Goldman Sachs’s decision to offer shares of Facebook only to offshore investors is simple risk management. The risk here can be attributable to the scrutiny that this transaction, and Goldman Sachs generally, are now under.
About a week ago, I discussed the legal issues associated with the Goldman-Facebook share sale. One of the items I noted was that in order to make sure that the full registration requirements of the securities laws were inapplicable, Goldman could not engage in a “general solicitation” of shareholders.
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 . . . .”
In this case, Goldman has not made a general advertisement or solicitation. In fact, it appears that Goldman has strictly complied with the practices and rules for a private offering of securities.
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.”
This is a stretched argument, and any case on these grounds by the Securities and Exchange Commission would have been an uphill battle.
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.
That the issue here was the threat of litigation rather than its success is evidenced by Goldman’s decision to limit the offering to foreign investors.
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.
There may be finger-pointing here, but clearly Goldman did not recognize the public outcry this sale would create. Had it done so, Goldman would have quietly placed the shares with only a few of its shareholders or had a much more expedited timetable (say 48 hours) to price and complete the sale.
Finally, Goldman’s decision is likely to step up the scrutiny of nonpublic markets for common stock. The fact that Goldman was unwilling to sell these shares to domestic investors but give the opportunity to foreign ones will raise some outcry to liberalize the rules for offering stock on these markets. This outcry will be countered by claims that the Facebook media fury is unique.
These markets should not exist unless the kind of information made available for a public company is made available for private companies or only investors who can truly assess the risks should be allowed to participate. This is a real debate and should spur a rethinking of how we want these markets to be regulated.