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Facebook, Goldman Sachs and the Poison Chalice

The Goldman Sachs booth on the floor of the New York Stock Exchange
Getty Images
The Goldman Sachs booth on the floor of the New York Stock Exchange

If Goldman Sachs were not the source of the leaks about its deal with Facebook, would it have been forced to withdraw the offering from US clients anyway?

Maybe.

The clearest reading of U.S. securities laws is that it would not. To qualify for an exemption from the full registration rules that apply to initial public offerings, Goldman and Facebook are barred from engaging in what the securities laws call the “general solicitation” of investors.

Steven Davidoff, the “Deal Professor” at DealBook, explains:

The idea behind this is that companies privately issuing stock should not condition the market to create hype in their securities. Instead, if the stock issuance is private, the trade-off is that limits apply with respect to how purchasers are solicited. The principle of the rule is purposely wide but is embodied in one form in Rule 502 of the Securities Act. Rule 502 is part of Regulation D which is one way under the federal securities rules that companies can make private offerings. This rule states that “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising . . . .”

Of course, neither Goldman nor Facebook engaged in a general solicitation.

“In fact, it appears that Goldman has strictly complied with the practices and rules for a private offering of securities,” Davidoff writes.

So why back-pedal from the offering to US clients? One possibility is Goldman’s decision to limit the offering to only non-US investors may have been prompted by concerns firm that news of the Facebook private placement had reached reporters at the New York Times through a leak at Goldman. If Goldman was the source of the news, this could be an underhanded “general solicitation.”

Davidoff raises another possibility: that Goldman blinked because it was concerned that the SEC could mount an aggressive interpretation of the securities laws to read that, regardless of whether the leak came from Goldman, the private nature of the deal had been spoiled.

But there is still risk here that is not present in other private offerings. The media hoopla surrounding the announcement of the sale could be characterized as coordinated in a way to create the type of hype that the securities rules are trying to avoid. The stampede of Goldman clients seeking to invest is evidence of this hype. In other words, Goldman arranged the mechanics of this sale to create a media fury that constituted a “general solicitation.”

Though the risk of a violation being found was low, the consequence could have been significant if one was found. The remedy for a violation of the general solicitation rule is rescission at the initial offered price. Still, Google was forced to make such an offer related to wrongly issuing stock options. No one took the offer, because the value of Google shares was significantly higher by then.

If Facebook’s valuation climbs, then a rescission offer is meaningless. Of course, this would mean Goldman was effectively guaranteeing the purchase, something it no doubt did not want to do and could not hedge. But the downside here was limited – even if Facebook went to zero, Goldman’s exposure was only $1.5 billion.

So given the low risks even with rescission, why did Goldman blink? The S.E.C. is under tremendous pressure these days to look relevant, and Goldman in particular does not want another clash given its reputation these days. The risk here was if the S.E.C. actually brought a case, whether or not it succeeded. And Facebook likely does not want anything to mess up its own possible initial public offering.

The basic idea, here, is that all the publicity around the Goldman private placement had turned it into a poison chalice: Goldman could not allow US investors to drink from it without incurring the wrath of the regulators.

Davidoff points out that Goldman is still running the risk that an aggressive SEC could go after the foreign offering on the grounds that it could reasonably be expected to condition the market for shares in Facebook.

The offering to foreign investors is likely being done under the Regulation S exemption, which is the one commonly used for foreign offerings by domestic companies. Regulation S requires that “no directed selling efforts” be made in the United States. This is defined as “any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered . . . .”

There is overlap here between the general solicitation requirement and the directed selling bar. But in the case of a foreign offering, the S.E.C. has also stated that the purpose of the rules is to prevent indirect offerings and distributions in the United States. The idea is to ensure that the securities are not resold through an offering in the United States after the distribution. And of course, principles of comity often prevent the S.E.C. from going abroad to enforce these rules.

Thus, there is also a lesser risk that the S.E.C. could challenge the foreign offering for the same reasons Goldman suspended its offering in the United States. In that case the commission would be pushing the jurisdictional envelope even further and risk backlash for trying to extend its reach into foreign waters.

But still, the fundamental violation here would have been the same. The difference is that Goldman assessed the risks and in the current environment was willing to bear only so much.

So, if you follow Davidoff, Goldman decided the risk of the US offering provoking an aggressive interpretation of securities laws was too great, while a non-US offering provoking an even more aggressive interpretation of the laws was tolerable. If so, those Goldman guys sure think they have the SEC figured out pretty well.

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