Facebook and its pre-IPO $1 billion Instagram acquisition is similar in size to the Ponzi schemes of Bernie Madoff. A quick review of the Instagram deal raises serious questions about the “independence” of the Facebook Board of Directors and their level of commitment to the Business Judgement Rule’s “disinterestedness” requirement for an ethically run board. It also raises concerns about their integrity and fair dealing; including parties with whom they have been judged to have infringed (Leader Technologies). Facebook S-1, p. 99, paragraph 3 (“each of these directors is ‘independent’”).
Fig. 1 – Patent infringement, inequitable conduct, material nondisclosure, breach of fiduciary duty, related party transactions and duties to former clients are just a few of the serious questions raised by the $1 billion Instagram deal that cashes out Facebook insiders with borrowed money before an IPO.
1. Andreessen & Thiel fingerprints are all over both sides of the Instagram transaction?
Yes, this is the very same Marc Andreessen whose social networking patents, (filed by Fenwick & West, Leader Technologies’ former attorney and Facebook’s current attorney), disclosed Leader’s U.S. Patent No. 7,139,761 as a “prior art” reference. However, Fenwick did not disclose it in subsequent patents filed by Facebook—thus raising the very real specter of “inequitable conduct” which could invalidate many of Facebook’s patents. See previous posts here and here.
Fenwick: “Is this wrong?”
Would Judge Strine’s opinion (see Fig. 4.) about Fenwick’s conduct as Leader’s former counsel and Facebook’s current counsel drip with as much sarcasm as he just leveled at Goldman Sachs six weeks ago?
1. Duties to Former Clients? Fenwick & West was the attorney for Leader Technologies in 2002—the pivotal period that Facebook contested in Leader’s patent infringement lawsuit Leader v. Facebook, 08-cv-862 (D.Del 2008). They sought no conflicts waiver.
2. Inequitable Conduct? Fenwick & West listed Leader Technologies’ US Pat. No. 7,139,761 as related-technology “prior art” references on two Marc Andreessen social networking US Pat. Nos. 7,756,945 and 7,603,352, yet never disclosed Leader’s patent in any Facebook filings.
3. Material Nondisclosure? Fenwick & West makes no mention in the S-1 of the Leader v. Facebook lawsuit that was just heard on March 5, 2012 in Washington D.C. at the Federal Circuit Court of Appeals—the second highest court in the land. The result of this case could result in billions of dollars in damages paid to Leader, and even an injunction (shut down Facebook?). Fenwick evidently does not consider such risks as material.
4. Breach of Fiduciary Duty? Ironically, Fenwick & West were the attorneys responsible for the Facebook purchase of Instagram. No wonder the deal took only 54 hours to complete over a holiday weekend! There weren’t any members of the deal who didn’t have a vested interest in making it happen! Since Facebook has been judged to be “literally infringing” 11 of 11 Leader patent claims, and in my opinion, argued a pretty flimsy case on appeal; shouldn’t Fenwick now reconsider their fiduciary responsibility to properly handle funds that may ultimately belong to their former client, Leader Technologies?
5. Related Party Transaction? Fenwick & West attorney, Greg Roussel, was quoted in a Bloomberg Businessweek article talking about the ease of operation in the Facebook-Instagram deal.
Fig. 3 – Even our children know that school sports referees cannot make bets on games they call. Why not the adults involved in Facebook? Oh yes, the M-O-N-E-Y. Source: Donna Kline Now!
2. Company directors are duty-bound to avoid conflicts of interest
According to Facebook’s S-1, Marc Andreessen and Peter Thiel are directors and comprise 2/3rds of the Audit Committee. So why are their fingerprints all over the Instagram side of this transaction? As both men are members of the Audit Committee, and Andreessen is a member of the Governance Committee, their responsibilities include:
“reviewing related party transactions”
“reviewing proposed waivers of the code of conduct”
—Facebook S-1, p.100.
WHAT?!?! “Related party transaction” means the party stands to benefit on the other side of a transaction. For example, you own stock in Company A that is looking to get a contract/deal from Company B. However, you are also involved in the hiring decisions at Company B. Often in such situations the person would “recuse” himself, or in other words, step away and not be involved in that decision. Did Thiel and Andreessen and James Breyer do that with the Instagram transaction? Did the replacement committee ask the tough questions about valuation and advisability of the transaction? Hm. Doubtful.
Goldman: “Was that wrong?”
Just last month Facebook’s IPO advisor Goldman Sachs was smacked down in Delaware Chancery Court for “disturbing behavior.” Judge Strine described Goldman’s conduct as “tainted with disloyalty.” They made secret arrangements with the CEO of the selling company for fees on the seller side while also holding stock in the buyer side company. Their attempt at addressing the conflict by bringing in Morgan Stanley was exposed as a charade since Morgan only received fees IF the transaction went through! In other words, their vested interest was in following Goldman’s wishes.
While the court did not grant the injunction for other legal reasons, it concluded that Goldman "concealed" motives and financial interests. Judge Strine said Morgan Stanley gave “questionable” valuation advice. His opinion dripped with sarcasm—citing Emerson and doubting Goldman’s capacity to serve the client while simultaneously maybe pocketing "billions" as a stockholder in the buying company.
Fig. 4 – In re El Paso Corporation Shareholder Litigation, C.A. No. 6949-CS, Del. Ch. Feb. 29, 2012). Source: Donna Kline Now!
3. Facebook is a “Controlled Company” . . . or not?
The S-1 on page 99 says that Facebook is a “Controlled Company” where Mark Zuckerberg makes all the decisions and where “we are not required to have a majority of our board of directors be independent.” However, in the next section titled “Board Committees” the S-1 describes normal and customary organization of board committees, namely audit, compensation and governance. Notably, in the prior section titled “Director Independence” Facebook describes their board of directors as “independent.”
Which is it? “Not required to be independent” or “independent.” The S-1 says both. Hmmmm.
The S-1 says that “Mr. Zuckerberg will be able to effectively control all matters submitted to the stockholders for a vote, as well as the overall management and direction of the company.” Of course no-experience Mark Zuckerberg is directing these deals and acquisitions himself. N-O-T.
4. Andreessen and Thiel are 2 of the 3 votes on Facebook’s Audit Committee!
Good corporate governance requires that Andreessen and Thiel (being a majority of the 3-person Audit Committee) should have recused themselves from this transaction completely. They used borrowed money to make this purchase, so presumably Facebook had fiduciary requirements in the spending decisions. If they did, do they owe the public a duty of disclosure to reveal the decision-making process and valuation models on which this transaction was based?
5. Here’s what happened in the Instagram deal. It would make Harry Houdini proud.
Step 1. Facebook takes down a $3 billion line of credit in March 2012.
Step 2. A month later Facebook acquires Instagram; a company with no revenue and no patents for $1 billion; presumably with the approval of directors Marc Andreessen, Peter Thiel, James Breyer (Accel Partners) and Mark Zuckerberg. Are these directors striving to show their commitment to transparent corporate governance for a public company? Or, are they attempting to sneak another large transaction by the SEC and the public before the IPO—that way, there are fewer disclosures for the muppets to gnaw on? What do you think? Meep. Meep.
Step 3. The Instagram beneficiaries include Andreessen & Thiel—multiple times!!!
- Marc Andreessen, investor in Instagram
- Benchmark Capital, investor in Instagram,; Marc Andreessen & Matt Cohler, principals
- Sequioia Capital, investor in Instagram; investor in Peter Thiel deals, incl. PayPal, LinkedIn
Step 4. The Matt Cohler Outlier. Matt Cohler, who is at Instagram of late, is tangled in a web of conflicting relationships with practically all the players on both sides of this transaction including Mark Zuckerberg, Peter Thiel (former Facebook bud), Marc Andreessen (current partner, former Facebook bud), Reid Hoffman (former Facebook bud), Benchmark Capital (a current partner), Sequouia Capital (bud of buds), Facebook (former VP), Dustin Moskowitz (former Facebook bud), Adam D’Angelo (former Facebook bud), PayPal (Peter Thiel’s & Reid Hoffman’s former company) and LinkedIn (“right-hand man” to Reid Hoffman).
- LinkedIn, former Peter Thiel, Reid Hoffman employee; Facebook investors
- Facebook, former VP, Zuckerberg employee,; spurned Mark Zuckerberg confidante
- Benchmark Capital, Instagram investor; Marc Andreessen, partner
6. Goldman Sachs smacked down on Feb. 29, 2012 by Judge Strine for dumbfounding conflicts of interest also involving $ billions in Goldman who advised the buyer and the seller and had holdings in the target. Goldman has major holdings in Facebook, is leading the IPO with JP Morgan (also fingered by the judge), collaborates with Fenwick & West.
Fig. 5 – Francis Pileggi and Kevin Brady of Eckert Seamans discuss a recent decision by the Delaware Court of Chancery in In Re El Paso Corporation Shareholder Litigation, which they wrote about in depth on the Delaware Corporate and Commercial Litigation Blog.
Francis Pileggi describes the conflicts of interest that existed in the case, including several on the part of Goldman Sachs, which served as financial adviser to both parties, and the court’s decision to to deny the injunction and allow the El Paso shareholders to determine the adequacy of the price offered by Kinder Morgan despite the existence of those conflicts. Source: YouTube
7. Did Andreessen (on the Governance Committee) waive the “code of conduct” for himself and Peter Thiel on the Audit Committee?
Hm. Let’s think about how this (hypothetical) conversation transpired.
|From the Desk of Marc Andreessen|
|Instagram Due Diligence|
|Andreessen:||"Marc, would you be interested in buying your own company, Instagram?"|
|Andreessen:||"How could I do that?"|
|Andreessen:||"How about you borrow money from an outside source for the transaction?"|
|Andreessen:||"Then, when the cash is raised from the IPO, you could pay off the loan."|
|Andreessen:||"Even better idea, Marc—that way the muppet public investor would be the ones to finance the operation!"|
|Andreessen:||"Right. Now how do we get this by the Audit Committee?"|
|Andreessen:||"Hello? You are on the Committee. Peter Thiel is on the Committee, too, and a bunch of his close friends are invested in Instagram. Why would he mind?"|
|Andreessen:||"How about the Governance Committee?"|
|Andreessen:||"Ding Dong. You are on the Governance Committee."|
|Andreessen:||"Fantastic news. I bet we could do this multiple times before the IPO."|
|Andreessen:||"Absolutely. And the best part is that we govern ourselves. Bwaah hahaha!!"|
Table 1 – Marc Andreessen’s hypothetical due diligence conversation with himself for the $1 billion Instagram deal. Drawing: EduBlogs.
Apparently. Meep, meep.
8. Hush money? IPO stock purchase money? Ponzi scheme? All of the above?
Instagram’s Matt Cohler had a falling out with Zuckerberg in 2008 after being with him from at least May 2004 (after the infringement of Leader Technologies’ patent had already begun). He was there when Stephen Dawson Haggarty was hired to implement the “groups functionality” that propelled Facebook’s popularity (the same month Leader’s patent first published at the USPTO describing the groups invention) (Click here for more on this). I blog about this here and here.
What does Cohler know that the Zuck does not want to be revealed about those formative years? Does he have information that would help Leader Technologies prove willful infringement (which could triple the patent infringement damages award)? Oh, I forgot. This is not a material risk either. Meep, meep.
9. $1 billion price tag hiding big secrets?
Auditors and analysts should ask Mark Cohler if he is hiding what would otherwise be a material disclosure. They should ask him if he believes the $1 billion valuation was justified, and if so, what model was used? For Facebook to pay $1 billion for a company with no revenue, no patents, and a short operating history can only mean one thing: the players are hoping to keep us muppets in the dark about what is really going on. As I wrote in my previous post, this is nothing short of arrogant recklessness.
Being forewarned is forearmed. R-U-N.
- Good Governance graphic. ESCAP. Accessed Apr. 12, 2012.
- Harry Houdini. “The Right Way To Wrong – An Expose of Successful Criminals.” Harry Houdini, 1906: Boston. Accessed Apr. 12, 2012.
- Ponzi Scheme cartoon. CartoonStock.com. Accessed Apr. 12, 2012.
- I Lost Lost My Other Shirt In A Ponzi Scheme. Wall Street Law. Accessed Apr. 12, 2012.
- Fenwick & West LLP logo. Fenwick & West LLP. Accessed Apr. 14, 2012.
- Goldman Sach logo. Goldman Sachs. Accessed Apr. 14, 2012.
- Bernie Madoff photo. Time. Accessed Apr. 17, 2012.
- Matt Cohler photo. Time. Accessed Apr. 17, 2012.
- Marc Andreessen photo #1. The Telegraph (UK). Accessed Apr. 17, 2012.
- Peter Thiel photo #1. Jin Lee/Bloomberg, Tabish.me. Accessed Apr. 17, 2012.
- Peter Thiel photo #2. Valleywag. Accessed Apr. 17, 2012.
- Mark Zuckerberg photo. SickFacebook.com. Accessed Apr. 17, 2012.
- James W. Breyer photo. Beta Beat. Accessed Apr. 17, 2012.
- Marc Andreessen photo #2. The Business Insider. Accessed Apr. 14, 2012.
- Sneaky-Slick Smiley Face. Ownership unknown. Accessed Apr. 14, 2012.
- Let’s Make a Deal Door graphic. Electiondebates.com. Accessed Apr. 17, 2012.
- Francis Pileggi summary of In Re El Paso Corporation Shareholder Litigation. YouTube. Access Apr. 14, 2012.
- Marc Andreessen photo #3. Charlie Rose. Access Apr. 14, 2012.
- ClustrMaps. ClustrMaps.com. Accessed Apr. 14, 2012.
- Beaker from the Muppets. The Muppets are believed to be owned by The Walt Disney Company. Accessed Apr. 14, 2012.
- Devil drawing. Mobypicture.com. Accessed Apr. 14, 2012.
- Good vs. Evil drawing. EduBlogs. Accessed Apr. 14, 2012.
- Bernie Madoff Ponzi Scheme. Mike Luckovich, Atlanta Journal Constitution. Accessed Apr. 14, 2012.
- Honesty cartoon. Boston Catholic Insider. Accessed Apr. 14, 2012.
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