U.S. securities regulators are looking at how investors trade shares in four privately held companies, according to reports, but the inquiry may broaden to the exchanges and trading platforms that facilitate these transactions, experts said.
The two main online trading platforms for private company shares, SecondMarket and SharesPost, have been growing fast. SecondMarket has closed on about $400 million of private company deals this year, up from $100 million last year. So far SharesPost has signed up about 39,000 registered members.
That fast growth could attract regulators who are concerned about whether these markets can be manipulated by insiders, said Robin Bergen, a partner at Cleary Gottlieb Steen & Hamilton.
The U.S. Securities and Exchange Commission could also look at the fees these companies are charging for linking up buyers and sellers, and how the trading sites ensure that buyers are eligible to purchase securities from private companies, said Alan Berkeley, a partner and securities regulatory lawyer at K&L Gates.
These companies "will be intensely scrutinized and will be the subject of SEC regulation before very long," Berkeley said.
The SEC may have an easier time with scrutinizing SecondMarket, because the trading platform is already registered with the SEC as a broker-dealer. "That would be a clear hook for the SEC," Bergen said.
Registration means that SecondMarket is subject to disclosure requirements and oversight by the SEC and the Financial Industry Regulatory Authority.
A report in the New York Times on Tuesday said the SEC has asked for information from parties involved in buying and selling the stock in four companies, including Facebook, Twitter, Zynga and LinkedIn.
An SEC spokesman declined to comment.
SecondMarket is a broker dealer and says it is fully compliant with all rules and regulations, while SharesPost — which is just an automated platform with a third party bank and escrow agent — is not required to.
"We welcome whatever examination that the SEC may undertake here," SharesPost CEO David Weir said, adding that his company has been talking to regulators since before its launch.
Every transaction that SecondMarket conducts is scrutinized by the SEC and FINRA, said Mark Murphy, a company spokesman. The SEC has not approached his company for information, Murphy said.
SecondMarket and SharesPost began linking buyers and sellers of private company shares in 2009. They allow employees of these companies to cash out of their shares, or venture capital firms to make an exit.
In order to be a buyer of stock on either platform, the investor must meet SEC requirements, including having sufficient net worth.
The SEC may look into whether SecondMarket and SharesPost are securities exchanges under the 1934 Act, which would require them to be regulated in the same way as the New York Stock Exchange.
Cleary Gottlieb's Bergen and K&L Gates' Berkeley have not been retained by any of the parties involved.
These platforms may in some ways be accelerating the level of transparency in the secondary market trading of private companies, as each transaction is recorded and documented, said Adam Oliveri, head of private company market at SecondMarket.
Still, trying to attain information about a stock on either platform poses some challenges for a new buyer. One tech investment banker who is not authorized to speak to the media told Reuters he signed up for SharesPost but found the market to be opaque.
As an example, the investment banker looked at the stock available for Twitter. "Someone is offering X number of shares at Y dollars. There could be 100 shares outstanding or there could be 100 billion shares outstanding; I don't know what their revenues are; I don't know what rights I have as a shareholder. How do I know what any of this stuff is? And that feels pretty bubbly when people want to exploit it so badly," he said.
SharesPost offers independent third party research, but the banker, who said he has a master's degree in business administration from Wharton, still did not know what these companies' shares are worth.
Although SharesPost and SecondMarket are ahead of their peers in terms of numbers of users and transactions, other firms that offer secondary market trading in private company stock include GATE Technologies.
As with SecondMarket, GATE immediately registered as a broker dealer and transfer agency with the SEC during its inception. "You are conducting a private placement... we elected early on not to dance around that issue," CEO Vince Molinari said.
Although Molinari said he applauds the creativity in trying to address a market opportunity, there needs to be a better way to regulate the market.
In an open letter that Molinari is drafting to the SEC, he identifies a number of loopholes including how private companies are finding ways to sustain their 500 shareholder headcount, often to the detriment of smaller shareholders. The company, for example, may charge high transfer fees to the seller, such as the employee, making a transaction more manageable for larger investors.
If a private company exceeds the 500 shareholder threshold, it is required to start filing as a public company with the SEC.
But for now, these trading platforms appear to be sitting tight. "Regulators are always looking to educate themselves about developments in new markets, whether it is new products or new fund structures,"
SecondMarket's Oliveri said. "Hopefully that never stops."
© 2021 Thomson/Reuters. All rights reserved.