6 ms·

Facebook Derivatives: Wall Street Goes Rogue-er

71 points by cwan 16y ago

d2viant 16y ago
Investors should steer clear of this, leave this for the speculators who have money to throw away. You're investing in an instrument that is leveraged against a company who's financial details are not public knowledge. This is a very dangerous situation as you're unable to make an objective assessment of the underlying value.
- almond 16y ago
  Your comment makes me nostalgic for the times when much of anything was traded based on an objective assessment of its underlying value. Despite the crash of 08 and subsequent deleveraging, we are still several generations removed from trading on fundamentals. Trading today is more about AI trader bots battling each other for a fraction of a cent of spread in the millisecond timescale than making a rational projection about the future profit potential of the company at the year or decade timescale. Like most other derivatives, this is a side bet, and Wall Street loves offering side bets on anything. You can even buy weather derivatives to hedge against rainy days, if that matters to you.
  - noname123 16y ago
    I hate to defend the Street because most people in the industry are self-righteous duches. But then again so are most people who think that their latest RoR Web2.0 project are going to change the world, just poorer duches. Just facts, 1) Creating a derivative market on Facebook employee options creates value for the Facebook employees because it means that they can now sell their options in a more liquid and better-priced market for cash (to potentially finance their kids education, help buy for a house or for hookers). 2) High frequency/automated trading tightens the bid-ask spread of stocks and does away with the "old boys" network of market-makers; making the purchase of stocks for both mutual funds/retail investors cheaper by $0.02/share-$0.05/share; at a volume of 4+ billion shares daily average volume. These cents add up to savings for market participants. But these machines could also turn around and manipulate the market and help save for hookers for traders/programmers who run them. 3) Weather derivatives, like other derivatives do have intrinsic values. For hedgers (such as hotels/ski slopes/airline industry/agriculture harvest that could be severely affected by inclement weather), they are insurance policies against risk that they are not willing to bear and help ensure that these businesses stay in business. However, if you have an army of Physics PhD who could model the risk/probability in weather derivatives; you could sell these insurance policies and make money to get hookers.
    - deleted 16y ago
      [deleted]
    - roel_v 16y ago
      Your ideas on using financial markets to pay for hookers are intriguing to me and I wish to subscribe to your newsletter.
    - arethuza 16y ago
      That's the surprising thing I took away from reading quite a lot about the financial crisis - most of the trading makes perfect sense, and seems quite reasonable, when looked at in isolation. In "A Colossal Failure of Common Sense" there is a description of trading in distressed corporate bonds - I always wondered how you actually make money in bond markets and this was an interesting (to me) example of a scenario where what they were doing was obviously profitable and useful.
    - adw 16y ago
      3) http://weatherbill.com/ http://weatherbill.com/ (army of ex-Googlers, no direct business relationship but we have investors in common)
- cturner 16y ago
  Investing is often dangerous. If you invest in a mining exploration company, you're investing in minerals which may or may not be in the ground, and a management which may or may not have the acumen to extract them. People who think they have edge will invest, and so will some people who don't have a clue what they're doing. Some people will fit into both categories. I think that's true of investing generally. you're unable to make an objective assessment of the underlying value I'm not contradicting you here, but developing this idea. I'm always interested to hear the justification that people give for investing in blue-chip technology stocks like Apple and Google. They rarely deliver a dividend and some companies have a stated policy of not doing so. What's an objective assessment for the value of a company that's too big to be acquired, and which has committed to not delivering a dividend?
  - philwelch 16y ago
    After decades of growth, they will grow old and fat and give up and pay dividends, like Microsoft. And when that day comes, the decades of not paying dividends will finally pay off in terms of the stratospheric heights the company has grown to. Which would be a far more convincing argument if it wasn't the fashionable thing in the tech industry to try as hard as possible to never grow old and fat.
jaydub 16y ago
Investors in private companies need to be accredited per SEC regulations (correct?) [1]. Do investors in these derivatives also need to be accredited? Clearly, "because private-company financials are opaque" investing in the derivatives is speculative. The securitization of Facebook shares is not inherently "evil", but the issues arise if/when these derivatives are misunderstood and overly available for public consumption. [1] http://www.sec.gov/answers/accred.htm http://www.sec.gov/answers/accred.htm
- zach 16y ago
  Since they're actually investing in an LLC, the rules (search "506 offering") would be the same. It can only be "sophisticated" investors and no more than 35 can be non-accredited. Note that there can be no solicitation or advertising of the offering to the general public. In practice, as you can see, this means you can leak all the details to Bloomberg but then cannot comment for the story. Because, you see, that would be solicitation.
- billboebel 16y ago
  Yes, you need to be accredited (I am an investor in one of these funds)
copper 16y ago
> By creating derivatives of the stock, the investment firms are helping Facebook keep its shareholder count at 499 or less, the maximum number a company can have before it has to disclose results to the public. Out of curiosity, what does this imply for stock options? Are people who exercise them included in this count?
- zach 16y ago
  Yes, they would be. So as a result, there are not a lot of stock options floating around anymore. They have been replaced by, you guessed it, derivatives.
  - copper 16y ago
    Facebook apparently has 1700+ employees, though: does that mean those who joined at the 500+ mark were either not granted options, or are not exercising them? That seems strange to me. Assuming I was given options in a fast-growing company, I'd want to buy them as and when they vested, to have some protection against dilution :)
    - zach 16y ago
      I heard they started issuing restricted stock units instead of options three years ago. They are rights to stock, like a risk-free, cost-free stock option. Now, allegedly, the twist is that they vest when the company becomes public. In any case, the company presumably has a right of first refusal clause on their stock, which means that Facebook can match any stock buyer's offer themselves, or broker a trade to someone else instead. That's only in case of emergencies, though. A lot of other companies did so around that time, since this was following the accounting standards change which required options to be expensed. If you're going to expense options, you might as well expense something more flexible.
    - roel_v 16y ago
      I'm not familiar with SEC regulations, but would putting the options for a pool of employees into a separate LLC or trust be enough to circumvent this 500 people rule? Or would all shareholders/beneficiaries be counted separate?
noname123 16y ago
Well, derivatives all have to somehow tie back to the underlying. Should be interesting to see the financial engineering on this. Depends on the way they'll do this, one way is that they could approach some major stakeholders of Facebook (e.g., a pool of employees with vested or unvested employee stock options) and draw up some agreement with that entity to buy the rights to buy these stock options at a whole-sale strike price (let's say $0.05/share to buy the share at $75).Then the brokerage firms will chop these options to different strike price bins and re-distribute to investors (e.g., $0.15/share for the right to buy the share at $75, $10.15/share for the right to buy the share at $65; with the broker collecting a $0.10/share underwriting fees.). So you are buying an option at a certain strike price to buy a potentially unvested option to buy a illiquid, pre-IPO stock at a certain strike price. If this was Google in 1999, someone is going to be rich. But since it is my opinion that Facebook is going to the way of AOL, I wouldn't buy into it; but then again, it depends on when Facebook is going to IPO and if it is before the Web 2.0 exuberance dies down.
- olefoo 16y ago
  If you read the Businessweek article he quotes from, the investors are buying shares in an entity that does nothing but own shares of facebook. Shares that they presumably bought on a private secondary market like the one detailed in http://www.avc.com/a_vc/2008/08/a-secondary-mar.html http://www.avc.com/a_vc/2008/08/a-secondary-mar.html It sounds rather like a bucket shop to me, and those were made illegal for some fairly good reasons.
  - yummyfajitas 16y ago
    ...an entity that does nothing but own shares of facebook You just described an index fund (albeit with only one stock in the index). Bucket shops are nothing like this - bucket shops are casinos where the source of random numbers is the stock market, but no shares are ever traded.
    - borism 16y ago
      is an index with just one underlying company actually possible? I don't think so - we're not talking commodities here, but equity. Every index fund I've seen or traded had multiple underlying assets, even if some of them were derivatives... BTW, stock market must be pretty bad random number generator...
zach 16y ago
One jump ahead of the lawmen. Impressive. I would think this is heading for trouble, though. The SEC and public policy in this area are oriented toward protecting non-accredited investors (let's call them "noobs") from the potential hazards of stock ownership (getting "pwned"). Now that being public (and even widely-held) is onerous, setting up a noob-free server (a private market) seems like a win. The company gets liquidity, the noobs have no chance of getting pwned, everyone should be happy. But this particular innovation is a little concerning, because it's primarily going to appeal to noobs and the total amount of noobs at risk of pwnage can get much larger than intended. That's when the regulators are going to step in. So as clever as this seems, this is just begging for trouble.
- nl 16y ago
  This isn't about avoiding non-accredited investor laws, it's about the 499 shareholder limit for non-financial disclosure. Google ran into the same problem in the run-up to their IPO
  - deleted 16y ago
    [deleted]
  - zach 16y ago
    It is primarily about that (q.v. my post on RSUs). But if this reaches an extreme where hundreds of non-accredited investors (very) indirectly hold ownership in a private company, it's far more likely to raise regulatory and legislative eyebrows. Today, I presume they don't need to hassle with non-accredited investors because the demand is so huge. But the door would seem to be open to this in the future since there's not much to stop it, possibly apart from Facebook's control over transactions. I admit it's a far-ahead concern. But it's a real danger.
- roel_v 16y ago
  Don't non-accredited investor regulations only kick in under a certain investment floor under SEC regulations? They do here in most of Europe, there are plenty of shady investment opportunities here for people with more than 50k to invest - to the point where my spidey sense starts to tingle when I see a commercial on TV saying 'minimum inlay 50k'. (come to think of it, haven't seen many of them over the last year or so - a couple of people went to jail or worse over some real estate funds gone sour, seems to have stopped that industry dead in its tracks).
nl 16y ago
This seems a pretty unconventional use of the word derivatives. Unless I'm missing something, the story here is that people are pooling money to setup a company to invest in Facebook. That's just normal investing - exactly like investing in a VC fund that invested in Facebook. I suppose technically they are investing in a Facebook derivative, because they get returns from the investment company rather than Facebook stock directly. But people don't say a Vangaurd find is a Walmart derivative just because it invests in Walmart, nor do they say investing in the Accel Funx X (which funded Facebook) is investing in a Facebook derivative.
- nickpinkston 16y ago
  Yea, the category of derivatives is actually quite broad. Options, futures, forwards, etc. are all derivatives - in that they derive their value indirectly from the underlying assets, but they're traded so broadly that the specific names make more since. I believe these are derivative because they aren't buying the stock directly, but purchasing rights to them. This is done to Fortune 500 CEOs option/stock pools to sell off their rights to purchase others' rights to their stock for the sake of diversification without selling publicly and causing a scare - to the board or investors.
- alex1 16y ago
  I have also never seen the word derivatives used in this context. Isn't "derivatives" usually used to describe options, futures, warrants, etc? Derivatives in that sense are used to add some leverage on a bet and are known for their high risk, compared to the risk in directly owning their underlying equity securities. They aren't directly related to the underlying (same idea in calculus: y = f(x) ≠ dy/dx). I don't see how this adds additional risk in addition to the risk associated directly with owning Facebook stock. While this technically is a derivative (underlying is Facebook stock), I think using the term "Facebook derivative" is a bit misleading.
- roel_v 16y ago
  Note that this guy's blog seems to be mostly about ragging on the financial industry and how it's going to kill us all. Using scary words like 'derivatives' is much more effective for that sort of fear-mongering than using 'investment fund' which was much less tainted by the economic woes of the last few years.
joelhaus 16y ago
Most interesting is that for each of these long positions, there's a short. The key is that these derivatives are synthetic shares of facebook, not true equity. When available/required, the fund will acquire these shares. The difference btw this and mortgage CDS, is that this is "equity", not debt. That's my reading of it anyway. Here's another attempt at an over-simplified explanation: http://news.ycombinator.com/item?id=1936037 http://news.ycombinator.com/item?id=1936037
- roel_v 16y ago
  As I understand it, there's no long here; there's no other party promising to pay a certain amount for each share. They just bought options from the people who had them and in case of an IPO, there will be (hopefully) a cash fountain that the investors in this company get to tap into. And if the IPO turns out to be less than whatever they paid for the options, tough luck. In other words, it seems like all assets are paid for already with the inlay of the shareholders of the investment vehicle. So I think that disqualifies it as a long, where no cash changes hands at the time the deal is done, no?
  - eru 16y ago
    Depends on how you look at it. The current shareholders of Facebook did not actually sell the stock. They just sold rights to the stock options. So if you net out their position, there's no short. If you do not net out their position, there's a long and an equal short for them, and another long in the new investment company.
    - roel_v 16y ago
      Maybe it comes down to the definition of 'long', I don't know if there is a well-established one. But since these people who the options were bought from presumably have contractual valuations of these options, it seems to me that there is no risk in the deal, except for the valuation at IPO of Facebook stock. Thinking of it, maybe it's the same as a 'regular' long, i.e. a non-naked one (I guess there's a real term for it ;) ) I originally had a mental comparison with naked longs in mind, in which case the risk profiles would deviate much more from the construction in the article; but yes if you compare it to a long on an asset someone already has, it may not be that different. Then again it seems to be that the scary stories and the bad image of shorts and longs are about the naked variants, and that this is implicit in the article. That may just come from my lack of grasp on the subject.
deleted 16y ago
[deleted]
fleitz 16y ago
Sounds like an ETF that invests in private companies. I don't see a big deal. It's not much different than NYSE:GLD. If people feel that it's a poor investment strategy they don't need to invest in it. This whole model is probably a phenomenal way to get public money into a private company and avoid all that regulatory BS that public companies need to go through. (Note: If you think the regulations are great then just avoid investing in this kind of company)
cantbecool 16y ago
Is there any good resources to learn about derivatives, options, etc? The nomenclature of finance is extremely difficult to understand.
- cturner 16y ago
  They're reasonably straightforward concepts in themselves (I originally learnt shorting from the wiki page), but I struggled to make the jump to get a feel for them, to be able to build thoughts using them, rather than look on as an outsider. What Heinlein calls "to grok". Here's a puzzle in the spirit of building the series of logical gates by combining NAND gates. You could learn enough about the concepts using wikipedia. Consider a scenario: the government bans short-selling. Your task: find a way you could synthesise a short using just forwards. What are some practical considerations that might make it less practical to do this than pre-ban shorting? I find that when I understand how something emerged, I have a good feel for it. A lot of these concepts go back a long way - stock practices that developed through trading stock of the dutch east india company. For this reason, I'd recommend Niall Ferguson, _The Ascent of Money_. Das _Traders, Guns and Money_ is a good read. I couldn't follow all of it when I read it, but found it to be good for feel. There's a late 20th century writer John Kenneth Galbraith who wrote some good histories. I like _the end of uncertainty_ but it's hard to get. He wrote others that will be fine. It would probably be useful to read a book about Drexel Burnham Lambert, and how Milken developed their junk bond trades. I don't know of one, perhaps someone else can recommend. For broader economic picture stuff, I recommend Hazlitt _Economics in One Lesson_; Schiff _How an Economy Grows and Why It Crashes_; Soros, _The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means_.
  - zandorg 16y ago
    The Predator's Ball and Den of Thieves for Milken & Drexel. Avoid Payback (about Milken) as it goes off on a stupid tangent.
billboebel 16y ago
I am an investor in the Felix fund mentioned in the business week article. All they did is buy up several million dollars of Facebook stock from original shareholders, put it into a simple LLC, and then sell shares of that LLC. Investors pay an upfront transaction fee on the investment, a minimal operational cost, and then a fee on the backend if there is a liquidation event but only after the investor gets 100% of their investment back. This is very similar to how traditional VC funds are structured and the only reason this is getting press is because it is another story about Facebook. These funds actually do a service for the original Facebook shareholders because it allows them to take some cash off the table, rather than waiting for the IPO.
- joelhaus 16y ago
  Any ideas about why they are calling these investments, "derivatives"? Capital markets aren't unfamiliar to this publication.
  - btilly 16y ago
    Because they are a type of derivatives. See http://en.wikipedia.org/wiki/Derivative_%28finance%29 http://en.wikipedia.org/wiki/Derivative_%28finance%29 for more on that. (Also my explanation at http://bentilly.blogspot.com/2009/10/what-are-financial-derivatives.html http://bentilly.blogspot.com/2009/10/what-are-financial-deri... has some interesting points.)
    - joelhaus 16y ago
      Still not convinced that derivative is the correct way to describe this (assuming that billboebel's comment is accurate). I'd prefer if they called it securitization. It's possible that the funds offering statement lays out a clear goal, but also provides enough flexibility to employ some fancy engineering techniques. Then they raise funds and put the capital to work. Due to the illiquid nature of the target company, it wouldn't be surprising if the fund assets end up being a mix of synthetics, equity shares and employee stock options. Regardless, the article doesn't really provide enough information to draw a firm conclusion.
wladimir 16y ago
Interesting times. You can see the new IT bubble grow larger every day. And, just like back then, all kinds of strange 'new' investment schemes form.
retube 16y ago
"Unbelievable, dangerous, greed-headed and yet another example of the craven idiocy of what passes for regulatory oversight in this country." He provides no justification for this statement. Why is it these things? Given the title of his blog, I'm assuming he has a pre-disposed bias on such matters.

71 points by cwan 16y ago

Investors should steer clear of this, leave this for the speculators who have money to throw away. You're investing in an instrument that is leveraged against a company who's financial details are not public knowledge. This is a very dangerous situation as you're unable to make an objective assessment of the underlying value.

almond 16y ago
Your comment makes me nostalgic for the times when much of anything was traded based on an objective assessment of its underlying value. Despite the crash of 08 and subsequent deleveraging, we are still several generations removed from trading on fundamentals. Trading today is more about AI trader bots battling each other for a fraction of a cent of spread in the millisecond timescale than making a rational projection about the future profit potential of the company at the year or decade timescale. Like most other derivatives, this is a side bet, and Wall Street loves offering side bets on anything. You can even buy weather derivatives to hedge against rainy days, if that matters to you.
- noname123 16y ago
  I hate to defend the Street because most people in the industry are self-righteous duches. But then again so are most people who think that their latest RoR Web2.0 project are going to change the world, just poorer duches. Just facts, 1) Creating a derivative market on Facebook employee options creates value for the Facebook employees because it means that they can now sell their options in a more liquid and better-priced market for cash (to potentially finance their kids education, help buy for a house or for hookers). 2) High frequency/automated trading tightens the bid-ask spread of stocks and does away with the "old boys" network of market-makers; making the purchase of stocks for both mutual funds/retail investors cheaper by $0.02/share-$0.05/share; at a volume of 4+ billion shares daily average volume. These cents add up to savings for market participants. But these machines could also turn around and manipulate the market and help save for hookers for traders/programmers who run them. 3) Weather derivatives, like other derivatives do have intrinsic values. For hedgers (such as hotels/ski slopes/airline industry/agriculture harvest that could be severely affected by inclement weather), they are insurance policies against risk that they are not willing to bear and help ensure that these businesses stay in business. However, if you have an army of Physics PhD who could model the risk/probability in weather derivatives; you could sell these insurance policies and make money to get hookers.
  - deleted 16y ago
    [deleted]
  - roel_v 16y ago
    Your ideas on using financial markets to pay for hookers are intriguing to me and I wish to subscribe to your newsletter.
  - arethuza 16y ago
    That's the surprising thing I took away from reading quite a lot about the financial crisis - most of the trading makes perfect sense, and seems quite reasonable, when looked at in isolation. In "A Colossal Failure of Common Sense" there is a description of trading in distressed corporate bonds - I always wondered how you actually make money in bond markets and this was an interesting (to me) example of a scenario where what they were doing was obviously profitable and useful.
  - adw 16y ago
    3) http://weatherbill.com/ http://weatherbill.com/ (army of ex-Googlers, no direct business relationship but we have investors in common)
cturner 16y ago
Investing is often dangerous. If you invest in a mining exploration company, you're investing in minerals which may or may not be in the ground, and a management which may or may not have the acumen to extract them. People who think they have edge will invest, and so will some people who don't have a clue what they're doing. Some people will fit into both categories. I think that's true of investing generally. you're unable to make an objective assessment of the underlying value I'm not contradicting you here, but developing this idea. I'm always interested to hear the justification that people give for investing in blue-chip technology stocks like Apple and Google. They rarely deliver a dividend and some companies have a stated policy of not doing so. What's an objective assessment for the value of a company that's too big to be acquired, and which has committed to not delivering a dividend?
- philwelch 16y ago
  After decades of growth, they will grow old and fat and give up and pay dividends, like Microsoft. And when that day comes, the decades of not paying dividends will finally pay off in terms of the stratospheric heights the company has grown to. Which would be a far more convincing argument if it wasn't the fashionable thing in the tech industry to try as hard as possible to never grow old and fat.

jaydub 16y ago

Investors in private companies need to be accredited per SEC regulations (correct?) [1]. Do investors in these derivatives also need to be accredited? Clearly, "because private-company financials are opaque" investing in the derivatives is speculative. The securitization of Facebook shares is not inherently "evil", but the issues arise if/when these derivatives are misunderstood and overly available for public consumption. [1] http://www.sec.gov/answers/accred.htm http://www.sec.gov/answers/accred.htm

zach 16y ago
Since they're actually investing in an LLC, the rules (search "506 offering") would be the same. It can only be "sophisticated" investors and no more than 35 can be non-accredited. Note that there can be no solicitation or advertising of the offering to the general public. In practice, as you can see, this means you can leak all the details to Bloomberg but then cannot comment for the story. Because, you see, that would be solicitation.
billboebel 16y ago
Yes, you need to be accredited (I am an investor in one of these funds)

copper 16y ago

> By creating derivatives of the stock, the investment firms are helping Facebook keep its shareholder count at 499 or less, the maximum number a company can have before it has to disclose results to the public. Out of curiosity, what does this imply for stock options? Are people who exercise them included in this count?

zach 16y ago
Yes, they would be. So as a result, there are not a lot of stock options floating around anymore. They have been replaced by, you guessed it, derivatives.
- copper 16y ago
  Facebook apparently has 1700+ employees, though: does that mean those who joined at the 500+ mark were either not granted options, or are not exercising them? That seems strange to me. Assuming I was given options in a fast-growing company, I'd want to buy them as and when they vested, to have some protection against dilution :)
  - zach 16y ago
    I heard they started issuing restricted stock units instead of options three years ago. They are rights to stock, like a risk-free, cost-free stock option. Now, allegedly, the twist is that they vest when the company becomes public. In any case, the company presumably has a right of first refusal clause on their stock, which means that Facebook can match any stock buyer's offer themselves, or broker a trade to someone else instead. That's only in case of emergencies, though. A lot of other companies did so around that time, since this was following the accounting standards change which required options to be expensed. If you're going to expense options, you might as well expense something more flexible.
  - roel_v 16y ago
    I'm not familiar with SEC regulations, but would putting the options for a pool of employees into a separate LLC or trust be enough to circumvent this 500 people rule? Or would all shareholders/beneficiaries be counted separate?

noname123 16y ago

Well, derivatives all have to somehow tie back to the underlying. Should be interesting to see the financial engineering on this. Depends on the way they'll do this, one way is that they could approach some major stakeholders of Facebook (e.g., a pool of employees with vested or unvested employee stock options) and draw up some agreement with that entity to buy the rights to buy these stock options at a whole-sale strike price (let's say $0.05/share to buy the share at $75).Then the brokerage firms will chop these options to different strike price bins and re-distribute to investors (e.g., $0.15/share for the right to buy the share at $75, $10.15/share for the right to buy the share at $65; with the broker collecting a $0.10/share underwriting fees.). So you are buying an option at a certain strike price to buy a potentially unvested option to buy a illiquid, pre-IPO stock at a certain strike price. If this was Google in 1999, someone is going to be rich. But since it is my opinion that Facebook is going to the way of AOL, I wouldn't buy into it; but then again, it depends on when Facebook is going to IPO and if it is before the Web 2.0 exuberance dies down.

olefoo 16y ago
If you read the Businessweek article he quotes from, the investors are buying shares in an entity that does nothing but own shares of facebook. Shares that they presumably bought on a private secondary market like the one detailed in http://www.avc.com/a_vc/2008/08/a-secondary-mar.html http://www.avc.com/a_vc/2008/08/a-secondary-mar.html It sounds rather like a bucket shop to me, and those were made illegal for some fairly good reasons.
- yummyfajitas 16y ago
  ...an entity that does nothing but own shares of facebook You just described an index fund (albeit with only one stock in the index). Bucket shops are nothing like this - bucket shops are casinos where the source of random numbers is the stock market, but no shares are ever traded.
  - borism 16y ago
    is an index with just one underlying company actually possible? I don't think so - we're not talking commodities here, but equity. Every index fund I've seen or traded had multiple underlying assets, even if some of them were derivatives... BTW, stock market must be pretty bad random number generator...

zach 16y ago

One jump ahead of the lawmen. Impressive. I would think this is heading for trouble, though. The SEC and public policy in this area are oriented toward protecting non-accredited investors (let's call them "noobs") from the potential hazards of stock ownership (getting "pwned"). Now that being public (and even widely-held) is onerous, setting up a noob-free server (a private market) seems like a win. The company gets liquidity, the noobs have no chance of getting pwned, everyone should be happy. But this particular innovation is a little concerning, because it's primarily going to appeal to noobs and the total amount of noobs at risk of pwnage can get much larger than intended. That's when the regulators are going to step in. So as clever as this seems, this is just begging for trouble.

nl 16y ago
This isn't about avoiding non-accredited investor laws, it's about the 499 shareholder limit for non-financial disclosure. Google ran into the same problem in the run-up to their IPO
- deleted 16y ago
  [deleted]
- zach 16y ago
  It is primarily about that (q.v. my post on RSUs). But if this reaches an extreme where hundreds of non-accredited investors (very) indirectly hold ownership in a private company, it's far more likely to raise regulatory and legislative eyebrows. Today, I presume they don't need to hassle with non-accredited investors because the demand is so huge. But the door would seem to be open to this in the future since there's not much to stop it, possibly apart from Facebook's control over transactions. I admit it's a far-ahead concern. But it's a real danger.
roel_v 16y ago
Don't non-accredited investor regulations only kick in under a certain investment floor under SEC regulations? They do here in most of Europe, there are plenty of shady investment opportunities here for people with more than 50k to invest - to the point where my spidey sense starts to tingle when I see a commercial on TV saying 'minimum inlay 50k'. (come to think of it, haven't seen many of them over the last year or so - a couple of people went to jail or worse over some real estate funds gone sour, seems to have stopped that industry dead in its tracks).

nl 16y ago

This seems a pretty unconventional use of the word derivatives. Unless I'm missing something, the story here is that people are pooling money to setup a company to invest in Facebook. That's just normal investing - exactly like investing in a VC fund that invested in Facebook. I suppose technically they are investing in a Facebook derivative, because they get returns from the investment company rather than Facebook stock directly. But people don't say a Vangaurd find is a Walmart derivative just because it invests in Walmart, nor do they say investing in the Accel Funx X (which funded Facebook) is investing in a Facebook derivative.

nickpinkston 16y ago
Yea, the category of derivatives is actually quite broad. Options, futures, forwards, etc. are all derivatives - in that they derive their value indirectly from the underlying assets, but they're traded so broadly that the specific names make more since. I believe these are derivative because they aren't buying the stock directly, but purchasing rights to them. This is done to Fortune 500 CEOs option/stock pools to sell off their rights to purchase others' rights to their stock for the sake of diversification without selling publicly and causing a scare - to the board or investors.
alex1 16y ago
I have also never seen the word derivatives used in this context. Isn't "derivatives" usually used to describe options, futures, warrants, etc? Derivatives in that sense are used to add some leverage on a bet and are known for their high risk, compared to the risk in directly owning their underlying equity securities. They aren't directly related to the underlying (same idea in calculus: y = f(x) ≠ dy/dx). I don't see how this adds additional risk in addition to the risk associated directly with owning Facebook stock. While this technically is a derivative (underlying is Facebook stock), I think using the term "Facebook derivative" is a bit misleading.
roel_v 16y ago
Note that this guy's blog seems to be mostly about ragging on the financial industry and how it's going to kill us all. Using scary words like 'derivatives' is much more effective for that sort of fear-mongering than using 'investment fund' which was much less tainted by the economic woes of the last few years.

joelhaus 16y ago

Most interesting is that for each of these long positions, there's a short. The key is that these derivatives are synthetic shares of facebook, not true equity. When available/required, the fund will acquire these shares. The difference btw this and mortgage CDS, is that this is "equity", not debt. That's my reading of it anyway. Here's another attempt at an over-simplified explanation: http://news.ycombinator.com/item?id=1936037 http://news.ycombinator.com/item?id=1936037

roel_v 16y ago
As I understand it, there's no long here; there's no other party promising to pay a certain amount for each share. They just bought options from the people who had them and in case of an IPO, there will be (hopefully) a cash fountain that the investors in this company get to tap into. And if the IPO turns out to be less than whatever they paid for the options, tough luck. In other words, it seems like all assets are paid for already with the inlay of the shareholders of the investment vehicle. So I think that disqualifies it as a long, where no cash changes hands at the time the deal is done, no?
- eru 16y ago
  Depends on how you look at it. The current shareholders of Facebook did not actually sell the stock. They just sold rights to the stock options. So if you net out their position, there's no short. If you do not net out their position, there's a long and an equal short for them, and another long in the new investment company.
  - roel_v 16y ago
    Maybe it comes down to the definition of 'long', I don't know if there is a well-established one. But since these people who the options were bought from presumably have contractual valuations of these options, it seems to me that there is no risk in the deal, except for the valuation at IPO of Facebook stock. Thinking of it, maybe it's the same as a 'regular' long, i.e. a non-naked one (I guess there's a real term for it ;) ) I originally had a mental comparison with naked longs in mind, in which case the risk profiles would deviate much more from the construction in the article; but yes if you compare it to a long on an asset someone already has, it may not be that different. Then again it seems to be that the scary stories and the bad image of shorts and longs are about the naked variants, and that this is implicit in the article. That may just come from my lack of grasp on the subject.

deleted 16y ago

[deleted]

fleitz 16y ago

Sounds like an ETF that invests in private companies. I don't see a big deal. It's not much different than NYSE:GLD. If people feel that it's a poor investment strategy they don't need to invest in it. This whole model is probably a phenomenal way to get public money into a private company and avoid all that regulatory BS that public companies need to go through. (Note: If you think the regulations are great then just avoid investing in this kind of company)

cantbecool 16y ago

Is there any good resources to learn about derivatives, options, etc? The nomenclature of finance is extremely difficult to understand.

cturner 16y ago
They're reasonably straightforward concepts in themselves (I originally learnt shorting from the wiki page), but I struggled to make the jump to get a feel for them, to be able to build thoughts using them, rather than look on as an outsider. What Heinlein calls "to grok". Here's a puzzle in the spirit of building the series of logical gates by combining NAND gates. You could learn enough about the concepts using wikipedia. Consider a scenario: the government bans short-selling. Your task: find a way you could synthesise a short using just forwards. What are some practical considerations that might make it less practical to do this than pre-ban shorting? I find that when I understand how something emerged, I have a good feel for it. A lot of these concepts go back a long way - stock practices that developed through trading stock of the dutch east india company. For this reason, I'd recommend Niall Ferguson, _The Ascent of Money_. Das _Traders, Guns and Money_ is a good read. I couldn't follow all of it when I read it, but found it to be good for feel. There's a late 20th century writer John Kenneth Galbraith who wrote some good histories. I like _the end of uncertainty_ but it's hard to get. He wrote others that will be fine. It would probably be useful to read a book about Drexel Burnham Lambert, and how Milken developed their junk bond trades. I don't know of one, perhaps someone else can recommend. For broader economic picture stuff, I recommend Hazlitt _Economics in One Lesson_; Schiff _How an Economy Grows and Why It Crashes_; Soros, _The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means_.
- zandorg 16y ago
  The Predator's Ball and Den of Thieves for Milken & Drexel. Avoid Payback (about Milken) as it goes off on a stupid tangent.

billboebel 16y ago

I am an investor in the Felix fund mentioned in the business week article. All they did is buy up several million dollars of Facebook stock from original shareholders, put it into a simple LLC, and then sell shares of that LLC. Investors pay an upfront transaction fee on the investment, a minimal operational cost, and then a fee on the backend if there is a liquidation event but only after the investor gets 100% of their investment back. This is very similar to how traditional VC funds are structured and the only reason this is getting press is because it is another story about Facebook. These funds actually do a service for the original Facebook shareholders because it allows them to take some cash off the table, rather than waiting for the IPO.

joelhaus 16y ago
Any ideas about why they are calling these investments, "derivatives"? Capital markets aren't unfamiliar to this publication.
- btilly 16y ago
  Because they are a type of derivatives. See http://en.wikipedia.org/wiki/Derivative_%28finance%29 http://en.wikipedia.org/wiki/Derivative_%28finance%29 for more on that. (Also my explanation at http://bentilly.blogspot.com/2009/10/what-are-financial-derivatives.html http://bentilly.blogspot.com/2009/10/what-are-financial-deri... has some interesting points.)
  - joelhaus 16y ago
    Still not convinced that derivative is the correct way to describe this (assuming that billboebel's comment is accurate). I'd prefer if they called it securitization. It's possible that the funds offering statement lays out a clear goal, but also provides enough flexibility to employ some fancy engineering techniques. Then they raise funds and put the capital to work. Due to the illiquid nature of the target company, it wouldn't be surprising if the fund assets end up being a mix of synthetics, equity shares and employee stock options. Regardless, the article doesn't really provide enough information to draw a firm conclusion.

wladimir 16y ago

Interesting times. You can see the new IT bubble grow larger every day. And, just like back then, all kinds of strange 'new' investment schemes form.

retube 16y ago

"Unbelievable, dangerous, greed-headed and yet another example of the craven idiocy of what passes for regulatory oversight in this country." He provides no justification for this statement. Why is it these things? Given the title of his blog, I'm assuming he has a pre-disposed bias on such matters.