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How a Failed Deal Got Goldman Entangled in Sex Trafficking

Monday, 2 Apr 2012 | 5:51 PM ET
Image Source | Getty Images

It’s another day of nightmare headlines for Goldman Sachs.

“Goldman fund to exit company owning sex traffic site,” reads the Reuters headline.

“How Goldman Sachs Invested in Child Sex Trafficking,” Jezebel’s headline proclaims.

At pixel time a search on Google for the phrase “sex traffic” coupled with “Goldman Sachs” produced more than a half a million hits.

The ugly headlines are the result of a column by New York Times’ columnist Nicholas Kristoff who broke the news a private equity fund controlled by Goldman was exiting its 16 percent ownership of Village Voice Media, an alternative media conglomerate that derives a substantial amount of revenue from a subsidiary Kirstoff calls “the biggest forum for sex trafficking of under-age girls in the United States.”

The subsidiary in question is Backpage.com, a classified ads business that looks a lot like Craig's List. When pressure from the public and regulators convinced Craig’s List to ban sex ads from its forums, Backpage scored a windfall. The ads basically migrated over to Backpage. These days, according to an earlier column by Kristof, “Backpage accounts for about 70 percent of prostitution advertising among five Web sites that carry such ads in the United States, earning more than $22 million annually from prostitution ads, according to AIM Group, a media research and consulting company.”

Goldman now pleads innocent on the grounds that when its private equity fund invested in Village Voice Media back in 2000, there was no connection to BackPage.com at all. That came later, thanks to another deal in 2005.

But I’m not sure that really holds water. I grew up in New York City and read the Village Voice every week. That paper has always been full of hooker ads. There’s no way this can come as a surprise to Goldman.

By the time Goldman got involved, the Village Voice already had a long and controversial history regarding its advertisements. In the late 1960s it was targeted by activists for its refusal to run ads for a gay dating service, a position from which it backed away. For most of the rest of its history the paper has run ads for “escort services” and “massage parlours” that are barely disguised fronts for prostitution.

In 1970, the Village Voice was purchased by a company principally owned by City councilman and Vanderbilt heir Carter Burden. Under Burden, the paper temporarily stopped running prostitution ads, according to a person familiar with the matter. Burden merged the Voice with the publisher of New York magazine, run by Clay Felker. Burden and Felker later sold the paper to Rupert Murdoch.

Wall Street & Sex Trafficking
Discussing the recent defense plays involving Goldman Sachs and its former stake in a media company accused of facilitating sex trafficking, with CNBC's John Carney and Jessica Pressler, New York Magazine.

(Full disclosure: My first job reporting on Wall Street was for DealBreaker.com, which was owned by a company then called Dead Horse Media. Carter Burden’s son, also named Carter Burden, was one of our principal investors. A number of my friends have worked for the Village Voice at one time or another. I've written for the New York Post and the Wall Street Journal, which are owned by Murdoch's News Corporation, and the New York Times. I've never placed or answered a classified ad, although I really enjoyed Amy Blair's "This Week in Craiglist" column at Blacktable.com)

When Murdoch wanted to buy a New York radio station in 1985, the FCC forced him to sell off one of his papers (the other was the New York Post). Murdoch sold the paper to Leonard Stern, an heir to a pet food fortune and investor in real estate. (Libertarians take note: this is where you say that even this Wall Street scandal has regulatory roots.) Stern spent several years rolling up other alternative weeklies, including the LA Weekly and the Seattle Weekly.

By 1999, we were reaching the crescendo of the Internet bubble — which was also a media bubble. Stern decided to put the company on the block. It was a hot bid at the time. The auction was won by a group of financiers led by the investment group Weiss, Peck & Greer, which owned a small chain of newspapers and Nashville’s alternative weekly. They reportedly paid $160 million.

From what I can tell, this is where Goldman’s came in — as part of the Weiss, Peck & Greer consortium. Goldman’s original investment was $30 million, according to a person familiar with the deal. That person says the plan was to do a roll-up of various newspapers and alternative weeklies, then exit with an initial public offering. The timeline, according to my source, was three years—tops. It was, that is, a typical LBO to IPO deal of the era.

Like so many similar deals, it didn’t work out as planned. The Internet bubble crashed — and the market for IPOs crashed right along with it. The idea of taking a media company public was almost laughable for much of the period that followed.

In 2005, a cash-strapped Village Voice Media was acquired by New Times Media, a big alternative weekly owner based out of Phoenix. New Times owned Backpage.com, the classified ads company. Goldman wound up having its stake in the Voice converted into a stake in the merged company, which continued to be called Village Voice Media. And that meant Goldman had a stake in the subsidiary, Backpage.com.

Interestingly enough, when the deal was reported in 2005, the managers of Village Voice Media announced their intention to buy out the financial backers — presumably including Goldman Sachs — in five years. Well, we all know what followed: a financial crisis of epic proportions, a slump in ad sales as the economy crashed, and a credit crunch that would have made financing a take-out impossible.

Goldman probably once again found itself blocked from an exit. Believe me, there’s no way that Goldman is happy still owning a stake in this company 12 years after it first bought it.

At least as far back as 2008, Backpage.com was accepting paid ads for its “erotic services” section. These include, of course, prostitution ads. Here’s a 2008 blog post from Backpage bragging that it’s policy of charging for “erotic services” actually reduces “illeagal postings.”

Craigslist will start charging for erotic services soon. Backpage.com has been doing this for years. It is perhaps the best way to reduce the prank postings, illegal postings, and postings by under aged users.

Not many solutions for user content generated sites are perfect when it comes to content quality. Craig will face some of the same challenges we face. While there is fraud with employer postings, it is significantly higher in adult. I outlined a few challenges below.

So Goldman knew or should have known a company in which its private equity fund was invested was deriving revenue from paid ads for “erotic services.” This doesn’t necessarily mean illegal activity, much less trafficking in sex slavery. But it certainly means that Goldman has had years to determine whether it was comfortable with its, ahem, exposure to Backpage.com.

Craig’s List got out of the erotic services businesss altogether in 2010, right about the same time that Goldman relinquished its board seat. This was like hitting the jackpot for Backpage.com, which started being the place to go for "erotic services" banned by Craig.

“The [Goldman PE] Fund relinquished its board seat in January 2010 as a result of being uncomfortable with the direction of the company and an inability to influence its operations. We have been trying to exit this investment for a considerable period and have now entered into an agreement to sell the fund's stake in the company,” Goldman said in a statement.

That’s all very true. Goldman never set out to invest in the leading prostitution ad website. They got there through a failed private equity deal.

In some ways, this is all very unfair to Goldman. I’ve seen sex services ads on many websites, including the New York Times-owned About.com. Goldman just had the misfortune of accidentally owning a stake in the biggest of them.

I have no idea what value the Goldman fund assigned to its Village Voice investment all these years later. It’s very likely that most of it was written off. No doubt they are now asking why they didn’t just divest entirely — at any terms — back when they gave up the board seat.

The answer is probably that the numbers on the spreadsheet told them that the risk was minimal. But spreadsheets can’t tell you the risk of having "Goldman" and "Sex Trafficking" screaming from the headlines.

Follow John on Twitter. (Market and financial news, adventures in New York City, plus whatever is on his mind.) You can email him at john.carney@nbcuni.com.

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