Goldman Sachs and Facebook are veritable American icons that bestride their respective industries. Goldman, for instance, has survived its searing caricature as a great, greedy vampire squid; it continues to dominate the financial industry from its world headquarters in lower Manhattan. And Facebook, likewise, has survived a film portrayal of its founder, President and CEO as a ruthless social climber; it now dominates the social media sector of the internet from its Silicon Valley base.
This pair of quintessential American firms joined forces last week, with Goldman selling $1 billion of Facebook shares. Given each firm’s powerful position in the American economy, it would have been reasonable to assume that the stock sale would have focused on American investors. Surprisingly, though, Goldman actually arranged to restrict its sale to buyers who were located outside of the United States.
In other words, Americans were the only investors in the world who were denied the opportunity to purchase Facebook stock! But why would Goldman, with Facebook’s approval, refuse to sell stock to American investors? And why would American regulators sit by and allow these firms to cater exclusively to foreigners?
Oddly enough, Goldman reportedly feared being charged with legal violations by the United States Securities and Exchange Commission (SEC) if it sold Facebook stock to Americans, and thus refused to do so in order to reduce the risk of prosecution. In other words, Goldman believed that the SEC actually preferred that it cater exclusively to foreign investors.
To be specific, Goldman believed that it might have been accused of violating two distinct regulations if it sold Facebook shares to investors in the United States. One involved the rather arbitrary number 500; under SEC regulations, any American company that is owned by 500 or more investors must disclose its financial statements to the general public.
Because Facebook did not wish to make such disclosures until some time next year, Goldman created a single Special Investment Vehicle (SIV) that invested in Facebook; it then sold shares in the SIV to outside investors, thereby avoiding the restriction. Nevertheless, Goldman was concerned that the SEC might not count this SIV as a single investor because it actually represents the ownership interests of many client investors.
The second law involved a prohibition against private companies engaging in “general solicitation and general advertising” activities to attract investors; apparently, such activities are only permissible when conducted by publicly traded firms and not by privately owned firms. Although Goldman assiduously avoided any such formal activities, word of the transaction leaked out and set the public financial press on fire. The news leaks stoked immense public interest and reporting about the sale, and thus Goldman feared that the SEC would treat its private activities as public solicitations.
So Goldman, with Facebook’s approval, decided to eliminate any chance of prosecution involving a breach of one or both of these regulations by simply refusing to sell any stock to American investors. In fact, Americans who responded enthusiastically to a preliminary Goldman sales pitch were later contacted and told “thanks but no thanks; we are no longer willing to sell shares to you!”
Future Transactions and Public Policy
How will Goldman’s and Facebook’s “foreigners only” policy affect future equity sales transactions? One ramification, clearly, is that the continuation of this policy would drive ownership shares of successful American organizations into the hands of foreign investors. Last week’s sale, for instance, involved the placement of $1 billion of stock for a firm (i.e. Facebook) that was valued at $50 billion, thereby banishing 2% of the iconic American firm’s equity from the portfolios of American investors. As a result, 2% of all of Facebook’s future profits, dividends, and gains from increases in market capitalization will be claimed by foreigners.
In addition, this policy might help drive future stock sales transactions into the hands of foreign banking institutions and away from Goldman and other American firms. Facebook’s executive team was reportedly displeased about Goldman’s difficulties in managing this equity sale; in the future, they and other firms might simply opt to hire foreign banks to manage such transactions, particularly those that continue to exclude American investors.
Furthermore, the SEC’s professional judgment may be called into question as well. After all, why bother with a 500 investor threshold for public reporting purposes if this regulation can be easily skirted through the creation of a single SIV that purchases stock on behalf of multiple parties? And why ban American firms from engaging in general solicitation and advertising activities when such information might help address rumors that are circulating in the press about their private placements?
From a public policy perspective, the biggest question of all might involve whether American regulators are appropriately positioned to protect American investors in an increasingly global environment. Ultimately, an entirely new regulatory system might be preferable to one that denies American citizens the right to invest in their own home-grown firms.