Goldman Circumvents the Rules
By Staff News & Analysis - January 05, 2011

Perhaps even more intriguing than Goldman's direct stake in Facebook is the "special purpose vehicle" that it is creating to allow its wealthy clients to invest in Facebook alongside the firm … Goldman did not pioneer this type of investment structure. Over the last several months, a number of smaller Wall Street brokerages have formed vehicles to enable individual investors to acquire shares in private Internet companies like Facebook and Twitter … The S.E.C. generally requires companies with more than 499 shareholders to report their quarterly earnings and audited financial information to the public. Under a technical interpretation of the statute, the vehicle that Goldman is creating for its clients would be considered a single Facebook shareholder of record. But several securities lawyers say the S.E.C. could argue that these structures subvert the spirit of the law and look through the vehicle to count the investors individually. – Bloomberg

Dominant Social Theme: Regulations are important but fungible. And Goldman is so big that it must be right. Right?

Free-Market Analysis: Once upon a time, long ago, God created the earth and a little later American regulators created the "public company." They did this simply by asserting that a private company could have no more than 499 investors and investment pools (hedge funds and the like) no more than 99 shareholders. It happened in the mid 1930s and investors have been living with the definitions ever since. But today, as we can see from Goldman's announcement, the definition of a "private company" may have changed. Clever Goldman!

Goldman maintains that it can set up a private investment vehicle, presumably limited to a certain amount of accredited investors, and offer the vehicle to regulators as a single shareholder. Apparently, following Goldman's argument, the firm could do this over and over, finally generating perhaps 10,000 investors instead of 499. Thus it is, regulations are reshaped by clever firms with deep pockets and savvy litigators.

We see again, as always, that regulation is far more apt to favor the large entity than the small one. Does anyone really think that a pocket-sized firm would get the same level of attention and respect as Goldman Sachs? For small firms, regulations work effectively as barriers to entry. For large firms, regulations are merely an irritant to be circumvented. In fact, Goldman is not the first to propose this formulation. Private venture capital groups have been doing it for years, and the SEC has gone along with it. No surprise there.

Nothing much the SEC does – or decides – makes much sense in our view. For one thing, financial regulatory systems worldwide are run along Keynesian lines. Keynesian economics does not recognize the existence of the central-bank created business cycle. But who determined that? Who determined that regulatory agencies would adopt a failed Keynesian economic vision?

Here's a question: Why aren't SEC regs developed within the parameters of Austrian, "free market" economics? If they were then the SEC would have to regulate central banking rather than investment firms. It would finally be acknowledged that the booms and busts that regulators blame on the private sector are actually caused by central bank monetary inflation generated under color of law.

Does the SEC have a council of economists that it convenes when it is about to put a new regulation into practice? Does the SEC even have regular input from economists? Not that we know of. Does the SEC consult with Austrian economists about the business cycle and try to develop market-based regulations that respect the damages caused by central banking and excessive credit creation?

What is the SEC? It is an agency that operates via precedent, each giving rise to a new one. It is like an engorged earthworm munching its way through dirt. It doesn't stop. It simply opens its mouth and pushes ahead. There is no logic to any of it.

What is insider trading? Why hasn't the SEC ever defined it? What is a public company? Why is the delineation set at 500? Why are only 99 "sophisticated" investors available to place funds in a private investment vehicle? Why isn't the central banking business cycle taken into account when developing and enforcing regulations.

In fact, public companies in our view are just as risky as private ones – and perhaps moreso – because they are exposed (especially in America) to the inevitable booms and busts of the central banking economy. First the central bank prints too much money; businesspeople are fooled by the expansion and over-commit; finally the market crashes and many firms, inevitably, go bankrupt, taking investors' funds with them.

These are PUBLIC COMPANIES. Over and over the stock market crashes and ruins millions of small shareholders. They have no idea what happened. They have no idea what a business cycle is. They are told they must hold onto their investments, but it is hard to do when you have no other savings and your stocks have lost half their value in a fortnight. What if your holdings go to zero? And so you sell.

Why hasn't the SEC informed people of the business cycle? Why hasn't the SEC declared the Federal Reserve to be a menace to the investment public? Why hasn't the SEC banned fiat money a danger to the general welfare of the larger citizenry? Why hasn't the SEC sought the input of reputable free-market economists who could explain what is really going in the marketplace?

Free-market economics has consistently been proven correct. Free-market economists, most self-identified and non-academic, identified the downturn of 2008 well before it actually happened. Not just a few of them – but literally thousands of economic bloggers on hundreds of websites. All came to the same conclusion – that the system was failing because of the overprinting of the dollar reserve currency and there would be Hell to pay.

The SEC and its "braintrust" has no relationship to economic common sense. Its regulations are entirely unmoored from the marketplace. (There is in fact no such thing that we know of as a well-thought-out regulation.) Regulations are inevitably price fixes – transferring advantages from one group to another and distorting the larger marketplace via queues, scarcity, etc. Private investors are held by regulatory fiat to be more "sophisticated" than public ones. They are likely more sensitive, anyway, about public scrutiny.

This brings us to another point regarding why Goldman came up with the idea of bundling investors into one "shareholder." It is very possible that Facebook does not want to reveal the first 499 investors; it needs cash but wishes to forego the transparency of a public company. Enter Goldman and its "special relationship." Of course, if reports are to be believed, it will end up public anyway. The SEC will "push" the issue.

Facebook was developed the way many important American companies are developed nowadays from what we can tell. The company was discovered at Harvard and nurtured through venture-capital incubators affiliated with US intel operations. These funding mechanism are no secret; US agencies proudly announce their availability, positioning their creation as a public service rather than the ruinous conflicts-of-interest that they are. Nonetheless, there is probably sensitivity about the current roster of Facebook investors as from our point of view the company – like too many in the US today – is a partially inauthentic creation, nurtured by the powers-that-be for various purposes, including ones that are intended to contravene US privacy rights.

Between the mercantilism of Wall Street and the pervasive and stifling economic illiteracy of the SEC and Congress, there really is no capital market anymore – not from a free-market perspective anyway. Central banking itself constantly collapses the economy and entrepreneurial ventures besides. The SEC's regulations are nothing but a barrier to entry; Wall Street is merely a mercantilist expression of the power elite's overwhelming desire to control every kind of industry in every possible niche.

After Thoughts

Goldman Sachs may not get away with its current gambit, but the trend is clear; and investors should take note. Investing at this point – both in the US and Europe – is an elite game and those who seek capital for startups might well look to family and friends in order to fund a business. The miracle of market capitalization that was supposed to be such a boon to startups has become a sour, centralized phenomenon. The Goldman gambit is just more evidence.

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