• The Wall Street Journal
    • JANUARY 10, 2011

    By making it harder for companies to go public, Congress and regulators tilt the playing field in favor of the wealthy and well-connected.


    Facebook raised $500 million last week, but the only people who could invest were the wealthiest private clients of Goldman Sachs. Instead of offering shares to the public, Facebook chose a private version of a public offering.
    The case of an unsocial Facebook should be a wake-up call about how regulations have undermined public markets. Facebook’s customer base could not be more mass. The site is used by some 600 million people around the world. It got almost 9% of all Web visits in the U.S. last year, more than Google. According to comScore, a majority of all Canadians have a Facebook account.

    As the leading social-media site, Facebook depends on people sharing information about themselves. Yet the very people whose posts directly created Facebook’s value are banned from investing in the company.

    In this context it is useful to recall that for the past century the public stock markets set a vibrant, pre-Internet example of social media combined with crowd sourcing: People gathered information on companies and through their trading moved share prices. This combined wisdom rewarded good companies and punished others.

    “Nobody in Wall Street knows everything,” explained William Peter Hamilton in his 1922 classic, “The Stock Market Barometer,” which focused on the investment theories of Charles Dow and his Dow Jones Indexes. Hamilton, then editor of The Wall Street Journal, described how information flowed through the still-young U.S. stock markets, which had funded utilities and industrial companies: “The market represents everything everybody knows, hopes, believes, anticipates, with all the knowledge sifted down to . . . the bloodless verdict of the market place.”

    Private markets close off this exchange of information, making it likelier that prices are wrong, letting bubbles brew. Private capital is funding highly valued startups beyond Facebook, including gaming site Zynga and social-coupon company Groupon. Having these companies grow to huge sizes without disclosing their performance beyond a small group of private investors means we are losing the benefits of public-market disclosure.

    Facebook CEO Mark Zuckerberg


    Facebook founder and privacy skeptic Mark Zuckerberg is blamed for hypocrisy, since putting off a public offering means he can retain confidentiality about the details of his company. But the fault lies with Washington, not with Goldman Sachs, Facebook or Silicon Valley.

    Regulations arising from the bust that followed the dot-com boom of the late 1990s caused the collapse of the IPO market. Congress and regulators made it harder for companies to go public. If they do go public, Sarbanes-Oxley forces managers to spend time on audits and accounting that is better spent developing new products and services.

    Under the banner of “fair disclosure,” public-company executives are also barred from giving analysts deep briefings on their businesses. The intent was to level the playing field against analysts at banks, but the result is fewer expert analysts covering companies, reducing information available to markets even from publicly traded companies.

    “The increased costs of being public have helped exclude ordinary people from the ability to own the stars of the future,” Illinois law Prof. Larry Ribstein wrote on his blog last week. “Rules designed to make the markets safe for ordinary investors have ended by excluding them. Maybe it’s time to start considering whether we got what we wanted.” Indeed, by the time these companies go public, it will not be for the historic reason of raising capital to build their business, but to give private investors a way to realize their profits.

    “These companies are going to be more or less fully developed by the time they eventually come to the public markets, with most of the upside having been captured by private investors,” Albert Wenger of Union Square Ventures argues on businessinsider.com. “That’s especially annoying when it seems that with the Internet we should be seeing IPO 2.0—direct to small investors without the historic flip opportunity for well-connected investors.”

    Instead of reforming securities laws, the Securities and Exchange Commission threatens to shoot the messengers. Regulators are reviewing new online exchanges such as SecondMarket and SharesPost that give shareholders in private companies, such as employees, a way to cash out. These markets are the logical result of delaying IPOs.

    Until recently, U.S. capital markets were the world’s most open, public and well-informed. A free flow of information can’t eliminate booms and busts, but as we saw a decade ago, companies in fast-growing industries such as the Web can be the quickest to implode—so the more public information about them the better.

    The goal of securities regulation should simply be to ensure that accurate information gets to the market as quickly as possible. By this measure, the regulations of the past decade have undermined public stock markets and their vibrant flow of information about companies. Now that Washington has defriended investors, the would-be investing public should defriend the politicians who took away their markets.


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