Facebook, Goldman Sachs & How Money Seeks Regulatory Free Zones

from the this-is-not-efficient dept

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 It also built up an entire industry around SOX compliance, that almost guarantees the law can never be repealed.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.

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

SEC Concerned About High Frequency Trading

from the so-what-do-you-do-about-it? dept

Back in December, we had an interesting discussion on high frequency trading and whether or not it was just (as its supporters' claim) "adding liquidity to the market to make it more efficient or whether it was a dangerous arbitrage bubble based on questionable practices that put the whole system at risk (or, of course, somewhere in between). The general consensus appeared to be that high frequency trading was pretty bad -- and even if you believed that it had some useful applications, the fact that it has come to so dominate the market was not a good thing. The key point was that it wasn't generating money by doing anything useful, but just from moving money around faster than someone else. Overall, there was definitely a concern about the practice.

It appears the SEC shares your concern, and has voted to do something about it. The real question, though, is what are they going to do -- and will it help or will it actually make things worse? It looks like the suggested changes just involve trying to make the brokerages more liable for actions done by unregulated clients using the brokerage's access to exchanges. The idea is that the brokerages would then force partners to crack down on really risky behavior. While I understand the logic, it worries me. It seems like the opposite of safe harbor type laws on the internet, and would, in fact, make "service providers" more liable for actions of third parties. That always seems like the wrong approach. It's outsourcing policing and risk management and hoping that by adding liability the service provider will do a good job of it. But what if the service provider can't do that well? And what if the third party screws up anyway? Does it make sense to put blame on someone who is effectively a middleman?

Filed Under: bubbles, efficiency, high frequency trading, liquidity
Companies: sec

Gannett And AP Tell SEC They Won't Sign Up For Restricted Reporting

from the pushback dept

Well, we've already joked about how the Associated Press seems to have a bit of a double standard in complaining about the Southeastern Conference's (SEC) restrictions on journalistic activity during SEC sporting events, but it's nice to see the Associated Press and the Gannett chain of newspapers both take a stand and tell the SEC that it simply won't sign the agreement. It's not entirely clear what happens next. The SEC is likely to change the policies and try to come to some sort of compromise, but I'd love to see news organizations get a backbone and tell such sports leagues that there's no compromise and no deal to be had. They're reporters and they'll report as they see fit.

Filed Under: journalism, restrictions, southeastern conference
Companies: associated press, gannett, sec

A Love Of Competition, Not Protectionism

from the culturally-difficult dept

There's an interesting dichotomy that goes on in captialist societies. We all know that markets grow and innovation occurs through competition and the ongoing process of companies trying to out-innovate each other -- but each individual organization is always looking to monopolize its own world. In fact, that is what innovation is all about. You innovate to get a monopoly on whatever that innovation is, for as long as you have it. The problem, however, is that too many have build up the belief that these monopolies should be lasting, or even permanent. That's not true. For the health of society and the company, they absolutely should be fleeting monopolies. That's the only way to make sure a company changes with the times and is flexible enough to handle market changes. But that quixotic and dangerous pursuit of permanent monopolies leads to dangerous situations -- often using or demanding protectionist policies from gov't regulators.

Eliot Spitzer (yes, that Eliot Spitzer) makes some interesting points in a column where he attacks both the SEC and GM for focusing on protectionism rather than competition. When it comes to GM, the argument is easy to understand. GM has done much to try to resist novel and useful innovations in the interest of protecting its own business. As for the SEC, that's a bit more of a stretch -- and obviously stems from Spitzer's own efforts back when he was NY's Attorney General and attempted to take on Wall St. while the SEC resisted any such investigations and lawsuits. Thus, to him, he represented "competition" and the SEC tried to block out such competition (which brings up some weird questions concerning whether or not it's good to have competition within the regulatory structure).

But the key point Spitzer makes is that we need to build a "culture of competition" into American organizations, rather than protectionism. That sounds good, but I'm having trouble seeing how you could actually make that work directly. There are some things you can do on the margins -- and, in fact, research has shown that making noncompete agreements unenforceable actually does increase competition (is it worth pointing out at this time that noncompetes went from unenforceable to enforceable in Detroit in the 80s...?). But, you can only do things like this at the margin. There is no way to flat out change a culture in this manner. Instead, I think you actually need to create incentives for companies to take a longer term view, rather than the short term view we get today. With the quarterly report set up, everyone has a 3-month time horizon on pretty much everything they do (in some cases one year, but never more). If companies actually had incentives to look at the significantly longer term, they would recognize themselves that ongoing competition and innovation are the only way they're going to continue successfully serving a market in the long run. But until someone comes up with a way to create incentives that allow for both transparency and longer term views, then it's likely that companies will focus on beating down competitors rather than winning through innovation.

Filed Under: competition, eliot spitzer, protectionism
Companies: gm, sec

SEC Suspending Trades On Spam Scam Stocks

from the about-time dept

Pump and dump spam scams have been quite successful for scammers, but the SEC is apparently increasingly successful in stopping the practice. It's now suspending trading on certain stocks that appear susceptible to pump and dump scams -- and that's more than cut in half the number of complaints its received in the last few months. What still isn't clear, however, is why it's so difficult to track down those responsible for pump and dump scams. You just need to follow the money and look at who bought the stock right before the scam started and who sold out immediately afterwards and you probably have a pretty short list of suspects.

Filed Under: pump and dump, scams, spam
Companies: sec