Snap's Board Facing Blowback for Not Disclosing Whistle-Blower Lawsuit in IPO

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Snap Inc. banner on Wall Street

In March 2017, Snap Inc. co-founders Evan Spiegel and Bobby Murphy rang the opening bell at the New York Stock Exchange, and cheers erupted among floor traders as the social media messaging company engineered an IPO at $17 a share. Investors thought Snap was worth well north of the $24 billion the company was being valued at and pushed the share price even higher. But what Snap didn't share in any of the offering documents in connection with the IPO was that a former employee named Anthony Pompliano had highlighted concerns about the growth of daily active users in a wrongful termination suit filed at the beginning of the year. Pompliano's lawsuit was soon put under seal, but before that happened, The Hollywood Reporter revealed the existence of the heavily redacted complaint.

Now, Snap is facing blowback over the lack of disclosure in the wake of later acknowledging user stagnation. Within months of the IPO, several class actions were filed, and after these investor suits were consolidated in California federal court, Snap was unable to defeat claims last year on a motion to dismiss. The company is also being investigated by both the Justice Department and the Securities & Exchange Commission for statements in connection with the IPO, while more lawsuits continue to arrive. For example, a stockholder derivative lawsuit was filed last month in Los Angeles Superior Court alleging that Snap board members violated fiduciary duties by not disclosing Pompliano's allegations.

The newest complaint, which itself was under seal until last week, repeats the charge that there should have been more disclosure, but adds some details about what happened at a board meeting after Pompliano, a former sergeant in the U.S. Army who was hired away from Facebook, came forward with concerns about the inaccuracy of user metrics being used. A day after he sent Spiegel a final draft of a PowerPoint presentation about his findings, he was fired. The subsequent wrongful termination suit from Pompliano in January 2017 wasn't exactly a secret outside of Snap's headquarters, but nevertheless it didn't attract tremendous attention at the time. A Snap spokesperson then told THR, "We've reviewed the complaint. It has no merit. It is totally made up by a disgruntled former employee."

The plaintiffs in the derivative suit say they got a chance to review Snap's books and records, and what's clear, they say, is that Snap's rosy picture of user growth at the time of the IPO was a fiction. Rather, Snap's growth was slowing as Instagram copied Snap's features. The plaintiffs add that metrics kept by the company were unreliable and inflated. Perhaps most important, Pompliano's lawsuit was discussed at a board meeting weeks before the IPO.

Despite how Snap publicly characterized Pompliano's allegations, the board of directors was "aware that the Company's own actions supported Pompliano's allegations," according to the latest investor suit, and "knew the Company's growth was significantly slowing."

Here's Snap's S-1, which at least nodded to risks from competition.

"Without any mention of Pompliano, his allegations, or slowing DAUs because of Instagram, the IPO was a success," adds the complaint. "The Company and other early investors sold 230 million shares at $17 each. The Company sold approximately $2.6 billion worth of stock. The Individual Defendants, either personally or through their investment funds, sold nearly $900 million worth of their own personally held stock."

A month after the IPO, an unredacted version of Pompliano's complaint was released, with Snap telling the press it had "nothing to hide" and that alleged "minor metrics deviation hardly measures up to Pompliano's gasping rhetoric about Snap being built 'on a house of cards.'"

Soon, though, Snap came under pressure about its numbers.

"The next quarter defendant Spiegel admitted that the Company engaged in the very growth hacking he previously disparaged," states the complaint. "In the wake of these disclosures, Snap's stock plunged more than 72% from its relevant period high, to just $4.99 per share on December 21, 2018, over $13 billion from the high it reached soon after the IPO, and significantly below the Company's IPO of $17 a share."

What should Snap have disclosed?

In securities filings, it's routine for corporations to talk about legal matters in highly general terms, but in many of these lawsuits against Snap and its board members, plaintiffs express a theory of an affirmative obligation that the company share word of a "material" lawsuit from a former employee.

"The Offering Documents discuss other litigation besides the Pompliano lawsuit," states the derivative complaint. "In particular, the Offering Documents discussed two lawsuits, one concerning a claim that Snap improperly used the plaintiff's image and the second concerning a personal injury. By disclosing these two lawsuits, but not the Pompliano lawsuit, the Offering Documents misleadingly implied that these were the only pieces of litigation pending against the Company."

Snap's board members haven't had the opportunity to respond to the latest lawsuit, but upon similar allegations in the consolidated action, their lawyers argued that both competition with Instagram as well as the existence of Pompliano's allegations about user growth was in the "public domain," that Snap had no obligation in its S-1 to credit him and disclose those findings.

In June 2018, U.S. District Judge Stephen Wilson ruled the case should continue. This month, a new lead plaintiff was picked.

Given that those investors filed pretty quickly — at a time when Snap's share price was still above its IPO price — Snap expresses doubts about whether any claim for damages can be sustained. Snap failed to convince a judge to certify an interlocutory appeal to explore that issue, and Wilson deferred that subject to a later point.

If the consolidated investor class action in federal court finds itself hobbled on the damages issue, that could make the newer derivative suit filed in state court, brought for the benefit of Snap against the board members, more consequential. In the newer suit, plaintiffs demand a proposal to strengthen Snap's controls over financial reporting, a provision to permit stockholders to nominate at least three candidates for election to the board, a provision to control insider selling, and a proposal to strengthen oversight of its disclosure procedures, among other requested relief.

Here's the full complaint.