There’s something ickily uncomforting about the Facebook/Goldman mash-up — and not just the scars of a well flogged horse. A well flogged horse going public with financial information by 2012, no less.
As you know, the SEC is looking into “pre-IPO Pooled Investment Funds” such as the one Goldman set up, and which may operate via private share markets.
We (and others) explained on Tuesday that the technical issue at stake was whether Facebook (or other such companies) is deemed to have over 500 shareholders “of record”.
Lawyers disagreed over whether there is a rule break. Supporters of the SEC case point out that “beneficial” shareholders should also be included, while opponents such as ex-SEC commissioner Joseph Grundfest say that “If someone says Goldman is violating the law, then they obviously don’t know the law. ” (H/T Economist).
Ouch. But it’s worth pausing for a second and asking what the purpose is of the 500 rule, first included way back in the 1964 amendments to the 1934 Securities Act.
Handily, and ironically, there’s some useful information to be found in Facebook’s 2008 successful request to be granted exemption from the 500 rule. Excerpts from a paper prepared by Fenwick & West LLP:
The purpose of the 1964 Amendments has been expressed in various ways:
(a)
The preamble to the legislation states that its purpose was “to extend disclosure requirements to the issuers of additional publicly traded securities.”
(b)
A report of the House Committee on Interstate and Foreign Commerce accompanying
H.R. 6793, the version of the bill introduced in the House of Representatives, states that “Section 3(c) of the bill would .. . provide for registration of securities traded in the over- the-counter market and for disclosure by issuers thereof comparable to the registration and disclosures required in connection with listed securities.” H.R. 6793, U.S. Code Cong. and Admin. News, 88″ Cong. 2d Sess., at pages 3027-3028.
(c)
A release of the Securities and Exchange Commission, citing a report on its study that made the legislative recommendations on the basis of which the 1964 Amendments were enacted, describes the scope of the registration and reporting provisions of Exchange Act as extending “to all issuers presumed to be the subject of active investor interest in the over-the-counter market.” Exchange Act Release No. 181 89, October 20, 1981(citing Report of the Special Study of Securities Markets of the Commission, House Committee on Interstate and Foreign Commerce, H.R. Doc. No. 95, pt. 3, 88th Cong. 1″ Sess. (1963) at pages 60-62).
(d)
A later release of the Commission states that the numerical thresholds contained in Section 12(g) were selected because it was believed “that issuers in these categories had sufficiently active trading markets and public interest and consequently were in need of mandatory disclosure to ensure the protection of investors.” Exchange Act Release No. 23407, July 8,1986.
What’s clear is that there’s nothing special about the 500 number and that what matters is whether the rule is working to protect investors.
One speculates that Facebook revisited its 2008 report and accepted the likelihood that it’ll be pressured to disclose at some point in the next year or two.
However, there are broader, more important issues raised by the deal. Courtesy of some wise minds in the blogosphere, here are five:
1. Will there be a taxpayer-subsidised tech bubble?
Simon Johnson argues in Economix that because Goldman receives access to the Fed’s discount window, has an implicit too-big-to-fail guarantee from the government, and finances most of its operations through debt, it could encourage a more catastrophic version of the dot-com crash.
Yikes. But while we agree with the broader point about not fixing the too big to fail problem, the jury is still out on tech bubble 2.0. Facebook may be overvalued but let’s not confuse the outlier with the trend. Private markets deal in a handful of relatively well established tech companies (such as LinkedIn which announced IPO plans today) rather than, say, Webvan.
2.Will the Volcker Rule stand up to these types of deals?
The FT and others such as Felix Salmon have rightly asked whether Goldman’s investment is exactly the type of proprietary trading the rule is designed to stop banks doing with their own funds. Good question; we await the implementation of Volcker.
3. What does Facebook’s decision say about the desirability of IPOs amongst tech companies?
Justin Fox argues that the reluctance of Facebook to go public partly reflects a desire amongst less-established companies to avoid the correlative effects of hyper-efficient markets. Our best guess is that it says more about the relative benefits (such as non-disclosure) of private investment than it does about the costs and risks of a public listing. But a fascinating point and one worth looking at as more companies approach these decision points.
4. Will there be a knock-on effect on VC funds?
At least two issues come to mind here. The first is that any ruling on who counts as part of the 500 could make VCs (and potentially hedge funds) nervous. The second is whether they’ll be more nervous to invest in some start-ups if the prospect of an IPO cash-out is less likely. We’re not convinced this is the case but again, worth watching.
5. What is the future for private secondary market sites?
For a few years, sites like secondmarket have briskly bimbled along with little scrutiny, trading private shares in new, big name tech companies and claims in bankruptcy cases such as Lehman. Now a light is being shone on those still in the dark, while one, Xpert Financial, has formally registered with the SEC. It’ll be interesting to see whether the SEC tries to encourage more companies to formally register after resisting applications for the last few years.
Some food for thought for a flogged horse, then.
Related links:
SEC pokes – and friends – secondary markets - FT Alphaville
Why Facebook (and Others) Don’t Want to Go Public – Justin Fox
Facebook move lucrative for Goldman – FT
It’s not bubble 2.0 - FT