In Twitter IPO, Wall Street reserved best info for top clients

November 7, 2013: 5:00 AM ET

Twitter's investment bankers are telling their clients one thing while Main Street hears a different story.

131106151559-twitter-620xaFORTUNE -- Once again, Wall Street is telling its top-paying clients one thing, and the rest of us are getting a different story. This time it's the Twitter (TWTR) IPO.

According to the Wall Street Journal, analysts who work for Goldman Sachs (GS) and other banks on the IPO, which raised $1.8 billion, have been privately telling select investors that Twitter's revenue may not increase as fast as expected. The underwriters' analysts are predicting 55% growth next year. The rest of the Street is estimating 80%. For the following year, it's 32% vs. 58%. That's a huge difference for a company like Twitter that is not yet profitable and being judged mostly on its ability to grow.

Investment banks under-hyping a deal they're selling might not sound like a bad thing. It's the opposite of what happened during the 1990s dot-com boom.

But it became a big issue in the bungled Facebook IPO, leading many to call the offering unfair to average investors. Facebook (FB) executives, shortly before the IPO, allegedly told a group of analysts employed by its underwriters that sales projections for the company were too high. The analysts then passed that information on to certain investors. But it didn't come out until after the IPO that Wall Street's favorite clients got a glimpse at potential problems at Facebook, at the same time that average investors were being whipped into a frenzy about the deal.

MORE: How Twitter's largest outside investor tricked me

Morgan Stanley (MS) eventually had to pay $5 million to the State of Massachusetts for its role in Facebook's selective disclosure of information. Facebook and its underwriters are still facing class action suits related to the deal.

And yet the same thing appears to have happened in the Twitter IPO. Goldman declined to comment.

Analysts are allowed to have different opinions. And institutional investors generally pay, in indirect ways, but pay nonetheless, for Wall Street research. So it makes sense that they would have better access to Wall Street's research analysts than, say, an average investor.

But the key difference between the analysts who work for the underwriters and those who do not is that the former group gets access to Twitter's executives. That's what creates the problem. Companies are generally not allowed to tell one group of investors one thing, and not tell everyone else the same.

In fact, in the run-up to an IPO, corporate executives aren't supposed to speak publicly to anyone. It's called the quiet period. Nonetheless, while they are not talking publicly, the SEC does allow corporate executives to meet with potential investors. Once again, these meetings are generally restricted to the Wall Street firm's top paying clients. Those are the rules, even if they aren't fair.

MORE: 6 Things We learn from 'Hatching Twitter'

The rules around what analysts can and can't do during an IPO are murky at best. Traditionally, analysts at underwriting firms don't pick up coverage of a stock their bank is underwriting until a month or so after the IPO. Still, analysts are allowed to talk to investors, typically the firm's top-paying clients, privately about the deals, as long as they don't publish their research. However, they are not allowed to tell them how they will eventually rate a company's stock, or hint at what that rating will be. For some, revenue projections cross the line.

"You are not allowed to front-run your own rating," says Michael Pachter, an analyst at Wedbush Securities, who follows social media companies, and began covering Facebook before it went public. He has decided not to put out revenue projections on Twitter, though Wedbush is not one of Twitter's underwriters. "You might feel a revenue projection falls into the grey area, but my firm's opinion is it's off-limits."

Ironically, the much maligned JOBS Act, which was passed last year, could solve the IPO research problem. The JOBS Act specifically allows analysts to pick up coverage of a company before it goes IPO, even if they work for one of the underwriters. That would remove the information divide, because once an analyst picks up coverage they have to publish their research for everyone to see. That could be why none of the big Wall Street firms have taken advantage of this provision in the JOBS Act.

"The Wall Street firms have a monopoly on information in the IPO process, and they're trying to hold on to it," says Bill Hambrecht of WR Hambrecht, an underwriting firm pushing for a more open IPO process. "The quiet period is stupid."

We couldn't agree more.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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