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The Feds Are No Longer Investigating Snap

By Evan Niu, CFA - Oct 24, 2019 at 10:30AM

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Those IPO disclosures appear to have been sufficient after all.

Nearly a year ago, federal regulators at the Department of Justice and the Securities and Exchange Commission opened an investigation into Snap (SNAP 3.89%), focusing on whether the Snapchat parent had sufficiently disclosed competitive risks to prospective investors ahead of its 2017 initial public offering (IPO). Almost as soon as Snap went public, the narrative shifted from one of a social media upstart enjoying blistering growth to one of a company getting eaten alive by larger rival Facebook (META -0.11%).

The social networking juggernaut had been relentlessly replicating Snapchat's most popular features with varying levels of success. When Facebook got it right, however, it brought those copied features to far more users thanks to its massive scale across its platforms like Instagram. The investigation is now over.

A folder with "File Closed" stamped on it next to an "Investigations" sign

Image source: Getty Images.

Regulators are "no longer pursuing their investigations"

Snap reported third-quarter earnings this week, and buried in the related 10-Q the company confirmed that the agencies have called off the investigation.

"In September 2019, both the DOJ and SEC provided us with written confirmations that they are no longer pursuing their investigations of these matters," Snap wrote in the filing. "We continue to believe the underlying securities class action's claims are meritless and our IPO disclosures were accurate and complete."

The probe was related to a class action lawsuit that investors, who suffered losses due to Facebook's aggressive competition, have filed against the company. Those plaintiffs alleged that they were insufficiently warned, which also presumes they read the prospectus in whole. Most people don't do that, particularly retail investors.

Snap tried to warn investors

In fact, Snap was quite up front about the competitive risks it faces in its IPO prospectus, including those posed by Facebook. The company warned that its "competitors may mimic our products and therefore harm our user engagement and growth."

Additionally, Snap was worried that Alphabet subsidiary Google and Apple, which operate the underlying mobile platforms that Snapchat relies on, also compete to some degree. Apple introduced personalized emojis called Memoji in 2018, a direct rival to Snap's Bitmoji. These larger competitors, including Facebook, have "significantly greater financial and human resources and, in some cases, larger user bases," Snap cautioned.

The company even went as far as to explicitly cite Instagram Stories: "For example, Instagram, a subsidiary of Facebook, recently introduced a "stories" feature that largely mimics our Stories feature and may be directly competitive."

Instagram Stories' daily active users (DAUs) would proceed to eclipse Snapchat's entire DAU base in short order. The format that Snap pioneered, which is little more than slideshow, has now come to dominate the social media landscape.

Snap was undoubtedly on the ropes for a couple years as it struggled with various challenges, including competition and some self-inflicted wounds, but the company did appear to sufficiently warn investors of the risks. It seems the feds agree.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Apple and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Facebook. The Motley Fool has the following options: short January 2020 $155 calls on Apple and long January 2020 $150 calls on Apple and recommends the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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