SecondMarket’s unnecessary Facebook Fund

March 20, 2012
Jon Ogg, who has discovered a Facebook Fund over at SecondMarket.

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The latest sign that the Facebook IPO is going to be particularly bonkers comes from Jon Ogg, who has discovered a Facebook Fund over at SecondMarket.

This is odd, for a couple of reasons. For one thing, the SEC recently cracked down on two funds offering Facebook shares pre-IPO. (One of them was Felix Investments. No relation.) SecondMarket will obviously have learned from their mistakes, but why rock the boat like this? It’s pretty obvious the SEC isn’t a huge fan of people speculating in the pre-IPO markets.

More generally, SecondMarket has done a pretty good job of positioning itself as a way for people to trade shares in illiquid companies where they have no access to public markets.

This latest development, then, is more than a little off-brand for SecondMarket. Everybody knows that Facebook is going to IPO within a matter of weeks: it’s already started meeting with analysts. So if you want to sell your shares in the public markets, you won’t have to wait long.

But for some reason, there’s still a lot of institutional sell-side interest when it comes to Facebook. There’s a 180-day lock-up period after the IPO during which current shareholders can’t sell their stock, so if they miss the boat now, they won’t be able to sell until November or so. Clearly, that’s too long for some people to wait.

Meanwhile, there’s also buy-side interest in Facebook, from people who are convinced that they’re not rich or important enough to get an allocation of shares in the IPO. They’re not going to be able to flip their shares on day one: they, too, will be subject to the 180-day lock-up. But at least they’ll be buying in now, rather than after Facebook has already gone public.

So you can see where SecondMarket naturally comes in, here. There’s buy-side interest, there’s sell-side interest, and they’re a neutral intermediary broker-dealer which can provide weekly auctions where shares trade hand at a mutually acceptable clearing price.

But why the fund?

It turns out that SecondMarket is not like other auction houses. If I buy a Warhol from Sotheby’s, I write a check to Sotheby’s and they give me the painting. Meanwhile, Sotheby’s writes a slightly smaller check to the seller. I never deal directly with the seller. SecondMarket, however, refuses to face buyers and sellers in this manner. It acts more like a dating agency than an auction house: it works out who wants to transact with whom, and then ducks nimbly out of the way so that they can finish off the deal privately, facing each other.

And big institutional sellers, for one, are unhappy about this. If they’re selling $10 million of Facebook shares, they don’t want to have to sign lots of paperwork facing a long list of retail investors spending $200,000 or $400,000 on stock. SecondMarket tries to match up buyers and sellers in terms of the size of the deal they want, but right now the sellers all seem to be relatively big, and the buyers all seem to be relatively small. Which makes for awkward dates.

The obvious answer to this problem — insofar as it is a problem — would be for SecondMarket to act more like Sotheby’s, and face the sellers itself, while simultaneously selling the sellers’ shares to the buyers. But it didn’t go that route. Neither did it simply turn around to the sellers and say hey, if you want to play on our platform, you have to play by our rules, how much of a pain is it, really, to have to sign a dozen different identical sale documents rather than just one or two. One would think that’s why these companies employ lawyers.

Instead, SecondMarket created a fund. If you want to buy a relatively small amount of Facebook stock — say between $200,000 and $500,000 — then you’re no longer going to participate in the auction directly. Your only choice will be to place your money in SecondMarket’s Facebook Fund, which will buy shares on your behalf at the auction clearing price, and then hold on to those shares until 180 days after the IPO, at which point it will then transfer the shares to you, to do with as you wish. SecondMarket is going to continue its weekly auctions right up until the IPO; any smaller investors participating in those auctions will end up in this fund.

The cost of buying Facebook stock via the SecondMarket fund is double what other buyers pay: everybody pays SecondMarket a 3% fee when they buy stock, but participants in the fund will also pay a second 3% fee when they finally receive their Facebook shares, 180 days after the IPO.

All of the participants are still qualified accredited investors, with at least a million dollars to throw around or a salary north of $200,000 a year. And I’m pretty sure the minimum investment is still high, at $200,000. But this whole thing smacks of speculation to me, not to mention an attempt by SecondMarket to squeeze the last drop of revenue out of Facebook before it goes public.

Facebook has been incredibly lucrative for SecondMarket, despite (or maybe because of) the fact that it’s the exception to every SecondMarket rule, the single company traded on SecondMarket which isn’t itself a SecondMarket client. But this smacks of opportunism to me. I know that there are lots of people out there who are eager to buy shares in Facebook. But they’ll have their opportunity soon enough. The secondary market in Facebook shares right now serves no real public purpose at all. Instead, it’s just putting more money in the pockets of middlemen.

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