Like a lot of people, I’ve dismissed the Twins case against Zuckerberg and Facebook as sour grapes; yes, they had a bit of a claim, but the real work is in building a compelling app and getting people to use it. Not knowing the details, the settlement seemed fair; connecting people through a website was not a new idea.

But today’s NYTimes article about the twins’ effort to challenge the settlement is eye-opening–not in terms of who came up with the idea, but at least one example of poor corporate behavior by Facebook. (On a side note, the Times put the substantive info 80% into a long article).

As soon as I read this, I knew what happened (I think, anyway):

But according to court documents, the parties agreed to settle for a sum of $65 million. The Winklevosses then asked whether they could receive part of it in Facebook shares and agreed to a price of $35.90 for each share, based on an investment Microsoft made nearly five months earlier that pegged Facebook’s total value at $15 billion. Under that valuation, they received 1.25 million shares, putting the stock portion of the agreement at $45 million.

Yet days before the settlement, Facebook’s board signed off on an expert’s valuation that put a price of $8.88 on its shares. Facebook did not disclose that valuation, which would have given the shares a worth of $11 million. The ConnectU founders contend that Facebook’s omission was deceptive and amounted to securities fraud.

Well, yes, that would be fraud if they failed to disclose a board decision that set the valuation 75% lower. Here’s what likely happened–it’s about Microsoft’s strategic, and Facebook employee stock options.

Microsoft invested in Facebook at a very high valuation for strategic reasons; it understood Facebook’s trajectory, and wanted to have a special right to work more closely with them in the future. So they overpaid for the stock–that’s typical of a strategic corporate investment, though there are other ways to structure such a deal that are more advantageous for both parties.

At the same time, Facebook had a 409a (SEC/IRS) obligation to accurately price employee stock options. It’s in the employees’ interest to price the options as low as possible, and the “independent” (read: bullshit) valuation helps serve that purpose.

But as any investor in shares with no public market will tell you, the price of the shares is at least as low as whatever the most recent valuation is. Facebook failed to disclose a 75% discount given to employees from the MSFT investment. And that’s where the Twins have a legitimate case.

I don’t like the 409a regulations, but that’s another story (it’s so poorly worded and deliberately ambiguous). The salient point here is that Facebook effectively sold shares to the Twins in exchange for a release from claims on the basis of a price paid by MSFT 5 months before, but just days before had repriced 75% lower.

Ouch.

Sucks to be Facebook. Kind of–this is easily remedied. They should simply adjust the deal and get on with it.

Of course, the details of the article are slight compared to the overall evidence, so maybe I’m wrong.