Has Facebook Been Cooking the Ad Books? [Update]

Last Updated Sep 19, 2011 7:25 PM EDT

Does it add up?
Facebook has grown its revenue like crazy, even if not enough for a reasonable $70 billion valuation. But a would-be class action lawsuit suggests that Facebook benefits from ad click fraud, and so can't even justify its revenue, let alone pre-IPO drooling.

The suit isn't a slam dunk; Facebook was able to get parts of it dismissed. But enough remains to raise some good questions about whether the company is transparent to advertisers who want to verify consumer response to their campaigns and what they pay Facebook as a result. That could be enough for investors and analysts to discount whatever they hear about Facebook's financial performance.

Clicks off the back of a truck
The lawsuit was originally filed in 2009. But new court papers for class action status, obtained by Wendy Davis at Online Media Daily, detail the allegations, including that Facebook doesn't hold to certain industry guidelines, such as independent audits and publication of its methodology for counting clicks.

One attraction of online advertising is a marketer's ability to measure and verify actual results, rather than trusting to vague "exposure" of an advertising message. When it comes to pay-per-click ads, marketers want to know that the clicks are legitimate, not automatically generated in a way that inflates their costs without delivering additional commensurate results. The court papers allege that Facebook deliberately ignored industry practices to increase revenue (copy and paste the redacted PDF of the link into another file to see behind the black barred text):
Because loss of revenue was such a concern, Facebook consistently ignored its engineers' recommendations that would have brought its click legitimacy rules closer to industry practice. Even when its lead engineer proposed a rule change he believed was a "no brainer," Facebook management refused to adopt it. In essence, Facebook manipulated its determination of click legitimacy to achieve revenue goals.

As demonstrated below, plausible expert evidence shows that classwide liability and damages can be proven using Facebook's own historical data, without the need for individualized proof.
If that is true and the case moves forward, there are some sticky ramifications for Facebook.

Now, just where did that money come from?
Even with revenue doubling since last year and solid margins (at least, what you can tell third hand, which might mean nothing, as too many recent IPO filings have proven), Facebook still must make the case of why it is worth the $70 billion or so the markets have assumed.

If the plaintiffs can show -- through either independent evidence or Facebook's own documents in discovery -- that management shied away from industry practices in an attempt to pump up revenue, this could be even worse a public relations disaster than the memo from Groupon CEO Andrew Mason that effectively postponed that company's IPO.

[Update: I had emailed Facebook's PR department when I wrote this to get the company's view of the situation. I just got notice over the weekend (9/17/2011) that the email was deleted then without being read. Guess that's the answer.]

Related: Image: morgueFile user ronnieb, site standard license.
  • Erik Sherman On Twitter»

    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.

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