The Investment Scientist

Facebook Scam Hits Close to Home

Posted on: May 14, 2012

Facebook Scam

Facebook Scam

Two months ago, I got a call from client of mine, who asked my opinion about an opportunity to invest in pre-IPO Facebook shares. He explained that he and his business partner were offered the opportunity to invest in a private fund that will hold Facebook shares.

I know nothing about these funds, but I told my client to stay away. As a general principle, I always steer my clients away from private funds unless they run the funds themselves. The reason is very simple: these are unregulated vehicles where there is no government oversight and there is no transparency whatever. You don’t know what monkey business they do with your money. Most business people intuitively grasp that if the private deal is about starting a restaurant; but once the deal is about buying Facebook shares, many of them throw caution to the wind.

The Reformed Broker has a great piece explaining what’s going on behind the scenes, and it confirms my suspicion:

… their clients aren’t actually getting pre-IPO shares. What they’re getting instead is shares in a fund that may or may not hold a good amount of these shares. The funds are loaded with all kinds of contingencies and miscellaneous fees and caveats. They are also able to do whatever they want with the money raised, including taking shots on other venture deals that sound social media-y enough to qualify. The PPMs (private placement memorandums) are written so as to protect the firm from everything and anything that could go wrong (and it will all go wrong). The money is being held in escrow and the clients are signing their lives away.

The bottom line is, as we race toward the Facebook IPO, the brokerages are out in full force this week and next, milking this cow with both fists until its udders squirt blood. They are pounding the phones from morning til night, taking breaks only to smoke butts and holler at girls on Broad Street. Then it’s right back upstairs looking for the next Midwestern farmer to call with this deal. … And when it melts down and the customer complaints start rolling in, the principals of the firms will lawyer up and claim that everything was “fully disclosed” and that the buyers were “accredited investors”  

I don’t recommend buying Facebook shares – that’s the subject of another post – but if you have a burning desire to buy them, at least get them at the open market when you will get the real deal.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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