Goldman Sachs Group Inc's decision to scale back a heavily publicized sale of shares in social network site Facebook shows how the bank risks losing its edge as financial regulation intensifies.

Goldman said on Monday that it will not sell Facebook shares to U.S. investors, because the intense media coverage surrounding the offering could run afoul of U.S. securities laws. The Wall Street bank is likely to face questions on the topic on Wednesday, when it posts fourth quarter results.

Regulators would have trouble arguing that Goldman deliberately planted media stories to promote their offering, especially given how secretive this deal was, lawyers said.

But even so, the U.S. Securities and Exchange Commission was looking into Goldman's handling of the deal, according to reports. After the bank settled with the SEC last July for $550 million for transactions linked to subprime mortgages, analysts and investors say Goldman is less likely to risk regulatory intervention.

Having the best lawyers money can buy is no longer sufficient. There's an increased recognition there of the significance that regulators and the public have in (Goldman bankers') lives, said Mike Holland, founder of Holland & Co, which oversees more than $4 billion of assets.

Goldman last week released a series of recommendations from an internal committee to change the way the firm does business, changes seen by some as superficial.

But the bank's handling of the Facebook deal shows that even if Goldman has tended to resist change, it may have little choice.

SEC scrutiny of Goldman's deal spooked people inside the company, a person briefed by a key employee said.

They're trying to stick well within the letter of the law, because they know this deal will face a lot of scrutiny, the person said.

In the near term, stronger regulatory oversight could pressure earnings, said Jeff Harte, an equity research analyst at boutique investment bank Sandler O'Neill. Goldman earlier this decade often generated return on equity, a measure of how much profit a bank can squeeze out of its net assets, of around 25 percent. In recent quarters, that figure has been in the low single digits.

Former Goldman employees called the bank's decision to back away from its plan to sell Facebook shares to domestic investors an embarrassment for the firm.

It's a client nightmare, to tell them they can buy a stake in a hot company, and then tell them they can't, one former managing director said.

Goldman planned to raise up to $1.5 billion for Facebook, the message board and social network that is one of the most widely visited sites on the web. Goldman also invested $450 million of its own funds in the company.

The question for Goldman Sachs is, how long will the caution persist. Some analysts believe it is temporary.

They're in the hot seat for the time being. That will fade away over the next year or so, as the pain from the financial collapse becomes less acute, said Sean Egan, principal at ratings agency Egan-Jones Ratings in Haverford, Pennsylvania.

But others are not quite so confident.

Banks are getting singled out now, and I'm not sure how soon that will go away, a hedge fund manager said.

(Reporting by Dan Wilchins; Editing by Phil Berlowitz)

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