SEC investigating secondary market conflicts

Ronny Kerr · February 23, 2011 · Short URL:

Facebook, Groupon, Twitter, Zynga--kids on the block causing trouble before going public

I guarantee there is more than one person that saw this one coming.
The Securities and Exchanges Commission has opened an investigation into whether there are conflicts of interest in the unregulated secondary market, which has shot into prominence over the last year for originating what seem wildly high valuations for private companies like Facebook and Twitter. While the steep valuations are not necessarily problematic in of themselves, the absence of financial data about the companies indicates that those valuations could be skewed or misinterpreted.
This new investigation is related to one initiated by the SEC at the end of 2010, when Facebook and Goldman Sachs created a special investment vehicle to allow multiple partners invest in the social network under one head. That ended up being a $1.5 billion round for Facebook.
Through secondary market services like SecondMarket and SharesPost, buyers and sellers can trade in a variety of unregulated markets, including limited partnership interests, mortgage backed securities and private company stock. It’s the last listed there--private company stock--that has sparked the SEC inquiry, however.
Investors are so hungry to snap up shares of certain private companies that the question of when to expect an initial public offering has been overshadowed the ability to simply buy shares on the secondary market. Facebook, Groupon, Twitter, Zynga--these are just four of the most famous companies expected to have successful IPOs in the next couple years. But who’s waiting?

Not Silicon Valley venture capital firm Andreessen Horowitz, which just two weeks ago bought over $80 million in Twitter stock via the secondary market, the most recent purchase of this kind. It’s the valuations posted that make the biggest noise, however, as evidenced by Facebook’s $60 billion valuation conveyed on the secondary market in mid-December.

Even if the SEC finds no wrongdoing or foul play in its investigations, the fact remains that many people could be taking unwise risks by investing money in companies without the proper knowledge about those companies’ financials. In proper investment rounds, VC firms and angels know all about the state of the new addition to their portfolio. Investing without knowing a company’s potential as a business is ludicrous.

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