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Morgan Stanley Coughs Up $5 Million in Facebook Settlement

NEW YORK ( TheStreet) -- Massachusetts has settled a $5 million fine with Morgan Stanley (MS - Get Report) for what it deemed to be improper research tied to the initial public offering of Facebook (FB - Get Report).

The state's securities regulator said on Monday that the bank violated the 2003 Global Research Analyst settlement in its role underwriting Facebook's IPO.

In the days leading up to the May 18 offering, Morgan Stanley analysts downgraded earnings outlook of Facebook in an internal research report as a result of alleged conversations with company management orchestrated by underwriters.

In the wake of Facebook's poor post-IPO performance, the social network and its underwriters faced criticism of selective disclosure on upcoming earnings weakness. The Monday consent order alleges a Morgan Stanley banker unduly influenced communication between Facebook and research analysts, helping to communicate a lowered earnings outlook for the social network that wasn't fully shared with the investing public.

On May 9 -- roughly a week prior to Facebook's IPO -- the social network indicated in a filing with the Securities and Exchange Commission its advertising revenue growth relative to total users was slowing as a result of mobile devices.

Minutes later, according to the consent order, a phone call between Facebook's treasurer and analysts orchestrated by an unnamed Morgan Stanley banker then revealed "quantitative information regarding Facebook's second-quarter 2012 projections" not contained in the filing.

After the call, Morgan Stanley analysts cut their earnings and revenue forecasts for Facebook and questioned the company's execution on mobile devices-tied ad revenue, in a report shared with institutional investors.

In a statement explaining the statement Galvin of Massachusetts said that the analyst had been improperly influended by underwriters leading the offering. The unnamed banker, "not only rehearsed with Facebook's treasurer who placed the calls to the research analysts, but he also drafted the majority of the script Facebook's treasurer utilized when calling the research analysts," a statement adds.

Recently, Facebook has seen its shares recover to just 30% below its $38 a share IPO price as mobile device-based revenue begins to trickle in.

"We are pleased to have reached a settlement with Secretary Galvin and the Massachusetts Securities Division and to have put this matter behind us," Mary Claire Delaney, a Morgan Stanley spokesperson said in an e-mailed statement. "Morgan Stanley is committed to robust compliance with both the letter and the spirit of all applicable regulations and laws."

Morgan Stanley neither admitted or denied the claims, in Monday's penalty.

Monday's settlement follows a late October $2 million fine paid by Citigroup (C - Get Report) to the Massachusetts regulator.

In that fine, details of leaked non-public information cost one of the bank's analysts his job, and another left the firm as a result of compliance violations related to stock ratings of Google (GOOG).

What was initially seen as a coup by Morgan Stanley in winning the lead underwriting mandate for Facebook soon turned into a public relations disaster when the largest-ever tech IPO flopped falling roughly 50% in the wake of the offering.

Morgan Stanley, Citigroup and other underwriters of the Facebook IPO and its analysts were prohibited from disseminating any non-public information prior to the offeringr. Bloomberg reported in May that the 33 investment banks participating in the offering would pocketed roughly $176 million in fees related to the offering.

Both Morgan Stanley and Citigroup were among 10 Wall Street investment banks that agreed to the Global Research Analyst settlement. In the wake of the dot-com bust, the Securities and Exchange Commission found a host of conflicts of interest inside research and underwriting units of the banks. The fidelity of sell-side research, the settlement found, took a back seat to more lucrative underwriting activity.

In total, the Wall Street firms paid $875 million in penalties as a result of the settlement. A penalty against Solomon Smith Barney - now a joint venture with Citigroup majority owned by Morgan Stanley - was the harshest ever civil securities enforcement against a Wall Street firm at the time.

The banks involved also agreed to a series of reforms and so-called 'Chinese Walls' to ensure the objectivity of research reports.

Morgan Stanley shares were nearly 2% higher to $18.46 a share in Monday afternoon trading, while Facebook shares were less than 1% lower at $26.59.

Currently, Morgan Stanley rates Facebook shares 'Overweight' with a $31 a share price target, while Citigroup gives the social network a 'Neutral' rating with a $30 a share price target.

-- Written by Antoine Gara in New York

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