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The Facebook (NASDAQ:FB) IPO has been in the news seemingly forever. First, there were the endless stories of the brilliance of Facebook CEO, Mark Zuckerburg, and the plethora of new millionaires the IPO would create. Second, there was the $100 million or so of damages financial firms say they incurred due to technical difficulties they experienced in placing trades via the Nasdaq; the Nasdaq estimates those losses at closer to $40 million.

Then there was the speculation of how far Facebook's stock would fall below its IPO price; through June 7th, the stock was trading at $26/share, 31.5% below its IPO price of $38/share. And as if to add insult to injury, the newest fallout from the Facebook IPO fiasco is that Morgan Stanley (NYSE:MS), its lead underwriter, may have shared Facebook's earnings re-forecast with a select group of investors and not others.

During the investor road show, Facebook received news from investors that more customers than originally thought were accessing Facebook via mobile devices. Since mobile devices generate less advertising revenue, Facebook decided to lower its earnings estimates after consulting with Morgan Stanley. And that's where the details get murky.

According to Reuters:

"Morgan Stanley released a statement saying it followed the same procedures with Facebook that it does for all IPOs. 'These procedures are in compliance with all applicable regulations …' The bank declined to speak to the question of whether it advised Facebook to give detailed guidance to analysts based on the revised prospectus. Morgan Stanley said it provided the revised prospectus, though not the new earnings forecasts, to all retail and institutional investors. 'In response to the information about business trends, a significant number of research analysts in the syndicate who were participating in investor education reduced their earnings views to reflect their estimate of the impact of the new information. These revised views were taken into account in the pricing of the IPO,' the Morgan Stanley statement said."

Regulators are investigating whether Morgan Stanley provided the earnings re-forecast to certain big investors, and not all, facilitating their decision to reduce their allotment of shares just prior to the IPO's pricing. It was this type of special treatment that the makers of U.S. securities laws wanted to avoid. The fact that Morgan Stanley has not provided enough evidence to assuage regulators' fears on the matter is alarming in itself.

In Shock Exchange … How Inner City Kids From Brooklyn Predicted The Great Recession And The Pain Ahead, due out in July, Ralph Baker explains how China has stronger stopgaps in place to prevent certain investors from receiving special treatment. If Morgan Stanley had done Facebook's IPO in China under such dubious circumstances, bankers would be held personally liable:

"The Chinese government requires foreign firms operating in its capital markets industry to do business through a licensed JV, of which it can own no more than 33%. To keep its license, a foreign firm must employ a minimum of four 'sponsors' - bankers licensed by China to execute stock and bond offerings. At least two sponsors are required on every offering; the limited number of qualified sponsors allows China to control the flow of public offerings and limit fraud, since sponsors are personally liable."

Since the financial crisis, President Obama has made several references to the "public trust." After explaining to my teenage son the details of rumors that institutional investors in Facebook's IPO were given special treatment vis-a-vis individual investors, "Shouldn't that be disallowed?" he asked. I merely sat stone-faced, with no cogent reply. If U.S. regulators and lawmakers want to do more than give lip service to protecting the public trust, the Facebook IPO fiasco would be a good place to start.

Source: Should Morgan Stanley Bankers Responsible For 'Facebook IPO Fiasco' Be Banned?