Facebook CEO’s latest woe: accusations of securities fraud

Updated.

May has been a bad month for Facebook CEO Mark Zuckerberg, who just turned 26 last Friday but spent his birthday wrestling with an uproar over Facebook’s privacy practices. The latest unwelcome gift: accusations of securities fraud from former Harvard schoolmates who say he and other Facebook executives tricked them into a supposed $65 million settlement that was actually worth far less.

Divya Narendra and brothers Cameron and Tyler Winklevoss (pictured above) contend that they hired Zuckerberg to work on their social network, ConnectU, when they were all students at Harvard, only to have him delay the project and use ConnectU’s code to launch his own project, then called TheFacebook. Their side of the story gained credence after instant messages sent by Zuckerberg bragging about his success in duping them emerged in the press.

Both sides have been locked in litigation since their college years. ConnectU and Facebook reached a tentative settlement for $65 million in 2008, but the Winklevoss brothers and Narendra, in the brief filed in their appeal, said that the settlement was never finalized and that a judge acted improperly in allowing the settlement to proceed and awarding ownership of ConnectU to Facebook.

Judge James Ware ruled in the original case, tried in San Jose. A three-judge panel will hear the appeal once it reaches court.

That legal maneuver allowed Facebook, as the owner of ConnectU, to fire ConnectU’s lawyers, who included the famed law firm of Boies Schiller & Flexner. Partner David Boies prosecuted the antitrust case against Microsoft, putting Bill Gates through a grueling deposition. By claiming the right to dismiss ConnectU’s lawyers, Facebook’s legal team spared Zuckerberg from a similar fate.

The ConnectU cofounders are arguing that Facebook executives and lawyers presented the cash-and-stock offer’s value as $65 million, relying on a valuation of $15 billion that Microsoft paid in 2007 when buying preferred shares in the company. The settlement, however, was to be paid in common shares, not preferred shares, which Facebook itself valued at roughly 75 percent less for the purposes of calculating taxes on stock-based compensation — cutting the settlement’s offer roughly in half.

The real question here is why Facebook’s lawyers haven’t succeeded in making this lawsuit go away. Before, ConnectU’s founders were just after a piece of the Facebook pie. Now, the stakes keep getting higher as the case drags on. An actual finding of securities fraud would make it difficult for Zuckerberg to remain Facebook’s CEO if it were to go public. However unlikely that is, why take the risk?

Facebook did not respond to a request for comment.

This story has been corrected to reflect the following: Judge James Ware ruled in the original case; he will not hear the appeal. A finding of securities fraud in a civil case like this one would not constitute an indictment, which occurs in criminal cases.

Here’s the appeal brief:

http://viewer.docstoc.com/
The Facebook Inc. vs. ConnectU Inc. Appeal Brief