"...before testifying at a hearing of the California Corporations Department, which sought to determine if Facebook’s acquisition of the photo sharing service was in the best interest of Instagram investors."
Can someone explain why this department is doing that? It wasn't a publicly traded company or anything. I'm assuming that Instagram had a board which included seats to represent the VC's, which would have been involved in the various deals.
Are the VC's behind this, alleging that Kevin Systrom kept board members in the dark about a possible Twitter acquisition? Or are people who invest in the VC's behind this, alleging that the VC's betrayed a kind of fiduciary obligation or something? Is the state of CA an investor in the VC's?
Facebook was organized as a California company and selling securities in California.
Why would you think the state that creates and formalizes the laws under which a company organizes wouldn't have an interest in how that company sells securities in itself?
1. Corporate Securities Law of 1968 (Corporations Code § 25000 et seq.) requires persons offering or selling securities such as stocks or bonds to qualify (e.g., submit to the Department for review and approval) the proposed securities, and requires licensing and regulation of securities broker-dealers and certain investment advisers, except as specified; prohibits misrepresentations, fraudulent and deceptive acts in the offer and sale of securities; and provides administrative, civil (injunction, ancillary relief and appoint of receiver) and criminal remedies for violations of the law.
2. California Commodity Law of 1990 (Corporations Code § 29500 et seq.) prohibits misrepresentation, fraudulent and deceptive acts in the offer and sale of certain off-exchange commodities, except as specified; and provides administrative, civil (injunctions, ancillary relief and appointment of receiver) and criminal remedies for violations of the law.
Near the bottom the article briefly mentions that the regulators were worried about "self-dealing" in the Facebook-Instagram deal, where someone was offered a personal side benefit for making the sale happen.
It's a serious problem in corporate governance in the US, but it's not in the interests of any individual involved, including the victim, to uncover any particular instance of it, because the deal is done and a prosecution would only damage the company they presumably still own.
"Facebook requested the hearing as a way to speed up the approval of its acquisition."
I don't know if that was added to the article later, but it seems to explain. It wouldn't normally be a matter for the state, being a private transaction; but closing the deal is a matter for Instagram's investors (who have to agree to sell their shares for the agreed price), and it sounds like Facebook thought getting the investors' approval would be easier if a state department ruled that it was in their best interests.
"Can someone explain why this department is doing that?"
Besides the more general reasons that others have given, the last sentence of the first paragraph is, "Facebook requested the hearing as a way to speed up the approval of its acquisition."
If Systrom had an offer from Twitter on the table for an amount close to Facebook's offer, the state might view it as opportune to make Twitter and Facebook compete for the company, increasing the return for the investors (whose interest they are representing). If he ignored the Twitter offer but took the Facebook offer due to some personal gain, the state will have a problem with that if it wasn't disclosed to investors. The article discusses that near the end. The entire purchase was shaky -- remember the bit about Zuckerberg not talking to his board? -- so I suspect this isn't the last we'll hear of regulators poking around.
This regulation, which applies to all corporations everywhere, is there to protect investors from being swindled by executives. Without it, we'd have a very different corporate landscape. I don't know if it'd be better or worse, but it'd be very different.
CEO has more responsibilities than just fiduciary duty, and as well it could easily be argued that a deal for $1 b in Facebook stock would be much better than $1.5 b in Twitter stock because of the general uncertainties of the market when dealing with private companies rather than companies that have undergone the fiscal requirements outlined for public companies. tl;dr: Facebook is stock is liquid, Twitter is not.
Unless there are some serious smoking guns here this case is going nowhere fast, Twitter doesn't really have standing in a fiduciary duty case as they are not a shareholder. Since the vast majority of shareholders have not complained it's a pretty easy argument that the vast majority of shareholders are happy with the performance of Instagram.
To nail Instagram they'll have to prove an anti-trust violation, and/or fraud/perjury. Given the underwriters for Facebook this is highly unlikely.
Exactly. If there is evidence that Systrom did not act in the best interest of shareholders for personal gain, that would be a severe violation of is fiduciary responsibilities, and that would be the under the jurisdiction of the State of California. That is probably the only reason the state would or should be involved.
If Systrom (and his cofounder) had a controlling interest in Instagram, are they even required to act in the best interests of the other shareholders? That's kind of the point of a controlling interest, no? To break ties when shareholders can't decide what's in the overall best interest of the company/shareholders?
IANAL, however what the majority of shares vote for is not the same as what is in the best interest of shareholders.
For instance, Zuckerberg controls Facebook. He can not decide to use all Facebook's cash as his own personal bonus. That is because it's a clear violation of his fiduciary responsibilities to minority shareholders.
Minority shareholders have a right not to be screwed, though it is VERY difficult to establish misconduct in private companies.
The CEO may not have a fiduciary duty towards minority shareholders, but the controlling shareholders do, in this case it sounds like they are one and the same.
If you have to break a tie, then you aren't a controlling shareholder. The idea behind controlling shareholding is that as long as you follow your duties to the minority you can install whoever you want (perhaps yourself) on the board, the board can then install whoever they want as CEO (perhaps yourself)
These things get really murky in private companies where the board, controlling interest, and CEO are shared by one individual.
It appears that Systrom and Mike Krieger (the other cofounder) together held a majority stake. Assuming the two of them decided to accept the Facebook deal, then they are indeed acting in the best interests of the majority of shareholders, no?
Why do things get murky when the CEO/board/controlling interest is the same? They started and built the company, and structured their funding deals such that they were able to keep majority control wrt voting rights. If they want to screw over the minority shareholders, I think that's pretty lame, but that should be their prerogative.
> If they want to screw over the minority shareholders, I think that's pretty lame, but that should be their prerogative.
The law doesn't really give you blanket approval to do that, though. There are a lot of legal ways to screw over minority shareholders, but lots that aren't. When you sell part of your company, you agree to be bound by certain responsibilities to those minority owners. If you don't like those aspects of contract law, and want to do whatever you want without obligations to other co-owners, you need to keep 100% ownership.
There are public policy reasons why a simple majority shouldn't be able to do whatever they like. It would be much harder to ever raise any investment if it were trivial for a majority to simply take everything for themselves and never pass anything back to the investors.
In such a scenario you end up with a boilerplate contract that any right-thinking investor will insist on, just to protect themselves in such a scenario.
Basically, company law has simply declared that those clauses are there by default.
The interesting thing to me is all the comments saying "the state shouldn't be involved". Maybe that's true (I don't have an opinion because I haven't researched it at all), but it doesn't matter.
If you are running a company, these are the kinds of things you need to care about. One's personal sensibilities don't matter a lick when the regulators come knocking.
Instead, I would look at this (and whatever fallout occurs) as a warning of the kinds of things you have to think about and use it to sharpen skills so as to not be on the receiving end.
And, once again, if you don't skirt gray areas of ethics, you are less likely to face problems. Did Twitter give an offer? "Well, that's open to 'interpretation', and I'm going to interpret it as 'no'."
> The interesting thing to me is all the comments saying "the state shouldn't be involved". Maybe that's true (I don't have an opinion because I haven't researched it at all), but it doesn't matter.
You have no right to be able to engage in profit-seeking business and have your personal assets protected from any liability that might result from that activity. People take that basic, fundamental, fact completely for granted.
The corporate form and limited liability is a pure creature of state law designed to incentivize investment and building businesses. The state, the source of this privilege, thus has an automatic interest in any corporate activity, especially activity by corporate officers that might undermine the legitimate function of the corporation.
Any time you are selling or dealing with securities you need to be working closely with your lawyers.
From what I understand, Zuckerberg showed disregard to FB's board when going through this process, and it looks like Instagram's founders acted in the same manner. Sounds like they just sat around and hammered out a deal on a personal level.
That can't be the case. You have to have your board as well as lawyers involved because you could be breaking securities laws as well as breaching your fiduciary duty as a corporate director.
Generally speaking, 5% of the company's (and below) is not considered 'material' in common usage. But, self-dealing issue is another matter. Nearly any amount of compensation is likely to be material relative to the salary of the Instagram CEO (for example), and in any event self-dealing is a more of a bright-line test (unjust enrichement).
This is a slight side issue, but this section really struck me as interesting:
"Facebook has tangled with regulators before. What it does with its customers’ data attracted the attention of the F.T.C., which accused it last year of 'unfair and deceptive' practices. The agency’s settlement with the company required Facebook to submit to privacy audits for 20 years."
It reminded me a lot if that scene in Ghostbusters where the regulators showed up to inspect the facility and clearly had no idea what was going on, even though they had suspicions of something nefarious. With such a complex, proprietary system like Facebook I just can't see the efficacy of external security audits. Kind of scary territory.
An auditor is faced with a massive system of data collection that no one person in the world could possibly understand without having written it themselves. They can only go by the information the company gives them, which is obviously not trustworthy. I'm not saying that Facebook has done anything wrong, but if they had, an external audit wouldn't have a hope of finding it.
It's absurd that the State of California has any say in this private matter in the first place. This inquiry was not even based on an antitrust issue (which California has no right to contest anyways on a state level). This is simply the state government sticking its nose where it doesn't belong.
The state fairness hearings are there to represent the interests of the investors in a privately funded company.
Lets create a hypothetical example, you are an 'angel' investor and you invest in a company "WunderKund Inc". In exchange for your investment you get 10 or 15% of the company interest, now lets say WunderKund grows rapidly, they really hit a niche, maybe they have a series A, and people start to express an interest in acquisition. The angel investor is perhaps diluted down to 1 - 2% of the preferred stock, and maybe its one of those deals where the founders still have control of the preferred. Now along comes a buddy of one of the founders and says "Hey, awesome how about we make you rich, and you can come to work with me!?" and its awesome and all but there is this other less awesome company saying "Hey we really want to acquire you we'll pay what ever it takes..."
Now as the Angel Investor your interest is getting as good a return as possible on your investment because you know that only 1 out of 100 of your investments will pay off. How do you prevent the founders from making a sweet heart deal ("under market") with their buddy that makes them rich enough, and leaves a bunch of money from the other guys on the table that would have added to your return? If you are making less than full value that is one thing, but what if you're getting completely frozen out because the "sweet heart" company is offering very little cash or stock but big earn out bonuses for the founders if they stay on at BigCorp?
There are lots of ways that you can structure a deal that benefits one party more than the others and this commission was created to mitigate the damage done by unscrupulous business people.
There are many ways many people can get screwed in business deals but usually it is up to the injured party to show injury and file a claim of some sort. It is very unusual in the US justice system to have a state agency do an independent investigation of a business deal to protect the interests of particular investors. Government agencies are supposed to protect the interests of the public at large.
I would be very interested to know what the procedural background here is. (Unfortunately, this hit piece of an article does not go into detail about this).
> It is very unusual in the US justice system to have a state agency do an independent investigation of a business deal to protect the interests of particular investors.
Quite the contrary. In the United States, states watch dealings like a hawk and legal opinion is that states hold the line on antitrust and other anticompetitive corporate governance issues. Federal invention is seen as supplementary here. California v. ARC America Corp. (1989), at 490 U. S. 102[1]:
> Congress intended the federal antitrust laws to supplement, not displace, state antitrust remedies.
(IANAL, etc.) I'm curious. Why do you consider this article a hit piece?
If this was an antitrust investigation it might make sense. But nothing here indicates this is an antitrust investigation. First, the Attorney General of California is supposed to handle antitrust, not the Dept of Corporations. Second, to the best of my understanding, California antitrust law does not provide for the government to block mergers and acquisitions. Third, whether or what other offers Instagram received is not really relevant for an antitrust investigation.
This seems to be an investigation as to whether Instagram screwed their investors by taking a low ball offer. And I am curious why the state is investigating this to begin with.
Honestly the much more powerful effect to check that an entrepreneur is acting in an investor's interest is the entrepreneur's reputation. It counts for a lot here in Silicon Valley.
The compliance requirements are effectively a tax on acquisitions. We're only better off with this tax if it prevents more damage than it costs to enforce. The enforcement cost is not just on everyone's time, but it also effectively restricts their available decisions in unanticipated ways (for example wanting to ensure that there's appearance of compliance with the law). It's clearly costing Instagram/Facebook to comply, can anyone point to a case where having this regulation helped/would have helped an investor and therefore was a good thing?
I don't know why, but it seems like there's a pro-bureaucracy mindset on HN. People seem to be supportive of rules as long as there's a coherent reason for them without questioning if the rule is a net negative. Can someone explain this to me?
Nothing that happens to a corporation is a "private matter." Any time you do business in corporate form, you are taking advantage of certain privileges (namely limited liability) extended by the state. The State of California has an interest in any activity that affects its corporations. As Facebook and Instagram, as California corporations, derive their very existence from California law, this interest is much more specific than the general interest the state has in economic activity within its borders.
Agree. This is nonsense. Furthermore, according to the article Systrom said they had not received any formal offers, which is confirmed by the Twitter sources. "Verbal offers" don't count. They cannot be binding, because an offer to buy a company must be quite detailed. A term sheet is a formal offer. However, if one is "given" without a signature and by a person without formal authority to make an offer, it also doesn't mean anything.
Verbal offers do count, regardless of whether the person handing the term sheet over had authority, Instagram was required to act in the reasonable interest of investors and find out if the offer had teeth. Avoiding "formal offers" by evading "formal authority" is rather obviously not in investor interest.
This is most certainly not nonsense if true, though it is a bit ridiculous given the windfall for investors.
If you have ever been a major shareholder in a company, you would understand - not considering legitimate offers for acquisition is a major no-no and violates the most important responsibilities of a the corporate stewards.
I was and I do. My company (I was the CEO and single founder) was acquired by LinkedIn. However, "verbal offers" are very tenuous ground. You'd have to prove that the offer was believable, and that finding out was not a waste of time. Also, nobody said that he avoided a formal offer. Who knows who was the person who (allegedly) was handing a term sheet.
By the way, a term sheet is usually first sent over email, as it will be redlined several times before anyone signs it. As the CEO of a startup, a printed term sheet without the corresponding email trail would be very suspect.
And that's why there is an investigation, not a trial. There is probably some indication of wrongdoing but insufficient evidence for prosecution. A verbal offer may be difficult to prove, but far from impossible if there were witnesses or some sort of trail.
Nobody has said there is proof of anything, but the government has grounds for suspicion. That is all. Presumably an investigation is warranted.
In California verbal offers can be considered binding when made by an authorized representative. This has been litigated both with respect to the entertainment industry and the high tech industry.
Presumably Facebook at that point in time, is a business incorporated by the State of California. I don't know of any national corporation process.
It's not clear to me (and I am certainly not a lawyer) that the protection of investors and the protection of taxpayers at that stage of the company falls to the SEC and not at all to the state regulators of the state that incorporated the company.
The investors should be savvy enough to protect themselves. And protecting the taxpayers? What? The state is going to poke its head into every company and review your operations to make sure you'll be profitable enough to pay lots of taxes?
The investors should be savvy enough to protect themselves.
As others have pointed out, please remember what an extraordinarily weird thing the modern corporation is. In older conceptions of how to run a business, investors had the right to hold the directors personally liable for losses. Now, we have a system which largely removes that; in exchange for removing that check, others must be instituted, and a higher level of scrutiny (since a person who is not responsible for losses arguably has less incentive to avoid losses) is entirely appropriate. Since this privilege of freedom from liability is a creation of the state government, it is appropriate that the state government is actively involved in the oversight.
I am neither lawyer nor accountant so what do I know. I can believe that the various ways the sale of Instagram is structured and to whom can have huge tax differences. But I don't know.
If Twitter was prepared to make a higher offer, why didn't they? There was nothing stopping them from making a pre-emptive offer. It's not Instagram's responsibility to beg for a higher offer from Twitter, especially with a higher, time-sensitive offer on the table from Facebook.
Nick Bilton is among the most respected journalists, but he's written some really questionable articles lately.
> If Twitter was prepared to make a higher offer, why didn't they?
Why should they? They have a fiduciary duty to get Instagram for as low a price as possible; nothing about 'begging', they weren't even told about the higher time-sensitive offer (which are just two parts of the price to be negotiated...). They were told Instagram didn't want to sell at all, which is more than a little bit different from 'we think FB will pay more, do you disagree?'.
> The people familiar with the negotiations said Twitter executives were shocked that they had not been given an opportunity to present a counteroffer. They said Twitter was prepared to make higher offers.
Twitter had their chance. They offered roughly 50% less than Facebook, and without a liquid currency to boot. Apparently, they weren't even in the ballpark. It wasn't Instagram's responsibility to negotiate with Twitter given the relative disparity between the offers. If they chose not to take Facebook's offer, and hold out for Twitter to increase their offer by 100%, again, without it even being a liquid offer, they would have run the risk of Facebook walking away and being completely at the mercy of Twitter.
As you pointed out, time is part of a deal - and so Instagram could easily have said 'we close in a week with FB, offer more than their billion and liquidity in that time with a high penalty fee or forever hold your peace'. They didn't.
Not a fan of Instagram, and I think FB purchase was stupid, but still, it is a private dealing between two companies. Even if there were thousands other offers, they can choose the one that they prefer. Moreover, it's not only money, when choosing such an offer.
The board and executives work for the shareholders. They are required to maximize shareholder value, and taking a lower offer for personal gain is illegal. That is the concern here.
That said, it's hard to have sympathy for investors in a company that flipped for $750M in under two years.
I have a problem with your second statement. Why is it hard for you?? Why does the timing have anything to do? If anything, apploud to Mr. Systrom for building a service that attracted millions in such a short period of time. Every one of us trying to build a startup would love to have the same exit.
Instagram's investors have partial ownership of the company and presumably that comes with voting rights. If the founders hid other offers and presented only Facebook's offer to the investors because Facebook secretly offered more personal gain to the founders, then that would be fraud. The founders would be deceiving and effectively stealing from their own shareholders.
When a company recieves offers, the founders don't get to just pick and choose which offers they want to present to the board for a vote.
Agreed, if that is the case it is a fraud. If there was an official offer and they hide it, it is fraud. Every shareholder has the right to choose.
However, what I also meant is that in the article they talk only about the money side, there is no mention what else was on the table. For example, may be the strategy that Instagram is interested in is closer to that of Facebook than to the one of Twitter. Or maybe something completely different. We don't have the full picture.
"When he was handed the term sheet by a Twitter employee, a nonbinding document outlining the terms of a proposed acquisition, he read it and then handed it back, asking Twitter executives to hold on to it over the weekend as he weighed the details, those people said."
Anyone with legal insight comment on the idea behind these two maneuvers(meeting at restaurants and handing back termsheet)? If it has legal basis, why would twitter accept such terms?
They typically meet at restaurants (or a lot of times, hotel rooms) to discuss deals/potential deals, as being in the HQ can scare employees (who may not be comfortable with selling). It's much easier to get recognized in the HQ of a tech company, than a restaurant. And meeting in a HQ and going behind closed doors can make it seemed like somethings going on, where if they were caught in a restaurant, it could just be the typical M&A relationship building.
So what happens if it's determined that Mr. Systrom did lie under oath? Does he face criminal charges, is Facebook fined, or what? I assume it's too late to split up the companies again.
I don't know what implications it has for Facebook but lying under oath is perjury, which is a felony in California. Convicting someone of perjury is notoriously difficult though.
"It is possible investors would have been better off selling in an open auction, to Twitter or even to Google or Microsoft."
Really? This is not the sale of a Picasso painting. I believe there is always risk of putting off potential buyers, and you might not get the highest bid by optimizing the process down to the last detail. You might as well close it while you can. I believe the founders did the right thing.
Not specifically re Instagram but in general -- yep -- I have seen certain buyers walk from acquisition discussions when a process opened up. It's a tricky process, and the devil's in the details.
Good findings; can't wait to see how this all ends.
As I pointed before to this article [1], Andreessen and Sequioia Capital have/had closer relationship with Facebook than they do with Twitter. Won't be surpised if some "sentiment" in regards to who represents who, interfiered with the purchase.
And CCD has very good business sniffing into this kind of stuff. After all, lower price = lower taxes. Lower taxes = less for CCD and other Gov entities.
Please don't toss around casual aspersions like that. First, any behavior like that would be contrary to our obligations to our investors. Second, we were properly excluded from knowledge of the transaction due to conflict of interest.
Can someone explain why this department is doing that? It wasn't a publicly traded company or anything. I'm assuming that Instagram had a board which included seats to represent the VC's, which would have been involved in the various deals.
Are the VC's behind this, alleging that Kevin Systrom kept board members in the dark about a possible Twitter acquisition? Or are people who invest in the VC's behind this, alleging that the VC's betrayed a kind of fiduciary obligation or something? Is the state of CA an investor in the VC's?
The article seems so short on details.