Raleigh, N.C. — A class action lawsuit over Facebook's initial public offering has provided a window into both how North Carolina's pension system invests and the potential for perceived conflicts of interest to arise around an elected state treasurer.
The claims arise from the fact that Facebook underwriter Morgan Stanley cut its revenue forecasts for the company. Underwriters for initial public offerings general put as positive spin as possible on a stock heading to an initial public offering so that it will debut at as high a price as possible. The plaintiffs in the case, including big institutional investors such as North Carolina's Retirement System, allege that news of the downgrade wasn't widely circulated and those who bought the IPO at the relatively-high price of $38 per share ended up with losses they could have avoided.
These types of shareholder lawsuits "are certainly not unheard of. But you don't see usually see them with something as prominent as a Facebook offering," said Thomas Hazen, a corporate and securities law expert who teaches at UNC Law School. They are more typically in lesser known start ups, he said.
This is the third such lawsuit brought by the state, according to the Treasurer's office.
"The Treasurer rarely brings lawsuits, but felt litigation was important in this case because Facebook’s IPO was an extraordinary example of corporate governance failure.
said Julia Vail, a spokeswoman for the department. The state is looking to recover roughly $4.1 million in losses. While that's a lot of money in real-dollar terms, it is a fraction of one percent of the state's $75 billion in pension fund holdings.
"Facebook, Morgan Stanley, and the other underwriters and banks broke the law by telling only a few favored firms about the downward revision in Facebook’s earnings guidance," Vail said.
Even though Facebook is the ultimate target of this suit, many of the allegations thus far has been between the various investors involved with the case. As the Reuters news agency explained, competition between law firms to represent the lead plaintiff in this kind of blockbuster litigation can be intense
That's somewhat ironic, given a 1995 law passed by Congress was supposed to make sure the people who lost the most money in any one securities action were supposed to automatically become lead plaintiffs, Hazen said. That federal law was supposed to cut down on "races to the courthouse" and litigation more broadly.
"To a large extent, it has just changed what they litigate about. A lot of the battle now is about who is going to be the lead plaintiff," Hazen said. "Frankly that doesn't benefit the plaintiff as much as it does the plaintiff's lawyer."
Being the lawyer for a lead plaintiff, especially one that is ultimately successful, means a law firm will earn more money.
In this case, Bernstein Litowitz Berger & Grossmann represents the North Carolina and others who took some of the biggest losses in the Facebook IPO. The group includes the Arkansas Teacher Retirement System, Fresno County Employees' Retirement Association and Banyan Capital. But in documents filed with the U.S. District Court for New York's Southern District, Robbins Geller Rudman & Dowd claims their clients should be in the lead.
This gets especially interesting for North Carolina because Robbins Geller is alleging State Treasurer Janet Cowell has a conflict of interest. Cowell is the sole trustee of the North Carolina Retirement System, which means that even though she has people who advise her and work on her behalf, the ultimate decision making on where to invest stops at her desk. From the Robbins Geller filing:
Treasurer Cowell and NCRS maintain significant personal and financial ties with one of the defendants in this case, Erskine B. Bowles (“Bowles”). Defendant Bowles is not just a defendant in this case; he sits at the vortex of Defendants’ misconduct. Bowles is on the Board of Directors of both Facebook (as Chair of the Audit Committee) and the lead underwriter of Facebook’s IPO, Morgan Stanley. And, if it wasn’t enough that the sole fiduciary of the largest member of the Institutional Investor Group has a longstanding personal and financial relationship with the one defendant who sits on the board of the two primary defendants in the case, Treasurer Cowell also has Carousel Capital (“Carousel”), defendant Bowles’ investment firm, managing millions of dollars of NCRS’s money together with yet another underwriter defendant, Credit Suisse.
Calling the allegation against Cowell "innuendo," lawyers for the state write, ""Indeed, the mere fact that North Carolina DST seeks appointment as lead plaintiff in the Action — which names Bowles as well as the underwriters of the IPO as defendants — demonstrates that there is no conflict of interest springing from any relationship with Bowles or any of the underwriter defendants....Treasurer Cowell knew that Bowles sat on the Board of Facebook and still authorized North Carolina DST to proceed as part of the Institutional Investor Group."
Hazen calls the Robbins Geller claim against Cowell "a stretch," adding, "It just seems to me to be an awfully strained basis for disqualifying North Carolina as lead plaintiff."
"The idea here is that the person with the largest financial stake is going to make reasonable decisions about how to prosecute the case," said Tom Molony, an associate professor at the Elon University Law School in Greensboro. Robbins Geller basically has to convince the court that the state wouldn't make a good plaintiff either because they are somehow different from all other plaintiffs or because they wouldn't fairly represent the interests of the class.
Like Hazen, he called the Robbins Geller complaint against Cowell "a stretch."
Campaigns and cash
Cowell's office confirms that she held a fundraiser at Bowles' House.
"Mr. Bowles’s wife, Crandall Bowles, hosted a fundraiser for Treasurer Cowell on June 22, 2011. The fundraiser was held at the house that Mr. and Mrs. Bowles share, but Erskine Bowles was not a host for the event," Vail said.
And a quick search of campaign records show that Crandall but not Erskine Bowles has been donor to Cowell. Still, it's more than fair to say Bowles has been a major donor to other Democratic causes.
And it's not unfair, as Civitas does, to point out that members of Bowles' investment firm -- Carousel Capital -- have been donors to Cowell's campaign, as have lawyers associated with Bernstein Litowitz Berger & Grossmann, which represents the state. Cowell's opponent in this year's election, Stephen Royal, raises Cowell's fundraising prowess on his website.
(For what it's worth, executives associate with Carousel Capital have also given to Republicans such as Robert Pittenger and Pat McCrory, although they have given far more to Democrats like Cowell, Gov. Bev Perdue and former Gov. Mike Easley.)
These kinds of conflicts of interest aren't new. And absent some smoking-gun kind of proof, whether someone views this as a real or merely apparent conflict of interest may depend on how they feel about Cowell or Democrats generally.
These kinds of conflicts for office holders who raise money from the people they regulate are nothing new.
"Janet Cowell has talked about it because of the pickle it puts her in," said Bob Hall, director of Democracy North Carolina, a good-government group that advocates for public campaign financing. Under public financing, politicians raise small-dollar donations and then receive taxpayer support for their campaigns.
Early in her term as treasurer, Cowell lobbied for the Treasurer's office to be put under the state's public campaign finance law. Instead, lawmakers have chose to by and large dismantle public financing for campaigns. That action came at the urging of groups such as Civitas.
"It would be better for everybody not to have these kinds of debates going on," Hall said. Public financing, he said, would eliminate them. "People don't like to see a Treasurer, or Insurance Commissioner or even lawmakers getting money from someone they're dealing with," he said.
In this case, the conflict would be more direct if Carousel had been involved in the Facebook stock purchase. However, the state is invested in a Carousel private equity fund.
The decision to buy into Facebook was made by Sands Capital Management.
"The public stock purchases are made within the limits of an agreed-upon overall strategy and investment guidelines set by North Carolina statutes. This is a standard industry practice," Vail said. "When that manager purchased Facebook, Facebook and its underwriters illegally concealed critical facts that would have provided strong reasons for the manager to not make that investment."
Given all that, experts say it seems unlikely that Bowles influenced the decision to buy Facebook stock. And certainly whatever relationship he has with Cowell hasn't stopped the state from alleging that two firms he is involved with lied to investors. Even so, the appearance of a conflict may stick.
"This is one reason why (the State Employees Association of North Carolina) has continually pushed to changed the system," said Toni Davis, a spokeswoman for the employees union. SEANC has pushed for the Treasurer to give up her role as sole fiduciary and for the state to switch to a board that would manage the pension. Have more than one person responsible for investment decisions, would allow officials to better avoid such apparent conflicts.