SEC Pokes Nose Into Private-Company Trading

Inplace #2

facebook_small.jpgADOTAS – In mid-November, Facebook was valued at $41 billion as its stock hit $16 on SecondMarket, an exchange for trading shares of private companies. That high figure hit many by surprise, especially considering that the private social network’s valuation was $14 billion at the beginning of the year and $25 million around June.

Following $40 million of Facebook stock — SecondMarket’s most actively traded — changing hands, the private company stock exchange reported the social network’s valuation at $52 billion on Dec. 11. One hundred thousand shares had been auctioned at $21.90 each; the total number of Facebook shares cleared by SecondMarket is 2.5 million.

Before you let your jaw completely drop, SharesPost announced on Dec. 17 that a sealed bid auction of 165,000 shares of Facebook common stock closed at $25 a share, giving the social network a valuation of $59.4 billion.

According to Nyppex, a brokerage firm for trading private companies, valuations of the top 11 private venture-backed companies have increased 54% since June. The top stocks are social networking and media companies such as Facebook, Twitter, LinkedIn and Zynga. Now The New York Times’ Dealbook reports the Securities and Exchange Commission is snooping around private exchanges, looking for some information on this unregulated business.

Although private companies don’t actually see any direct monetary benefits from private exchanges as employees and early investors use them to sell shares, the social networks in particular have seen a side benefit: pumped up valuations, which no doubt have helped Twitter and Groupon secure massive new funding rounds. Rapidly inflated valuations of social media operations have help give rise to chatter about a new tech bubble.

However, SecondMarket says it hasn’t heard a peep from the SEC. The firm, which only launched last year, will execute an estimated $400 million in trades for 40 private firms in 2010, a fourfold increase year over year.

The Wall Street Journal speculates the SEC is interested in “slew of company-specific funds that have cropped up in recent months focused on buying up private-company shares on behalf of limited partners – often individuals who may not be professional investors.”

Investors on SecondMarket and SharesPost must have at least $1 million in net worth to trade, so single investors may be pooling funds from multiple non-professional and non-qualified persons that want to get front-row seats before an IPO.

As SharesPost CEO David Weir explained to the NYTimes: “A decade ago, these companies would be public by now. Investors can now buy into these businesses and sellers can exit their already valuable stakes.”

The SEC would seem to be concerned because these investors are buying shares without consulting any actual financial information, which the private companies are not forced to disclose.

However, private companies must file an Exchange Act registration statement if they have “more than $10 million in total assets and a class of equity securities, like common stock, with 500 or more shareholders,” according to the SEC’s small business Q&A. Facebook was granted an exemption from this by the SEC in 2008 by arguing that its shareholders were primarily employees.

The SEC would re-evaluate that stance if Facebook had more than 500 external shareholders, one of the reasons in the last several months Facebook management has been adamant about employees not selling stock.

As Erick Schonfeld at TechCrunch cleverly surmises, “If it looks like a public company and trades like a public company then the SEC might just end up regulating it like a public company.”

So why not be a public company and roll out the IPO carpet? Dan Primack at Forbes doesn’t believe the SEC investigation will push an IPO — he knocks that theory that if the SEC forces Facebook to submit its financial information, the company should just go public.

But will this SEC investigation of private stock exchanges, and the media hoopla around it, alert Zuck and crew to the massive amount of cash their missing out on by continually postponing an IPO?