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Dumb Money for Dummies

A Commentary By Froma Harrop

Thursday, May 31, 2012

In the beginning, there was pump and dump. In the dot-com bubble of the late '90s, the stock-analyzing arms of investment banks would pump up a new stock's price with rave reviews. The banker arm underwriting the new stock issue would sit back, watch the price explode and then dump it -- as would their favored customers. The folks who fell for the hype and bought in at inflated prices were the little investors, also known as "dumb money."

This scheme was deemed unfair to ordinary investors, so a reform was put in place that appeared to require analysts to keep their mouths shut before an initial public offering. It forbade analysts to publish written reports, be they on paper or electronic, containing new information about the company. Notably absent was any mention of telephones.

Along comes the fantabulous Facebook stock offering and ensuing fallout. Suspicions are high that a select few were told about Facebook's recently disappointing revenues, which might not justify the initial public offering price of $38. They got out the minute they could, or they sold the stock short or made other bets that the stock price would fall. The Securities and Exchange Commission is looking into the matter. And a shareholder class-action suit has been filed. Meanwhile, if the conversations about Facebook's revenues were done by telephone or over cocktails, it is unclear that anyone broke the law.

But this is clear. The Facebook IPO dance was not about investing for the long term, though the dumb money may have thought so.

Did you notice how, in the goodness of their hearts, Facebook and the bankers made an unusually high number of shares available to the public at the initial offering price? As of Tuesday, Facebook's stock price was down 24 percent from the initial public offering.

Whether the analysts whispered into a few privileged ears almost should not have mattered, because the carnival surrounding the Facebook IPO should have set off all kinds of alarms. First off, serious commentary noted that having a zillion members didn't necessarily mean Facebook had found a way to make a zillion dollars off them. Just days before the offering, General Motors said that it was pulling its ad campaign off Facebook because the site apparently wasn't selling cars for them. This was in the newspapers, or at least the business sections.

But on many front pages and less insightful television news programs, it was all rock bands and glamour. It was about Facebook founder Mark Zuckerberg in his hoodie and how fabulously rich the 28-year-old was about to become. And there were reminders of other tech startups enriching early investors beyond their dreams. Remember Google.

Furthermore, Facebook was a product that its users understood. The company had infiltrated their daily lives. Perhaps it sold their personal information to advertisers, but it did so with a smiley face. Users would visit the pages of their celebrities, where they'd find tidbits of personal information, lending an air of intimacy. "I get the dish right from the celeb's mouth," a 42-year-old Michigan mother told The Wall Street Journal.

Like other social media, Facebook helped the big names develop their pages, on which it could place ads. For many ordinary people, Facebook ran the world.

The setup was complete, the lambs lined in a row. Naturally, the hedge funds pounced.

Do we need a new regulation? It's been suggested that analysts be banned from giving information to anyone before an IPO in which their bank is an underwriter. Think about enforcing it, and there's only one conclusion to make: In the end, there will be pump and dump.

COPYRIGHT 2012 THE PROVIDENCE JOURNAL CO.

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