SEC’s Yearlong Secondary Markets Investigation Reportedly Yields Charges Against SharesPost and Felix Investments [UPDATED]

"They were just blatantly violating some of the securities rules."

Frank Mazzola

It looks like the Securities and Exchange Commission’s yearlong investigation into trading private shares on the secondary market may finally be coming to a close.

Yesterday afternoon, Bloomberg first reported that the SEC is preparing to bring civil charges against Felix Investments, a Wall Street broker-dealer perhaps best-known for its twin funds Facie Libre 1 and Facie Libre II–meaning face book in Latin. “The firm is expected to be accused of violating securities laws related to soliciting investors,” DealBook wrote in a follow-up, adding that Felix “aggressively accumulated” and actively promoted shares of companies like Facebook and Twitter, going as far as to cold-call Facebook employees to try to get them to sell.

The SEC is also reportedly “nearing a settlement” with SharesPost, an online platform for selling private shares.  “Regulators had expressed concern that SharesPost was not registered as a broker-dealer when it began facilitating trades in private company shares in 2009,” noted DealBook.  SecondMarket, a SharesPost competitor which registered as a broker-dealer early in its history, however, “is not the subject of an SEC inquiry,” spokesman Mark Murphy told Betabeat.

The irony here, of course, is that the SEC’s action comes as many of the companies that were actively traded on the secondary market, like Groupon, Zynga, and LinkedIn have already gone public. In the wake of Facebook’s S-1 filing, for example, some wondered about the future of SecondMarket. A yearlong investigation seems par for the course of glacially-paced federal authorities like the SEC, who didn’t start sending out letters about “pre-IPO pooled investments” to Facebook, SecondMarket, and the like until late December, 2010, long after anxious headlines about bubbilicius valuations and the frenzy to invest.

Of the two potential results of the investigation, the potential civil charges facing Felix Investments appear to be more serious. A number of news outlets have exposed emails from the firm, which DealBook once described as “not part of Silicon Valley’s elite.” The emails show the firm engaging in comically aggressive sales tactics. Take this snippet, posted by CNBC, regarding a “special purpose” secondary fund called Pipio Associates 1 LLC (Latin for tweet) also set up by Felix:

“If you do not own stock in Twitter already it is a must. If you already own Twitter you need to add to your position.”

A source familiar with the industry called Felix’s solicitation brazen. “It’s the Boiler Room type thing, ‘You gotta get it on now! The price is going up tomorrow,'” said the source. “They were just blatantly violating some of the securities rules. Honestly, Felix is just on another level. What they were doing was so egregious and obvious.”

Felix doesn’t agree, which means the SEC should be prepping for a fight. As DealBook reports, Frank Mazzola, Felix’s chief executive, did not back down when he received notices from the SEC and FINRA last year.

In Finra’s report, Mr. Mazzola said he believed that “he acted appropriately at all times” and that he would “aggressively defend himself in this matter.”

The rumored settlement with SharesPost seems likely to go smoothly. SharesPost managing director of transaction services Tim Sullivan emailed Betabeat last month to say that SharesPost received its broker-dealer approval from the Financial Industry Regulatory Authority (FINRA) on January 3rd of this year, although the company says the registration went through on December 14th.

Registered broker-dealers are prohibited from doing things like showing pricing, said a source, because that implies you’re trying to attract new buyers and goes against rules about general solicitation. SharesPost used to list still lists pricing on their site, as well as the logos of startups like Facebook.

UPDATE:Another source familiar with the situation reached out to Betabeat to confirm that SharesPost is indeed nearing a settlement with the SEC expected “in short order.”

“The specific area of inquiry was centered around whether the company should have been a broker-dealer,” confirmed the source. Prior to getting FINRA approval, SharesPost was using third-party broker-dealers for transactions, the source explained. While DealBook reported that Felix Investment received a Wells Notice (typically a sign that the agency is planning enforcement proceedings) from both the SEC and FINRA, the source says SharesPost did not receive a Wells Notice. “The investigation [into SharesPost] was not a result of any customer complaint or result of any securities fraud, it only centered around whether the company was a broker-dealer,” said the source.

As to why SharesPost didn’t seek to register itself as a broker-dealer earlier, the source thought it had to do with the fact that existing “regulations were unclear.”

The source also said that SharesPost continues to list pricing, historical pricing and logos of startups whose shares are traded on its exchange because, “Information is power.” Those specific concerns, added the source, were not part of the SEC’s inquiry.

Meanwhile, SecondMarket, arguably the highest-profile company in the space, has managed to stay out of the fray. In a statement to Betabeat, the company attributed it to spending significant resources to make sure its playing by the rules:

“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.”

But that doesn’t mean SecondMarket has remained entirely unscathed. As we told you last year, Felix Investments filed a suit against SecondMarket for a failed attempt to buy 75,000 Facebook shares from one of its software engineers. Although the engineer returned the purchase price back to Felix, the firm sued for damages based on Facebook’s current valuation, rather than the valuation at the time it tried to buy the shares. We’re guessing if you’re sending emails like this to “accredited” investors, you’d be motivated to sue too (emphasis ours):

We have Facebook stock at $34 which implies a market cap of about $74 billion. They will file on Tuesday “we believe” and price the IPO in May in the mid $50’s and we believe the stock will be north of $100 when we can sell in November. If we are wrong here and are disappointed with the transaction it will be because we only doubled our money – which would be a major disappointment but a highly unlikely one in my opinion! Let me know if you have an interest. We had $10 million and have about $2 million left.”

SecondMarket has filed a motion to dismiss the suit and is currently waiting for a ruling. SEC’s Yearlong Secondary Markets Investigation Reportedly Yields Charges Against SharesPost and Felix Investments [UPDATED]