The preceding story provided an introduction to the venues for trading shares of red-hot privately-held companies, and the attendant risks that could force such companies to go public ahead of its time.   Below, we address topics 3 and 4 in this story, which you likely already know about:  

• that the SEC, alert to all the excitement and frenzy, wants to learn more about the business of these stock trading venues; 
• that Goldman Sachs has become a FaceBook investor. 

    SEC Begins Its Investigation.   The SEC wants to learn more about the business of these stock trades and, toward that end, has sent RFI's, or information requests, to several participants in the buying and selling of stock in these companies, according to 2 people with direct knowledge of the inquiry.  Peter Lattman of the NYTimes reports that It's unclear exactly what has piqued the agency’s interest, although several new exchanges are popping up to facilitate these trades. 

Investors are taking on substantial risk when buying shares in these private companies. Despite Facebook’s ubiquity (it is the subject of at least two books, countless magazine features and a critically acclaimed motion picture) it doesn't disclose its financial results.  Twitter, despite its popularity and influence, generates minimal revenue.  But investors are betting that Facebook, Twitter and their brethren will ultimately go public at sky-high valuations, delivering big profits similar to Google’s initial public offering in 2004. 

So, in addition to the SEC's interest in determining whether FaceBook now has more than 500 shareholders, the allowable limit, the SEC may be inquiring into disclosure issues or misrepresentations that may be made retail investors - by scam artists or individuals running legitimate investment pools. 

In 2008, the SEC and FaceBook tangled over a related issue.  The SEC allowed Facebook to issue restricted stock to employees without having to register the securities, which would have required the company to provide financial information to prospective investors.  

The SEC may also be searching for possible "roach motels" that can tie up an investment for a period far longer than an investor may have in mind.  Not unlike the situation with ARS's, or auction rate securities.  Although trading in these companies has increased over the last year, the market remains illiquid. After all, it's market is capped by the amount of stock for sale - e.g., at Facebook, only former employees can sell stock.

So while supply is capped, the number of potential buyers is also limited.  That's because these privately-held companies are considered high-risk securities by the SEC, and SEC s rules permit only qualified institutions (like ones that manage $100 million or more) and accredited investors (individuals whose net worth exceeds $1 million) to buy their shares. Also, many of the companies, including Facebook, have the right of first refusal to buy any shares of their stock offered on these private exchanges.

    Goldman Sachs Invests.   As we learned today, FaceBook has raised $500 million from Goldman Sachs and a Russian investor in a transaction that values the company at $50 billion.  As part of its deal with Facebook, Goldman is expected to raise as much as $1.5 billion from investors for Facebook.

Goldman Sachs already has begun reaching out to its wealthy private clients, offering them a chance to invest in FaceBo.  On Sunday night, 1/2/11, a number of Goldman clients received an email from their Goldman broker, offering them the opportunity to invest in an unnamed “private company that is considering a transaction to raise additional capital."  Another person briefed on the deal said that Goldman clients would have to pony up a minimum of $2 million to invest and would be prohibited from selling their shares until 2013.   The email also warns that recipients who trade in secondary markets where private firms like Facebook trade may want to steer clear of participating because if they opt in they may receive material non-public information on the unnamed company that will restrict future trading.

The new money will give Facebook more firepower to steal away valuable employees, develop new products and possibly pursue acquisitions - all without being a publicly traded company. The investment may also allow earlier shareholders, including Facebook employees, to cash out at least some of their stakes.

Under the terms of the deal, Goldman has invested $450 million, and Digital Sky Technologies, a Russian investment firm that has already sunk about half a billion dollars into Facebook, invested $50 million, people involved in the talks said.  Goldman reportedly has the right to sell part of its stake, up to $75 million, to the Russian firm.  For Digital Sky Technologies, the deal means its original investment in Facebook, at a valuation of $10 billion, has gone up fivefold.  Goldman’s involvement also means it may be in a strong position to take Facebook public when it decides to do so in what is likely to be a lucrative and prominent deal. 

In a rare move, Goldman apparently is planning to create a “special purpose vehicle” to allow its high-net-worth clients to invest in Facebook.  While the SEC requires companies with more than 499 investors to disclose their financial results to the public, Goldman’s proposed special purpose vehicle may be able get around such a rule because it would be managed by Goldman and considered just one investor, even though it could conceivably be pooling investments from thousands of clients.  It's unclear whether the SEC will look favorably upon the arrangement.

At the same time, other Wall Street brokerage firms have begun forming investment pools to buy these companies’ shares.  Another batch of small Wall Street firms is also trying to get in on the action - including GreenCrest Capital and Felix Investments, who are raising “Facebook funds” or “Twitter funds.”  These firms are pooling their clients’ money into investment vehicles to acquire blocks of stock of these companies.

For further details, click onto these source documents:  

• [WSJournal, 12/28, Hot Trade in ...];
  
• [NYT Dealbook, 12/28, Share Rules...];  
• [NYT Dealbook, 12/27, Stock Trading ... SEC Scrutiny] 
  
• [NYT Dealbook, 1/3/11, Goldman Offering Clients...]