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.com.”
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,
Greg
Brogger, paid a combined $100,000 in fines but did not admit or deny guilt.
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
SecondMarket
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.
As I had reported with the two companies who misled investors, you get caught violating SEC guidelines and you will either get fined, suspended or have your license revoked.
Concerning these pre-IPO shares it is my understanding the large investors need a platform created by either Second Market or SharePost to do the actual execution of trading. Small stakeholders, such as an employees who are allotted shares by the company as either a bonus or compensation for their employment, wish to cash in a portion or all of their shares to have the cash for what ever they wish or need to do.
I read where lawyer told Facebook to stopped employees from continuing to liquidate their holdings or trading in secondary markets as the real IPO date approaches.
I hope this helped. I understand the confusion concering public and private trading, its quite confusing.
Hey The Dream Chaser, I saw this report Friday afternoon as the reports were still coming to light. I am familiar with BATS and the "fat finger" trade isn't unusual. However, the fact that it happened on its IPO day is actually too funny. I can also say in all my years on Wall Street I have never, ever heard of an IPO being cancelled. I don't understand the ramifications surrounding such a move. I will be anxious to see how this plays out.
It just goes to show you nothing is what it seems. Thanks for the article, just fascinating.
but this whole thing of "pre IPO shares" seems shady to me. How can a company even do that? Are they public or not? What sort of laws are there regarding public disclosure, as there are with regular public companies?
If it were easy we'd all be rich. In fact if the playing field was level it might be considered fair but still not easy. I'll say it again, if your not in your out. But you can make a fairly educated guess and still do well....or not.
It does make sense. Despite how accurate the current evaluations might be, the future still remains unknown and the end of the day it is a gamble to choose where to invest.
Well taimur_tz, for companies like Twitter or Facebook they probably are as accurate as any publically traded company. Based on their popularity and media attention these companies have garnered, they have been scrutinized from every angle possible.
Lesser down the food chain, not so much. But I imagine institutional investors or large angel investors may get analysis from their own analysts. But for the smaller guy they are subject to what the press releases have provided and the company itself.
It comes down to a prediction of current and future valuation. Can I personally determine the value of an upstart company and think I got a fair price, maybe? But the key is how do I know in a year or five years will the valuation rise? Does the company grow at a profitable rate to shareholders? Will they pay a dividend or re-invest in man power or R&D? If so do I have the wherewithal to take this ride?
For the small guy, you are basically buying a lottery ticket.I hope this was somewhat helpful.
@Chris: How accurate are the evaluations by individual analysts about the financial strength of these companies? Are they heavily cooked up or is there some reliability in them?
The financial statements, i.e. income statement, balance sheet and cash flow statement are not by law subject to GAAP standards for privately held companies.
The ThinkerNet does not reflect the views of TechWeb. The ThinkerNet is an informal means of communication to members and visitors of the Internet Evolution site. Individual authors are chosen by Internet Evolution to blog. Neither Internet Evolution nor TechWeb assume responsibility for comments, claims, or opinions made by authors and ThinkerNet bloggers. They are no substitute for your own research and should not be relied upon for trading or any other purpose.
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