Facebook implemented a new policy against insider stock trading last Friday. The point is to keep employees with stock to sell from getting in legal trouble, according to a source familiar with the matter.
It comes at a time when Facebook’s valuation is climbing fast, based off of strong user and revenue growth. The secondary market for Facebook shares, including private market sites and brokers, is seeing sale prices go up as well.
The US Securities and Exchange Commission requires that stock buyers and sellers have access to the same information about the value of the stock. The rationale is that both parties need to be able to make independent and informed judgments about the value of the stock in order for them to be confident in the overall market. But this usually applies to public companies. How the SEC decides to enforce its rules for private-market stock sales is not clear.
If employees don’t provide buyers with relevant but non-public information about the value of the shares, they are potentially falling under the SEC’s definition of “illegal insider trading.” But if they do provide this information to the buyer, they are violating their Facebook employee confidentiality agreement.
The company statement on the matter: “Facebook has implemented an insider trading policy to better comply with insider trading laws and to protect the interests of the company and its employees and shareholders.”
Facebook On the Private Market
The result here is that increasingly hot private market for Facebook shares may see a decrease in supply as a result, although some stock will likely still be coming available. Although private stock valuations are based on what investors think Facebook could be worth in the long-term, perhaps a decrease will drive the amount people are actually willing to pay even higher? Some stock could continue to come on to the market, in any case, as former employees may be looking to sell. The company could also arrange for special circumstances where employees would be able to sell. It essentially did this with Russian media investor Digital Sky Technologies last year. Employees and then former employees got the ability to sell it a portion of their stock at a predetermined price.
Note that this rule only applies to current employees with options. Former employees aren’t obligated to follow current Facebook policies, of course, although they should talk to a lawyer before selling. It’s possible that even if they left years ago, they could get in trouble with Facebook (or the SEC) for disclosing (or not disclosing) private information to buyers. The other thing is that Facebook switched from issuing options to employees back in 2007. Instead, it began giving them “restricted stock units,” or RSUs.
Options vest on pre-defined schedules at pre-set prices, and allow holders to buy stock with them at the original price, then sell this stock at the current market value price. Assuming the value of the stock has gone up, the difference between the original price and current price is the profit that a holder makes. RSUs, on the other hand, are grants saying that employees will get a certain amount of stock (or cash equivalent) at a later date, like when an initial public offering happens — and what most Facebook employees have. Only a small number of employees have options, or both options and RSUs.
All this said, former employees with stock to sell should go talk to a lawyer before proceeding. It’s unclear how the SEC, or Facebook for that matter, would consider these people as still having access to relevant but confidential information. So the legal issues could be the same as for current employees with options.
Another angle here is that Facebook could also be trying to limit its total number of stock shareholders. The SEC requires that private companies have beneath 500 of them; options and RSU holders are not counted in this tally. Law.com, which broke the news about the new Facebook policy earlier today, talked to a few outside lawyers who suggested this possibility. However, our source tells us that the number of Facebook shareholders is “well below” 500, and if it was concerned about the issue, it would use another mechanism to control share numbers, the first right of first refusal clause. Facebook, like many other companies, retains the right to directly purchase or otherwise arrange the purchase of stock if a current or former employee is looking to sell.