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Thursday, January 6, 2011

A Facebook & Goldman Deal: Why Do They Bother?

Nicole Gelinas of the Manhattan Institute had a really great post on The Corner yesterday concerning the recent deal between Goldman Sachs and Facebook. Gelinas analyzes the situation very well, but fails to ask a key question: why isn't Facebook going public? Why bother with this arrangement?

Going public involves incurring a very high cost of compliance. I was disappointed to see that the blog post doesn't mention Sarbanes-Oxley. After all, since this act was passed in 2002, IPOs have steadily declined in the US, with some US companies listing in places like Frankfurt instead. Yet it is more than that, these regulations, even when complied with, are a foot in the door for all kind of government pressures. So,while we'd be better off with open markets, the answer isn't to shove SEC regulations further. Rather, it is to deregulate public markets. (Maybe that will be her next column, who knows! As an aside, I truly love reading her work.)

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  1. read yesterdays wsj

    was alson an editorial on it

  2. The concern with going public is not simply that Facebook is afraid of Sarbanes-Oxley disclosure or that Facebook wants to limit the pool of people who can evaluate its value (I'm sure Goldman saw Facebook's financial statements before making any such deal). Rather, Facebook's concern about going public would be control. Facebook doesn't want to have to defer to shareholders in making broad operational decisions. Also, going public opens Facebook up to a non-regulatory threat such as a hostile takeover. Facebook is more afraid of a potential tender offer or proxy fight than they are of mere public disclosures. The concern is based less on the current regulatory scheme than it is on the drawbacks inherent in a public offering.

  3. Here's another take:


    Circumventing SEC? Why does Facebook has to cut anyone else in at all? It's not like they need the money.

  4. The high cost of compliance really isn't a concern for major companies that decide to go public. The concern is control--shareholder rights, 14a-9, proxy fights, 10b-5, the ebbs and flows of the market, etc. Try not to limit your discussion to statutes taught in your Intro to Business 101 class.

  5. You kind of missed another chance to do justice to your law blog category. The real story here, as pasadenaphil notes, is that this appears to be a blatant and likely illegal end-run around SEC regs. Can't you walk down the hall and ask a securities law prof about this?

    And Phil, I suspect Facebook does need the money in order to compete with Google in the acquisition space. They have no stock to spend as a currency surrogate in acquisitions.

  6. @Carmine, it seems you're making a point about control. There are many ways to avoid shareholder control while still going public. For instance, a company could distinguish shares with special voting rights. Google did just that, their class A shares have only one vote, while their Class B shares have ten. The co-founders of Google had more than 50% of votes until recently. There is a similar example in the case of Berkshire Hathaway, their Class A stocks have 3/20 the voting power of Class B per every dollar. Also, again, if the issue was control, poison pills are classic examples as a way to avoid takeover. I think this deal is a means to avoid giving leverage to regulators since a public company is more vulnerable to government ire.

    @Blythe, this is Kathleen. Yes it's a way to circumvent SEC regulation. I think the more interesting question is why a circumvention is necessary.

  7. @Kathleen,

    With all due respect, you are way off base here. FB is reporting revenue north of $1B for 2010. SEC compliance costs are not significant on the P&L of a $1B company. The cost of compliance argument is simply not credible.

    Nor is the Sarbanes Oxley argument. Yes, SOX imposes some draconian liability provisions, but lots of other companies have gone public since SOX, either in the US or abroad.

    More likely explanations would include:
    1. FB has been fraudulently inflating its revenue numbers or other performance numbers such that it is now effectively precluded from accessing public markets, or (more likely)
    2. An honest audit/accounting of FB would result in a valuation much, much lower than the $50B that Goldman pulled out of thin air on this one.

    Reggie Middleton has analyzed the structure of the Goldman deal in detail. Not surprisingly, Goldman makes out nicely even if the investment implodes which would happen, for example, if FB is grossly overvalued at $50B.

    In sum, this deal appears to be a blatantly transparent, formalistic, and probably illegal end-run around the 500 investor threshold for SEC reporting. It is structured such that FB gets the cash horde it needs and a flagship valuation and Goldman makes book even if it blows up in investors' faces. The interesting question here is: Where the Hell is the SEC??

  8. @Blythe: You say "this deal appears to be a blatantly transparent, formalistic, and probably illegal end-run around the 500 investor threshold for SEC reporting" like it's a bad thing.

    What is blatantly wrong is the very existence of the SEC. I for one salute the ingenuity to go around crappy liberal institutions from the New Deal era.

    As for the cost of compliance, you are correct that it affects large companies like Facebook much less than smaller companies, but I think the bigger issue as mentioned in the post is the government's foot in the door. The government, through the SEC, has more teeth to pressure private companies, which is a serious danger for Facebook.

    Facebook doesn't want to provide the government with a list of people whose status oppose the healthcare reform? Well I guess they could easily be convicted of violation of securities law and see their stock crash. There is a Damocles sword hanging on public companies.

  9. @Anon7ysyXAvA

    Your logic for arguing in favor of bypassing the SEC illegally is the epitome of corruption. FDR made a lot of big mistakes during his reign of terror but creating the SEC was not one of them. Neither was Glass-Steagall and the creation of the Financial Accounting Standards Board.

    The two problems plaguing the SEC have been chronic underfunding that leaves it understaffed to address excessive and increasingly complicated regulation and interference from Congress when the SEC tries to perform its enforcement duties.

    Regulation is not a dirty word. All it means is that there are rules to the game. What matters is whether the rules make sense and whether they are enforced fairly. They used to make much more sense than they do now but the enforcement has become too politicized and corrupt.

  10. http://online.wsj.com/article/SB10001424052748704739504576068332459947012.html