Wiretapping Suit Could Be 'KO' For Facebook

| About: Facebook (FB)

Perhaps the most troubling practice by Facebook (NASDAQ:FB) is one that has not gotten the attention it deserves: the lawsuit, "In re: Facebook Internet Tracking Litigation, Case No. 5:12-md-02314-EJD, U.S. District Court, Northern District of California" (link to scribd copy) was started by various Facebook users whose individual actions were consolidated into one case before US District Court Judge Edward Davila. The case was highlighted in an article by Bloomberg titled "Facebook Seeks Dismissal of $15 Billion Privacy Suit". Here is an excerpt of the action:


1.This class action lawsuit, seeking in excess of $15 billion in damages and injunctive relief brought by, and on behalf of, similarly situated individuals domiciled in the United States who had active Facebook, Inc. accounts from May 27, 2010 through September 26, 2011...

We added the bold type above to highlight who can be part of the "class". We recommend a thorough read of the case to all interested parties to see who may qualify to participate as part of the "class". In our opinion, the legal question posed by this case is potentially more harmful than the other shareholder suits outlined by the Wall Street Journal's article: "Facebook's Next Fight: Suits, and More Suits".

The privacy "wiretapping" lawsuit accuses Facebook of secretly tracking users' Internet activity after they log out of their Facebook accounts. This is done using "cookies" which are activated when a user logs into a Facebook account. These cookies can also be used by hackers in intercepting a user's data which is yet another privacy concern. Facebook has filed a motion to dimiss the suit for lack of establishing a Facebook user's harm. We believe that the value of one's privacy is "priceless". The suit accuses Facebook of violating federal wiretap laws with statutory damages per user of $100 per day per violation, up to $10,000 per user. With over a billion users, let's assume that the court decides that $10,000 is too much to award to each user and asserts the $100 floor per user, this would equate to $100 billion in damages and would wipe out more than all the equity in FB.

While this may seem highly speculative at first blush, according to the Wiretap Act, it's a crime for anyone that is not a party to a communication to be eavesdropping. If a crime in this case is established, Facebook could be ordered to shut down much like Kim Dotcom's Megaupload shutdown which was based on violation of US Copyright laws. In addition, the "wiretapping" lawsuit also charges that Facebook is violating the Stored Communications Act and the Computer Fraud and Abuse Act. Any way you look at this battle, it seems like a high stakes issue for Facebook which is not seriously being weighed by investors.... yet.

Barron's "Still Too Pricey" article by Andrew Barry and Forbes follow up article "Facebook:Headed To $15?" certainly caused a stink in Silicon Valley and on Wall Street since their publication several weeks ago. What's become very clear is that Facebook is a controversial company and its products and business practices have come under fire. Most recently, Bloomberg published the expose' "Facebook Fought SEC to Keep Mobile Risks Hidden Before IPO" highlighting questionable practices by Facebook and its advisors. The article describes in detail the dialogue between the SEC and Facebook management before the IPO completion on May 18th of this year.

The biggest hurdle for Facebook in the short term has been covered extensively in the media and in our articles about FB's "Float Bloat" tsunami which is already pressuring its stock. Goldman Sachs acknowledged it as well by saying in a recent note to clients, "With the next lockup ending soon, coupled with the market's allergy to supply, we would expect the shares to remain volatile over the next few months." We have never seen the word allergy used in a note to Internet technology investors.

Facebook also is facing a migration of its users to wireless mobile platforms with smaller screen devices. The problem with this is the ads on mobile devices, all ads, not just Facebook ads, are annoying to users with non-child size fingers. We see more mobile ads that have the "X" to close feature on them presumably so advertisers can get rebates if users don't view them to completion.

Despite all of its problems, Facebook may very well overcome its naysayers. But, even if it does, there is no compelling reason to buy shares until the smoke clears on the ghastly "Float Bloat" saga that will only subside with time.

Disclosure: I am short FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.