Goldman Sachs Group Inc.’s plan to offer clients up to $1.5 billion in Facebook Inc. equity may invite U.S. regulators to take a closer look at whether the owner of the world’s most popular social-networking site is circumventing disclosure rules, securities lawyers said.
The Securities and Exchange Commission, whose rules require any company with more than 499 investors to disclose financial information, is already scrutinizing 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 isn’t 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 $1.5 billion, 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 channeled 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 finance professor at Georgetown University’s business school in Washington. If the investment is 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.
SEC Request
Further public confirmation of the SEC’s interest in such investment funds came yesterday when SecondMarket Inc., which matches buyers and sellers of shares in private companies such as Facebook and Twitter Inc., received a request for information from the agency.
“We have now received a voluntary request for information from the SEC regarding ‘pre-IPO pooled investment funds,’ ” said Mark D. Murphy, a spokesman for the New York-based broker- dealer. “We are fully cooperating.”
The law of the 500-owner limit was created to make sure those who invest in larger companies are provided sufficient information about the firm. The rule applies to companies with more than $10 million in assets. The Goldman Sachs investment values Facebook at about $50 billion.
Facebook told the SEC in 2005 that it had under 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.
Beneficial Holders
While the law counts so-called owners of record toward the 500-shareholder threshold, people who invest in a private company through a fund -- the so-called beneficial holders -- aren’t 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 LLP in Washington. A private company can 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 may interpret it as a deliberate attempt to dodge its rules, said John Mahon, a former lawyer in the SEC’s Division of Corporation Finance who is now a partner at Sutherland, Asbill and Brennan LLP in Washington.
‘Potential Risk’
“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 that if it improperly manages the investor interest, it could accidentally cross the 500 shareholder threshold, going public without an initial public offering, Angel said.
A spokesman for Facebook, Larry Yu, declined to comment. Goldman Sachs didn’t immediately respond to a request for comment.
As part of the agreement, Goldman Sachs can sell up to $75 million of its stake to Russia’s Digital Sky Technologies, which it partly owns. Digital Sky Technologies also added $50 million to an earlier stake in Facebook.
“The whole venture capital industry is based upon funds investing in private companies,” said Paul N. Roth, a partner at Schulte, Roth and Zabel LLP in New York, 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.”
SEC spokesman John Nester declined to comment.
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