
Instagram Testimony Doesn't Add Up - nikunjk
http://bits.blogs.nytimes.com/2012/12/16/disruptions-instagram-testimony-doesnt-add-up-2/
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crazygringo
_"...before testifying at a hearing of the California Corporations Department,
which sought to determine if Facebook’s acquisition of the photo sharing
service was in the best interest of Instagram investors."_

Can someone explain why this department is doing that? It wasn't a publicly
traded company or anything. I'm assuming that Instagram had a board which
included seats to represent the VC's, which would have been involved in the
various deals.

Are the VC's behind this, alleging that Kevin Systrom kept board members in
the dark about a possible Twitter acquisition? Or are people who invest _in_
the VC's behind this, alleging that the VC's betrayed a kind of fiduciary
obligation or something? Is the state of CA an investor in the VC's?

The article seems so short on details.

~~~
jspthrowaway2
If Systrom had an offer from Twitter on the table for an amount close to
Facebook's offer, the state might view it as opportune to make Twitter and
Facebook compete for the company, increasing the return for the investors
(whose interest they are representing). If he ignored the Twitter offer but
took the Facebook offer due to some personal gain, the state will have a
problem with that if it wasn't disclosed to investors. The article discusses
that near the end. The entire purchase was shaky -- remember the bit about
Zuckerberg not talking to his board? -- so I suspect this isn't the last we'll
hear of regulators poking around.

This regulation, which applies to all corporations everywhere, is there to
protect investors from being swindled by executives. Without it, we'd have a
very different corporate landscape. I don't know if it'd be better or worse,
but it'd be very different.

~~~
aneth4
Exactly. If there is evidence that Systrom did not act in the best interest of
shareholders for personal gain, that would be a severe violation of is
fiduciary responsibilities, and that would be the under the jurisdiction of
the State of California. That is probably the only reason the state would or
should be involved.

~~~
kelnos
If Systrom (and his cofounder) had a controlling interest in Instagram, are
they even required to act in the best interests of the other shareholders?
That's kind of the point of a controlling interest, no? To break ties when
shareholders can't decide what's in the overall best interest of the
company/shareholders?

~~~
fleitz
The CEO may not have a fiduciary duty towards minority shareholders, but the
controlling shareholders do, in this case it sounds like they are one and the
same.

If you have to break a tie, then you aren't a controlling shareholder. The
idea behind controlling shareholding is that as long as you follow your duties
to the minority you can install whoever you want (perhaps yourself) on the
board, the board can then install whoever they want as CEO (perhaps yourself)

These things get really murky in private companies where the board,
controlling interest, and CEO are shared by one individual.

~~~
kelnos
"Breaking ties" was a poor choice of words.

It appears that Systrom and Mike Krieger (the other cofounder) together held a
majority stake. Assuming the two of them decided to accept the Facebook deal,
then they are indeed acting in the best interests of the majority of
shareholders, no?

Why do things get murky when the CEO/board/controlling interest is the same?
They started and built the company, and structured their funding deals such
that they were able to keep majority control wrt voting rights. If they want
to screw over the minority shareholders, I think that's pretty lame, but that
should be their prerogative.

~~~
_delirium
> If they want to screw over the minority shareholders, I think that's pretty
> lame, but that should be their prerogative.

The law doesn't really give you blanket approval to do that, though. There are
a lot of legal ways to screw over minority shareholders, but lots that aren't.
When you sell part of your company, you agree to be bound by certain
responsibilities to those minority owners. If you don't like those aspects of
contract law, and want to do _whatever_ you want without obligations to other
co-owners, you need to keep 100% ownership.

------
SoftwareMaven
The interesting thing to me is all the comments saying "the state shouldn't be
involved". Maybe that's true (I don't have an opinion because I haven't
researched it at all), but it doesn't matter.

If you are running a company, these are the kinds of things you need to care
about. One's personal sensibilities don't matter a lick when the regulators
come knocking.

Instead, I would look at this (and whatever fallout occurs) as a warning of
the kinds of things you have to think about and use it to sharpen skills so as
to not be on the receiving end.

And, once again, if you don't skirt gray areas of ethics, you are less likely
to face problems. Did Twitter give an offer? "Well, that's open to
'interpretation', and I'm going to interpret it as 'no'."

~~~
joonix
Any time you are selling or dealing with securities you need to be working
closely with your lawyers.

From what I understand, Zuckerberg showed disregard to FB's board when going
through this process, and it looks like Instagram's founders acted in the same
manner. Sounds like they just sat around and hammered out a deal on a personal
level.

That can't be the case. You have to have your board as well as lawyers
involved because you could be breaking securities laws as well as breaching
your fiduciary duty as a corporate director.

~~~
001sky
_Zuckerberg showed disregard to FB's board..._

Generally speaking, 5% of the company's (and below) is not considered
'material' in common usage. But, self-dealing issue is another matter. Nearly
any amount of compensation is likely to be material relative to the salary of
the Instagram CEO (for example), and in any event self-dealing is a more of a
bright-line test (unjust enrichement).

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leoh
This is a slight side issue, but this section really struck me as interesting:

"Facebook has tangled with regulators before. What it does with its customers’
data attracted the attention of the F.T.C., which accused it last year of
'unfair and deceptive' practices. The agency’s settlement with the company
required Facebook to submit to privacy audits for 20 years."

It reminded me a lot if that scene in Ghostbusters where the regulators showed
up to inspect the facility and clearly had no idea what was going on, even
though they had suspicions of something nefarious. With such a complex,
proprietary system like Facebook I just can't see the efficacy of external
security audits. Kind of scary territory.

~~~
nwh
An auditor is faced with a massive system of data collection that no one
person in the world could possibly understand without having written it
themselves. They can only go by the information the company gives them, which
is obviously not trustworthy. I'm not saying that Facebook has done anything
wrong, but if they had, an external audit wouldn't have a hope of finding it.

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jamiequint
It's absurd that the State of California has any say in this private matter in
the first place. This inquiry was not even based on an antitrust issue (which
California has no right to contest anyways on a state level). This is simply
the state government sticking its nose where it doesn't belong.

~~~
ChuckMcM
The state fairness hearings are there to represent the interests of the
investors in a privately funded company.

Lets create a hypothetical example, you are an 'angel' investor and you invest
in a company "WunderKund Inc". In exchange for your investment you get 10 or
15% of the company interest, now lets say WunderKund grows rapidly, they
really hit a niche, maybe they have a series A, and people start to express an
interest in acquisition. The angel investor is perhaps diluted down to 1 - 2%
of the preferred stock, and maybe its one of those deals where the founders
still have control of the preferred. Now along comes a buddy of one of the
founders and says "Hey, awesome how about we make you rich, and you can come
to work with me!?" and its awesome and all but there is this other less
awesome company saying "Hey we really want to acquire you we'll pay what ever
it takes..."

Now as the Angel Investor your interest is getting as good a return as
possible on your investment because you know that only 1 out of 100 of your
investments will pay off. How do you prevent the founders from making a sweet
heart deal ("under market") with their buddy that makes them rich enough, and
leaves a bunch of money from the other guys on the table that would have added
to your return? If you are making less than full value that is one thing, but
what if you're getting completely frozen out because the "sweet heart" company
is offering very little cash or stock but big earn out bonuses for the
founders if they stay on at BigCorp?

There are lots of ways that you can structure a deal that benefits one party
more than the others and this commission was created to mitigate the damage
done by unscrupulous business people.

(Found the link: <http://www.corp.ca.gov/ENF/FairnessHearings/Default.asp>)

Its the California Department of Corporations

This is the result of the Instagram / Facebook hearing :
<http://www.corp.ca.gov/Press/news/2012/Facebook_08-29-12.pdf>

~~~
tedunangst
I would think investors at this level would be capable of retaining their own
lawyers and filing lawsuits if they felt cheated.

~~~
codewright
>I would think investors at this level would be capable of retaining their own
lawyers and filing lawsuits if they felt cheated.

That'd be a faux pas in this context.

Between two corporations, fine, but to bring in lawyers against
Facebook/Instagram in this context would bring a lot of stigma.

Better to let the gov't be your barking dog.

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jonathanmarcus
If Twitter was prepared to make a higher offer, why didn't they? There was
nothing stopping them from making a pre-emptive offer. It's not Instagram's
responsibility to beg for a higher offer from Twitter, especially with a
higher, time-sensitive offer on the table from Facebook.

Nick Bilton is among the most respected journalists, but he's written some
really questionable articles lately.

~~~
gwern
> If Twitter was prepared to make a higher offer, why didn't they?

Why should they? They have a fiduciary duty to get Instagram for as low a
price as possible; nothing about 'begging', they weren't even told about the
higher time-sensitive offer (which are just two parts of the price to be
negotiated...). They were told Instagram didn't want to sell at all, which is
more than a little bit different from 'we think FB will pay more, do you
disagree?'.

> The people familiar with the negotiations said Twitter executives were
> shocked that they had not been given an opportunity to present a
> counteroffer. They said Twitter was prepared to make higher offers.

~~~
jonathanmarcus
Twitter had their chance. They offered roughly 50% less than Facebook, and
without a liquid currency to boot. Apparently, they weren't even in the
ballpark. It wasn't Instagram's responsibility to negotiate with Twitter given
the relative disparity between the offers. If they chose not to take
Facebook's offer, and hold out for Twitter to increase their offer by 100%,
again, without it even being a liquid offer, they would have run the risk of
Facebook walking away and being completely at the mercy of Twitter.

~~~
gwern
As you pointed out, time is part of a deal - and so Instagram could easily
have said 'we close in a week with FB, offer more than their billion and
liquidity in that time with a high penalty fee or forever hold your peace'.
They didn't.

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fidanov
Not a fan of Instagram, and I think FB purchase was stupid, but still, it is a
private dealing between two companies. Even if there were thousands other
offers, they can choose the one that they prefer. Moreover, it's not only
money, when choosing such an offer.

~~~
aneth4
The board and executives work for the shareholders. They are required to
maximize shareholder value, and taking a lower offer for personal gain is
illegal. That is the concern here.

That said, it's hard to have sympathy for investors in a company that flipped
for $750M in under two years.

~~~
joering2
I have a problem with your second statement. Why is it hard for you?? Why does
the timing have anything to do? If anything, apploud to Mr. Systrom for
building a service that attracted millions in such a short period of time.
Every one of us trying to build a startup would love to have the same exit.

~~~
aneth4
I'm not sure you read me right.

I think the investors would have a lot of difficulty establishing that they
got a raw deal here given the incredible rate of return.

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zaidf
_"When he was handed the term sheet by a Twitter employee, a nonbinding
document outlining the terms of a proposed acquisition, he read it and then
handed it back, asking Twitter executives to hold on to it over the weekend as
he weighed the details, those people said."_

Anyone with legal insight comment on the idea behind these two
maneuvers(meeting at restaurants and handing back termsheet)? If it has legal
basis, why would twitter accept such terms?

~~~
kunaalarya
They typically meet at restaurants (or a lot of times, hotel rooms) to discuss
deals/potential deals, as being in the HQ can scare employees (who may not be
comfortable with selling). It's much easier to get recognized in the HQ of a
tech company, than a restaurant. And meeting in a HQ and going behind closed
doors can make it seemed like somethings going on, where if they were caught
in a restaurant, it could just be the typical M&A relationship building.

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graue
So what happens if it's determined that Mr. Systrom did lie under oath? Does
he face criminal charges, is Facebook fined, or what? I assume it's too late
to split up the companies again.

~~~
georgemcbay
I don't know what implications it has for Facebook but lying under oath is
perjury, which is a felony in California. Convicting someone of perjury is
notoriously difficult though.

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robot
"It is possible investors would have been better off selling in an open
auction, to Twitter or even to Google or Microsoft."

Really? This is not the sale of a Picasso painting. I believe there is always
risk of putting off potential buyers, and you might not get the highest bid by
optimizing the process down to the last detail. You might as well close it
while you can. I believe the founders did the right thing.

~~~
pmarca
Not specifically re Instagram but in general -- yep -- I have seen certain
buyers walk from acquisition discussions when a process opened up. It's a
tricky process, and the devil's in the details.

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joering2
Good findings; can't wait to see how this all ends.

As I pointed before to this article [1], Andreessen and Sequioia Capital
have/had closer relationship with Facebook than they do with Twitter. Won't be
surpised if some "sentiment" in regards to who represents who, interfiered
with the purchase.

And CCD has very good business sniffing into this kind of stuff. After all,
lower price = lower taxes. Lower taxes = less for CCD and other Gov entities.

[1] <http://donnaklinenow.com/investigation/instagram-scam>

~~~
pmarca
Please don't toss around casual aspersions like that. First, any behavior like
that would be contrary to our obligations to our investors. Second, we were
properly excluded from knowledge of the transaction due to conflict of
interest.

