Facebook IPO

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The story of HFT and arrogance. It's also retail investors getting screwed, but speculators always win. But the winner's game can never be taxed because....ugh..they're winners? They create phantom money and won't skim off a little for the system that allows phantom money.

Occupy Silicon Valley?

Some in Silicon Valley are attempting to tap into the anti-bank sentiment stoked by Occupy Wall Street to suggest that the IPO was a victory for entrepreneurs. The basis of this argument is that by pricing the IPO at the higher end of its expected trading range, more money ended up in the hands of the company and less in the hands of IPO speculators. Purveyors of this argument recall the dot-com boom in the late 1990s when many technology companies went public at, for example, $30 a share only to see the stock price shoot up in the first few days due to a near hysterical hunger for shares.

In retrospect, the dot-com period should be seen as an early stage of a massive bubble of “fictitious capital” building up in the American economy of. Despite warnings of what Yale economist Robert Shiller, following former Federal Reserve Bank chairman Alan Greenspan, called “irrational exuberance,” money flowed into the American economy from around the globe. Low interest rates put in place by the Federal Reserve enabled consumers to borrow and spend and investors to borrow and invest. Too much money flooded into too few good investment projects. The dot-com bubble burst only to see capital migrate to the housing market and its associated derivative instruments, such as credit default swaps and synthetic CDOs, which, in turn, magnified that market and the wider impact of its subsequent collapse.

Now, as we struggle to recover from the disintegration of the housing market, a new bubble has appeared in the social networking and broader high-tech sector. Hopes have been stoked that social networking can trigger a broader shift in investing and job creation. Its apparent success even led President Obama, who raises significant campaign funds from Silicon Valley, to sign the JOBS (Jumpstart Our Business Startups) Act—a law drafted and lobbied for by venture capital and the tech sector—which dramatically weakens protective features of federal securities law that have been in place for many decades. The Facebook IPO was seen as a potential savior for the cash-starved California state government, which hopes to cash in on taxes collected from newly minted Facebook millionaires and billionaires. A wave of follow-on IPOs by other Valley social networking companies was widely expected to follow a successful Facebook IPO.

Valley entrepreneurs were said to be smarter about the wily practices of Wall Street than they were in the dot-com days. Thus, Facebook should actually be congratulated for pricing their IPO high enough that there was no early “pop” in the stock price, and most of the money raised went to the company instead of to “Wall Street speculators.” In theory, that means more money can be used to create jobs, build these new businesses, and apply their allegedly magical technical features to creating new efficiencies for the entire economy.

The only problem with this argument is that this is not what happened.

douglaslee's picture
Jul. 31, 2007 4:01 pm


Insider Capitalism

Insiders including Mark Zuckerberg and other founders, venture capitalists like libertarian Peter Thiel, and later investors like Goldman Sachs and the Russian investment firm DST actually sold far more shares than the company itself. Of the 421 million shares sold in the offering, existing insiders sold 241 million while the company sold only 180 million. Zuckerberg sold 30 million shares, Thiel—on behalf of his venture capital firm—sold 16.8 million shares, DST sold 45.6 million shares, and Goldman Sachs sold 24.3 million shares. That means that of the $16 billion raised in the IPO, $9 billion went to insiders while $6.7 billion went to Facebook itself, and the underwriters collected $176 million in fees and commissions. That lopsided sales structure is highly unusual and was one of the warning signs that some analysts expressed concern about in advance of the offering. It is not considered prudent for insiders to be seen selling their shares in an IPO while the company is asking new investors to put their money into it. Typically, employees and early investors sign lock-up agreements that don’t allow them to cash out of the company for six months.

But at Facebook key insiders were allowed to sell immediately, while others were granted rights to sell in follow-on offerings at the end of three months. In addition, the amount that those insiders could sell immediately increased significantly very late in the offering process. This step took many analysts by surprise. But this step is, in many ways, the key to unraveling what caused the IPO process to go so badly.

I think it is called Pump and Dump.

douglaslee's picture
Jul. 31, 2007 4:01 pm

The only explanation is that the company, which is controlled by a young and, by many accounts, rather hubristic CEO—who, unlike the lawyers and bankers advising him, has never participated in an IPO before—pushed back against their recommendations. It appears that Zuckerberg pushed back so hard that it took until May 9, more than three months after the first version of the prospectus was filed with the SEC, to disclose critical information to the SEC, NASDAQ, and, most importantly, potential investors.

The decisions to increase 1) the price well above the $32 per share sophisticated investors said was the right price, 2) the percentage of shares that insiders sold in the offering, and 3) the percentage of such shares offered to unsophisticated retail investors suggest that this IPO was a giant “pump-and-dump” operation. The transaction was not intended to link entrepreneurial talent with the savings of thousands of ordinary Americans but instead aimed at stroking the ego of a company led by arrogant and inexperienced twenty-somethings.

“Other People’s Money”

The critical early-stage investor in Facebook was current board member Peter Thiel, a noted fan of Margaret Thatcher and Ayn Rand. Ironically, this recipient of two degrees from Stanford argues that a college education is overrated. Thiel funds a program that encourages young people to emulate Zuckerberg and drop out of college to start companies like Facebook. He is also a supporter of Singularity University, a new private education program-cum-technology think tank. Both Thiel’s business offices and Singularity are located, again ironically, on federal government property: NASA’s Research Park on Moffett Field in Mountain View and the Presidio in San Francisco.

Thiel, according to a recent profile in the New Yorker, thinks the social unrest visible in movements like Occupy and strikes in Greece contains the potential for a worldwide conflagration. He is critical of both welfare provisions and the extension of suffrage to women. He has openly longed for the 1920s (which was certainly before the emergence of the modern welfare state and securities laws, but followed the passage of the Nineteenth Amendment). In the manner of Rand’s hero John Galt, Thiel sees investment in young technology entrepreneurs like Zuckerberg or Sean Parker as a way to rescue humanity from what he believes are the totalitarian instincts of “social democracy.” In a 2009 manifesto he posted on the Cato Institute website, he wrote, “The fate of our world may depend on the effort of a single person who builds or propagates the machinery of freedom that makes the world safe for capitalism.” Apparently, his vision of capitalism includes the possibility of a single individual controlling more than 50 percent of the shares of a $100 billion global corporation that openly aspires to exploit the personal information of its nearly 1 billion users.

Instead of fantasizing that the global economic crisis can be solved by college dropouts or by the weakening of federal securities law, however, aspiring young capitalists should be reminded that when one is using what Justice Louis Brandeis called “other people’s money,” certain principles of social responsibility must be respected.

Perhaps these media darlings should be reminded as well of the myth of Icarus, who thought he could fly to the sun on the wings prepared by his father, Daedalus. The wings, though, were made of wax and melted as Icarus approached his destination. He fell to his death in the sea far below. The silence of Mark Zuckerberg in the wake of the Facebook disaster suggests that like Icarus, he, too, is feeling some heat.

Stephen F. Diamond teaches securities law at Santa Clara University’s School of Law. Prior to teaching he was an associate at a major corporate law firm in Silicon Valley for four years. He has also served as an adviser to major labor unions on issues related to the financial markets and corporate governance. You can follow him on Twitter at @stephenfdiamond or on his blog at www.stephen-diamond.com.

I don't use facebook, and find it annoying at every site it interferes with. I also run a cookies dump and register fix about every day. Icarus's parrafin should continue to melt until about $19.00 a share.

douglaslee's picture
Jul. 31, 2007 4:01 pm

Is the Republican Party Fit to Govern?

Repeal and replace is dead.

Long live repeal and replace!

Whatever the fate of the Senate GOP's so-called healthcare bill, this chaotic week of Obamacare repeal makes one thing very, very clear: the Republican Party is simply not to fit to govern.

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