No Accountability: Goldman Sachs Wants You To Invest In FacebookRead the article here
by Francine McKenna - Forbes
Facebook wants the public’s money – and their trust – with none of the disclosure and none of the regulatory scrutiny of a public company. Goldman Sachs strategy to raise $1.5 billion for Facebook from “sophisticated investors” and invest another $450 million of their own money is an example of wanton disregard for accountability to the securities markets. But it’s more a function of Facebook’s “have your cake and eat it too” attitude towards the markets than any subterfuge on Goldman’s part. The investment bank and Facebook’s lawyers get paid to make their client happy.
I’m not surprised that the SEC, so far, hasn’t put the breaks on this money train. Regulators and legislators are often accused of looking the other way when companies excite the stock market or play the jobs card.
Just look at the overwhelming support for an exemption from Sarbanes-Oxley internal controls certifications that was granted to smaller public companies under the Dodd-Frank Act. Sarbanes-Oxley made law what is best practice for all companies soliciting public share ownership or issuing public debt. Small business has effectively used the rhetoric of entrepreneurship and aphorisms such as “small business is the key to the economic recovery” to imply that regulations, accountability, transparency and the attendant cost for willing companies taking public investors’ money is somehow un-American.
Facebook has already received “Exemptive Relief from Registration under Section 12(g) of the Securities Exchange Act of 1934” from the SEC in October of 2008. (Yes, that was right after the failures of the banks.) The exemption was granted because the shares they issued were intended to be limited to, “restricted stock units (“RSUs”) that the Company has granted and proposes to grant to employees, directors and certain consultants of the Company under its 2005 Stock Plan (the “Plan”).” The exemption is valid unless there is a “Change in Control” as defined by Facebook’s plan.
Objections have been raised regarding the Special Purpose Vehicle (SPV) Goldman Sachs is proposing as the structure for the investments. The SPV has been organized so, even though Goldman Sachs is soliciting new investors, it does not cross the 499 investor threshold. Going over that number would trigger public financial disclosures by Facebook. Recall, SPVs and SIVs are legal entities used to put investments into limbo, neither on the managing entities’ books nor subject to audit scrutiny on their own. These off-balance sheet structures were the vehicles of choice for Enron, for moving subprime assets off the books at Citigroup and other banks, and for hiding bad assets for Lehman.
I’m not saying that Facebook shares are bad assets. But there’s really no way for anyone other than insiders to know for sure. If Goldman is considered the sole investor in form then why not in substance, too? That would mean their investment in Facebook should go on the Goldman Sachs balance sheet. And what’s to prevent the SPV with the Facebook shares from being used as collateral for debt, just like the commercial paper issued out of SPVs by the banks? If Goldman is legally – to skirt the reporting rules - the sole investor in Facebook under this structure, what do you as an investor really own when you put your $2 million or more into it?
Facebook is dismissing a near-term IPO using the argument that a high growth technology company can’t afford the cost or interference of messy regulation and compliance. Why doesn’t Facebook CEO Mark Zuckerberg want to be CEO of a public company – once considered the ultimate reward for a successful startup?
The Wall Street Journal’s Dealbook on January 3, 2010: (Note the quote from a partner in Mark Andreessen’s VC firm, an investor. Andreessen is on the Facebook board.)
Facebook hopes for an even bigger advantage from the deal, the ability to delay an initial public offering. That would allow it to remain free of government regulation and from the volatility of Wall Street. It would also allow Mark Zuckerberg, the company’s chief executive, to retain near absolute control over the company he co-founded in a Harvard dorm room in 2004…. Those alternatives have become more attractive for companies, in part because of the increased regulations imposed on public companies but also because of the rise in short-term trading, which leaves some executives feeling they have lost control of their companies.
Ben Horowitz, a partner with Andreessen Horowitz, a venture capital firm, said the cost of being a public company had risen to about $5 million a year, from about $1 million a year. Mr. Horowitz, an early employee of Netscape, said that such costs would have eaten into the meager profits of the pioneering Internet company when it went public in 1995. Additionally, accounting and legal requirements have become distractions for many start-ups, said Mr. Horowitz, whose firm is an investor in Facebook.
Those distractions are bothersome for strong-willed entrepreneurs like Mr. Zuckerberg.
So let’s summarize Facebook’s strategy of being a private public company from the perspective of the investor:
- Facebook limits access to their financial information.
- Goldman will manage the SPV used to market “shares” of Facebook to outside investors. Goldman has access to Facebook’s books but your access is through Goldman.
- Facebook likes to say they have $2 billion in revenues but who is testing the quality and veracity of those revenues? Advertising revenue is one thing – although notoriously easily manipulated from an accounting perspective as we saw in the Time-Warner case. But “transaction revenue” from equally opaque companies such as Zynga is like cotton candy – potentially all fluff.
- Facebook’s CEO wants absolute control of the company so he can “realize his vision.”
- Facebook thinks regulatory control over the securities markets, accounting requirements that protect investors, and legal compliance with these laws and regulations is a “distraction.”
- Facebook’s CFO is not an accountant, not a CPA and has no public accounting experience. What’s wrong with that? It may be barely tolerable when a company is in startup mode, but this is a big global company that has to be run, run well, and run according to GAAP.
- Facebook has no requirement to have independent directors on its board who protect the interests and rights of this growing class of outside investors. Oh, wait… Goldman Sachs can look out for them.
- Facebook has no requirement to be audited as long as it’s a private public company. It’s notoriously difficult for outsiders to find out who their service providers are – the audit firm or consultant that’s currently reviewing financial and IT controls over the production of financial reporting for investors. Given the amount of outside investment, I’m sure one of the largest global audit firms is advising them. But their reports, and any concerns they may have about controls or corporate governance, are not public nor do they go to the SEC. Facebook is not subject to Sarbanes-Oxley including whistleblower and CEO/CFO certification requirements. Given estimates of Facebook’s “valuation” and expected market capitalization post-IPO, isn’t it a good idea to make sure they’re ready for prime-time?
The television show Saturday Night Live has a running parody of Wikileaks’ Julian Assange. One segment has the Assange character commenting on the recent announcement of Facebook CEO Mark Zuckerberg as Time Magazine’s person of the year:
“I give you private information on corporations for free and I’m a villain. Mark Zuckerberg gives your private information to corporations for money and he’s ‘Man of the Year.’”
If only the joke wasn’t on the investor.
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Wednesday, January 5, 2011
Francine McKenna has written an excellent description of the Goldman Sachs/Facebook relationship regarding accountability.