Facebook, Blodget And The Return Of The Internet Bubble

It has been nine years since the Securities & Exchange Commission brought an epic enforcement action against Wall Street to deal with conflicts of interest that raged during the first Internet bubble between investment banking and analyst departments at the big investment banks.

But days after the Facebook IPO, there was Henry Blodget on CNBC, urging the SEC to investigate Morgan Stanley and possibly other banks that underwrote the Facebook offering for cutting Facebook forecasts during the roadshow.

Blodget was referring to a blockbuster article written by Reuters’ Alistair Barr describing how Morgan Stanley’s consumer Internet analyst, Scott Devitt, reduced his revenue forecasts for Facebook. The bank, which was the lead underwriter on the Facebook deal, communicated the new analysis to some of its big clients and Barr cited investors who said the analysis might have contributed to the weakness in Facebook’s  shares.

Blodget, of course, was a major target of the SEC enforcement action that produced what is known as the Global Research Settlement, which resulted in Blodget’s former firm, Merrill Lynch, and others like Goldman Sachs and Citigroup, paying $875 million in civil penalties. Blodget also settled with the SEC, agreeing to pay $4 million, and was permanently barred from associating with a brokerage firm or investment adviser.

Blodget has gone on to become a successful and compelling media entrepreneur and personality, co-founding Business Insider. It’s hard to imagine a more suited person to talk about investment research-related shenanigans on Wall Street. “I have now been around the tech IPO business for about 20 years, as you mentioned inside it and watching it on the outside,” Blodget told CNBC’s Scott Wapner. “I have never heard of an underwriting analyst changing estimates in the middle of a roadshow before.” Blodget’s point was it was not okay for some big institutional clients to get the information if other IPO investors were not getting the same information.

Ironically, when I called up Morgan Stanley for comment, the bank referred me to the very same Global Research Settlement that targeted Blodget and the banks back in 2003. Morgan Stanley was particularly interested in the part of the settlement that stated that after an investment bank gets an IPO deal, research analysts at the bank can verbally communicate with investors regarding the IPO as long as the analysts don’t appear jointly with management of the company—in this case Facebook—or the investment bankers selling the deal. In addition, the Global Research Settlement says that once a bank gets an IPO deal, research analysts can “participate with the equity capital markets group, or independently, in efforts to educate the firm’s sales force regarding the transaction, including assisting in the preparation of internal-use memoranda” as long as research analysts don’t appear jointly with the executives of the company being sold or the investment bankers.

A hot tech IPO turning into financial losses and controversy. Watching the consequences of Sarbanes-Oxley. We will be hearing from Eliot Spitzer soon for sure.