Misleading Investors About Private Stock Sales Will Get You In Trouble, Registering With The Feds Won’t

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Employees of hot web companies like Facebook have been selling shares to private investors in recent years, and a few firms have jumped in to take advantage of the situation.

So naturally the Securities and Exchange Commission has taken an interest in such a new and unregulated part of the finance world. After a lengthy investigation into the budding industry — and ahead of a big Facebook initial public offering — it’s going after two stealthy financial groups as well as popular private market SharesPost.

It alleged today that EB Financial Group, led by Laurence Albukerk, and Frank Mazzola’s two funds, Felix Investments and Facie Libre, used various means to overcharge investors for shares in privately-held Facebook. SharesPost, however, made the much more forgivable mistake of not registering early enough for its broker-dealer status. But not completely forgivable, in the SEC’s eyes. After all, rival SecondMarket has had the appropriate paperwork since it was founded back in 2005.

Here’s a quick look at each case. Note that the first two sets of funds offered special-purpose vehicles created to buy Facebook stock, that investors bought into in order to get access.

EB Financial Group, Laurence Albukerk

Albukerk told investors in writing that he charged a 5% fee for their initial investments and another 5% fee when investors received the shares in the event of Facebook’s IPO. But he used another fund in his wife’s name to buy up the Facebok stock, then he bought into it from the main fund at a higher price than what the shares had cost him — without disclosing it. He also didn’t tell investors that he’d been charging a brokerage fee to the stockholders he was buying from.

Result: A disgorgement and prejudgment interest payment of $210,499 and a penalty of $100,000. And “without admitting or denying the SEC’s findings,” an acknowledgement that the SEC had found it had broken various financial laws. We’ll see what happens next.

Felix Investments, Facie Libre, Frank Mazzola

This one is a doozy. He and his funds also charged secret commissions. But it got messier. Facie Libre purported to own Facebook stock that Mazzola and his colleagues knew it lacked, actually. The patterned continued, with at least one investor being led to believe that Felix owned stock in Zynga. They also made misleading statements about Twitter revenue to try to create investor interest.

Result: not just fines. The SEC “seeks court orders prohibiting them from engaging in securities fraud and requiring them to disgorge their ill-gotten gains and pay financial penalties.”

SharesPost

The issue here is far less serious than the previous situations.  SharesPost was acting as a broker-dealer, in that did what it openly said: provide a marketplace for buyers and sellers of private company stock. The problem was that the federal government requires you to register in order to do this. So instead of misleading investors like the other guys, the startup was moving faster than its paperwork kept pace with.

Result: While it gained the appropriate registration in 2011, the investigation covered 2010. So now the company has to pay $80,000 in fines and its chief executive, Greg Brogger, has to pay $20,000, but it’s otherwise free to get back to business.

More detail on its recent compliance, from an email it sent out to users this evening:

First, since its membership approval by the Financial Industry Regulatory Authority (“FINRA”) on December 14, 2011, SharesPost Financial Corporation (“SPFC”) now directly serves our members as a registered broker-dealer, a member of FINRA and the Securities Investor Protection Corporation (“SIPC”). In addition, we have now registered SPFC as an Alternative Trading System with the U.S. Securities and Exchange Commission (“SEC”). These steps allow us to more directly serve the needs of our members as they engage in transactions on our platform. It also lets our members know that FINRA and the SEC regulate SharesPost in the same way they do other, similar marketplaces.

The company’s big competitor, meanwhile, is SecondMarket. It received an SEC letter of inquiry regarding pre-IPO pooled investment vehicles back in late 2010, but it was not about SecondMarket itself. And nothing came of it, as the SEC has nothing to say today. The reason is that the company filled out all of the necessary paperwork years ago.

Its statement on the matter today:

SecondMarket is not the subject of an SEC inquiry. The private companies, buyers and sellers that utilize SecondMarket trust that we understand and comply with the regulatory framework governing secondary transactions. SecondMarket is a FINRA-registered broker-dealer and SEC-registered alternative trading system. Our top-notch legal, compliance and operations teams, which include former regulators, ensure that we correctly follow the relevant rules and regulations. For the secondary market to continue to prosper, it’s important that all market participants act honestly and follow the rules.

So, besides a public black eye for SharesPost, the two private stock markets can continue on with business as usual. But the Wild West of private company stock sales has gotten a little tamer.

[Zuckerberg trillion dollar bill via thinkspace.]