Facebook-Goldman: Where Is the S.E.C.?

http://www.newyorker.com/online/blogs/johncassidy/2011/01/facebook-goldman-where-is-the-sec.html

by jsm386 • 16 years ago

130 86 16 years ago

tptacek6• 16 years ago

This particular SEC reg is designed to protect the investors, not the integrity of the market. Are we now expected to believe that Goldman --- or any private client of Goldman --- is getting snookered by Facebook?

The same logic used by the SEC suggests that every limited partner of every VC that invests in any startup should also count to the total number of investors.

Umalu• 16 years ago

Although the SEC considers itself the "investor's advocate," it usually steps back and allows "accredited investors" and "qualified purchasers" (terms it uses for "rich investors") to invest on their own. So if Goldman Sachs and its clients are truly rich and sophisticated, I don't think the SEC will view protecting them as a good use of its time.

That being said, Goldman Sachs and its investors will likely insist on financial disclosures from Facebook and maybe even some governance rights that, while not quite public company-strength, will lead to Facebook disclosing more information to more people than it had previously.

tptacek6• 16 years ago

Goldman can't sell shares of a Facebook investment vehicle to non-accredited investors.

JoelSutherland2• 16 years ago

Yes, Goldman's private clients are getting snookered.

This is exactly how Goldman managed to be so successful in the subprime crisis. When they decided to unload their holdings, they were sold to their clients. There is a strong conflict of interest at Goldman between shareholders and clients.

My understanding is that Goldman can do two things to make money here: 1. charge fees on transactions and 2. decide when and how to sell/buy shares for themselves.

Whether the clients should be protected by the SEC is another matter.

tptacek6• 16 years ago

You're missing my point. The SEC protects non-accredited investors by forbidding companies from selling them shares. Goldman doesn't trade for non-accredited investors. If you are a Goldman private client, you are by definition outside the purview of those protections.

Starting a big long thread about how Goldman is a vampire squid or whatever Taibbi called them is a waste of time, because I'm not arguing that Goldman is a good company or a bad company or that its interests are aligned with its clients.

I'm saying that the logic that assails Goldman's Facebook vehicle is nonsensical; Goldman is doing nothing more sinister than creating an ad-hoc venture capital fund and using it to invest in Facebook. Does every California public employee also count as a Facebook shareholder if CalPERS is an LP of a VC that invests in Facebook?

(Answer: no.)

tedunangst• 16 years ago

Do Goldman's clients know they are getting snookered? (How can they not?) And if you know you're going to get snookered, are you still getting snookered?

myth_drannon• 16 years ago

Interesting take from ZeroHedge : http://www.zerohedge.com/article/goldman-creates-facebook-he...

trotsky2• 16 years ago

The only thing that's really left for one of these private share vehicles to do is pull a reverse shell merger with an OTC listed firm and let joe retail investor start day trading the result. Now that's the bubble I remember.

ramanujan2• 16 years ago

This is a fantastic, precedent setting move and a response to the political sector's irrational laws (see: Sarbanes-Oxley). It was presaged by the DST style investments over the last few years, and we can only hope that more companies follow suit.

If you want to reduce speculation and uninformed trading, at least one way to do that is to give companies rights over who trades their shares and under what circumstances. You're not forced to sell your house to anyone, so why should you be forced to sell your company to anyone -- particularly day traders who will just introduce volatility and aren't in it for the long haul?

A long overdue organic reaction to the silly laws passed in the wake of the last financial crisis. No doubt we will see similar workarounds for the work of art that was "FinReg", though those workarounds may take the form of debuting on the Hong Kong Stock Exchange rather than the NYSE.

It's a little known fact, but Google also made use of certain legal workarounds to avoid going public for as long as possible (among other things, they split the company into two units of 499 people apiece, or so I recall).

alexwestholm• 16 years ago

While I get your point about volatility, I'm not so sure I agree with the idea that large companies ought to have absolute control over who owns their shares. That's fundamentally contrary to the idea of open markets, and sets up too much potential for abuse. It's not hard to envision a marketplace where pervasive use of this technique concentrates wealth even further than it already is.

ramanujan2• 16 years ago

> It's not hard to envision a marketplace where pervasive use of this technique concentrates wealth even further than it already is.

Don't see how that follows. If you are restricting the market to only a fixed number of sellers, you are leaving a potentially significant amount of money on the table.

You're doing that to prevent the abuse of your company's shares by investors, who generally have more money than you do.

Imagine if you didn't have the right to turn down a VC who only wanted to put in money once you got hot, and then came to your board meetings as a shareholder and caused problems. Or to be criminally responsible if an accountant somewhere in your organization makes an error. That's what it is to be a public company in the post-Sarbox/Finreg US. This is about protecting the entrepreneur, not about protecting the old money.

magicalist• 16 years ago

correct me if I'm wrong, but aren't they not forced to sell their shares to anyone? once they pass the 499 shareholder mark they have to disclose financial information, at which point most companies go public, but if they have enough interest from private investors, I don't believe they have to.

RuadhanMc• 16 years ago

Irrational laws for irrational investments.

euroclydon• 16 years ago

Companies can be forced to go public when they reach a certain size? What? Really?

evgen• 16 years ago

Once a company has a certain number of shareholders (investors and employees with options, for example) then they are forced to complete a lot of the paperwork that makes being a public company so onerous. They are not forced to go public, but they are forced to pay the costs of being a public company whether or not they are actually traded on the open market.

ankimal• 16 years ago

Just to clarify (its in the comments) too but as the law stands, FB does not have to go public anyway but only disclose financial results. http://www.sec.gov/about/laws.shtml (Corporate Reporting)

cynicalkane2• 16 years ago

Back when Berkshire Hathaway only had Class-A shares worth thousands of dollars, there were a few investment firms at work on similar vehicles to allow ordinary investors to buy fractions of a share at smaller prices. Berkshire responded by issuing their own fractions, at 1/30th of a Class-A share (since split to 1/1500th), because they wanted investors, not investment firms, owning the shares.

It's interesting that now Facebook is doing a sort of converse of Berkshire's actions; that the pain of a public company is so onerous that having a bank involved is apparently seen as an advantage.

nostromo• 16 years ago

Alternatively, FB may just want to keep financials a secret because they are worth a lot more when people are wildly speculating than they would be if they had to be as open as a public company.

(Goldman probably got a look under the hood, but I doubt they will pass that along to the investors they hope to sell Facebook investments to, so both FB and Goldman will benefit from uninformed speculation.)

rhizome• 16 years ago

...at least until they can ride those numbers into an IPO.

vessenes3• 16 years ago

Any prospectus put together by Goldman will have significant disclosure and results of their internal audits. Despite the hoopla, this is a pretty regulated area of commerce.

As to who will read such a prospectus, that's likely a different beast altogether.

It's my belief that FB is more likely to be in a pre-IPO Google situation right now, that is, that they're sitting on more than people realize, not less. I recall Google routinely requiring academics to cut the server and request numbers by a factor of 10-100x when giving talks about what was going on, pre-IPO. A luxury I'm sure they would appreciate still having.

joe_the_user• 16 years ago

that the pain of a public company is so onerous that having a bank involved is apparently seen as an advantage

Let's be specific about this "pain". What I recall from various articles, Facebook is very reticent to have it's actual revenue numbers floating around.

One might argue that there is too much regulation of public companies in general but the specific regulation that a public company has to engage in public disclosure seems sound to me. Facebook's skirting of this regulation seems questionable to say the least.

tptacek6• 16 years ago

They're not a public company, or even effectively a public company, even with Goldman facilitating, if you still need to be a RegD accredited investor to buy a share.

vessenes3• 16 years ago

If you read the Berkshire annual reports from back then, I think Buffet would have strongly preferred to do what FB is doing now, if he could have, or the vehicles existed.

He knew his mom-and-pop investors needed liquidity, and wasn't able to buy them all out himself, so he went for the market option. But, he was clearly ambivalent about it. I believe his first instructions to his floor trader were that he hoped there would be no transactions in the first year of listing.

cynicalkane2• 16 years ago

At the time, Berkshire was already public. Buffett maintained the high share price because he wanted his owners to be serious about owning the stock, the test of seriousness being the high cost of ownership. When investment firms threatened to remove this barrier, Buffett went ahead and preempted them.

powera2• 16 years ago

I still don't get why anybody would invest in a company at $50 billion with no knowledge of how much money they are making.

sploink2• 16 years ago

You can bet that Goldman would have got hold of Facebook's financial statements from it before making that investment. You don't invest a few hundred million dollars before kicking the tires first.

powera2• 16 years ago

Sure, Goldman has it, but the sub-investors in their fund probably just get a "Very Good Valuation" assessment.

javanix2• 16 years ago

I really can't imagine that this is the first time this particular move was tried.

Google had been a dominant search engine for years before they went public, and I can't imagine they turned down many $50 billion funding rounds simply to avoid turning public before their IPO.

Symmetry2• 16 years ago

The law was different back when Google was having its IPO.

javanix2• 16 years ago

From http://dealbook.nytimes.com/2011/01/03/facebook-and-the-500-...:

The Securities Exchange Act of 1934 sets forth certain requirements for companies to register their shares with the S.E.C.

Specifically, Section 12(g) requires that a company register its securities with the S.E.C. if it “has total assets exceeding $1,000,000 and a class of equity security … held of record by five hundred or more … persons…”

Sounds to me like this law has been around for a while.

d2viant• 16 years ago

I think people are missing an angle in this story. I don't think the interesting part is the $450 million they invested or the vehicle they're setting up for investors. It's Facebook's future IPO and Goldman likely just bought themselves the primary role in issuing that IPO -- of which they stand to make billions off of.

nir• 16 years ago

That's right. If they can hype Facebook enough, Goldman will cover their investment easily. It's less about what Facebook turns out to be actually worth in the long term than what GS can help make people believe it's worth in the near term.

Nate75Sanders• 16 years ago

"All problems in computer science can be solved by another level of indirection"

Looks like it works in finance, too. And a whole lot of other disciplines.

kenjackson• 16 years ago

But there's always one nagging problem which it doesn't. In CS it is performance. In finance, maybe solvency?

smokinn• 16 years ago

In finance it's returns (ironically, also often referred to as performance).

Each level of indirection means a middleman somewhere is taking a cut.

boredguy8• 16 years ago

Anyone else remember when people were freaking at the $15b valuation of FB? Now it's not the valuation but rather the method of the investment.

Charuru• 16 years ago

Facebook has proven itself since them. When TV stations start promoting their facebook pages rather than their own websites you know they're onto something.

mishmash• 16 years ago

But they also did that with MySpace and look how that is turning out.

fleitz4• 16 years ago

The SEC is where they always are, fighting the last war. Investments create return because there is risk, not every investment is going to be a winner. When investing in startups with new business models there is a lot of risk and hence a lot of return. Hopefully the SEC stays out of it because the combination of the SEC, Federal Reserve and Federal Gov't create untold havok in the market. Even a GIC has risk because of the underlying fractional reserve system. The same thing that allows the economy to expand faster than the rate of gold mining also allows the leverage to unwind just as fast.

The Fed, SEC, and Federal Gov't collude to prevent the free market from working and bad ideas from failing. Look at a graph of global IPOs vs. IPOs on american exchanges since Sarbox was passed. You'll see how the overly onerous regulations prevent the market from functioning properly and create an environment of moral hazard where undue risks are taken, and investors who correct the market have their returns taken away from them. The investors who shorted AIG, Bear Stearns, GS, Citigroup, BOA, etc and recognized their impending fiscal collapse should be handsomely rewarded for their prescient view of the market. Having your company collapse is the right way to handle reckless investing.

Hopefully the SEC stays out of it, an ETF/Shell corp for Facebook shares is the ideal balance between public money and few onerous requirements. If an investor feels that the lack information available for Facebook prevents an informed decision from being made then perhaps they should not invest.

Yes, you may lose your shirt investing in Facebook, but you might also make a lot of money. I don't see a problem with either outcome.

encoderer• 16 years ago

But this hack that GS created -- bypassing the 500 shareholder limit by creating a company that owns a stake in FB and then selling shares of said company -- completely undermines the law.

This is a temporary loophole that will be fixed. I don't begrudge facebook a thing. They get most the upside of an IPO with nearly none of the downside. But to act that it's perfectly alright because, hey, caveat emptor... i disagree strongly with that.

brc• 16 years ago

I don't want to disagree with your main point, but it's wrong to link risk and return so closely, as though one always brings the other. Just because there is a lot of risk doesn't mean there will be a lot of return. Risk is simply the likelihood that you will get your original money back, plus any return. The higher the risk, the higher the chance you won't get any return or indeed your original capital. While this often means that people will only take on risky investments if there is a chance of high return, the way it reads is that all you need to do is create some risk and your returns wil flow. It's entirely possible to have high risk, low return and low risk, high return.

However I agree entirely that SEC always fights the last war like the French building the Maginot line, and that this type of innovation is just a response to the Sarbox rules.

patrickgzill4• 16 years ago

I don't know if Goldman did this, but Morgan Stanley did: they sold silver bullion to their clients, then charged them an ongoing storage fee to hold the bullion on their behalf in their vault.

Problem was, as it came out, that MS never actually bought the bullion and thus was charging storage fees on non-existent items. If you went to remove or claim your silver, they just gave you cash as settlement, making the scam opaque.

The cynic in me says GS will do something similar, like put a very high valuation on the FB units they sell, both marking them up a great deal over what they paid FB for it AND inventing some of the units out of whole cloth (i.e. issuing 10,000 units for sale when they only bought enough FB for 1,000 units), then, over time, the FB units will be seen to "decline" in value and GS will pocket the profits twice, first on the markup of the units, then on the decline.

fleitz4• 16 years ago

This process is essential to what the banking industry does. Banks are one of the few institutions authorized by law to do this.

When you deposit money in a bank, they create 9X the loans of what you've deposited.

I'd bet if you read the fine print on the MS offering it would tell you that this is exactly what they were doing. MS & GS are too smart and too big of a target to engage in outright fraud.

borski• 16 years ago

True, Enron was tiny.

xenophanes7• 16 years ago

> When you deposit money in a bank, they create 9X the loans of what you've deposited.

Source? I thought what they did is loan out 90% of what you deposited.

cschneid• 16 years ago

Please be aware that this is blatantly false. The bank can only loan out less than the amount they have on hand (after subtracting the reserve percentage).

What happens is that you loan the money, it gets spent, and ends up in your deposits again. THEN, you are effectively counting a dollar as: "Owe $ to original depositor, Get $ from person taking the loan, Owe $ to new depositor". Adding up to 1 dollar. Except when reporting dollars on deposit, you say 2.

Individual banks don't "create" money. But as a quirk of lending and taking deposits, the banking system creates money, at least on the books.

kqr2• 16 years ago

The cynic in me says that GS will go to AIG and have them underwrite an "insurance" policy which guarantees that if anyone wants to redeem more FB shares than they have on hand, AIG will cover the remainder.

fleitz4• 16 years ago

And the Fed will cover what AIG is short.

edge17• 16 years ago

Do you have a link to the Morgan Stanley story? I'm curious about some of the finer details

patrickgzill4• 16 years ago

The Reuters story is a little short on details: http://www.reuters.com/article/idUSN1228014520070612

A search for "morgan stanley silver bullion storage fees" will get you lots more links, commentary, etc.

rmrm• 16 years ago

a company I recently left ran up against this same 500 shareholder rule. To get back down comfortably below 500, they performed a substantial reverse split, which caused many former employees to be taken down below 1 share. Apparently at that level, the company can cash them out as you can't hold only a fraction of 1 share.

Once those former employees were rounded into nothingness, they performed a forward split to restore everything to their previous levels.

I thought that was a rather clever workaround.

known• 16 years ago

Govt fears big companies.

Facebook-Goldman: Where Is the S.E.C.?

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