What started as an exciting announcement for Goldman Sachs – that it would lead a major investment round in fast-growing social network Facebook with its renewed focus on banking is quickly turning into a public relations nightmare for the firm. While the story has quickly become a black mark for Goldman, there are more serious implications for the American markets and economy that deserve a closer examination than they’ve seen so far, obscured by all the drama of the deal itself.
To recap, in an odd twist early in the announcement of the Goldman’s Facebook investment, it appeared the two companies were going to great lengths to try and avoid an Initial Public Offering (IPO) for the still private Facebook. They were aggregating all the investments from Goldman clients into a single large Special Purpose Vehicle (SPV), initially supposed by many to be an attempt to circumvent SEC regulations requiring private companies with 500+ shareholders to start reporting financials, nearly like a public company.
It wasn’t the case. That would have been obviously illegal, a fact that Goldman quickly pointed out publicly by declaring they would reach the investor limit regardless and start reporting financials possibly even before the deadline. But reporters were quick to jump on the story because Facebook’s founder and CEO Mark Zuckerberg had declared on numerous occasions in the past few years that he wasn’t interested in an IPO for the company. So, it was easy (and lazy) for reporters to jump to the spurious conclusion about the IPO. But it is possible they actually weren’t far off.
In addition to the SPV mishap, the most recent turn of events that added fuel to fire was the revelation, once Goldman started notifying investors precisely how they could get in on the Facebook stock sale, that the stock sale is not open to U.S. investors.
Citing “regulatory concerns,” the firm made a surprise – at least a surprise to those who assumed Facebook would want more U.S. investors – announcement at the last minute that only non-U.S. investors would be allowed to participate. Normally such private deals are open to the select set of U.S. investors classified as accredited, those with $1M+ in liquid assets or working on behalf of an institutional investor. But this time around, Facebook wants no U.S. investors at all, not even the big boys.
The firms quickly cleared up the mix-up on the initial suppositions about the SPV. Regardless, the very public embarrassment went hand in hand with an almost immediate SEC investigation into Goldman’s intentions. Now, U.S. investors find themselves frozen out of the deal entirely.
Now, I have no more insight behind the closed doors of those client meetings than any journalist reporting on the matter. But I’ve seen the inner workings of multi-billion-dollar multinational companies enough in my time to make a very educated guess as to what is going on. Facebook is IPO shy, for sure. They don’t want to have to certify earnings – their accounting systems are probably still being reprogrammed day to day just to keep up with the rapidly growing revenues, and getting them SOX-compliant would absolutely slow down innovation. The millions in additional cost is little concern with their purported 30%+ margins (according to the Goldman prospectus on the investment), but the complexity of compliance grows with the size of the business and could certainly be a motivating factor.
On the flip side, with its already tarnished public image, the last thing Goldman Sachs needs is more bad publicity. Unfortunately for the firm, their perspective – that the world is flat, you can raise that kind of money basically anywhere, and you should work to reduce costs and headaches for your clients even if it means not offering products on your own home turf – runs counter to the popular culture and political sentiment that our banks should be supporting American business and markets.
Goldman only tries to give Facebook what they want. And, it appears from the actions that Goldman is taking, that Facebook’s wish is to not deal with U.S. regulators any more than they absolutely have to. Given the extreme regulatory scrutiny they’ve brought on themselves in the subprime scandal, it’s no surprise that taking a few steps in that direction have brought the SEC into the middle of the deal.
The reality that Goldman works for its clients, and not for the U.S. government regulators, is not about to change. This is a time where Goldman might be better served restoring its former intense media silence, and staying out of the spotlight altogether. Trying to restore its image publicly can only lead to more public scrutiny.
However, the outcome of that scrutiny is bone chilling for U.S. investors.
First, you have a startup reluctant to raise money from the public because of the extreme burdens they’ll have to assume to do so. That leaves the deal in the hands of the existing established wealth of the country, and out of the reach of pretty much any individual investor, thanks to regulations supposedly made to protect those very investors.
Then, with the rules restricting such private deals to accredited investors, you have a set of regulations that once again prevent the overwhelming majority of individual investors – certainly everyone who has not already made their independent fortune – from even being allowed to participate in the deal. Once again, only established money has access to what many might dub the best deals. All to safeguard those same investors.
But now, under the guise of protecting U.S. investors, the SEC has ended up pushing the entire deal offshore and taking most U.S. investors out of the deal. Now, that announcement has little effect on institutions – they all have the means to invest via non-U.S. vehicles, subsidiaries, JVs, etc. And individual investors with significant wealth can certainly do the same with very little effort. But the effect is to set the bar even higher, pushing the remaining few American individual investors out of the deal loop.
Not only have regulators hurt American investors directly by pushing these deals further into backrooms and now further outside of our borders. Even worse, the effect is to take the deal away from the prying eyes of the SEC, reducing transparency for all investors. The goal of the regulatory scheme should be to keep markets fair to all investors and ensure maximum transparency. Restricting deals to fewer and fewer investors does nothing to advance fairness or transparency.
But also, regulators have a burden to keep markets competitive as well. Excess process and complexity is not only reducing the interest of companies in public financing; it’s now crossing over into actively driving business away from this country.
You could keep thousands of people from electrocuting themselves by banning electricity to only certified electricians, but certainly no regulatory agency would agree to that. Even if they did, the people wouldn’t accept it. Yet with financial markets, we not only accept it – in many cases, we are clamoring for more.
Regulation, however, is a case where “more is less.” Less opportunity for investors. Less interest from companies. Less wealth built here in America.
Goldman Sachs exists to make money for its clients. To them, sovereign borders are nothing more than annoying obstacles to navigate around in search of good places to do business. For Goldman, and any other multi-national investment bank, patriotism only runs as deep as banking secrecy laws and corporate tax rates. It may not be fun to hear, but it’s not about to change.
Regulators must drop this whole attitude that doing business in America is a requirement and a privilege before they start forcing billions of dollars more to seek friendlier shores. As is, bureaucrats are giving a big middle finger to both businesses that want access to our capital markets and to the individual investors it is their mandate to serve.
As for Facebook… who can blame them for wanting to avoid going public and skip on all the hassles and costs of complying with GAAP accounting practices that do their business structure no justice, reporting requirements that take an entire department to keep up with, Sarbanes-Oxley certifications, and more?
With the ability to raise billions privately and set the terms of their engagement with investors when they do, it is likely the most practical route for management and best deal for existing investors. They might not just be better off staying private; they might be even better served following Goldman’s lead and heading offshore entirely.
