Monday, April 5, 2010

Facebook Tells Employees Not to Sell Shares

Facebook has an interesting problem - it is in danger of having too many shareholders, an outcome that is being made possible by online trading sites like, which allows shareholders in private companies to sell their shares to others.

There are plenty of issues surrounding these sites for private companies, including not knowing who your shareholders are, and having your shares too widely dispersed. One of the more significant issues however, is Section 12(g) of the Securities Exchange Act of 1934. That section requires a private company with total assets in excess of $10 million and 500 or more record holders of a class of equity security, to register the class of equity security with the SEC, unless it has an exemption from such registration.

(The SEC has a plain English explanation of the rule and filing requirements in "Q&A: Small Business and the SEC - A guide to help you understand how to raise capital and comply with the federal securities laws").

Facebook is concerned that the expansion of its number of shareholders to 500 will force it to go public before management decides that it is time to do so, and has enacted a policy to attempt to forestall that event.

According to a article, the company has enacted a prohibition on the sale of securities by its shareholders to limited periods of time when a "trading window" is opened. Trading windows are commonly found in public companies, and permit sales by employees only during these specific time periods. The policies are designed to prevent insider trading, or more to the point, to limit allegations of insider trading, by preventing trades except has previously designated times, under particular procedures set by the company.

The use of a similar policy by a private company is an interesting development, and one has to question whether it is a legitimate corporate policy - in the private context. Corporations have the ability to restrict transfers or sales of their stock. Those restrictions are commonplace in small corporate entities, and I have written dozens of such policies over the years - typically requiring the selling shareholder to offer the stock back to the corporation, or the other shareholders, either at a pre-determined price, or a price set by some other calculation.

Those policies are a creature of contract - the shareholder agreed to that provision when he acquired his shares. However, the Facebook prohibition appears to be a condition placed on the shares after purchase or acquisition, and could be viewed as a unilateral modification of the underlying agreement.

Obviously an examination of the underlying documents would be required in order to determine the validity of the prohibition and I am confident that Facebook already has restrictions on transfers of its shares. The problem is that the requirement that the shares be offered to the company first can become a financial drain on the company, forcing it to use its capital on purchases at unrealistic prices.

Whether trading blackouts and trading windows are the answer remains to be seen. The article has more on the issues relating to sales of stock by private company shareholders at here.

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