Tavakoli Structured Finance, Inc.

Facebook: Soaring Fraud and Decelerating User Growth

November 26, 2012

(See also: “Facebook’s Fake Numbers: One Billion Users May Be Less Than 500 Million,” – December 11, 2012)

by Janet Tavakoli

Post IPO Comments

Before I get to the fast growing fraud—defined as a user who is not what the user pretends to be, which may or may not have legal ramifications—let me recap some things about Facebook. A tech blogger wrote me: “I didn’t realize that FB’s last quarter was a net loss on a GAAP basis. I should be paying more attention I guess.” Facebook clearly disclosed the loss. But many financial “reporters” omitted the loss from recent articles that hyped the stock. For the third quarter of 2012, on a GAAP basis (the accounting standard for U.S. corporations), Facebook lost 2 cents a share versus making 10 cents a share the prior year. It lost money in the second quarter, too. In other words, Facebook lost money every quarter since its IPO on a GAAP accounting basis. Its margins were squeezed as decelerating revenues didn’t keep up with growing costs—“user growth” isn’t always a good thing—and it lost important gaming revenues. It also annoyed users, alienated advertisers, and had an exodus of top talent.

Facebook’s initial public offering (IPO) came to market at a price of $38 on May 17, 2012, and it rose as high as $45. It closed on November 23 at $24, a 37% decline from its IPO price and down 47% from its high. Facebook’s IPO sold 421 million shares. But between the IPO and the end of the year, a total of about 1.4 billion more shares owned by insiders and employees are available for sale, and some have already been sold. (See Appendix I.) That doesn’t count Chairman and CEO Mark Zuckerberg’s more than 444 million shares. The controlling shareholder has “no intention” of selling for at least a year, but that’s not a legal obligation, so you’ll just have to trust him. (See Appendix II.)

Like many companies, Facebook is paying employees’ tax liabilities on stock awards, but unlike most companies, it is doing it by withholding around 46% of the shares and essentially buying them back at the price listed the day before the stock award settlement. This is a case where a stock buy-back is not necessarily a good thing. Facebook is using the company’s resources and credit instead of doing a secondary issuance of shares. But the market is already being flooded with enough Facebook shares as it is. In February 2012, Facebook took out a five-year revolving credit facility to borrow up to $5 billion (undrawn as of September 30, 2012). It also took out a bridge credit facility with JPMorgan to borrow up to $3 billion to pay for the stock buybacks, which it has to pay back one-year from being drawn or by June 30, 2014 at the latest. If drawn, bank lenders quickly close or pressure these credit lines when a company gets into trouble, and that often helps push a company into bankruptcy. Facebook is paying too much at its current multiples—in my view. Moreover, Facebook’s “intention” can change at any time, and it can sell the shares when it chooses.

Facebook’s financial reports filed with the SEC are posted on its web site. But first you have to wade through the filings of key insiders and officers reporting their ongoing sales of Facebook stock.

How Did Post-IPO Losses Happen and Will Things Get Better or Worse?

In 2011, 19% of Facebook’s revenues came from Zynga’s games and Zynga apps displaying third-party ads, but Facebook changed its algorithms and both Facebook and Zynga had a sharp decline in revenue. (Zynga’s IPO came to market at $10 in December 2011; Zynga’s price closed at $2.32 on November 23, down 76% from its IPO.) Most of Facebook’s revenues come from advertising. GM famously pulled its $10 million in advertising before Facebook’s May IPO, because it didn’t get results. But GM still buys ads on Twitter. Since then, an advertiser left after his research showed most of the clicks Facebook charged him for were from bots. Then on October 14, 2012, the Financial Times reported that Facebook’s frequent algorithm changes have other advertisers worried. Eyeo, developer of AdBlock Plus, just announced new software that will block ads on Android phones, the phone Facebook is urging its employees to use. Eyeo’s app will block Facebook’s ads.

In 3Q 2012, Facebook had a $431 million tax expense for the options and restricted stock it gave employees, and it will have whopping tax expenses for quarters to come for the same reason. (See Appendix I.) Campaign spending could possibly help a little this quarter, but that revenue is gone next quarter. Facebook is now hyping “gifts” for friends as a potential revenue generator—similar to a strategy it tried a couple of years ago, and the strategy failed. Moreover, Facebook is plagued with gift scams. But the biggest problem is that Facebook touted its mobile revenue strategy, as the answer to the fact that it lost money last quarter. According to Facebook, the mobile strategy is dependent on “sponsored stories.” A court case’s coming settlement puts the strategy in deep trouble (more on that later).

Facebook’s Fraud Problem: Worse than It Appears in Disclosures

Many financial reporters didn’t mention Facebook lost money last quarter, and as far as I know, none of them reported the enormous percentage increase in fraud. Perhaps that’s because you have to crunch some numbers to see it.

In its S-1 filed May 16, 2012, Facebook reported it had 483 million daily active users (DAUs) and 845 million monthly average users (MAUs) as of December 31, 2011. It said it made “reasonable estimates” that 5-6% of the MAUs were fakes and repeated this in its Prospectus filed May 18, 2012. But in its 10-Q filing for the period ending June 30, 2012, Facebook reported 552 million DAUs and 955 million MAUs, and fakes were estimated at 8.7% of MAUs. The reported percentage of fakes had climbed, and the percentage was reported on a higher “user” base.

Now here’s the tricky part. One would hope that Facebook netted out its estimated fakes when it reported its MAUs. If so, that wasn’t clear to reporters, and it isn’t specifically stated (that I could find) in the S-1, Prospectus, or the 10-K for the period ending June 30, 2012. If you don’t net out the estimated fakes before reporting, then 8.7% of 955 million, or 83 million are estimated fakes as of June 30, and that number was widely reported. If you assume Facebook netted out the fakes before reporting numbers, then the fakes are 91 million for June 30. Why is that important? It determines the base upon which growth is calculated. If Facebook doesn’t net out the fakes, it makes MAU growth look higher (because if Facebook didn’t underreport at its IPO, then fakes are growing much faster) and it makes the growth of fakes look lower. For purposes of showing the fast rate of fake growth, I’ll show numbers assuming first that Facebook didn’t net out fakes—as many financial reporters assumed—and I’ll show growth rates in parentheses as if Facebook did net out the fakes. The MAU growths shown in the next paragraph are calculated based on Facebook’s reported MAUs.

During the six month period from December 31, 2011, to June 30, 2012, daily average users (DAUs) grew 14.3% or around 30.6% annualized. Monthly average users (MAUs) grew 13% or around 28% annualized. Relative to the December 31, 2011 base of 845 million with 5-6% fake users, Facebook reported a 64-97% increase in fake users (69-104% increase in fakes if Facebook netted before reporting the 845 million MAUs), or an increase of around 168-287% in fake users on an annualized basis (185-319% increase in fake users on an annualized basis if Facebook netted before reporting the 845 million MAUs).

No matter how you look at it, at the time of its IPO, Facebook either underreported the fraud problem, or the fraud growth soared. When was Facebook first invaded by this “new” herd of the walking dead? If Facebook didn’t underreport, then why is fraud soaring?

Laughable Disclosure Claim: “Meaningfully Lower” Fake Profile Percentage in Developed World

Facebook’s 10-Q for the period ending 9/30/12 claimed: “We believe that the percentage of accounts that are duplicate or false is meaningfully lower in developed markets such as the United States or Australia and higher in developing markets such as Indonesia and Turkey.” Facebook goes on to explain why its claim isn’t trustworthy. It’s great comedy.

Based on my unscientific poll of 50 Facebook U.S.-based users (I’m not a user), many have multiple accounts. Reasons given included 1) one account for gaming and another for job applications, 2) a false persona account to be friended by an old girlfriend to spy on her (I gave that guy a wide berth), and 3) fantasy persona accounts to interact as a kind of “second life.” Even when a user profile was “genuine,” many users gave alternate email addresses and fake phone numbers, because they don’t trust Facebook to protect their privacy. Facebook itself lists more reasons, including—but not limited to— profiles of pets and spammers. (See Appendix III.)

In its disclosures, Facebook never specifically mentions the word “impersonator” i.e., identity thief. I found that personally interesting, because as I wrote in July 2011, someone put up a fake profile of me. Thanks to Google Alerts, I discovered the problem. In order to get it removed, I had to prove my identity to Facebook with a government issued I.D., yet the identity thief didn’t have to prove anything at all to create the fake. I didn’t want to fork over personal information to Facebook, but the alternative was that a fraudster might use the fake profile maliciously. Facebook reminded me of a punk holding a screw driver over your parked car’s paint job demanding payment to “protect” it as you run errands. To be clear, I’m not accusing Facebook of creating the fraudulent profile. Anyone—including Facebook—could have done it, but Facebook made it easy for fraudsters. (See Appendix IV.)

Derek Muller’s “Facebook Fraud” Video

N.B. The following video was added on February 10, 2014. Derek Muller of Veritasium demonstrates that likes are fakes and ads aren’t reaching target audiences. He kicks off the video with “Virtual Bagel,” put up by BBC’s tech correspondent Rory Cellan-Jones to illustrate the fake like problem:

Facebook’s Controls are Still Lax: Fraudster Just Impersontated HuffPo’s Exec Tech Editor (This section was added on December 3, 2012)

On November 27, 2012, Bianca Bosker, Executive Tech Editor for the Huffington Post, wrote that last week she discovered an account set up by someone impersonating her: “After being ‘friended’” by myself on Facebook, I set out to learn as much as I could about who had created the bizarre—and unsettling—Bianca Bosker impostor account, a profile created under my name, with my profile photo, my cover picture, my personal information and even my most recent status update.”

Since she was already on Facebook, she was able to get Facebook to pull down the fake profile. But when she asked Facebook for the information it collected about the fraudster, she had to scan her driver’s license and provide a notarized statement verifying her identity. Her independent investigation with Alex Horan of Core Security revealed IP addresses appeared to be in Ahmedabad, India, and he said it seems to be the source of lot of fraudulent Facebook accounts. But there are ways to make it only appear that way, so the source could be anywhere.

(End of December 3, 2012 addition.)

Facebook doesn’t know how many profiles are impersonators, imposters or other types of frauds. Yet to prove identity to purge an identity theft, Facebook demands a government issued I.D. So why shouldn’t you demand the same proof before accepting any of Facebook’s user profiles as genuine? Using its own standards, the quality of Facebook’s user data stinks.

Deceleration in User Growth

Here’s something else I bet you didn’t know about Facebook’s growth: it’s slowing down. Let’s look at Facebook’s 10-Q claims for the period ending September 30, 2012. For the year September 30, 2011-2012, worldwide daily average users (DAUs) increased from 457 million to 584 million, or 28%. In contrast, September 30, 2010-2011 growth was 55.9%, and growth from September 30, 2009-2010 was 103% for DAUs. For September 30, 2011-2012, monthly average users [MAUs, including mobile and desktop users] increased from 800 million to 1.007 billion, an increase of 26%. In contrast, September 30, 2010-2011 growth was over 45%, and September 2009-2010 growth was over 80% for MAUs. (See Appendix III for definitions of DAUs and MAUs.) User growth is decelerating and the cost of bringing in new users is rising.

Mobile MAUs reportedly grew from 376 million to 604 million or just under 61% from September 30, 2011-2012, but even that didn’t stop deceleration of user growth overall. Mobile MAU growth from September 30, 2010-2011, was 92%, and growth from September 2009-2010 was 161%. This growth is also decelerating. There’s also a caveat: Facebook can only guess at users with both mobile and desktop accounts, so it can’t tell you how much it double counts multi-platform users. Furthermore, Facebook “estimated” 5% of daily mobile users were just automatic mobile activity, but it could be more; Facebook doesn’t really know. But there’s a much bigger problem: Facebook said its mobile revenue strategy is dependent upon “sponsored stories.” That’s now problematic.

Facebook’s ability to use “sponsored stories” is in trouble due to a California consumer privacy lawsuit. Facebook had taken users’ likes and then promoted “sponsored stories” as if the user sponsored a product. Now adult users will be able to opt out per the proposed settlement agreement. (Consumer privacy advocates want children to opt-in only with parental consent. Facebook is fighting so that parents must opt-out children, but parents will have to prove their relationship. It sounds to me like Facebook’s punk-with-screwdriver policy.) Facebook’s mobile revenue strategy—touted as the solution to GAAP losses—is in trouble.

Advertising: Facebook Keeps Digging Itself a Deeper Hole

In a previous commentary, I wrote that a Facebook advertiser pulled out, because its research showed 80% of the clicks it paid Facebook for were from bots. It wasn’t accusing Facebook of generating the bot clicks—it could have been done by a third party. Facebook claimed it couldn’t verify the research. I also mentioned that Marc Cuban had a different complaint (as reported by Dan Lyons at Readwrite). In disgust, Cuban decided to emphasize alternatives to Facebook for the Dallas Mavericks and 70 other brands, and it turns out that the problem may be even worse than Mr. Cuban thought.

Cuban suspected Facebook suppressed posts in order to essentially cyber-blackmail him into paying to reach fans he previously reached for free. Facebook claimed it made the change to reduce spam in users’ News Feeds. But now Facebook’s explanation is suspect.

Jeff Bercouvici wrote a November 21 Forbes story wherein he explained he’s careful not to “like” brands on Facebook. He doesn’t want his friends spammed with unintentional “endorsements,” or “sponsored stories.” (The California court case puts Facebook’s “sponsored story” revenue strategy in peril anyway.) So when Bercouvici found an ad for “Hitman Absolution” in his News Feed, he figured it was from a friend’s “sponsored story.” He investigated and found it was something new, a “suggested post.” Facebook was apparently spamming his News Feed with an unsolicited paid ad.

The backlash has begun. Nordic countries have threatened legal action to get rid of “suggested post” spam saying it violates their privacy laws.

Why would Facebook do this? Desperation is my guess.

Since “sponsored stories” are in trouble, Facebook appears to be knocking out posts from “liked” brands to insert a paid-for “suggested post” from a brand that was never “liked” by the user or even “liked” by a user’s friend.

Regulators and Lawyers Are Successfully Fighting Facebook

Regulators have stepped in. On November 21, Facebook said it would change its privacy policy to share user data with Instagram. On November 23, European regulators said Facebook is in conflict with the law, and European users will be able to block data sharing. The U.S. trade commission hasn’t yet commented. (See Appendix II.)

In a separate issue, placing unsolicited ads in News Feeds violates the European Directive on Privacy and Electronic Communications. So not only is Facebook’s mobile revenue strategy in danger because of its proposed “sponsored stories” settlement, “suggested posts” are in trouble in Europe. The U.S. hasn’t yet weighed in.

Facebook has a variety of legal problems in the United States. Here are some highlights: 1) Facebook faces litigation related to its IPO, 2) Facebook is still seeking dismissal of a $15 billion lawsuit related to secret tracking of users after they logged off, 3) As mentioned earlier, the “sponsored stories” settlement is closer to completion, and the latest proposal already hurts Facebook’s mobile revenues strategy—the final settlement could be even worse for Facebook.

To cap it all off, Facebook has some new competition.

Competition for Investment and Advertising Dollars

Facebook is banned in China, where social media seems dominated by YY Inc. But it’s not a Facebook clone, and it seems to offer what Facebook offers and more. It has developed its own proprietary technology for group real-time voice and video. It also offers YY music and games. Tomio Geron at Forbes described it as a “cross between Skype, Zynga and American Idol.” YY Inc., a Cayman shell company linked to China’s YY Inc., listed its American Depository Shares on the NASDAQ on Wednesday, November 21, with light reporting, a Form F-1 Registration Statement, enabled by the so-called JOBS Act. Like Facebook, YY is struggling to become profitable even though it has increasing revenue and gross profits, or so its reporting claims. Beware of complex structures like YY’s and read about past companies with accounting reporting deficiencies in which investors came to grief. YY’s lack of transparency is a huge red flag. My point here is that YY planted its flag in China where Facebook is banned, and that risk lovers who dismiss Facebook’s red flags can find other highly speculative bets in the social media tech space

Facebook’s former investors and advertisers may divert dollars into Twitter, Google+, New My Space, Spotify, or another social media site. Justin Timberlake, who played Sean Parker in the Social Network, is an investor in New My Space. Users are “connecting” instead of using “like, subscribe, friend, or follow.” The site looks clean and cool and fun. Google+ may win more of Facebook’s users (or not). A new, as yet unheralded, up-and-comer may arrive on the scene. Facebook’s user growth rate has slowed, and “user” fraud is a problem. Facebook has annoyed investors, users, advertisers, and regulators. In November, its change of privacy policies ran afoul of European regulators, and raised questions with U.S. regulators. Facebook isn’t the only game in town, and many users and advertisers are looking for a better alternative.

Disclosure: I’ve bought and monetized puts on Facebook since they became exchange-traded shortly after the IPO. (“Investors Bet on Facebook Fall,” Kaitlyn Kiernan and Jonathan Cheng, Wall Street Journal, May 19, 2012.)

Read more finance articles by Janet Tavakoli

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Appendix I

Schedule of shares available for sale: (From 8K August 30, 2012)

Facebook free to trade share schedule

* According to Facebook’s 8K of August 30, 2012:

The table above excludes the 444 million outstanding shares and 60 million shares issuable upon the exercise of an option that are held by Mr. Zuckerberg [Chairman, CEO and controlling shareholder ]because he has informed us that he has no intention to conduct any sale transactions in our securities for at least 12 months. In addition, as of August 30, 2012, options to purchase 45,693,252 shares held by former employees were outstanding and fully vested and the shares underlying such options will be eligible for sale on November 14, 2012. We expect an additional approximately 4 million shares to be delivered upon the net settlement of RSUs following the date of the initial settlement of RSUs described above and December 31, 2012 will be eligible for sale in the public market immediately following settlement.

 JT Note: Mr. Zuckerberg’s “intention” is not a guarantee or a legal obligation. He may sell shares at will. After trading hours on Friday, October 26, several senior Facebook officers made required filings of 4s forms reporting conversion of 10-vote-but-can’t-sell-‘em “B” shares to one-vote-but-ready-for-sale “A” shares. Sheryl Sandberg, COO: 34 million shares ($790 million), with 15 million ready for sale. Theodore Warren Ullyot, General Counsel and Secretary: 2.5 million shares ($58 million) of which 1.4 million are ready for sale. David Ebersman, CFO: 4.2 million shares ($97 million), with 2.2 million ready for sale. David Fischer, VP Mktg: 1.1 million shares ($26 million), with 568, 282 shares ready for sale. Michael Todd Schroepfer, VP Engineering: 2.8+ million ($66 million), with 1.5 million shares ready for sale. David Spillane, Chief Accounting Officer: 0.7 million shares ($16 million), with more than 415 thousand ready for sale. Selling has already begun. Form 4 filings of key insiders and officers, and their actual sales as they occur, are posted on Facebook’s web site.

Appendix II

Mark Zuckerberg’s Controlling Shares

Mark Zuckerberg, the Chairman and CEO, retains an estimated 22% ownership share in Facebook and owns 57% of the voting shares (there’s a tiered stock structure); that’s likely to be an ongoing negative for both users and advertisers.

Zuckerberg’s IM: People Who Trust Him Are “Dumb F**ks”

The New Yorker profiled Mark Zuckerberg and included IM’s from Zuckerberg’s college days:

Zuck: Yeah so if you ever need info about anyone at Harvard

Zuck: Just ask.

Zuck: I have over 4,000 emails, pictures, addresses, SNS

[Redacted Friend’s Name]: What? How’d you manage that one?

Zuck: People just submitted it.

Zuck: I don’t know why.

Zuck: They “trust me”

Zuck: Dumb fucks.

The article mentions there are even more equally embarrassing IMs. Zuckerberg admitted to the New Yorker that he wrote the IM’s and says he regrets writing them. I can well imagine Zuckerberg regrets that this is now public information, but the problem is he doesn’t seem to have grown out of the underlying behavior. In fact, there’s a pattern of problems at Facebook that suggests to me the philosophy represented by his earlier IMs is entrenched in Facebook’s culture.

Facebook’s August 30, 2012 disclosures say Mr. Zuckerberg, the Chairman, CEO and controlling shareholder, has “no intention” of selling his 444 million outstanding shares and 60 million shares issuable upon the exercise of an option for at least 12 months. But his “intention” is not a legal obligation or a guarantee. It’s a matter of trust.

Appendix III

Excerpted from Facebook’s Form 10-Q for period ending June 30, 2012 filed July 31, 2012. [Emphasis added in text body.]

Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party website that is integrated with Facebook, on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement.

Mobile MAUs . We define a mobile MAU as a user who accessed Facebook via a mobile app or via mobile-optimized versions of our website such as m.facebook.com, whether on a mobile phone or tablet such as the iPad, during the period of measurement.

Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party website that is integrated with Facebook, in the last 30 days as of the date of measurement.

Limitations of Key Metrics

The numbers of our MAUs and DAUs and ARPU are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. For example, there may be individuals who maintain one or more Facebook accounts in violation of our terms of service, despite our efforts to detect and suppress such behavior. We estimate that “duplicate” accounts (an account that a user maintains in addition to his or her principal account) may have represented approximately 4.8% of our worldwide MAUs as of June 30, 2012. We also seek to identify “false” accounts, which we divide into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. As of June 30, 2012, we estimate user-misclassified accounts may have represented approximately 2.4% of our worldwide MAUs and undesirable accounts may have represented approximately 1.5% of our worldwide MAUs. We believe the percentage of accounts that are duplicate or false is meaningfully lower in developed markets such as the United States or Australia and higher in developing markets such as Indonesia and Turkey. However, these estimates are based on an internal review of a limited sample of accounts and we apply significant judgment in making this determination, such as identifying names that appear to be fake or other behavior that appears inauthentic to the reviewers. As such, our estimation of duplicate or false accounts may not accurately represent the actual number of such accounts. We are continually seeking to improve our ability to identify duplicate or false accounts and estimate the total number of such accounts, and such estimates may be affected by improvements or changes in our methodology.

Our metrics are also affected by applications on certain mobile devices that automatically contact our servers for regular updates with no user action involved, and this activity can cause our system to count the user associated with such a device as an active user on the day such contact occurs. For example, we estimate that less than 5% of our estimated worldwide DAUs as of December 31, 2011 and 2010 resulted from this type of automatic mobile activity, and that this type of activity had a substantially smaller effect on our estimate of worldwide MAUs and mobile MAUs. The impact of this automatic activity on our metrics varies by geography because mobile usage varies in different regions of the world. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user’s IP address and self-disclosed location. These factors may not always accurately reflect the user’s actual location. For example, a mobile-only user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user’s actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. For example, in early June 2012, we discovered an error in the algorithm we used to estimate the geographic location of our users that affected our attribution of certain user locations for the period ended March 31, 2012. While this issue did not affect our overall worldwide MAU number, it did affect our attribution of users to different geographic regions. We estimate that the number of MAUs as of March 31, 2012 for the United States and Canada region was overstated as a result of the error by approximately 3% and these overstatements were offset by understatements in other regions. In addition, our estimates for revenue by user location are also affected by these factors. We regularly review and may adjust our processes for calculating these metrics to improve their accuracy. In addition, our MAU and DAU estimates will differ from estimates published by third parties due to differences in methodology. For example, some third parties do not count mobile users.

Appendix IV

“Smishing” Friendly: Facebook Openly Listed Your Mobile Number on Its Mobile Version

Suriya Prakash, a security researcher, discovered that a user’s mobile number could easily be accessed by scam artists on Facebook’s mobile version. Facebook called it a “feature” not a flaw. If so, it was an unacceptable feature.

Prakash found that Facebook’s default privacy setting allowed “everyone” to find a user using the email or mobile phone number the user provided.

Facebook only blocked this on October 8, after Prakash contacted Facebook about the flaw. But who knows how many numbers and names have already been mined.

AARP’s October 2012 article, “Spam in Your Hand,” reported that at least 70% of cellphone text spam is an attempt to defaud you. Here’s a bonus. You’ll pay around 20 cents for each one of these fraud attempts you receive if you don’t have a text message plan.

It’s much worse if you respond. You’ll probably be directed to a site that installs malware to steal all the personal data stored on your cell. Alternately, you may be asked to dial a phone number, and your personal information will be solicited. This type of cell phone phising is called “smishing.”

Facebook Accused of Being Lax on Child Porn

According to Kate Drury of The Watchers in Australia, a new meme targeted underage users who were encouraged to post nude pictures of themselves on Facebook, and she has accused Facebook of allowing this to go unchecked. Apparently there are multiple pages allowing creation and dissemination of child porn on Facebook.

She reported Facebook to Crime Stoppers, the Australian Federal Police and other authorities. An investigation has been launched. Facebook did not respond to her emails according to an August 20, 2012 article in Technolgy.

Your “Private” Messages Aren’t Private

Facebook admitted it scanned so-called private messages. The Next Web reported that Facebook claimed it found a bug with social plugins on off-site pages, and it was attempting to fix the bug.

Appendix V

Facebook: SEC Should Investigate Pump and Dump

TSF – November 30, 2012

Facebook isn’t the worst example of financial shenanigans that need investigation by the SEC, but I’ve chosen to give it attention recently, because the general public can easily understand the mechanics of a stock pump and dump.

Facebook’s underwriters currently face allegations that at its May 2012 initial public offering (IPO), they gave downward earnings guidance to select investors while other investors were uninformed. Giving downward earnings guidance during an IPO is alarming and extremely rare. Facebook’s insiders and officers sold stock.

As I’ve mentioned before, Facebook insiders have been selling stock this past month. Meanwhile, Facebook and games-maker Zynga have been revising the terms of a five-year deal they struck in 2010 to make the terms more favorable to Zynga. Now newly launched Zynga.com won’t have to use Facebook as the only way for gamers to log in. Moreover, Facebook took 30% of Zynga’s sales through Facebook’s virtual payment system via Facebook ads, but now Zynga.com isn’t obliged to use Facebook’s system. Facebook will still get a new game at the same time as, or shortly after, Zynga launches it elsewhere, but Zynga isn’t require to use Facebook as its non-Zynga platform.

Any officer of Facebook who knew about this contract rewrite-in-progress had material insider information. How do I know this is material information? Facebook told us so. In its 10-Q for the period ending 9/30/12 and filed with the SEC on 10/24/12, Facebook stated the following in original bold italicized letters:

In the first nine months of 2012 and the full 2011 year, we estimate that up to 13% and 19% of our revenue, respectively, was derived from Payments processing fees from Zynga, direct advertising from Zynga, revenue from third parties for ads shown on pages generated by Zynga apps, and Facebook ads and Sponsored Stories displayed on Zynga.com. If Zynga does not maintain its level of engagement with our users or if we are unable to successfully maintain our relationship with Zynga, our financial results could be harmed.

Facebook emphasized this because it is required by law to do so. That was one little month ago.

Meanwhile, the PR narrative from analysts and from so-called financial “reporters” has often dismissed the new threats to Facebook’s mobile revenues strategy—again it was Facebook itself that said “sponsored stories” was key to its strategy and now “sponsored stories” are in trouble due to a California lawsuit. Now that this strategy is in peril, there’s been hype about all the money Facebook will make from gifts, even though a similar strategy failed a couple of years ago. Even worse, its “sponsored stories” and “suggested posts” that are supposed to deliver the gift message in News Feeds are in trouble with regulators. More than that, Eyeo, developer of AdBlock Plus, just announced new software that will block ads on Android phones, the phone Facebook is urging its employees to use. Eyeo’s app will block Facebook’s ads. Remember, just a month ago, Facebook warned us about the threat to user engagement if its relationship to Zynga should change.

Decelerating and Possibly Declining Number of U.S. Users

In my November 26, 2012 report, I mentioned that overall user growth is decelerating. The deceleration problem is most pronounced in the U.S. and Canada. From September 30, 2011-12, the number of Daily Active Users (DAUs) grew from 124 million to 132 million—by only 8 million or 6%. Monthly Active User (MAUs) grew from 176 to 189 million—by only 13 million or 7.3%. Should you rely on those numbers? Given Facebook’s own estimation of its percentage of fakes, the number of users may have actually declined.

You’ll also recall that relative to the December 31, 2011 Facebook reported a 64-97% increase in fake users (69-104% increase in fakes if Facebook netted), or an increase of around 168-287% in fake users on an annualized basis (185-319% increase in fake users on an annualized basis if Facebook netted). It reported worldwide 8.7% fakes which translated to 83 million fakes (91 million fakes if Facebook had already netted out the fakes before reporting its numbers).

By having poor controls and leaving the door wide open for fraud, Facebook can claim that—in its opinion—users in the United States are increasing, but that’s not really clear at all. Facebook’s poor controls and the shakiness of its numbers have other plausible interpretations not found in its SEC filing. It’s also likely that U.S. users are declining. Facebook doesn’t really know.

Additional Comment on Facebook’s U.S. Market (Section added December 3, 2012)

When it comes to desktop usage, Facebook’s had a double-digit loss of its U.S. audience from October 2011-12 (“Myspace grows as Facebook Slows” – by Kevin Sablan, Orange County Register, November 27, 2012.) It was down 10.2% according to ComScore. Desktop usage had been down for five months in a row, but this is the first report of a double digit desktop year-over-year decline.

From October 2011-12, Facebook’s U.S. desktop visitors declined from 166 million to 149 million or 10.2%. That trend might be explained away as a growth in mobile as opposed to loss of market share, except for Myspace’s numbers. (Facebook users are also said to be migrating to Twitter) Three years ago, Myspace was the most popular U.S. social network, and while Facebook was down double digits, Myspace’s U.S. audience increased by 1% to 28.8 million in the month of October. This may be more than a desktop migration-to-mobile phenomenon, since Facebook’s desktop numbers are crashing while New Myspace is seeing an improvement.

(End of section comments added December 3, 2012)

Disclosure: I’ve bought and monetized puts on Facebook since they became exchange-traded shortly after the IPO. (“Investors Bet on Facebook Fall,” Kaitlyn Kiernan and Jonathan Cheng, Wall Street Journal, May 19, 2012.) Update 2013: I have no position long or short in Facebook.

Read more finance articles by Janet Tavakoli

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