Goldman Sachs’s plan to offer clients up to $1.5 billion (R9.9bn) in Facebook equity might invite US regulators to take a closer look at whether the owner of the most popular social-networking site was circumventing disclosure rules, securities lawyers said yesterday.
The US Securities and Exchange Commission (SEC), whose rules require any company with more than 499 investors to disclose financial information, is already scrutinising the market for trading shares of closely held companies including Facebook, according to a person familiar with the inquiry, who declined to be identified because the matter is not yet public.
Goldman Sachs invested $450 million in Facebook and is planning to create a special purpose vehicle for its clients to make additional investments worth as much as $1.5bn, according to two people familiar with the matter, who spoke on condition of anonymity because the deal is private.
Some private companies avoid crossing the disclosure threshold when investors’ funds are channelled through a single entity, such as a private equity firm or hedge fund.
“The real question is, what are the details of this special purpose vehicle?” said James Angel, a professor at Georgetown University’s business school. If the investment was designed to circumvent the rule, “the SEC should be looking very closely at it”.
The investment and the plans for the special purpose vehicle were previously reported by the New York Times.
Further public confirmation of the SEC’s interest in such investment funds came on Monday when SecondMarket, which matches buyers and sellers of shares in private companies such as Facebook and Twitter, received a request for information from the agency.
“We have now received a voluntary request for information from the SEC regarding ‘pre-initial public offering (IPO) pooled investment funds’,” Mark Murphy, a spokesman for the broker-dealer, said. “We are fully co-operating.”
The law of the 500-owner limit was created to make sure that those who invest in larger companies are provided with sufficient information about the firm. The rule applies to companies with more than $10m in assets. The Goldman Sachs investment values Facebook at about $50bn.
Facebook told the SEC in 2005 that it had fewer than 500 shareholders and asked for an exemption from making public disclosures about the restricted stock units it was giving employees. The SEC granted the exemption.
While the law counts so-called owners of record towards the 500-shareholder threshold, people who invest in a private firm through a fund – the so-called beneficial holders – are not included in the tally.
“The company only has to count record holders; that’s sort of neutral terminology,” said David Martin, a former director of the SEC’s division of corporation finance, who is co-head of the securities practice at Covington & Burling.
A private company could officially be well under the limit while exceeding it in practice by being “owned by thousands of people”, he said.
Investment funds generally are treated as single owners of record. Still, the SEC’s rules state that if a vehicle is set up “primarily to circumvent” securities law, the beneficial holders will be counted as individual owners of record.
If the Goldman Sachs vehicle is established only to invest in Facebook, the SEC might interpret it as a deliberate attempt to dodge its rules, said John Mahon, a former lawyer in the SEC’s corporation finance division who is now a partner at Sutherland, Asbill and Brennan.
“There’s that potential risk that the SEC, in essence, could basically look through that vehicle” and count the investors individually, Mahon said.
The danger for Facebook is if it improperly manages the investor interest, it could accidentally cross the 500-shareholder threshold, going public without an IPO, Angel said.
A spokesman for Facebook declined to comment. Goldman Sachs did not immediately answer a request for comment.
As part of the agreement, Goldman Sachs can sell up to $75m of its stake to Russia’s Digital Sky Technologies, which it partly owns. Digital Sky Technologies also added $50m to an earlier stake in Facebook.
“The whole venture capital industry is based upon funds investing in private companies,” said Paul Roth, a partner at Schulte, Roth and Zabel, who leads the hedge funds subcommittee at the American Bar Association’s Committee on Federal Regulation of Securities. “They tend to count as a single investor.” – Bloomberg