The Securities and Exchange Commission (SEC) is said to be investigating secondary private equity trades in private companies like Facebook, a fast-growing phenomenon revealed in a ConsumerAffairs.com story last week.
Now, according to a report in The New York Times, the SEC "wants to learn more" about secondary stock trades in private companies like Facebook, LinkedIn, Twitter and Zynga. The Times article did not give any specifics as to the goal of the inquiry, but some legal experts say that one clear area relates to a federal law that establishes a limit for private companies of fewer than 500 shareholders.
Once a company has 500 shareholders, it must register its private shares with the S.E.C. and publicly disclose its financial results.
A secondary market in private equity has been around for a few years, as a subset of a larger market that focused mostly on buying and selling partnership interests in venture capital and private equity funds. Last year, however, a companies like SecondMarket.com and Sharespost.com brought what are called direct secondaries to the a new group of allegedly accredited investors. They launched an online marketplace where private company shares could be traded by either individuals or firms.
A spokesman for SecondMarket in an interview with Fortune.com says it hasn't received any request for information from the SEC, either formal or informal. Moreover, he claims to have apprised the New York Times reporter of that fact several days ago, and said he was "disappointed" to see it missing from the paper's final story.
The Times story, however, didn't specify that SecondMarket was one of the four firms to have received an SEC letter although it did imply as much when it said the Securities and Exchange Commission is asking questions about private stock markets like SecondMarket and SharesPost.
There are many different types of players in the direct secondary marketplace. Some, like SecondMarket, are registered broker-dealers. Others aren't. They farm out the broker-dealer duties to third parties and because there is no regulation of this market it isn't clear how the actual marketplaces are compensated.
Analysts say that this growing "shadow market" in the privately-held shares of Facebook could pressure the company into going public, even as its CEO Mark Zuckerberg denies he's even thinking about an initial public offering. Apparently it was similar pressure that helped push Microsoft and Google toward their own initial public offerings. And now that increased trading in Facebook, as well as in Twitter, Zynga and LinkedIn, has apparently caught the eye of the SEC, this pressure can only increase.
As we reported previously, Facebook has also tried to limit the number of employees selling shares by putting into an insider trading policy that bars current employees from selling stock. According to Sharespost.com, Facebook is now valued at $42.37 billion, more than tripling in value over the last 12 months.
The selling shareholders in these private companies are former employees and early-stage venture capital investors who are already sitting on huge profits. Buyers are wealthy speculators, many of them pooling their money into investment vehicles sponsored by Wall Street firms.
The one potential legal issue that keeps getting raised is whether the investment pools formed by a group of investors are a way to sidestep the 500-shareholder restrictions. Two years ago, former employees of Facebook approached SecondMarket about whether they could unload their stock on the alternative-investment marketplace. At the time, SecondMarket's trading platform allowed for the trading of illiquid assets like auction-rate securities but not private-company stock, so it declined.
But then Microsoft invested in Facebook which was then valued at $15 billion, and SecondMarket decided to take a second look. SecondMarket now runs an active private-company market, enabling more than 200 private-stock transactions worth about $359 million since launching the platform in early 2009. And Facebook now accounts for 40% of SecondMarket's trading volume.
