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The Reformed Broker

Facebook stock: the biggest Ponzi scheme in history?

Facebook stock had a meteoric rise and quick collapse that reeks of a scam. But is Facebook stock a Ponzi scheme? Not quite.

By Guest blogger / August 20, 2012

In this May 2012 file photo, television correspondent Sabrina Quagliozzi reports from inside the Nasdaq MarketSite in New York's Times Square. Facebook stock's quick collapse has some calling it a Ponzi scheme – a description that Brown argues isn't quite right.

Richard Drew/AP/File

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Bernie Madoff's ponzi scheme ran for multiple decades and was, at one time, estimated to encompass roughly $50 billion dollars - a record-breaker.  Underlying it was a legitimate business (broker-dealer, investment advisor, hedge fund) but the returns were faked and so was most of the activity.  I bring this up because I keep hearing a persistent undercurrent of furor about how "Facebook's IPO was the largest ponzi scheme of all time."  Upon researching all available definitions of the term, I believe that it was not.  But it took me awhile to get there, I admit.

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Joshua has been managing money for high net worth clients, charitable foundations, corporations and retirement plans for more than a decade.

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Facebook stock attained a valuation of almost $100 billion dollars and when it ran out of new investors (upon coming public), it's value promptly collapsed.  In half.  In an extremely short period of time (90 days).  Everything about that feels scam-my.  But a ponzi scheme?  Let's look at what that term actually means:

Investopedia:

"A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns for older investors by acquiring new investors. This scam actually yields the promised returns to earlier investors, as long as there are more new investors. These schemes usually collapse on themselves when the new investments stop."

Merriam-Webster:

"an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risk"

Business Dictionary:

"Scam in which gullible public is enticed with the promise of very high returns in a very short time, but is based on paying off the early 'investors' from the cash from (hopefully ever increasing number of) new 'investors.' The whole structure collapses when the cash outflow exceeds the cash inflow. The originators of the scheme, however, usually disappear with large sums a few days before the crash."

So far, all of this lines up almost perfectly - Facebook resembles these descriptions almost perfectly.  Early investors (venture financiers) being paid out an amazingly high rate upon the recruitment of new investors (the public in IPO day and in subsequent lockup expiries).  But there is one aspect of a traditional ponzi where Facebook differs drastically - there were never any promises made in terms of rates of return.

One of the classic features of a ponzi are the promises of a high payment to investors on an ongoing basis, which is the very reason why new investors must be recruited all the time.  Outside of the analysts' expectations from the underwriting banks, it would be hard to say that anyone from Facebook ever promised anyone anything.  In fact, the prospectus is even more loaded with warnings, risk factors and caveats than is usual for new issues.

The SEC's definition of the term "ponzi scheme" features this promised returns aspect rather prominently:

"A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity."

And so while Facebook's IPO (not the company - the stock offering itself) does truly resemble a ponzi scheme from almost every possible angle, there is one respect in which it is not one:  They never promised their investors anything, they never pretended there was a rate of return coming to anyone.

And so as disgusting and unforgivable as the whole episode was, the ponzi label seems not to stand up upon closer investigation.

The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here.To add or view a comment on a guest blog, please go to the blogger's own site by clicking on www.thereformedbroker.com.

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