Securities Fraud Attorney Blog

Last week, we wrote about private shares fraud and how we think there may be significant litigation and/or arbitration in the future in this space. Today's NY Times has a very good Dealbook piece (below) by the "Deal Professor" about the lack of disclosure in the private shares markets of SharesPost and SecondMarket. The most important sentence: "The lack of information combined with this illiquidity contributes to the volatility and mispricing of shares." That's spot on. We're talking about large investments in unregistered shares within an unregulated market. Major exposure to potential fraud. Major.

November 22, 2011, 4:37 pm
Private Markets Offer Valuable Service but Little Disclosure
By STEVEN M. DAVIDOFF
Harry Campbell

Information is the lifeblood of capital markets. In the movie “Wall Street,” Gordon Gekko demanded confidential information from a young would-be Master of the Universe, Bud Fox, played by Charlie Sheen. The value of stocks is based on information, which is why securities laws are intended to ensure that all investors have at least minimum amounts of information.

Private, closed markets like SharesPost and SecondMarket aid in the cause of market transparency, providing platforms to trade shares of companies that have yet to go public. At the same time, the limited amount of information available to investors in these markets raises some questions. Regulators, which have been looking at these markets, may be right to be concerned.

Both SharesPost and SecondMarket, to be sure, are aimed at sophisticated investors, who can buy shares in up-and-coming companies, mainly Internet start-ups, before their initial public offerings. The two markets have cut their teeth on connecting buyers and sellers in hot pre-I.P.O. tech companies like Facebook and Groupon.

Yet gaining entry to both markets is simple. Before trading or being allowed full access to the market’s platforms, a user must first register and attest to being an accredited investor under the securities laws. This generally means that the user must have an individual income greater than $200,000 a year or a net worth of more than a million dollars. Lying on the Internet is easy, though, as anyone who has ever been on a dating site knows.

Both SharesPost and SecondMarket review the potential buyer’s declaration to ensure that these standards are met, including requiring government identification, but neither appears to ask for tax returns or require independent verification of a person’s salary and net worth. After being certified, an investor can bid to buy shares of these companies.

The problem is that potential buyers sometimes have little information on which to base their purchase. Public companies are required to make copious disclosures to the Securities and Exchange Commission, including audited financials that are reviewed by the S.E.C. The agency recently prompted Groupon and Zynga to revise their accounting disclosures before their I.P.O.’s.

SecondMarket changed its business model in 2010 to require companies to provide two years of audited financials and other information to potential bidders. The exception is Facebook, the most actively traded stock on SecondMarket. For Facebook, there is no information requirement. Shareholders fly blind, relying on anything they can glean from almost anywhere but the companies themselves.

SharesPost does not appear to provide the information that SecondMarket requires. SharesPost strives to fill this gap by arranging to have privately prepared research reports posted on its site. But without full information, the research providers cannot do any better than buyers in accurately pricing stocks. The result is volatility.

Facebook’s value on SharesPost has fluctuated wildly. In January, Facebook shares traded at a price that gave it an implied market value of more than $141 billion . Less than one month later, Facebook shares traded at an implied value of about $71 billion. Four days later it was at about $87 billion. Since that time, Facebook shares have traded in a range that values the company at $73 billion to $87 billion.

This summer, Groupon was reportedly trading on the private markets at an implied market valuation of about $20 billion. Groupon is now trading at a value of about $13 billion.

The problem is not just overvaluation. In January, Bloomberg News reported that shares of LinkedIn were trading on the private markets at $30 apiece, valuing the Internet company at $2.51 billion. LinkedIn is now public and trading at a market valuation of about $6.7 billion.

SharesPost appears to provide more market information than SecondMarket. It posts all of the prices of its trades and has enlisted research providers to assist investors.

One of the largest research providers on SharesPost traditionally was Global Silicon Valley Partners.

Brad Flynt, a law student at the University of Georgia School of Law, has written an unpublished paper questioning the independence of Global Silicon Valley Partners.

The research provider is affiliated with the Global Silicon Valley Corporation, a publicly traded company that is active in purchasing shares on the private markets. G.S.V.C. is headed by Michael Moe, who is also a director of SharesPost.

Last spring, Global Silicon Valley Partners published a research note that estimated Facebook shares at $22.24 to $22.57 apiece, valuing Facebook at $52.3 billion to $53.1 billion. About this time G.S.V.C. purchased 225,000 shares of Facebook at $29.28, valuing Facebook at roughly $68 billion.

This raises conflict-of-interest issues because Global Silicon Valley Partners set a low valuation target at the same time its affiliates, Mr. Moe and G.S.V.C., were buying shares at a higher one.

In an interview, Mr. Moe said that Global Silicon Valley Partners was now defunct and that, though this was not disclosed in the research reports, Global Silicon Valley Partner’s research was always independently prepared by Candlestick Advisers, a consulting and advisory firm based in India.

Mr. Moe said that there was no economic relationship between Candlestick and G.S.V.C. but rather a personal one between himself and Candlestick’s owners. According to Mr. Moe, Candlestick is compensated by SharesPost for its research reports but neither he nor G.S.V.C. received money from Candlestick. SharesPost declined to comment on the relationship between Mr. Moe, G.S.V.C. and its research providers, instead referring me back to Mr. Moe. Candlestick Advisers did not reply to a request for comment.

It all raises questions about what exactly shareholders know and how they know it on these markets.

SharesPost appears to be trying to do the right thing by putting more information out there. Given the lack of information on the companies itself, however, this is a roll of the dice. And there needs to be more disclosure about these research providers that would explain their motivations and compensation.

This is also an illiquid market. Except for trades in Facebook, shares of other private companies appear to be infrequently bought and sold. Twitter and Zynga do not appear to be available for purchase on SecondMarket. The last trade in Zynga on SharesPost was on Sept. 9. Twitter appears to have traded only once this year on SharesPost. The lack of information combined with this illiquidity contributes to the volatility and mispricing of shares.

The S.E.C. thus faces a quandary. These private markets offer an increasingly desirable service by providing an outlet to sell shares in companies that do not want to subject themselves to the increased regulation and scrutiny that comes with being public.

But it is too often all or nothing in terms of information. Congress is considering a number of bills intended to make trading in these markets easier, and the S.E.C. is also reviewing its rules governing private markets. Congress may also want to consider enacting requirements for companies with shares actively trading on these markets to disclose sufficient information to allow informed trading. SecondMarket has already taken a step in the right direction but could do more and provide data on purchases and sales.

Investors will otherwise remain in the dark, gambling without information.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.

Private shares fraud? We've been talking about it internally for months. Unregulated space where investors buy and sell private shares often of pre-IPO companies such as Groupon and Facebook. We think the potential fraud claims will occur in the pricing of the private shares. The seller, perhaps a company insider, plays around with valuations. But the Dealbook story posted below of John Mattera is an old school fraud. He allegedly stole people's money by promising to sell them his personal private shares in high flying pre-IPO companies. Here's the problem for his "investors": may be no one to collect from. Mattera likely going to jail. His fund is finished. Good luck trying to sue and collect from the unregistered Long Island firm and/or its principals and the escrow service. What a shame. Private share investors need to be careful out there. Even in the more legitimate secondary private share markets run by larger firms. Due diligence is king.

DealBook - A Financial News Service of The New York Times
November 17, 2011, 4:32 pm
Manager Who Claimed to Own Facebook Shares Charged With Fraud
By KEVIN ROOSE
John A. Mattera was arrested in Florida on Thursday.

It may be the new, new thing in fraud.

John A. Mattera, 50, a Florida-based investment manager, was arrested Thursday on charges of running an $11 million, two-year fraud that falsely promised investors access to coveted shares of Groupon, Facebook and other private companies.

Mr. Mattera, the head of the Praetorian Global Fund, claimed to own more than a million shares each of Facebook and Groupon, according to a complaint filed in Federal District Court in Manhattan. He represented to investors that those holdings, bought on the private markets, would surge in value after the companies went public, the complaint said. Prosecutors allege the fund didn’t have such investments.

Instead, Mr. Mattera used millions of dollars of investor money to finance his lavish lifestyle, the complaint alleges. Among Mr. Mattera’s expenses: more than $245,000 for home furnishings and interior design services, more than $11,000 for tailored clothing and more than $17,000 for “boat-related expenses.”

Prosecutors have charged Mr. Mattera with one count of conspiracy to commit securities fraud and wire fraud, one count of securities fraud, one count of wire fraud and one count of money laundering. The Securities and Exchange Commission is also taking civil action against Mr. Mattera.

“As alleged, John Mattera duped investors into believing they had bought rights to shares of coveted stock in Facebook and other highly visible and attractive companies which had not yet gone public,” Preet S. Bharara, the United States attorney in Manhattan, said in a statement. “With today’s charges, his charade is exposed and he will be held to account for his alleged crimes.”

Carl F. Schoeppl, Mr. Mattera’s lawyer in the criminal case, declined to comment.

The charges against Mr. Mattera come as investors clamor for shares of newly public Internet companies, a frenzy that echoes the early days of the last dot-com boom in the 1990s. Getting into a company early can be lucrative. Groupon, the daily deals site, jumped more than 30 percent on its first day of trading.

To attract clients, Mr. Mattera allegedly enlisted the help of Joseph Almazon, an unregistered broker with Spartan Capital Partners on Long Island, who solicited investments for Mr. Mattera’s Praetorian funds using LinkedIn advertisements that offered customers “the opportunity to buy pre-I.P.O. shares” in Facebook, Groupon, Twitter, Zynga and other companies. Mr. Almazon promised that “unlike most of the other investment banking firms, we let you sell your shares right at the open” — referring to the first day the company goes public, according to the civil action.

After investors signed up, their money was transferred to an escrow service headed by John R. Arnold. Mr. Arnold, in turn, passed the money along to himself and to Mr. Mattera, as well as to accounts registered to Mr. Mattera’s mother and wife, the complaint said.

Mr. Mattera is no stranger to the law. In 2009, he was accused by the Securities and Exchange Commission of evading registration requirements by backdating certain promissory notes. He paid a penalty of $140,000 and was barred from trading penny stocks, shares of smaller public companies that are worth less than $1 apiece.

Three of the current criminal charges against Mr. Mattera, who was arrested at his home in Fort Lauderdale, Fla., on Thursday, carry a maximum sentence of 20 years in prison each. He faces a maximum sentence of five years on the conspiracy charge.

Mr. Mattera and his associates “exploited investors’ desire to get an inside track on a wave of hyped future I.P.O.s,” George S. Canellos, the S.E.C.’s New York regional director, said in a statement. “Even as investors believed their funds were sitting safely in escrow accounts, Mattera plundered those accounts to bankroll a lifestyle of private jets, luxury cars, and fine art.”