The secondary markets for privately held companies is about to get rocked.  The SEC, which has conducted a year-long investigation into the buying and selling of shares of closely held Internet start-ups, reportedly is preparing civil charges against 2 firms -

• Felix Investments, a Manhattan-based broker-dealer that was among the pioneers in the trading of social-networking companies;  
• SharePost, one of a group of exchanges that has popped up in recent years to accommodate the fast-growing market for privately held shares.

Felix Investments. The firm is expected to be accused of violating securities laws related to soliciting investors.  Felix has raised pools of money from outside investors who wanted to buy shares of Facebook, Twitter, LinkedIn, and Zynga before they went public.  The firm aggressively marketed its funds, sending e-mails to potential investors.  Last year, the firm emailed its clients that Twitter was a "must buy," and added:

"This is the first Twitter stock we or anyone else has had in the past 6 months and like Facebook it will continue to trade up in price rapidly!"

Felix was an early player in the trading of shares of private companies, raising capital from clients to invest in "Facebook funds" or "Twitter funds."  It aggressively accumulated shares of the hot social-networking companies.  The firm cold-called Facebook employees to try to get them to sell their shares, and promoted their offerings in emails to prospective clients. According to FINRA, Felix CEO Frank Mazzola received a Wells Notice from both the SEC and FINRA last year.  In Felix's report to FINRA, Mr. Mazzola said he believed that "he acted appropriately at all times" and that he would "aggressively defend himself in this matter." SharePost. The SEC reportedly is said to be nearing a settlement with SharesPost, which was not a registered broker-dealer when it began facilitating trades in private company shares in 2009.  SharesPost became registered in December. An SEC spokesperson declined to comment on either of these cases. At a Crossroads for Private Share Markets. The government’s actions come as the so-called secondary market for private stock has reached a crossroads.  Many of the top names that traded in these markets have gone public, or are in the process of doing so.  Facebook, the "leader of the pack," recently filed to list its shares on a public exchange. Others, like Zynga, Groupon and LinkedIn, which also were actively traded on these private exchanges, have already gone public. In 2010, securities regulators began closely monitoring trades of private shares.  The market formed around sellers who largely were former employees and early financial backers (i.e., VCs) of Facebook and other companies who were looking to sell their stakes that had sharply appreciated in value.  The buyers were mostly wealthy investors looking to own a piece of the next Google or Apple.  A considerable factor that drove the growth of the private company trading was the weak market for IPOs following the financial crisis of 2008.

"We are serving a growing need.  A decade ago, these companies would be public by now. Investors can now buy into these businesses and sellers can exit their already valuable stakes." -- David Weir, former CEO of SharesPost, in a December 2010 Interview when news emerged of the SEC’s interest in the market.

Actions by Regulators. Last year, SEC rules helped scuttle a deal in which Goldman Sachs offered its U.S. clients a chance to invest in Facebook - Goldman had planned to raise a $1.5 billion pool to buy Facebook shares.  However, Goldman ended up excluding domestic clients because of concerns that the widespread news coverage of the deal could run afoul of securities law related to private offerings. A Growing Niche. Despite the secondary market’s growing pains and the transformation of some of its most actively traded companies into public stocks, the leading players say the business can grow.  SecondMarket, the largest private-company exchange, completed more than $558 million in transactions last year - up 55% from 2010.

"The private companies, buyers and sellers that utilize SecondMarket trust that we understand and comply with the regulatory framework governing secondary transactions.  For the secondary market to continue to prosper, it’s important that all market participants act honestly and follow the rules."  -- Mark Murphy, spokesman for SecondMarket.

SecondMarket, issued a statement on Monday saying that it was not the subject of an SEC investigation. Click to access the reference story:  [Dealbook, 3/12/12].