by Bill Singer
SEC Announces Historic Pre-IPO Enforcement Activity in Social Media Sector
March 15, 2012
The Securities and Exchange Commission ("SEC") apparently investigated the secondary market trading of shares in private, venture-backed companies that rose to prominence in 2009, when investors were clamoring to get in on the emerging social media craze and clean tech boom. In response to such demand, a number of online platforms were rolled out and some otherwise dormant vestiges of the Dot.com Boom (and the Tech Wreck aftermath) were resurrected.
As I realized through my law practice, a number of techies found their way into this emerging business of trying to match up buyers and sellers of non-publicly traded social media and Silicon Valley high-tech companies. For such folks, the challenge was purely technical: setting up bulletin boards, facilitating communications, etc. Unfortunately, despite all their savvy with creating online platforms, many of these entrepreneurs were woefully ignorant of securities laws that deemed certain activities as requiring a registered brokerage firm and the assistance of a registered person. What may have impressed these newbies as just another online project may have blinded them to the other reality: That they were offering and soliciting securities transactions and had, for some, inadvertently crossed over the line.
On March 14, 2012, the Securities and Exchange Commission ("SEC") announced a number of lawsuits involving the allegedly improper activities of fund managers and others in connection with sales of so-called "Pre-IPO" shares, many of which involved transactions in Facebook shares.
SEC v. Frank Mazzola, Felix Investments LLC, and Facie Libre Management Associates LLC CV-12-1258 EDL (U.S. District Court for the Northern District of California, filed March 14, 2012)
NOTE: A Complaint contains allegations and defendants are presumed innocent unless and until proven guilty in a court of law.
In Mazzola, filed in San Francisco, CA District Court, the SEC alleges that Mazzola and his firms created two funds to buy securities of Facebook and other tech companies; and, thereafter, improperly failed to disclose that they were paid commissions in excess of the 5 percent disclosed in offering materials. The SEC alleges that these non-disclosed charges had the effect of raising the price paid by investors for Facebook stock because it created a disincentive for Mazzola and his firms to negotiate a lower price for fund investors. Moreover, the SEC alleges that the defendants made false statements to investors in other funds they created to invest in various pre-IPO companies. For instance, they misled one investor into believing a Felix fund had successfully acquired stock of Zynga. They also made false representations about Twitter's revenue to attract investors to their Twitter fund.
In the Matter of EB Financial Group LLC and Laurence Albukerk
Without admitting or denying the SEC's findings, Albukerk and EB Financial consented to entry of a SEC order finding that they violated Section 17(a)(2) of the Securities Act of 1933 and Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. Albukerk and EB Financial also agreed to pay disgorgement and prejudgment interest of $210,499 and a penalty of $100,000.
The SEC alleged that the Albukerk told investors he charged only a 5 percent fee for an initial investment and a 5 percent fee when the shares were distributed to fund investors upon a Facebook IPO. However, the SEC claimed that Albukerk obtained additional compensation via the interposition of an entity controlled by his wife to purchase the Facebook stock. Thereafter, Albukerk purportedly bought interests in his wife's company for Defendant EB Funds, and took advantage of that opportunity to charge investors a mark-up on the transaction. Additionally, Albukerk was charged with earning a further brokerage fee on the acquisition of Facebook shares from the original stockholders. The SEC alleged that the net impact of these actions was to impose "significantly" higher fees upon investors than otherwise represented in offering materials.
In the Matter of SharesPost Inc. and Greg Brogger
SharesPost and Brogger consented to an SEC order finding that SharesPost committed and Brogger caused a violation of Section 15(a) of the Exchange Act of 1934. They agreed to pay penalties of $80,000 and $20,000 respectively.
Subsequent to the SEC's investigation, SharesPost acquired a broker-dealer and its membership agreement was approved by the Financial Industry Regulatory Authority (FINRA).
According to the SEC's administrative proceeding, SharesPost held itself out to the public as an online service to help match buyers and sellers of pre-IPO stock. Further, the defendant was charged with allowing registered representatives of other broker-dealers to hold themselves out as SharesPost employees and earn commissions on transactions they facilitated through the SharesPost platform.
The SEC also alleged that SharesPost and affiliated broker-dealers also created a commission pool that was distributed by an executive to employees who were representatives of these broker-dealers. The company also collected and published on its website:
- third-party information concerning issuers' financial metrics,
- SharesPost-funded research reports, and
- SharesPost-created valuation index.