Securities regulators have launched a broad investigation into
whether hedge funds and other investors are improperly selling hot
private technology stocks amid a boom in the trading of such
shares, people close to the probe say.
The regulatory scrutiny, which is at an early stage, follows a
March page-one article in The Wall Street Journal that delved into
the role of middlemen in the burgeoning market for private
shares.
The investigation, by the Securities and Exchange Commission, is
focused on a burst of new activity recently by people selling
pre-IPO shares as valuations of private tech companies have
exploded and companies have opted to remain private for longer.
The SEC also is examining a recent rise in firms selling
employee-owned shares of private companies through derivative
transactions, the people say. In some cases, the sale of employee
shares through such derivative transactions is prohibited by the
companies, these people say.
The SEC is looking into whether such derivative transactions
represent possible violations of the Dodd-Frank Act of 2010, which
makes it unlawful for most individual investors to trade swaps
unless the transaction takes place on a national securities
exchange with a registration statement from the SEC.
Swaps are contracts in which two parties agree to exchange
payments based, in this instance, partly on the value of private
companies.
The regulatory probe reflects concern about activity in the
swelling private market for tech shares of big, established
companies. Startups worth more than $1 billion have raised about
$15.5 billion in additional funds through the first half of this
year, according to Dow Jones VentureSource.
The SEC investigation comes as it filed on June 17 a case
against Silicon Valley-based Sand Hill Exchange, which operated a
website designed to allow people to buy and sell contracts related
to the value of private companies and their securities.
The SEC brought a cease-and-desist order against Sand Hill based
on findings in an administrative proceeding that the company's
business allegedly violated the Dodd-Frank Act because the stock
contracts weren't registered with regulators and weren't traded on
a national exchange as required by the law.
Sand Hill settled the charges without admitting or denying the
findings. It agreed to pay a $20,000 penalty.
A memo published in late June by law firm Davis Polk &
Wardwell LLP argued that the SEC's Sand Hill Exchange action may
have been a watershed moment, signaling that the agency is "willing
to exercise its statutory authority over" certain swap trades and
its intention to "scrutinize attempts to offer these products to
retail investors."
The SEC has sent letters to several firms that offer derivative
transactions to employees of private tech companies who want to
sell their shares, asking for information about the transactions, a
person close to the situation says. Many of the derivative
transactions are being offered by new firms that have opened in the
past six months, the person said.
The SEC is also looking into whether middlemen have possibly
misled investors about special funds known as special purpose
vehicles, which purport to invest in private tech shares, the
people say.
Among those being scrutinized is hedge-fund manager Jonathan
Sands, who attempted in January to raise money from investors for
an investment fund with $100 million in Uber Technologies Inc.
stock that Mr. Sands said he was getting "directly" from Uber to
sell to other investors in exchange for a management fee and a cut
of the profits, according to an email exchange between Mr. Sands
and an investor that was reviewed by the Journal.
Mr. Sands didn't actually have access to the shares, according
to people familiar with the matter. When Uber lawyers learned of
his actions they sent him an email asking him to stop, which he
did.
Mr. Sands was featured in the March article in the Journal. Mr.
Sands previously has said he did nothing wrong and that he aborted
his plans to raise money for the special fund. In an email exchange
Wednesday, he said any suggestion that he did anything improper in
selling the Uber shares was "materially false."
Before he ceased his efforts, Mr. Sands, who runs New York-based
Artist Capital Inc., asked investment bank Aldwych Capital Partners
to help him raise money for the Uber funds. An employee at Aldwych
in turn reached out to brokerage firm Raymond James Financial Inc.,
telling him the firm had an "exclusive" on a chance to buy Uber
stock.
A spokeswoman for Aldwych declined to comment Wednesday.
Previously, Aldwych said the bank made "a few enquiries" when asked
by Mr. Sands to "gauge investor interest" but in the end "nothing
was raised."
A Raymond James spokesman said the solicitation from the Aldwych
employee wasn't shared with clients and wasn't acted upon.
The probe of derivative transactions involving employee shares
is aimed at gauging the different varieties of transactions using
derivatives that allow employees to get money for their shares
without having to actually sell them, which can in some cases
violate company policy, the people familiar with the probe say.
Companies that help match employees seeking cash for their
shares with potential investors recently have grown sharply.
Two of the biggest such firms, EquityZen Inc. and Equidate Inc.,
now are exploring whether they are affected by swaps regulation,
according to people familiar with the firms. Spokespeople for the
two firms declined to comment.
Mr. Sands is emblematic of a group of brokers and fund managers
who do business trying to obtain private shares when they are sold
by companies or employees.
Such fund managers, who set up special funds for investors to
buy, take a cut of the profits and a management fee in exchange for
the private shares.
Mr. Sands was hoping to take a 1% management fee on the Uber
fund and 15% of the profits, according to an email reviewed by the
Journal.
Write to Susan Pulliam at susan.pulliam@wsj.com and Telis Demos
at telis.demos@wsj.com
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