Goldman's $450 million investment in Facebook raises the possibility that the SEC will seek a way to force the social networking company into an IPO.  At issue:  Should Goldman's planned special purpose vehicle ("SPV"), which would hold up to $1.5 billion in client investments in Facebook, be viewed as one person or many?

Steven Davidoff, writing as the Deal Professor for NYT Dealbook, thinks it's unlikely that Facebook would crash through the 500-person threshold - but if that happens, Facebook has until May 2012 before it has to comply with its new financial disclosure requirements - about the same date or time that CEO Mark Zuckerberg originally had in mind for a public offering.  

    The Rules.   Section 12(g) of the Securities Exchange Act of 1934 requires that a company register its securities with the SEC if it “has total assets exceeding $1 million and a class of equity security … held of record by 500 or more … persons…”  The SEC by rule-making has raised the $1 million threshold to $10 million. But either way, Facebook certainly exceeds this asset threshold.

The issue comes with the 500-person requirement.   This speaks only of shareholder-of-record ownership, although shares can be held “of record” or “beneficially.”  Because the SEC recognizes shareholders “of record,” and not "beneficial" shareholders, the seucrities rules will count “each person who's identified as the owner of such securities on records of security holders maintained by or on behalf of the issuer.”  Record ownership is thus clear.  It is the shareholders who are recorded as such on the books of the company that issued the securities.

    Factors That Can Keep Down the Number of Record Holders.   Most shares in public companies owned by investors are usually held beneficially - i.e., for the benefit of the investors.  These shares are typically held of record by a 3rd party - e.g., a broker on behalf of the shareholder, the beneficial owner.  The shares are held this way for administration ease.  Otherwise, every share trade would have to be recorded on the company’s books. Instead, there is only one entry on the books of the company for all shares held by Charles Schwab for its clients.

In fact, most brokers actually use another entity known as Cede & Company, the nominee name of the Depository Trust Company, for their record ownership of stock, and so there is only one entry for many brokers all of whom have thousands of beneficial owners they hold shares for.  The consequence is that companies with thousands of shareholders will often have fewer record holders.  Following that same logic, Goldman's SPV will be the owner of record, while all the Goldman clients who invested with the SPV will be beneficial ownerd of Facebook shares.

Yet, the SEC could seek to upend Goldman's special purpose vehicle, in order to count each SPV investor as a shareholder of record.  The Commission might rely on its definition of record holder, which includes this condition:   If the [company] knows or has reason to know that the form of holding securities of record is used primarily to circumvent the provisions of [the Securities Act], the beneficial owners of such securities shall be deemed to be the record owners thereof.  If it can prove its case, then legally, it would appear that the SEC would have grounds to force Facebook to begin reporting its financial results publicly. 

Okay, Let's Say Facebook Exceeds 500-Person Threshold.   Even if Facebook is deemed to exceed the 500-shareholder threshold, it would not be required to conduct an IPO, but rather would merely begin “reporting” to the SEC - i.e., start filing quarterly and annual reports with the SEC, among  other things.  These reports would include Facebook’s audited financial information.

The company can still stay private even if it is forced to begin reporting to the SEC.  However, in the case of Google, which faced with a similar choice several years ago, it chose to go public.  Google decided that if it was going to have to release its nonpublic financial and other information to the SEC and the public, it might as well get its bang for the buck and do it in connection with an IPO.  Though not required to do so, Facebook would probably come to the same conclusion if the SEC brings this reporting requirement to a head.

Facebook knows all of the above. However, if a company exceeds the 500-shareholder limit, then it is only required to start reporting within 120 days of the last day of its fiscal year it exceeded this amount. If Facebook has a fiscal year that coincides with the calendar, this would give the company until May 2012 before the requirement takes effect. So Goldman’s investment may be exactly in contemplation of such an event next year.

For the complete story, go to:   [ NYT Dealbook, 1/3/11, 'Deal Professor' ]