Forget Facebook privacy, now charges of Facebook securities fraud
Posted by andreaitis on May 20, 2010
Facebook CEO Mark Zuckerberg turned 26 last week. I wonder if anyone got him a bullseye with his picture in the center — because that’s where Zuck lives these days. People want the underdog to succeed, but once he does he becomes target practice.
The latest unwelcome gift: accusations of securities fraud from former Harvard schoolmates who say he and other Facebook executives tricked them into a supposed $65 million settlement that was actually worth far less.
Judge James Ware of the Court of Appeals for the Ninth Circuit will hear those arguments, filed in an appellate brief late last month, in an upcoming court case.
Divya Narendra and brothers Cameron and Tyler Winklevoss contend that they hired Zuckerberg to work on their social network, ConnectU, when they were all students at Harvard, only to have him delay the project and use ConnectU’s code to launch his own project, then called TheFacebook. Their side of the story gained credence after instant messages sent by Zuckerberg bragging about his success in duping them emerged in the press.
The battle between ConnectU and Facebook has been raging since they were all in college together at Harvard. A $65 million settlement was reached in 2008, but Cameron and Tyler Winklevoss and Divya Narendra filed an appeal. They claim “the settlement was never finalized and that a judge acted improperly in allowing the settlement to proceed and awarding ownership of ConnectU to Facebook.”
In the midst of the Facebook privacy fiasco, though, the smoking gun — or, in this case, the smoking instant messages — are an ironic twist. Business Insider walked through the overall timeline and revealed what they believe are the IMs ConnectU’s creators say support their case.
In January 2004, Mark met with the Winklevoss brothers and Divya Narendra for what would be the last time. The meeting was on January 14, 2004, and it was held at the same place Mark met with the HarvardConnection team for the first time — in the dining hall of Mark’s residence, Kirkland House.
By this point, Mark’s site, thefacebook.com, wasn’t complete, but he was working hard on it. He’d arranged for Eduardo Saverin to pay for his servers. He had already told Adam that “the right thing to do” was to not complete Harvard Connection and build TheFacebook.com instead. He had registered the domain name.
He therefore had a choice to make: Tell Cameron, Tyler and Divya that he wanted out of their project, or string them along until he was ready to launch thefacebook.com.
Mark sought advice on this decision from his confidants. One friend told him, in so many words, you know me. I don’t ever think anyone should do anything bad to anybody.
Mark and this friend also had the following IM exchange about how Mark planned to resolve the competing projects:
Friend: So have you decided what you’re going to do about the websites?
Zuck: Yeah, I’m going to fuck them
Zuck: Probably in the year
Interesting when juxtaposed against another instant message exchange a 19-year-old Zuckerberg had while in college.
Zuck: Yeah so if you ever need info about anyone at Harvard
Zuck: Just ask.
Zuck: I have over 4,000 emails, pictures, addresses, SNS
[Redacted Friend's Name]: What? How’d you manage that one?
Zuck: People just submitted it.
Zuck: I don’t know why.
Zuck: They “trust me”
Zuck: Dumb fucks.
Notice a pattern?
But the big question: Is this fancy legal eagle’ing because so much money is on the table, or is there a real case of securities fraud here? The best answer I found is in an excellent comment on Hacker News by Silicon Valley business lawyer George Grellas. He says, in part:
This appeal is a testament to what high-priced (and quite excellent) lawyers can do to stir things up when large amounts of money are at stake. I have been involved in countless mediations over the course of a 30-year-plus career and can strongly attest that no one in his right mind (or otherwise) even begins to think that federal securities laws should be taken into account when settling a case by which stock is transferred from one party to another as part of the settlement.
The alleged “fraud” is likely bogus here as well. The theory is that FB did a press release shortly before the settlement touting Microsoft’s $240 million investment and suggesting that, based on that investment, FB had a market cap of $15 billion. The claim is that the ConnectU founders relied on that valuation in determining what the value of the common stock was that they received. Later, supposedly, they discovered that FB had in fact done a 409A valuation of the common stock and that such valuation had placed an approximately $8/sh price on the common stock (in contrast to the $35/sh price placed on the preferred at the time of the Microsoft investment). Thus, the ConnectU founders were supposedly defrauded by having been misled about the value of the FB stock they were receiving to settle their claims (that is, as alleged, they thought they were getting stock worth $35/sh when it was in fact worth no more than $8/sh and, presumably, they would not have settled their claims for this supposedly lower amount had they known the true facts about the 409A appraisal, which facts were not disclosed to them at the time of the mediation). That might sound plausible to someone who knows nothing about startups but it is in fact an absurd argument to anyone who knows even the basics of startup financing. Every startup deal-maker knows that startups value preferred stock at 4 to 5 times higher (it used to be more like 10 times higher) than the common stock. This is vital for keeping employee incentives reasonably priced. Anyone who has been through even a single financing with a startup will know this. Therefore, what are the odds that the ConnectU founders, knowing that the $35/sh price was based on a press release discussing Microsoft’s preferred stock investment, did not immediately know and understand that a startup of this type would be putting a significantly lower price on the common stock at the same time. Thus, the argument strikes me as entirely artificial. It is a lawyer argument, very likely concocted after the fact. Because of this, too, in my judgment, I believe the argument will be rejected on appeal, just as it was by the lower court. If courts were to hold that no stock could be transferred in a settlement effected through mediation unless the parties stopped to comply with federal securities laws, the result would be utter chaos whenever a party sought to transfer equity as part of resolving a dispute.
If you want the nitty gritty, read Grellas’ full comment on Hacker News (yes, there’s more!).
As for Zuckerberg, I’d suggest someone get him a suit of armor as a belated birthday gift. He’s gonna need it.