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Facebook's Plan to Keep Zuckerberg in Control Was Flawed, Lawsuit Says

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12/09/2016 | 09:37pm CET
By Deepa Seetharaman 

Facebook Inc.'s move to change its capital structure was tainted by secret text messages and meddling from financial advisers that pointed to a process rife with conflicts of interest, according to investor lawsuits filed in Delaware.

Late last summer, Chief Executive Mark Zuckerberg asked the board to approve a plan to create a new class of nonvoting shares that would allow him to maintain control of the company he co-founded. The board formed a three-person special committee tasked with assessing the capital plan.

Morgan Stanley, which advised Facebook, appeared to pull the strings behind the scenes by convincing the board's advisers to water down parts of the plan that would have been unfavorable to Mr. Zuckerberg, according to court documents filed by the plaintiffs.

Meanwhile, longtime Facebook director Marc Andreessen, who served on the special committee, was privately coaching Mr. Zuckerberg by text message on how to win over the other two directors, according to court documents. In one instance, Mr. Andreessen texted Mr. Zuckerberg during a March meeting of the special committee with progress reports. "NOW WE'RE COOKING WITH GAS," Mr. Andreessen wrote.

The capital plan was approved by the eight-member board in April.

The lawsuits allege a web of entangled interests at Facebook and the covert dealings that allowed Mr. Zuckerberg to cement his control over the company. The board showed "stunning" disloyalty to shareholders in approving a plan that would diminish shareholders' say, investors said in court documents, which were first reported by Bloomberg.

The suits were filed in the spring, and later bundled into one by the Delaware Chancery Court. The documents were unsealed recently.

"It is clear that the process surrounding the reclassification was rife with actual, acted-upon conflicts of interest," according to the investor lawsuit, which said "virtually every aspect of the process was tainted."

Representatives for Mr. Andreessen and Morgan Stanley declined to comment. "Facebook is confident that the special committee engaged in a thorough and fair process to negotiate a proposal in the best interests of Facebook and its shareholders," a Facebook spokeswoman said. Mr. Zuckerberg declined to comment through a spokeswoman.

In August 2015, Mr. Zuckerberg told the board of his plans to give away 99% of his wealth to the Chan Zuckerberg Initiative LLC, a for-profit entity he created with his wife to donate to nonprofits and make private investments toward causes such as curing disease and education. He proposed a plan to overhaul Facebook's capital structure so he could keep his majority voting rights, according to court filings.

The special committee Facebook's board formed to study its options was made up of the three board members deemed by directors to have the fewest potential conflicts of interest: Mr. Andreessen, a well-known venture capitalist; Susan Desmond-Hellmann, chief executive of the Bill and Melinda Gates Foundation; and Erskine Bowles, a former White House official and president emeritus of the University of North Carolina.

Initially, the committee considered hiring Morgan Stanley as its adviser but opted not to because Mr. Bowles is a director on the bank's board, according to court documents. The committee ended up hiring Evercore Group LLC as its banker and Wachtell, Lipton, Rosen & Katz as its legal counsel. Morgan Stanley switched to providing advice to Mr. Zuckerberg's senior advisers, the lawsuit says.

Yet Morgan Stanley still was able to influence the committee's discussions in a way that favored Mr. Zuckerberg, according to the lawsuit. The bank urged Evercore and Wachtell to use as a blueprint a similar creation of nonvoting shares by Google parent Alphabet Inc. in 2014, according to the lawsuit.

Evercore removed portions of its presentation to the committee that "would have facilitated robust Committee negotiations with Zuckerberg" at the urging of Wachtell and Morgan Stanley, according a plaintiffs' brief. Evercore scrapped its conclusion that investors would place a higher value on voting shares over nonvoting shares after a call with Morgan Stanley and Wachtell in which Morgan Stanley pushed back, court documents say.

Wachtell Lipton declined to comment. Evercore didn't respond to a request for comment.

According to court documents, Morgan Stanley Managing Director Michael Grimes said the bank "landed in the right spot with the company" and was happy to have "volunteered" advice to Mr. Zuckerberg. "[T]he more we add value we could decide token fee a la goog [sic] but we wait to consider later," the bank wrote, referring to its advising of Google, according to the lawsuit.

Morgan Stanley ultimately was paid $2 million for advice, a proxy filing shows. Evercore was paid $2.5 million, according to the proxy filing. It wasn't clear what Wachtell was paid.

Throughout the special committee's deliberations, Mr. Andreessen kept in touch with Mr. Zuckerberg, assuring him that the negotiations were "all intended to protect the company and you personally," according to text messages included in the court documents.

In later text messages, Mr. Andreessen conveyed that the "biggest issue" was Mr. Zuckerberg's desire to be able to go into government service for two years without losing control of Facebook.

"Erskine is just massively uncomfortable with you getting to low economic ownership and then going off on leave with no involvement by the board and retaining control," Mr. Andreessen wrote. "I'm going to try to drag it over the line one more time."

The government service provision was approved and laid out in Facebook's proxy earlier this year.

Ms. Desmond-Hellmann, chair of the committee, and Mr. Bowles didn't reply to requests for comment.

On April 14, the committee agreed to approve the plan. "The cat's in the bag and the bag's in the river," Mr. Andreessen wrote. "Does that mean the cat's dead?" Mr. Zuckerberg asked. "Mission accomplished," Mr. Andreessen replied with a smiley-face emoticon.

Each director on the special committee was paid $20,000 for his or her work. The board's compensation committee, which also includes Mr. Andreessen, approved the payment, according to a proxy filing.

The capital plan was approved by shareholders in June. The outcome was no surprise, as Mr. Zuckerberg held majority voting power.

Write to Deepa Seetharaman at Deepa.Seetharaman@wsj.com

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Financials ($)
Sales 2016 27 297 M
EBIT 2016 15 982 M
Net income 2016 8 840 M
Finance 2016 22 156 M
Yield 2016 -
P/E ratio 2016 39,61
P/E ratio 2017 28,76
EV / Sales 2016 11,8x
EV / Sales 2017 8,54x
Capitalization 344 938 M
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Number of Analysts 47
Average target price 156 $
Spread / Average Target 30%
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NameTitle
Mark Elliot Zuckerberg Chairman & Chief Executive Officer
Sheryl Kara Sandberg Chief Operating Officer & Director
David M. Wehner Chief Financial Officer
Michael Todd Schroepfer Chief Technology Officer
Atish Banerjea Chief Information Officer
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