter than expected gave us even more conviction in our short." Hedge fund analysts at his firm were receiving calls from their personal brokers days before the IPO, hawking an allegedly rare chance to get shares of Facebook stock. "That never happens," the hedge fund investor said. "Supply was definitely exceeding demand."

But despite the growing consensus among some large investors that Facebook was overpriced, on May 15, three days before Facebook's market debut, the underwriting banks increased the IPO range from $28-$35 to $35-$38, citing heavy demand. A day later, they increased supply to more than 420 million shares.

The new share and price allocation placed Facebook's valuation at the iconic $100 billion mark.

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VII: THE GLITCH

Back in her home, Swaminathan didn't know about the reduced revenue estimates or about the vast number of hedge funds that were planning to short Facebook. After the opening bell ceremony neared its end at 9:30 a.m., she was still watching CNBC waiting for the stock to begin its scheduled trading at 11:00 a.m. "We are witnessing a lot of American wealth getting generated as we speak," said a CNBC reporter. "After years of people taking risks, dealing with uncertainty, unknowns, rivals, this is the pay-off."

"Awaiting Facebook's opening trade" showed in a breaking news box on the bottom of the screen, while an unchanged $38 opening price appeared on a split screen in anticipation of 11:00 a.m. Minutes later, Swaminathan, eager for the stock to open, called her son, who lives in New York City, to inform him about the 5,000 shares she had ordered. She had placed a buy limit order, a conditional transaction to purchase shares at a specified price -- $42 in her case -- or lower.

Her son, who studied finance at UC Berkeley, was livid. "Cancel the order immediately," he told his mother. "Cancel it! Cancel it!" Around 9:45 a.m., she hit the icon on her trading screen to cancel the order and then resumed watching TV. At 11:00 a.m., CNBC announced that Facebook's opening was delayed until 11:05 a.m. In all the times she had seen IPOs on television, Swaminathan had never witnessed a market delay on the opening day. Something is wrong, she thought.

She turned her attention to her computer screen only to realize that there was no sign of her having voided the order. She kept refreshing the page in hopes of seeing the notification. When no cancellation report appeared, she called her stockbroker at Vanguard. "What's going on?" she asked.

If the cancel order was placed, then it's probably cancelled, the broker told her. She got off the phone and went back to her computer screen. There was no sign of cancellation. She called Vanguard again. This time, she says, she waited on the line for a long time, but no one came to take her call.

Meanwhile, Facebook stock opened at 11:30 a.m. The mysterious delay was due to technical glitches. NASDAQ's electronic trading platform couldn't handle the high volume of trades. In the first 30 seconds, around 82 million shares were exchanged.

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Facebook did not experience the anticipated pop. The stock reached a high of around $45 per share. At 4:00 p.m., when the market closed, the stock was priced at $38.23, only 23 cents more than its opening price.

Later that day, the Wall Street Journal reported that Morgan Stanley had stepped in to stabilize the stock, using what is referred to in finance as a "greenshoe option" -- a common stipulation in the IPO agreement that lets underwriting banks sell more shares to investors than they are allotted. The mechanism lets banks buy back the shares at the offering price, in case the company's stock price needs a little help on the first day. The buying action puts upward pressure on the stock.

Her son came to New Jersey to stay with her over the weekend. For two days, they quarreled. He wanted to know why she put so much money into one stock, and she couldn't give him a satisfying answer. "He kept asking me what was going through my head when I bought the shares," she recounts.

On Monday morning, she called Vanguard. "Was my purchase cancelled?" she asked. The answer finally came: No, the broker told her, Vanguard had purchased 5,000 shares on her behalf at a price of $41.25, meaning about $206,000 from her retirement account was spent to acquire her stake.

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On that second day of trading, Facebook closed at $34.03. Swaminathan had lost, on paper, about $36,000. Her son advised her to hold onto her shares until she either resolved the matter with Vanguard or the price bounced back.

VIII: THE AFTERMATH

The next couple days were a blur. Swaminathan approached Vanguard again, asking why the cancel order wasn't processed. She could have sold the shares before the price plummeted, she said to the broker, asking to speak with a supervisor. The supervisor blamed NASDAQ and said they would notify the exchange about the incident. When she called a day later, Vanguard declared it a legitimate purchase. There was nothing that could be done for her.

In the meantime, she tuned into CNBC to watch coverage of the IPO's aftermath. When news started rolling in about class action lawsuits filed against Morgan Stanley and Facebook for selective disclosure, she was stunned. Institutional investors received warnings about lower revenue estimates before the opening day, CNBC reported. (Some of these class-action lawsuits are still ongoing.)

Swaminathan wasn't keen on using the court system. She had already lost money and was wary about losing more to legal expenses. But in June, one lawyer told her about the Financial Industry Regulation Authority (FINRA) -- a private corporation that acts as a self-regulatory body among securities firms, such as banks. She believed the agency had a way for her to seek restitution without the complexities of a formal lawsuit. FINRA offered a way for her to air her grievances without a hefty legal fee, and the organization's stated goal is to protect investors -- investors like her, she thought.

She quickly wrote a typo-riddled complaint, laying out her misgivings against Facebook, Morgan Stanley, NASDAQ and her brokerage firm Vanguard, to FINRA. It was a two-page explanation of what happened on the day of the IPO. "I was caught up in the Facebook IPO hype and thought that this would be a good investment and practically put all my retirement money in this stock purchase," she wrote in the complaint. She said Vanguard failed to inform her of the status of her trade, blamed NASDAQ, and then retracted responsibility to say her trade was a proper execution. She complained that "only certain customers, mostly big institutions and hedge funds" could file claims with NASDAQ about the trading glitches.

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Khadeeja Safdar is writer based in New York. Her work has appeared in The Huffington Post, The Express Tribune magazine, and The Tampa Tribune.

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