Facebook, Goldman Sachs & How Money Seeks Regulatory Free Zones

from the this-is-not-efficient dept

Thu, Jan 6th 2011 10:00pm — Mike Masnick

After the dot com bubble burst, quickly followed by major accounting scandals such as Enron, Congress, in the way that it normally does, overreacted with a kneejerk response. The most obvious part of this was the Sarbanes-Oxley rules, which didn't do much (if anything) to actually prevent future frauds, but did make the cost of being a public company much, much, much higher -- effectively creating a serious tax on startups looking to go public. It also built up an entire industry around SOX compliance, that almost guarantees the law can never be repealed. In response, an already weak IPO market went almost entirely dormant, an even as things picked up with startups, fewer and fewer actually wanted to go public. It was just too costly, and the potential liability for execs was way too high. Google resisted going public for as long as it possibly could, before it finally tripped an old SEC rule, that required companies with more than 500 shareholders and over $10 million in assets to effectively act as a public company -- at which point, it figured it might as well just go public.

That was in 2004. In the six years since then, a number of other companies have worked on a number of loopholes and ways to avoid going public even longer. Witness Goldman Sach's recent deal to invest a ton of its investors' money into Facebook shares -- which normally would have tripped this rule -- except that Goldman is playing a little game, and setting it up so that it pretends there's only one shareholder, keeping Facebook away from the magic 500 number. The SEC is apparently already looking into this.

But even before the Goldman/Facebook deal became public, the SEC had apparently begun probing the rise of these new efforts to let hot startups sell shares on a market, without actually going public. Hot startups including Facebook, Twitter, Zynga and LinkedIn have all been heavily involved in such markets, which basically let employees of those companies get many of the benefits of being a public company, without the massive costs and regulatory oversight.

This is, in many ways, the exact opposite of what was intended with things like SOX -- which was designed to increase oversight. But, instead, it's done the opposite. The end result is that wealthy clients of Goldman Sachs and other Wall Street firms can invest in these companies, but others cannot. Now, some might claim that this is a "good" thing, in that the general public shouldn't be investing in highly risky stocks that could easily collapse. But, it's also creating a tiered system where these companies are able to avoid going public for much longer, but the wealthy and well-connected can get in at about the same point that the public used to be able to get in. And, they are buying. Goldman has already announced that it's already oversubscribed.

While some are cheering on the SEC investigation of these practices, it seems to be missing the real lesson here: which is that money always seeks out the unregulated loopholes, and the more you regulate, the more hurdles you put up to efficient markets, the more money will pour into whatever side pools that are left unregulated. And that's dangerous. The economic collapse of 2008 was a result of this, as tons of money went into unregulated areas of the market and was sliced and diced in increasingly misleading ways. The classic response is to just regulate those areas -- but that ignores the fact that there will always be new loopholes and new unregulated areas that money will rush into. We're seeing it all the time.

What's happening with Goldman, Facebook and those other startups can be traced back to SOX in the first place. If we didn't make it ridiculously burdensom to be public, then firms wouldn't seek out these hidden alternatives. But our government refuses to let the market ever learn lessons. The lessons from the dot com bubble and Enron and such should have been that people learned to be more careful in their investments. But the government rushes in and sets up a pretend safety net -- so we never get to learn.

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Filed Under: ipos, private markets, regulations, sarbanes-oxley
Companies: facebook, goldman sachs, sec

28 Comments

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Aerilus, 6 Jan 2011 @ 10:23pm

the reason for the 2008 crash as well as others is imaginary money. Companies were able to manipulate the system to make it appear that money that was there was not. regulation should be geared toward making sure that every dollar is tied to something letting companies count and use dollars that don't exist is what the companies will always push for its the governments job to push back and make sure that the public isn't getting lied to.
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Anonymous Coward, 6 Jan 2011 @ 10:32pm

Re:
The entire US economy is set up on imaginary money.

Bring back the gold standard, get rid of foolish knee jerk regulations like SOX, and allow the market to be free.
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Anonymous Coward, 6 Jan 2011 @ 11:05pm

Culture Of Scheming
If you Americans want your economy to start performing again, you need to get rid of the culture of scheming in your finance industry. Sure, the schemers are doing very nicely, but that is at the expense of everybody else. In the long term, the culture of scheming will continue to damage your economy, more and more.

As for the pathetic sheeple who just called for the gold standard to be brought back -- you need to learn some history. Those who fail to learn the lessons of history are doomed to repeat it. The gold standard is a most useful concept. Anybody advocating it clearly does not understand the difference between commodities and money. Such a person should not be listened to for either economic or political advice.
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DataShade (profile), 6 Jan 2011 @ 11:39pm

Re: Culture Of Scheming
[Citation needed]

I'm not saying you're wrong, but ... come on. If you're only going to ipse dixit, stay home.
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The eejit (profile), 7 Jan 2011 @ 1:39am

Re: Re: Culture Of Scheming
No, the key problem of the gold standard is that it is at risk of commodity devaluation. Not in actual terms (there's only a finite amount of gold, after all), but in relative terms.

I'm sure an economist can improve on my argument somehow.
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Michael Lockyear, 7 Jan 2011 @ 1:45am

Its an opinion!
Why should the anonymous coward give a citation for his opinion? ... How do you *actually* give a citation for a personal opinion?
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yomismo, 7 Jan 2011 @ 1:57am

What's the answer then?
We have had light touch regulation causing problems, heavy regulation causing problems, so I guess the solution is a sort of enlighten regulation happy medium.
Truth of the matter is that, regardless of regulation they will look for loopholes, agreed that the higher the regulation burden the bigger the incentive to do so, but it is simply naive to think that they will not seek loopholes if regulation was light touch.

And if you think that the solution is no regulation, you have not learnt anything from the last 200+ years of capitalism
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Mike Masnick (profile), 7 Jan 2011 @ 2:18am

Re: What's the answer then?
I think the answer is in much greater transparency. The problems always occur when the actual information is hidden or obfuscated.
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yomismo, 7 Jan 2011 @ 3:11am

Re: Re: What's the answer then?
In an ideal world, yes. Unfortunately, the issue of information asymmetry is not going away any time soon.
I simply cannot see Goldman Sachs and their likes, explaining their loophole finding deals in public.
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Anonymous Coward, 7 Jan 2011 @ 3:39am

Re: Re:
Unfortunately the gold standard is not possible anymore, although imaginary money is base on only faith putting real hard limits on it would just make things worst because no government can abide by those rules, they just can't function that way. What people need is to be aware that current money is base on faith and don't depend on it or the state to come rescue them.
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Anonymous Coward, 7 Jan 2011 @ 3:40am

Re: Re: Re: What's the answer then?
I can't see it either but I can see Wikileaks posting them anyways can't you?
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martyburns (profile), 7 Jan 2011 @ 4:17am

Re: Its an opinion!
Sure, the schemers are doing very nicely, but that is at the expense of everybody else

..not an opinion..in my opinion.
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SUNWARD (profile), 7 Jan 2011 @ 5:38am

more
regulation is there because of abuses. Remove the regulation and you will get more abuse.

It is not going away.

These "secondary" markets will regulated next. And so they should be.
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Anonymous Coward, 7 Jan 2011 @ 5:53am

Actually, this is how ignorant money searches to make a greedy buck, nothing else.

There are no numbers for facebook. The idea of a 50 billion (or $5 for that matter) valuation is based on not much more than the top alexa ranking and some air. Nobody really knows how well Facebook does as a business. Is the 50 billion valuation truly justified?

The whole world got in trouble with fancy dodges around regulations in 2008. We don't need that again. The SEC needs to step in and stop this stupidity, before a whole bunch of people potentially get fleeced.
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Anonymous Coward, 7 Jan 2011 @ 6:19am

Re: Re: What's the answer then?
So you think that investing in what is effectively a blind, uninformed investment based on really nothing is somehow good? What Facebook and Goldman Sachs are doing is creating another perfect storm, where investors are working without information, in the dark, with the least amount of transparency possible.

I don't understand your logic on this one either.
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Anonymous Coward, 7 Jan 2011 @ 6:41am

I just feel burned and have a real bad taste in my mouth after reading this. They better watch their ass. Revenge seems to be very popular these days.
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Marco, 7 Jan 2011 @ 6:44am

While ...
Companies like this playing with non-existent money will be taking to bankrupt those who really produce goods. Sooner or later the basis of the economy is going to fall ... and that is food, houses, cars, fuel, electricity ... all 1st needed good to cover the holes of investing in a bunch of nothing.

Goldman Sachs is a shitty company and should be taken down as well as similar ones for the good of the American people, but Americans are not really smart and let corrupt politicians screw them up.
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ben, 7 Jan 2011 @ 7:25am

Posts like this one
Posts like this one are what keep me coming back to TechDirt. Long live libertarian thought. It rings true. Down with liberals and conservatives alike and their over-regulation of everything.
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vastrightwing, 7 Jan 2011 @ 7:49am

Can you say Ponzi scheme?
Fiat currency is nothing more than a "legal" Ponzi scheme. it will come crashing down like a house cards. The only problem is knowing when. GS has been instrumental in all of our economic disasters. Look as far back as you can, and you'll find GS at or near the center of all of it. Matt Tiabbi has done a great job of documenting many of their exploits. What is GS doing next? Carbon offsets? It's simply amazing.
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Anonymous Coward, 7 Jan 2011 @ 8:10am

Re: What's the answer then?
It's not necessarily no regulation. The problem is that regulation is almost always reactive. Instead of letting the market react regulation comes in and does the equivalent of Godzilla in Tokyo. Afterward the market has to then figure out new ways to do what they were going to do anyway. Heavy regulation doesn't stop the disasters from happening but it does cost a lot of tax money.
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Richard (profile), 7 Jan 2011 @ 8:49am

Re: Re: Re: Culture Of Scheming
The problem with the Gold Standard is that it can't cope with a rapidly expanding economy. The amount of money in the economy has to be roughly matched to the available goods and services. When the economy starts to do well the gold miners can't keep up and you get deflation - which is a disaster.
In fact it would be a really good thing if we could get rid of the use of gold as a store of value altogether. At present a large stock of useful material that could be used in electronics, jewellery etc is locked up in vaults doing nothing.

btw Mike could we lose the advert script that is slowing the browsing of this site to a crawl.
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The Mighty Buzzard (profile), 7 Jan 2011 @ 9:50am

Re: more
Yes, because playing catch up vs bad behavior has worked soooo well every other place it has been tried. Since this is TD, take piracy as an example. How well has regulation done at stopping that?

I have to go with Mike on this one. Transparency from anyone who wants to shuffle around tons of money that isn't theirs.

And if you're all having a WTF moment over saying "full transparency good" here after the arguments I've put forth against it for government... Financial institutions, investment firms, and publicly traded companies don't have any of the legitimate reasons governments have for keeping secrets. Every possible reason I can come up with for secrecy from them, and I've been sitting here trying to devil's advocate myself for half an hour now, is a bad one.
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Anonymous Coward, 7 Jan 2011 @ 10:18am

Re: Re: What's the answer then?
There is already a wealth of information in the ACT and OATS reports. Granted, there are several exemptions from the reporting rules but the exemptions are also captured in some form and need to be justified. Extending trade reporting to private transactions might be considered a slippery slope to a more intrusive government - and would involve regulation which we know from experience here only makes things worse (net neutrality, ACTA, etc).

And I'm generally for more trade reporting because I've seen up close how the trading world works. But even if you had all that information and made it transparent, there is no governing body to review or regulate it. The SEC and FINRA are not those organizations.

Compared to GS, JPMC, CITI, and BofA, the feds aren't the smartest guys in the room (pun intended). But even if they were - and could isolate the algo trading that's systematically altering market conditions - the enormous amounts of information would overwhelm them; they're overworked now as it is. And even if they had the tools and resources to pick out market manipulation, shady deals, and loopholes, they don't have much of an enforcement arm. GS, in particular, seems to get away with trivial fines for what appear to be serious and market manipulating infractions to me.

I agree, though, that SOX is the reason why companies are looking for reasons to stay private. The expense is enormous and it doesn't reduce your overall risk. In fact, it increases it. Why would you want to increase your risk and costs at the same time with a clear negative return?

So you do need to regulate to increase the transparency. But once you do that, you need a regulatory body who can act on that information. Otherwise, you've got a bunch of data that no one will look at.
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Thomas Grebinski (profile), 7 Jan 2011 @ 11:39am

Regulatory escalation by the SEC
Unfortunately, all this may do is cause the addition of new regulatory requirements to follow when starting a company. New regulatory requirements translate into more up front and ongoing legal and administrative costs for the start-up. An investigation by the SEC could lead to the enactment of unrealistic constraints which then discourages innovation by diminishing the current "residual" risk entrepreneurs feel they can take when starting a new enterprise.
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DV Henkel-Wallace (profile), 7 Jan 2011 @ 11:45am

What about carving out an experimental zone?
Before Glass�Steagall was revoked, banking was sliced in two: parts that needed to change slowly, and needed protection (e.g. deposit-taking commercial banking) was highly regulated and the more risk-taking side (investment banking) was less highly regulated.

Instead of trying to regulate or deregulate everything, allow experimentation as long as it is decoupled from systemic risk. Stuff that can cause systemic risk can be left to its own devices.

So in this example, as long as the only people who can invest in Facebook are people who can afford to lose 100% of their investment, what's the harm?
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k, 8 Jan 2011 @ 11:19am

Hang em all
Standard Goldman Sachs Standard....rape, pillage and hid behind those you bought and paid for on capital hill. hang em all!
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Anonymous Coward, 10 Jan 2011 @ 9:21am

Re: Re: Re:
Well, one question is over who defines the total amount of currency?

Do we want to give an important chunk of this power to gold mining companies and those in position to manipulate the value and quantity of gold? Their already existing leverage will be magnified over the entire economy.

But more importantly, if we don't let money float, then we end up with some serious inconsistencies and short-term exploitation. Eventually, no one will want to use $ as the government prints up a huge amount of it.

Derivative issues are just contracts that make promises that on the whole cannot be met, but it's difficult for individuals seeing only a small part of the pie to make that analysis. This is a sort of re-run of what I think was the case when money was largely privatized before the government(s) seized effective control.

The most important form of regulation we can have (if followed) is to increase transparency. It's one reason I like wikileaks and think it is such an important tool to preventing a greater number of abuses by powerful institutions.
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Jose_X, 10 Jan 2011 @ 9:40am

Re: Re: What's the answer then?
When the scale of a problem is very large, I don't think you will see government step back and let things resolve themselves. We already went through the Great Depression.

I don't know the details of the current problems we faced (so can't give a "strong" opinion), but I understand the need to take action sooner rather than later if the problem is deemed to be potentially very destabilizing, just like I can understand putting money into the system to support it while other rules and effects are taking place.

Also, SOX might be too much (again, I don't know), and if that is a problem, ignoring it won't help.
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