Stephen Foley: Casting some light on Facebook's finances

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The Independent Online

US Outlook: Pleasing to hear, this week, that the Securities and Exchange Commission, the American investment watchdog, is investigating the frenzy of trading in Facebook shares.

Yes, you're right, Facebook is not a publicly traded company. But that hasn't stopped the stock that it has privately issued so far, to employees and early-stage venture capital investors, from changing hands at higher and higher valuations.

Electronic trading platforms have been connecting desperate buyers and eager sellers, ever since Facebook first agreed to find a way for former employees to cash out. That was the rubicon crossed, and Facebook shares are out there now fluttering around in the speculative wind.

The most worrying development has come in the last few months, with the creation of a number of so-called "single-asset funds". These funds buy up as much Facebook stock as they can and then sell shares in the fund to investors. It is like being granted access to an elite club. As the head of one such fund told me recently: "It is exciting to be at a party or to have friends over and to be able to say, 'I'm in Facebook'."

So, we have Facebook shares trading at prices that have doubled and doubled again, reportedly at $23bn in June, $56bn two weeks ago. Facebook is the poster child for this new phenomenon, but other, much-hyped, early-stage companies are soaring on these private marketplaces. Zynga, the games developer, the microblogging service Twitter and now marketing sensation Groupon have all hit multibillion-dollar valuations that may – or, most likely, may not – reflect their ultimate profit potential.

Two things in particular ought to be immediately alarming. First, this is a bad market. Illiquid, devoid of financial information on the companies being traded, outside of formal regulation, it cannot be enough for the SEC to just say "buyer beware" and walk on by.

Second, the principle that there must be transparency in widely traded shares was enshrined in all the post-1929 crash legislation here, and any company that has more than 500 shareholders must file its financial results with the SEC. The single-asset funds could neuter that rule, since each is theoretically only one single shareholder. The SEC must count the number of people invested in these funds – effectively, they are Facebook derivatives. If the total is more than 500, then the transparency rules must be applied and these private companies must lift the lid on their financial secrets, either by publishing financial results or, better still, floating on an official stock market.

The SEC did not acquit itself well this time last decade, when dot.com mania led to widespread abuse of unsophisticated investors. It must burst this new bubble, and quickly. If that means bouncing Facebook into flotation this year, then so be it. It is easy to feel sympathy for Mark Zuckerberg, Facebook's founder, and the executives there, who want more time to find a business model that can generate profits commensurate with the hype, and which wants to keep its commercial secrets out of the hands of its rivals. But not for the first time, financial innovation is wagging the corporate dog.

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