
Facebook-Goldman: Where Is the S.E.C.? - jsm386
http://www.newyorker.com/online/blogs/johncassidy/2011/01/facebook-goldman-where-is-the-sec.html
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patrickgzill
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.

~~~
fleitz
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.

~~~
xenophanes
> 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.

~~~
patrickgzill
I think the poster is talking about re-deposits and how, recycled, that can
end up being a multiple of what is deposited.

Example: you deposit $1000 in a bank with 10% reserve policy ($100 set aside
as capital reserve of the bank).

Bank loans out $900 to customer for new office furniture; then that money is
used to pay the office store, which is another depositor at the bank - which
then counts as another deposit, 10% of which is set aside as reserve ($90).
Another loan of $810 is then made, etc.

~~~
xenophanes
If I lend 20 bucks to my friend, then he lends it to his friend, who lends it
to his friend, that's the same kind of multiplier. The total outstanding loans
is $60. I really don't get what people make a big deal out of this. I guess
it's b/c they aren't economists.

~~~
edmccaffrey
Except that's not the same kind of multiplier at all. I don't understand why
you would make a comment without doing any research. I guess you're not an
economist.

~~~
xenophanes
The total loans in existence is a multiple of the starting money. Same thing.
And also the same is refusing to subtract the total debt for some reason.
Unless you have some kind of, you know, argument?

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cynicalkane
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
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.)

~~~
vessenes
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.

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fleitz
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
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.

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tptacek
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.

~~~
JoelSutherland
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.

~~~
tptacek
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.)

~~~
timr
_"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?"_

A venture capital fund is diversified over many investments -- that's why it's
a fund. A venture capital "fund" that invests only in Facebook is a fund in
name only.

Also, unless you're a lawyer specializing in securities law, I doubt you know
the answer to your own question. State employees can (and do) initiate
lawsuits against CALPERS, and CALPERS has sued public companies on behalf of
state employees. The pensioners clearly have some rights as investors.

~~~
tptacek
By your logic, CalPERS can't invest in any fund that invests in private
companies, as that investment would instantaneously tip the company over the
"500 investor" limit.

Meanwhile, what does diversification have to do with the structure of a
venture capital fund?

~~~
timr
_"By your logic, CalPERS can't invest in any fund that invests in private
companies, as that investment would instantaneously tip the company over the
"500 investor" limit."_

No, that's not what I said. I said that the investors clearly have rights --
presumably including the right to know the financial prospects for their
investments. CalPERS invests some money in private equity funds and limited
partnerships, but that just begs the original question. I don't know what the
disclosure requirements are for companies involved in that kind of investment,
but then, I'm not a securities law expert.

Do you actually know the answer, or are you just asking rhetorical questions
in the hope that people will interpret your questions as statements of fact?

 _"Meanwhile, what does diversification have to do with the structure of a
venture capital fund?"_

Risk.

~~~
tptacek
You made a straw man argument that drew me into a straw man argument and here
we are arguing about something totally irrelevant. Nobody is saying that
investors have no rights.

Are you saying that if Matasano took funding from a VC that had CalPERS as a
limited partner, we might have to make additional SEC-mandated disclosures to
account for CalPERS investors? You're right: I can't tell you that I _know_
that we wouldn't; I can only call "BS" and wait for someone else to add facts.

~~~
timr
_"You made a straw man argument that drew me into a straw man argument and
here we are arguing about something totally irrelevant._ "

Not really. You argued that Goldman Sachs created a venture fund, and that
therefore, Facebook is immune from disclosure laws. I'm saying that there's a
substantial _practical_ difference between a venture fund and what Goldman
appears to be doing here (not the least of which are issues of investment
diversity) and that, _even if that weren't true_ , it's not clear that
financial disclosure laws can be bypassed so easily (the CalPERS digression
was yours). Other experts happen to agree on these points, so I don't think
I'm coming out of left field.

But since I'm not one of those experts, and you don't seem to have any special
knowledge beyond your own opinions on the matter, this thread is more heat
than light. I'm done with it. Counterarguments aren't "straw men" just because
they don't directly refute your original points.

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powera
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.

~~~
sploink
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.

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

~~~
Travis
But isn't it the responsibility of the sub-investors to do their own due
diligence? After all, the entire purpose of accrediting investors is to get
them to acknowledge that they are being given less protection from the SEC.

It's a process where the SEC asks the investor, "OK, you have a million
dollars. Are you sure you know what you're doing?" And the individual says,
"Yes, I'm willing to accept the additional risk that comes along with less
oversight (ie. more flexibility)".

If an investor is putting money into the pot based on just the "Very Good
Valuation" argument, and they've acknowledged the risks, they are not eligible
for certain protections (because those protections also limit certain
financial vehicles).

In a similar vein, I feel no sympathy for the majority of the people who gave
their money to Bernie Madoff. I do, however, believe that there should be
legal consequences for money managers who make those types of investments
without proper due diligence.

~~~
gchpaco
How can you claim to have done due diligence investing in a company that is
notoriously reticent about any and all financial details?

~~~
Travis
You try to acquire the relevant information and data. You ask your broker (GS,
here), what the information is that they have, rather than just accepting
their "Good Value" label. If that information doesn't meet your requirements
for "due diligence", then you don't invest in that company.

Also, it's not particularly important to be able to _claim_ due diligence.

------
ankimal
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)

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myth_drannon
Interesting take from ZeroHedge : [http://www.zerohedge.com/article/goldman-
creates-facebook-he...](http://www.zerohedge.com/article/goldman-creates-
facebook-hedge-fund-hnw-clients-historically-ripped-such-vehicles-spits-face)

~~~
trotsky
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.

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d2viant
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
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.

------
ramanujan
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
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.

~~~
ramanujan
> 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.

------
rmrm
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.

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Nate75Sanders
"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
But there's always one nagging problem which it doesn't. In CS it is
performance. In finance, maybe solvency?

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

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

~~~
jrockway
Indeed. Investment banks do not make money with some magic computer program
that buys low and sells high eight billion times per second. They make money
by buying something, "adding value", calling up clients and asking them to buy
it, and then taking a cut when they do. In some cases, this has changed the
way the world works; consider options.

(In general, it's really not as evil as it sounds. I write software to help
price interest rate swaps, and those don't really ring any ethical alarm
bells: <http://en.wikipedia.org/wiki/Interest_rate_swap>

I don't think the Goldman/Facebook thing is particularly evil, either. The
government says that normal people can't buy Facebook shares, but normal
people want to. Goldman invented a solution to the problem, and will profit
from doing so. "Adding value" like this is great when it's a way to sell ads
to web 2.0 users, but not when it's a bank? Why?)

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javanix
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.

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

~~~
javanix
From [http://dealbook.nytimes.com/2011/01/03/facebook-and-
the-500-...](http://dealbook.nytimes.com/2011/01/03/facebook-and-
the-500-person-threshold/):

 _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.

~~~
Symmetry
That law has but Sarbanes-Oxely, which has caused Facebook to avoid an IPO and
Google not to, was much more recent.

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boredguy8
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
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
But they also did that with MySpace and look how that is turning out.

~~~
meric
Second Life too.

------
known
Govt fears big companies.

