Were it not for the source and recipients of the email—From: Goldman Sachs, To: Our most outrageously rich clients—it would have read like one of those Nigerian investment scams that slip through spam filters now and then. “When you have a chance I wanted to find a time to discuss a highly confidential and time-sensitive investment opportunity,” the secretive missive began. But this was clearly no shady dispatch from Lagos. What investment bank Goldman Sachs offered by way of the emails, sent out to thousands of its most valuable high-net-worth clients in early January, was the chance for them to buy a piece of the hottest company in America: Facebook.
Since the social networking site infused itself into every facet of our lives, investors have anticipated the day when the company would take its place in capitalist folklore beside Microsoft, Netscape, Apple and Google. Everything seemed to be in place—the phenomenal growth, chief geek Mark Zuckerberg’s rapid ascent to Bill Gates-ian prominence, The Movie!! It all suggested we were about to witness one of those rare moments when the spark of innovation meets the greatest wealth-creation machine the world has ever known: the American stock market.
Only that’s not how things have unfolded. In its email to clients, Goldman wasn’t talking about a public stock offering for Facebook. Instead, the bank, along with a Russian investment firm, injected US$500 million into Facebook’s coffers by way of a purely private transaction. Goldman, in turn, set up a fund through which wealthy clients could own those Facebook shares themselves, for a minimum of US$2 million. Based on that valuation, Facebook emerged a colossus worth more than US$50 billion.
Since the deal first made headlines, Goldman has had to backtrack somewhat, due to “intense media coverage.” Regulators were cool to the optics of rich Americans gaining access to hot companies when their less wealthy countrymen were shut out. So last week the investment bank made membership to its Facebook fund more exclusive still. Now only rich foreigners will be invited in.
The stealth arrangement is just the latest sign something is very wrong with Wall Street. The stock market has become dangerously disconnected from its primary function of uniting growing businesses with large numbers of long-term investors. Part of that disconnect can be seen in the growth of a so-called “second market” for private companies—like Facebook—off limits to all but the wealthy. But there’s more. Markets have come to be dominated by myopic short-term thinking. The vast bulk of trades now involve no humans at all, but rather sophisticated computer programs that swap stocks at lightning speed; many believe so-called high-frequency trading was one of the causes of the flash crash last year that exposed how fragile the whole game has become. And as more Americans have tied their savings to the market, regulators have sought to protect them with layers of rules and red tape that critics say is driving away public companies.
Now there are signs some institutional investors, such as pension funds, are giving up on equities and buying alternative assets like bridges and toll roads instead. No wonder American companies like Facebook are avoiding the hoi polloi of traditional stock markets in favour of raising capital from private, rich investors. “The idea of the stock market was to help businesses raise capital, and to provide people, individuals, with a chance to invest their savings and participate in that growth and have enough money to retire,” says Peter Cohan, president of Peter S. Cohan and Associates, a venture capital and management consulting firm in Marlborough, Mass. “But in the last decade the whole thing seems to have fallen apart.” Where the market once helped investors and companies, now it’s failing both.
In Canada it may seem academic to fret about the faulty mechanics of the U.S. stock market. Yet we should be very much concerned that it’s not working properly. Many Canadian investors put their money into U.S.-listed stocks, and as America’s largest trading partner, we also benefit when that country’s economy is functioning properly.
Perhaps billionaire Mark Cuban, who made his money off the Internet bubble of the late 1990s and now owns the Dallas Mavericks basketball team, has put it best on his blog and in interviews. “The stock market,” he says, “is for suckers.”
Facebook’s decision to shirk public stockholders in favour of rich, private ones has only driven home that point further, and sparked a debate about how America’s rising corporate stars are financing their growth.
Facebook is far from alone in choosing to “unfriend” the stock market. Despite rumours that some high-profile stock offerings could be coming down the pipeline—including social networking company LinkedIn and bargain-shopping site Groupon—the U.S. IPO market has been in decline since the mid-1990s. According to figures compiled by Jay Ritter, a professor of finance at the University of Florida, last year 96 operating companies went public on the major U.S. exchanges. True, that was a rebound from the depths of 2008, when just 21 companies went public. But in the mid-1990s, even before the tech bubble, 400 to 500 IPOs a year was common.
Why does it matter whether companies go public? Because that has historically been the best way for smaller businesses to boost themselves to the top of their industries. Instead, with fewer new companies coming to market, the number of U.S. stocks is growing worryingly thin, leaving regular investors with fewer options to choose from. In a report last fall, the New York Times noted there were 7,500 companies listed on the NYSE, Nasdaq and American Stock Exchange in 1997. Today there are fewer than 4,100. “In the 1990s going public was a badge of honour,” says Cohan. “Now companies look at it and say, ‘If we can avoid it, we will.’ ”
To do that, companies are increasingly relying on private investors, depriving the investing masses of access to exciting new businesses. Private investors are not new to Wall Street. Since the early 1980s, private equity funds have regularly gone shopping for unloved public companies with the goal of fixing them up and then taking them public again. Venture capitalists have also injected untold billions into upstart tech companies with the hope of cashing out with IPOs.