The regulators told the executives that they want more stringent checks of individuals’ accreditation and improved diligence regarding the financials of companies being auctioned to investors, according to multiple sources familiar with the discussions.
One participant in the discussions, who asked not to be named, said he expects the agency to formally propose new regulations for the secondary market by the end of this year.
“You will likely see more requirements coming out,” from the SEC, the source said. “There is no public information available [on some secondary market companies]. This is not good for investors.”
Another source acknowledged that the SEC may push to have all financial statements distributed by private stock auctioneers subjected to an audit that is presented to secondary market investors — adding a substantial layer of compliance for auction sites. The commission is also considering revising its investor accreditation rules, which would reduce the field of potential private stock buyers by as much as two-thirds of its current size, to 8 million individuals, sources said. This figure does not take into account institutional investors.
The potential regulatory shift signifies that the SEC is moving further from some members of Congress, who announced earlier this summer they would pitch legislation that would more than double the maximum number of shareholders allowed to invest in a private company before it would be required to file an S-1 statement. (The current threshold is 500.)
“We maintain an ongoing dialogue with the SEC and –- on our own initiative –- provide the SEC with demonstrations of our platform,” said Mark Murphy, head of public affairs with SecondMarket, an SEC-regulated broker-dealer that specializes in secondary transactions. “We will continue to keep our regulators apprised of our business processes.”
Murphy declined to provide specifics on talks held with the SEC. Senior officials at the Securities and Exchange Commission, as well as a spokesperson for SharesPost, an online exchange for private shares, declined to comment on the record for this story. (SharesPost is not a FINRA member broker-dealer.)
Word of the SEC’s push against secondary market operators comes at a bad time for the budding industry. Already, VCs and startups are increasingly working language into minority stake contracts that forbid ex-employees from selling on the secondary market, as well as restricting how much of their stake founders can sell. Multiple sources concede VCs have done this in an attempt to orchestrate better control over the size of startups’ shareholder bases.
So far, aside from peripheral brokers stepping in to take business from private stock sellers who would otherwise pursue secondary market platform stake exits, little has hampered the trajectory of the auction sites. Year-over-year, SecondMarket’s deal activity increased by about 75% in the first half this year, according to the company. Further, venture capital sources acknowledge that there are a substantial number of shares that can be sold via private stock auction with no interference from VCs and startups, save exercising the right of first refusal, because so many term sheets completed in recent years failed to anticipate secondary market exits.
“There is enough unrestricted stock that is already out there to fuel secondary trading for years,” one venture capital source said.