Is the Vampire Squid Wrapped Around Facebook?

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Goldman CEO Lloyd Blankfien has his hands around Facebook’s shares (Jim Young/REUTERS)

Goldman Sachs has been trying to wrestle free of its reputation for sucking money out of every market it can. The new Facebook deal won’t help.

You don’t have to dig very far to find something vampire squiddy about the deal. Companies over 500 investors are supposed to disclose their financial statements. But while the Goldman deal could bring in as many as 750 investors into Facebook alone, those investors are going to be counted as one, as long as they agree to continue to go through Goldman and its new Facebook-specific fund. It’s an arrangement that may suit both investors and Facebook, which doesn’t want to disclose its financials. But it also wraps Goldman’s tentacles pretty tightly around the market for Facebook shares, which could be as large as $50 billion.

The Securities and Exchange Commission was already looking into the growing ways shares of private companies are being traded. So Goldman is entering an area that was under scrutiny already. So far it seems the inquiry has been focused on this 500 investor issue. But there may be more at stake than defining who should or shouldn’t be counted as an investor. Here’s why:

The biggest issue is one of self dealing and how easy it seems to potentially manipulate the market for private shares. Consider the Facebook-Goldman deal. In December, some Facebook private shares traded on SharesPost, one of these markets for non-public stocks, for a price that gave the Facebook a value of $56 billion. Yet, other shares traded for considerably less. Market’s like SharePost are illiquid and prices are hard to believe. But Mark Zuckerberg liked the sound of $50 billion. So he called Goldman and asked if they could find investors who wanted to make a significant purchase of Facebook shares that would value the company at $50 billion. Who did Goldman find? Itself and a Russian technology investment firm Digital Sky Technologies, at least initially. It also opened a fund to invest in Facebook, but that was only after it let word get out that it and DST were investing $450 million into the social networking company.

But both Goldman and DST have a vested interest in pumping up the value of Facebook. For Goldman, it will get lucrative fees from making Zuckerberg’s valuation a reality. On much of the nearly $2 billion transaction, Goldman will receive a fee of 8%, or $160 million, paid both by Facebook and its new investors, for completing the deal. It will also set Goldman up well to run Facebook’s IPO, which when it eventually happens will generate a few hundred million more for the investment bank.

For DST, it’s a sweet deal as well. The Russian firm already owns a large chunk of Facebook shares, nearly 10% after the most recent deal. So the $50 million it kicked in as an investor, boost its the value of the much larger stake in the company it already has. Indeed, shares of DST’s publicly traded subsidiary in London Mail.ru jumped nearly 12% on the deal. And DST was likely to have been easily influenced by Goldman. Three of its top executives recently came from Goldman. Goldman has been a DST investor, though it is not clear if it still is. And Goldman was one of the underwriters of DST’s Mail.ru subsidiary. Goldman got 12 million shares in Mail.ru as part of that deal, though it is not clear whether it still owns them. That’s all to say that Facebook’s now good as gold $50 billion valuation is in good part due to a very clubby deal. “When you have a relationship that is this intertwined you wonder how much of this transaction is really an investment or whether this is all part of a ramping up of interest,” says financial industry consultant Susan Webber, who writes as Yves Smith on the popular blog Naked Capitalism.

Just to raise a little more doubt. Goldman’s pure investment arm apparently initially passed on the Facebook deal, saying $50 billion was too rich. It wasn’t until the deal was brought to the main investment banking division, which would benefit from the fees, that Goldman agreed to sign on.

Of course, in the case of the Facebook deal this will all probably work out fine. Even if Facebook isn’t really worth $50 billion now, it probably will be some day. The Goldman deal is already sold out. But now that this maneuver has been pulled off, Goldman or another investment bank is likely to do it again. And the next time it won’t be with Facebook, but maybe some other company where the outcome is much less sure, and value much more inflated. There are a lot of things to not like about our current public markets. It forces companies to grow at all costs and for executives to focus on the very short term. High-frequency trading potentially adds volatility. Sarbanes Oxley certainly adds to the cost of being public, but not necessarily the safety of the market. But is this better? You tell me.

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