Just about two years ago, I posted a blog warning Internet Evolution readers, “I’ll take the
whipping post anytime before I actually commit a penny to
SharesPost, you’ll recall, provides a secondary market platform for pre-IPO stock purchases. The SEC
recently charged it with facilitating securities transactions without being a registered broker-dealer. That would be a violation of Section 15(a) of the Securities Exchange Act of 1934. SharesPost and its founder,
Brogger, paid a combined $100,000 in fines but did not admit or deny guilt.
SharesPost has since announced that it has become a registered broker-dealer and a member of the Financial Industry Regulatory Authority and the Securities Investor Protection Corporation as an alternative trading system.
In separate but related cases, the SEC sued two private fund managers
for misleading investors and pocketing fees and commissions in an undisclosed manner.
As one can surmise, eager investors can turn a blind eye to certain things to get in on potentially hot IPOs like Facebook, Twitter, or Foursquare.
What lessons can we learn from the temptation of trading privately held companies in a secondary market? What type of investor should participate in these ultra-risky financial instruments? And at what level does SharesPost and the like provide a service for the average investor who just has to have a slice of these technology juggernauts?
In the movie Wall Street, Gordon Gekko told the young upstart Bud Fox, “If you aren’t inside, you are out.” Gekko was alluding to the people in the know -- the ones with connections. These are the guys at the front of the line who are uncharacteristically rewarded. Translation: The pre-IPO market that is traded on online secondary market sites should be left to angel investor funds, institutional market makers, or the future underwriters of those specific securities.
If you have money to burn, then trading in the secondary pre-IPO market just may be acceptable. But you must be an “accredited investor” as defined by Regulation D of the 1933 Securities Act, which basically states you need to be a hedge fund, an investment bank, someone with a net worth of $1 million and an annual income of $200,000, or a couple with joint income of $300,000 to start investing.
What can alternative systems like SharesPost or
offer to those who don’t meet those criteria? Unequivocally, these sites are professionally run, and their analytics, financial research, and corporate information provides a solid foundation for investors’ due diligence. However, let me reiterate a point I tried to get across in my previous blog: The financial information provided by these sites is only as good as the information granted by the companies they research. And there is no law that says any privately held company must provide any degree of financial transparency.
There are also analysts who participate in the pre-IPO companies they are covering. Although unethical, their potential conflict of interest is not illegal, as it would be with a publicly held stock.
For the sake of clarification, there is tremendous risk in trading pre-IPO shares. Moreover, there are also firms such as
Felix Investments and
EB Financial Group -- the two firms accused in the SEC lawsuit of misleading investors and failing to disclose certain commissions. Both paid stiff fines and were forced to return ill-gotten gains to investors.
Add this to a market that doesn’t necessarily allow the buyer an equitable opportunity to liquidate shares, and you are asking for a world of fiscal trouble. I implore everyone always to use reputable brokers and investment companies with longstanding reputations. Remember: When opportunity knocks, sometimes the
Grim Reaper answers.
— Chris Poley has been a professional trader for more than 20 years.