Felix Salmon

The SEC comes round to private markets

By Felix Salmon
April 8, 2011

Jean Eaglesham has a big piece of news today: yes, the SEC is looking into the private share dealings in Facebook. But not necessarily with any kind of enforcement in mind. Instead, it’s thinking about raising the 500-shareholder limit which marks the point at which companies need to start making public filings.

A move in this direction would be a huge ratification of private markets by the SEC, which was created to protect investors. I guess that one way of protecting investors is to ensure that they never get an opportunity to invest in the first place:

The move could potentially delay or derail IPOs by tech companies that want to grow but would rather avoid having to disclose vast amounts of information. It could also shut out many ordinary investors from one of the fastest-growing market sectors, since shares in private companies are generally available only to investors whose individual net worth is at least $1 million. And at a time when investors are seeking more market transparency, it would lessen the amount of publicly available data about those companies.

The point here is that there is literally an opportunity cost to such a move, which is almost impossible to calculate. How much diversification (in the technical sense) and diversity (in the more colloquial sense) are the public markets going to miss out on if important, fast-growing companies stay private rather than going public?

But I have to admit I don’t understand this:

The possible changes come amid concerns about a dearth of U.S. stock listings, which politicians on both sides of the aisle worry could hurt American competitiveness with the rest of the world.

I don’t know which politicians Eaglesham is talking about (Tim Geithner, perhaps?), but in what sense are stock listings a sign of international competitiveness? There might be a vague correlation there, but I can’t see much in the way of causation. Indeed, there’s a strong case to be made that US companies can be more competitive internationally if they’re free to concentrate on running themselves as best they can, and don’t need to use up precious management cycles dealing with analysts and journalists and people second-guessing all of their actions on the basis of how their share price is moving that day.

The sourcing on the story is about as annoying as it possibly can be: Eaglesham says that the SEC review was “disclosed in a letter to a lawmaker,” without saying who did the disclosing, posting a copy of the letter, naming the lawmaker in question, or even explaining how the letter came to be written. This kind of coyness does nothing to advance the public interest; instead it looks like little more than a petty way of jealously guarding Eaglesham’s Capitol Hill source so that her competitors can’t find the same letter. Come on, WSJ, your job is to make news public, not keep it to yourself.

Eaglesham’s story comes in the wake of two very different takes on the prospects facing private markets. Evelyn Rusli has the bullish view from Silicon Valley, where entrepreneurs are turning down millions of dollars in funding and indeed are cashing out long before any IPO.

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Meanwhile, Gregory Zuckerman has the more bearish view from Wall Street, where Goldman Sachs’s attempts to put together a private stock exchange called GSTrUE have gone absolutely nowhere.

Goldman has largely stopped working on GSTRuE, merging it into the Portal Alliance, a fledgling network developed by Nasdaq, Goldman and Wall Street firms to act as a single market. That effort hasn’t attracted any new listings, either.

“When everyone ran for the door in the crisis it changed people’s desire to invest in things that aren’t listed” on an exchange, says Anton V. Schutz, manager of Burnham Financial Funds, who says he no longer buys issues that aren’t listed. “Even deeper markets than this haven’t come back after the crisis.”

Why was GSTRuE a failure while SecondMarket and SharesPost are much bigger successes? I suspect that the answer might have something to do with the fact that GSTRuE was set up to mimic a public exchange, with a common set of rules for every company looking to list and every investor looking to trade. The auction sites, by contrast, are happy approaching every deal on a case-by-case basis, structuring auctions to exactly the specifications of the company in question. And, of course, there’s also the fact that there’s a Web 2.0 bubble right now, while GSTRuE launched mainly with asset-management firms which are much less hot.

In any case, it looks very much now that all the current shareholders in SecondMarket were quite right to hold on to their shares rather than sell them on SecondMarket. (There have never been any SecondMarket trades in itself, because no one wanted to sell.) Today’s news has surely increased the value of the company substantially, and you can probably add SecondMarket founder Barry Silbert to the list of people who is politely telling would-be investors that sorry, he has no use for their money right now.

3 comments so far | RSS Comments RSS

so how many privately held companies are being impacted by the 500-shareholder rule? There’s AOL II, I mean Facebook, there’s MinutiaeAlerts, I mean twitter, and then Web Trading Stamps, I mean Groupon. Those are the ones that are always given as examples of privately held companies not going public. How many other startups are profitable enough to go public, yet their VC investors have stopped IPOs because they want to let their winnings ride? Should this really be a high priority for the SEC?

VCs invest in startups because they want a liquidity event in a relatively short time. Private markets like SecondMarket will not provide enough liquidity for VCs to unload their shares. Most startups will go public when they have the opportunity, or be acquired. The dearth of IPOs is more due to a shortage of new companies than anything else. Let the SEC spend more time policing things like ponzi schemes and speed trading.

Posted by KenG_CA | Report as abusive

I’m not very sophisticated financially, but my guess is that the goal is to provide a mechanism for up-pricing IPOs in a weak IPO market. Usually, going public works out very nicely for the insiders and the underwriters and their inside clients, sticking the eager public with whatever profits remain to be made. Right now, the public is risk averse.

My guess is that going “semi-public” will allow a laundering period with minimal reporting requirements, but lots of fancy names, to establish the company as a hot property for the eventual IPO. It might work.

Posted by spiffy76 | Report as abusive

Seriously, Felix, how can you say that
“there’s a strong case to be made that US companies can be more competitive internationally if they’re free to concentrate on running themselves as best they can, and don’t need to use up precious management cycles dealing with analysts and journalists and people second-guessing all of their actions on the basis of how their share price is moving that day.”

There is a reason that listing on U.S. stock exchanges is so highly sought after. And shares of U.S. companies (as well as German and U.K and no doubt others) are desirable for investors. That reason is “disclosure requirements” and GAAP (or international GAAP for Germany UK others). If U.S. companies didn’t have disclosure requirements, they would also be a lot less attractive to international investors!

Private stock, restricted stock, whatever, is not appropriate for everyone. It is particularly inappropriate as an investment for those who don’t have access, or time, to do the sort of research necessary to estimate valuation with a pro-forma. Most non-institutional investors have their hands full with investing and following exchange traded equities.

I have an account with SharesPost, have had one for over a year. SharesPost has very explicit disclaimers and warnings about lack of transparency and liquidity. I think well of SharesPost, I am not disagreeing with your assessment of them, as they offer a service, along with disclaimers that any analysis or research reporting provided is based on limited information about these private companies. This is not investing for the general public, and SharesPost makes that very clear.

I think that spiffy76 (the previous comment) is right on the mark in his assessment.

Trying to turn private markets into “semi-public” ones, as spiffy76 said, subverts the whole concept of SEC disclosure requirements, and will result in an even less equitable IPO market. Right now it isn’t great, but at least we know how it works.

One other thing. I’ve been wondering about this for awhile, would be appreciative if anyone addressed: Why DOES Facebook want to do a semi-private IPO, or any sort of IPO at all now? Why would they want to give up any amount of ownership in this company? It is hard for me to believe that they lack for funds so much that they would want to sell equity.

As a private company, Facebook isn’t burdened by disclosure, public scrutiny, shareholder accountability. That is the benefit of their status as a privately held concern. Why change now?

Posted by EllieK | Report as abusive

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