Investor distrust likely to rise after Facebook IPO debacle

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Susan Fulton says about 100 clients of her Bethesda asset-management firm were "up for the risk" last month and invested a total of $1 million the day Facebook went public.

"We bought it at the open, though we couldn't get confirmation on their trades," says Fulton, founder and president of FBB Capital Partners. "Nasdaq was shut down."

The stock exchange's technical problems aren't Fulton's only complaint. She's also upset over allegations that Facebook told underwriters before the initial public offering that revenues would be weaker than expected — and that this information was passed on to institutional investors but not to small investors like her clients.

The experience soured Fulton and her clients on IPOs.

"This one was so poorly handled on a hundred different levels," she says. "Nobody is happy."

IPOs are risky, and small investors should dabble in them only if they have money they can afford to lose. Or, if your heart is really set on getting in on the ground floor of a new public company, do so by investing in a low-fee mutual fund or an exchange-traded fund that's buying the IPO shares. That way, if the IPO is a bust, at least the funds hold other stocks that haven't tanked, and your losses will be mitigated.

It would have been hard for Facebook to live up to its IPO hype. But the debacle that ensued was far greater than the usual public offering risks and glitches: The shares were overpriced, Nasdaq was ill-prepared to handle the trades, and now Facebook and underwriters are being dogged by accusations that all investors weren't given the same information beforehand.

Investors are suing the main IPO players, seeking class-action status on behalf of small investors who feel they got burned.

Maryland investor Phillip Goldberg sued Nasdaq last month. Goldberg placed a series of buy orders on the morning of the IPO, but they failed to go through, his lawsuit states. Goldberg then tried to cancel the trades, but the cancellations were noted as "pending" throughout the day.

One trade eventually did go through after three hours — despite Goldberg's cancellation — and he wound up paying $41.23 a share, although by then Facebook was trading at around $38, the suit claims. Goldberg lost money as soon as the trade went through.

And just days ago, a California investor sued Facebook, CEO Mark Zuckerberg, Morgan Stanley and other underwriters of the offering. The investor claims that Facebook told underwriter analysts before the IPO to revise revenue projections downward, and that they passed this information along primarily to institutional investors.

Nasdaq and Facebook did not respond to requests for comment. Morgan Stanley declined to comment.

Maryland investment experts say one result of Facebook's IPO is the postponement of other initial public offerings. But they add that the IPO also has shaken the trust of investors, who already feel the playing field isn't level.

"It's one of the worst things that could happen among the worst times, when the public is already cynical about Wall Street," says David Berman, a financial planner in Timonium.

And it didn't help that institutional investors that bought into Facebook when it was private and bailed out on the first day of public trading appeared to come out of the IPO unscathed, Berman says.

Berman says he received a few calls from clients before the IPO, asking for his thoughts. He told them that IPOs tend to get an initial bump-up in price followed by a significant dip before settling within a more regular trading range. He suggested his clients wait to see if a dip occurred.

Michael Dougherty, a vice president of investments with the Chapin Davis brokerage in Baltimore, fielded about a dozen calls about Facebook. He says he talked clients out of buying the overpriced stock — yet he maintains the IPO will still have an impact on them.

"They will be cautious about IPOs in the future, and they will take a hard look at stocks," he says.

"One of the reasons [investors] hire people like us is they do feel the system is rigged," says FBB's Fulton. "The thing that has me, as the principal of the firm, most upset: We were supposed to keep this from happening to them."

Her clients invested no more than a half-percentage point of the total value of their portfolio in Facebook, she says, and the firm lessened losses with a stop-loss order to sell shares once the price fell to $30. On Monday, Facebook closed at $26.90, down 82 cents.

"We do tend to see small investors pull back once they have been burned," says Yuval Bar-Or, an adjunct professor at Johns Hopkins University and author of "Play to Prosper: The Small Investor's Survival Guide." That happened after the market crash in 2008.

"And there they are again getting hammered," he says. "The cumulative effect is that there will be more and more people losing faith in the integrity of the markets."

You can't blame investors for being wary. And it's healthy to be skeptical of IPOs. The problem is that many people might shun the stock market, to the detriment of their financial future.

Investors were already moving in that direction before the Facebook IPO. A survey by Baltimore's T. Rowe Price last year found that young investors' confidence about stocks had taken a hit and that more than one-quarter of those planning to contribute to an IRA were going to invest in a money market — the equivalent of a mattress.

This should be a wake-up call to Wall Street: Unless changes are made so that everyone feels the system is fair, the marketplace could lose a generation of investors.