Everybody's talking about Goldman Sachs' deal to invest $450 million of its own capital in Facebook and to raise another $1.5 billion from its wealthy clients to do the same. The deal raises fascinating questions. Does it violate the Volcker rule (a provision in the 2010 Dodd-Frank financial reform bill named after its proponent, former Federal Reserve Chairman Paul Volcker), which is meant to limit the amount of money banks may risk in proprietary investments? Probably not. Is the deal's structure, which presents that $1.5 billion as coming from a single investor, a way to game the Securities and Exchange Commission rules requiring companies with more than 499 investors (as Facebook would be if each investor were counted individually) to file financial statements as a public company would? Of course!
But the true fascination in this deal is that somebody is getting something most of us can't have. You need multiple millions to invest your money at Goldman Sachs. (The firm doesn't disclose precisely how much, which brings to mind the old adage, "If you have to ask, you can't afford it.") These very wealthy clients are stampeding to make a (relatively) early-stage investment in a smoking-hot company. Who wouldn't do the same, given the chance? While Goldman does have mutual funds for non-millionaires, these average Joes won't get any Facebook shares. (Did you even have to ask?)
Goldman's Facebook deal is just one more piece of evidence that the claim Wall Street's made repeatedly over the last two decades—average individual investors can compete on a level playing field with the big boys!—is total bunk. The regulators have sometimes, sort of, tried to make it true, but these efforts have either failed or made things worse.
The last time there was an investor frenzy surrounding start-up Internet companies was during the late-1990s dot-com bubble. After it burst and many individual investors lost most of their money, it turned out that the "research analysts" working for Wall Street investment banks, who had been telling investors that stocks could double, triple, fly to the moon, were doing so not because they believed it was true, but because saying so could help their firms win lucrative investment-banking business. Meanwhile, big investors were often getting advance notice of important information from companies.
To solve this problem, the Securities and Exchange Commission in 2000 implemented "Regulation Fair Disclosure" (otherwise known as Reg FD). This rule required companies to disclose material information to all investors at the same time. Elaborate mechanisms were put in place to prevent research analysts from being influenced by the bankers. In addition, the SEC made Wall Street firms pay a $1.4 billion settlement. Goldman's share was $110 million.
Did the world became a better, safer place? Um, no. Rather than improve their research departments, brokerage firms made them a backwater, so the quality of information available to average investors went down, not up. At the same time, so-called "expert networks" sprouted. These are firms that specialize in putting big investors, particularly hedge funds, in touch with "experts"—maybe in the medical community, or inside technology firms—to help those big investors get an informational edge on everyone else. The SEC and the Justice Department are currently trying to figure out how much of that information qualifies as insider trading. Even if most of it doesn't, it's perfectly clear that big investors found a new way to keep—actually, to increase—their edge.
You don't have to be a cynic to wonder whether the Goldman-Facebook deal is just Wall Street's latest trick to inflate stocks in the post-2008 financial market. Using research analysts to whip individual investors into a frenzy is no longer kosher, so maybe the new method is to create such an aura of exclusivity that by the time Facebook does go public, investors will be absolutely crazed, allowing Goldman and the others to sell their stakes at a high price.