Why Facebook IPO Is a Bonanza for Wall Street


Wall Street is about to make $100 millionthanks to a once obscure law passed nearly 50 years ago.

The law is a 1964 amendmentto the Securities Exchange Act of 1934 that requires companies with over $10 million in assets and 500 shareholders to register under the Exchange Act.

Since registration carries all the costly disclosure of going public, many companies that hit the threshold decide that they might as well go public.

Facebook is in no hurry to go public. It has unlimited access to private capital, as last year’s Goldman Sachs sponsored deal demonstrated. Even after Goldman excludedU.S. investors from its offering, its Goldmanfunds were oversubscribed.

But because Facebook has far more than $10 million in assets and exceeded the 500 shareholder limit last year, the company is required to register with the SEC by April 29, 2012. It is likely to go public when it registers or sometime shortly afterwards.

Although the 500 hundred shareholder rule is often thought to be a shareholder protection provision, it has really never been anything more than a hidden subsidy for Wall Street. The principal beneficiaries of the rule are Wall Street investment banks and the stock exchanges.

The rule was passed following the publication of the 1963 “Special Study of the Securities Markets,” an investigation into the markets called for by President John F. Kennedy following an insider trading scandal involving an AMEX market maker.

The lobbying of SEC Commissioner Bill Cary is often described as one of the main drivers of the passage of the 1964 Amendment. Cary, a former Columbia law professor, has been described by one of his former assistants as “an intellectual snob” who “was not someone with sparkling genius intelligence, but with a discipline and a drive, and a clarity of where he wanted to go, that took him far beyond what other people with his abilities would do.”

To this day, Cary is very well thought, regarded as one of the great reformers of the SEC and the securities industry. Not only was he instrumental in the passage of 1964 Act, he also helped turn policy-maker views against Wall Street’s specialists. (A stance adopted by many snobs who followed Cary.) In many ways, the current market structure—for better and for worse—can be seen as the embodiment of Cary’s vision.

Even as the 1964 Amendment were being passed, critics noticed that it was pressuring companies to register on the New York Stock Exchange. A paper of the Amendment published last year by business school professors Robert Battali, Brian Hatch, and Tim Loughran included this citation:

In an article in Barron's National Business and Financial Weekly, Ralph Colman Jr., publisher of the Over-the-Counter Securities Review, noted with respect to the 1964 Amendments that "while purporting to extend the long arm of federal regulation over-thecounter, its thrust is aimed at the bigger unlisted companies, many of which long ago voluntarily embraced full disclosure. Small, speculative or fraudulent O-T-C ventures, which led to the heaviest losses in recent years, will come under no greater SEC scrutiny in future than in the past... What the new law has done, however, is more disturbing than what it fails to do. In particular, the looming threat of regulation has touched off a massive flight of corporate enterprise from the over-the-counter market to an organized exchange.”

The paper, titled “Who Benefited from the Mandated Disclosures of the 1964 Securities Acts Amendments?” finds that the amendment didn’t actually increase investor information all that much. Most of the information required to be disclosed following registration was already available to the investing public, either because companies were already disclosing the information or the information could be obtained from Moody’s.

“We find that the sole beneficiary of the 1964 Amendments appears to have been the NYSE,” the paper concludes.

The paper didn’t look at one other possible beneficiary—Wall Street investment banks. These banks stood to benefit by taking companies public once they exceeded the law’s threshold. The law cut companies off from private sources of capital, such as venture capital firms. It also limits the number of employees who can receive stock, making need to raise funding on the public market—that is, with the aid of Wall Street—all the more urgent.

Last year, Senators Pat Toomey (R-Pa.) and Tom Carper (D-Del.) introduced legislation that would reform the ruleby expanding the shareholder threshold to 2,000 and exempting employee shares altogether. Unfortunately, the law seems to have gone nowhere.

The SEC's Advisory Committee on Small and Emerging Companies is set to recommend—perhaps as early as tomorrow—that the commission “take immediate steps to ease a rule requiring startup companies to register whenever they reach 500 shareholders,” according to a report in The Deal.

But this will almost certainly come too late for Facebook—and just in time for Wall Street.

Like so many other regulations that allegedly protect shareholders, the 500 hundred shareholders rule has always been about protecting the business of investment banks. It’s a scandal that this give-away scam is about to make Facebook go public.

Mark Zuckerberg: Inside Facebook

In seven years, Mark Zuckerberg has gone from Harvard dorm to running a business with a possible value of $100 billion. On CNBC, an interview with the Facebook CEO tonight at 10p ET/PT and Wednesday at 8p ET.

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