By LIZ RAPPAPORT And JEAN EAGLESHAM, February 22, 2011
The Securities and Exchange Commission is investigating potential conflicts of interest in the fast-growing market for buying and selling shares of private companies such as Facebook Inc. and Twitter Inc.
The move is part of a broadening probe by the U.S. agency, still at an early stage, of the thriving bazaar that has sprung up largely beyond the reach of regulators and traditional securities firms. Trades handled by SecondMarket Inc., SharesPost Inc. and other market makers specializing in privately held shares are conveying eye-popping valuations on some companies while disclosing little about their financial results.
* J.P Morgan Plans New-Media Fund (02/14/2011)
* Twitter as Tech Bubble Barometer (02/10/2011)
* Goldman Flooded With Facebook Offers (01/06/2011)
* SEC Probes Private Trades In Facebook, Other Firms (12/29/2010)
* Hot Trade in Private Shares of Facebook (12/28/201)
Such market makers connect holders of private-company stock, often former employees, with potential buyers. But SEC officials are concerned that the middleman role could cause conflicts of interest, especially given the challenges of ascribing a fair value to privately traded shares, according to a person familiar with the situation.
SEC officials also believe some of the firms promoting stock-trading in private companies should be registered as broker-dealer operations but aren't, according to people familiar with the matter. Licensed securities firms are subject to oversight and inspection by the Financial Industry Regulatory Authority and the SEC.
The probe began in late 2010 and gained speed after Goldman Sachs Group Inc. struck a deal with Facebook allowing the Wall Street giant's non-U.S. clients to buy $1.5 billion worth of stock in the social-networking company.
The controversial deal was the catalyst for a continuing SEC review about whether disclosure rules for privately held firms need to be rewritten. The rules require firms with at least 500 shareholders of record in a given type of stock to publicly disclose certain financial information.
"This marketplace is like the early days of the 'junk'-bond market, where companies are finding creative avenues to raise capital," said Lou Kerner, a social-media analyst at Wedbush Securities Inc. The junk-bond market allowed start-up firms with thin track records to tap the capital markets, but it encountered growing pains that included scandals in the late 1990s.
SecondMarket and SharesPost have been communicating with the SEC about their business models and recent transactions, according to people familiar with the matter. They have told agency officials their operations include numerous safeguards for investors, including compliance departments. Investors using their operations are knowledgeable and do their own due diligence, the exchanges also have told the SEC.
SecondMarket already is regulated as a broker-dealer operation. In contrast, SharesPost isn't a licensed securities firm but doesn't need to be, said the company's chief executive, David Weir. He described the firm as an "information portal" that makes money from fees it charges investors or buyers. Its "transaction specialists" collect sales commissions from sellers for helping buyers and sellers agree on a price and sign contracts agreeing to a sale.
"We go to great lengths to provide our members with as much context as possible so they can make informed investment decisions," said Mr. Weir.
A SecondMarket spokesman said the company's "role is to be an objective intermediary." He added that SecondMarket doesn't "do any proprietary investing in our markets or create funds and act as a buyer because we want buyers and sellers to know we are always agnostic in these trades."
The SharesPost specialists are licensed brokers at an affiliated company, Emerson Equity LLC, based in San Mateo, Calif. Shares Post specialists collect a transaction fee of 2% to 5%. Valuations of private-company shares on its website are based on contracts signed using the brokers. SharesPost doesn't disclose the number of contracts that lead to completed transactions.
SecondMarket said it has more than 35,000 members and has completed more than $500 million worth of transactions since April 2009. The company said it works closely to match private companies where shares are for sale with would-be buyers, who must be approved by SecondMarket. A broker helps the two sides meet at a price, with the exchange processing the paperwork needed for the shares to change hands. SecondMarket also sells some shares through an auction.
The private-share exchanges, which also include newer entrants Xpert Financial and GATE Technologies, have shown little interest in making a market in mature, nontechnology companies such as Levi Strauss & Co. or candy maker Mars. Those closely held firms often have access to capital through the corporate debt markets.
"We need transparency in this marketplace," said Vincent Molinari, founder and CEO at GATE Technologies, adding that his firm provides reams of outside research and offers buyers and sellers as much transparency as possible about every trade. "We need the same monitoring and tool sets that the institutional marketplace has come to rely on for credibility and trust. This market is getting bigger, stronger and faster."
Thomas Foley, founder and chief executive at Xpert Financial, said his firm works closely with companies whose shares transact on its system and that it provides investors with companies' audited financials and presentations from management teams. "This market is in its infancy," said Mr. Foley, adding he feels it is important that there is robust regulation and oversight.
On Friday, SharesPost said Facebook was worth about $84 billion, based on a "recent contract" showing that one share of the social-networking company would sell for $37.
In December, the $500 million infusion into Facebook by Goldman and Russian technology company Digital Sky Technologies gave Facebook an implied valuation of $50 billion.