Tracing consequences both seen and unseen.
John W. PayneIn Government, Every Day Is Opposite Day
Posted at 12:24 am on July 30, 2010, by John W. Payne

There is a brief but important article in Wired on how regulations designed to protect small investors have made it impossible for them to seek out attractive investments in non-public companies, and it’s worth quoting extensively:

Here’s a hot stock tip: Buy Facebook. Sure, the company’s valuation has bounced around over the past six years, but now it’s believed to be around $20 billion and likely to keep climbing. If you buy a chunk of Facebook and flip your shares in a few years, you could make millions.

Oh, but wait: You can’t. Facebook isn’t a public company. The only people who can invest in it already are millionaires.

The hot IPO market of the 1990s, which allowed Regular Joes to buy stock in new companies, has been replaced by a rich insider’s club that trades in pre-IPO equity sales. The middle-class folks who daytraded their way through the dotcom boom are now locked out. And that’s a problem. The current government regulations just make the rich richer, and they block alternative avenues of investment at a moment when funding is hard to find. It’s time to change the rules.

Here’s how the current system works: Even though no IPO is in sight, a company can still give contractors, advisers, and employees equity to keep them fat, happy, and working. But SEC rules limit the number of shareholders to 500. To get around this, talent can be granted something called restricted stock units, which they can get without being official shareholders. Then the contractors, consultants, and employees who leave the company can sell their vested stakes privately in what’s called a secondary market. “We have seen explosive growth in the private market across dozens of different companies,” says Barry Silbert, CEO of SecondMarket. “We are on track to do $500 million in private-company transactions this year.”

But the Securities and Exchange Commission doesn’t let just anyone buy shares in a corporation that hasn’t gone public. Pre-IPO sales are limited to “accredited investors,” people with a demonstrated net worth of $1 million or a yearly income of $200,000. It’s been that way since 1982, when Rule 501 of Regulation D of the Securities Act went into effect. The measure was intended to protect less-informed investors—widows and orphans, in Wall Street parlance—from gambling away their savings. So who has bought pre-IPO Facebook stock? A reported 10 percent of the company went to the Russian investment group Digital Sky Technologies, whose backers include one of that country’s richest oligarchs. In other words, the extremely wealthy.

I get very tired of saying this, but it will never cease to be true, so I will keep at it: the government is the primary tool by which the rich and powerful preserve their riches and power, and whenever a law is passed for the purpose of helping the weakest in society, it will be manipulated to the advantage of the strongest. These problems are systemic and intractable because the powerful have the time and money to invest in keeping their stranglehold on the political system. No matter if they are monarchial, communistic, or democratic, governments all prop up some set of oligarchs.

Link via Hit and Run.


Filed under: Regulation, Unintended Consequences
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Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson
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