SEC Eying Secondary Market Regulation

by: NYC Trader

Facebook is valued at $56 billion, Twitter at a more modest $3.6 billion and Zynga, somewhere in between the two. Facebook's recent valuation carried the company's market cap above companies like American Express (NYSE:AXP) (10x higher revenue than Facebook) and Kraft Foods (KFT) (20x higher revenue than Facebook). Investors are betting on growth and the trading in the secondary markets has become more liquid than its nature would imply.

The stocks are extremely sought after as the new and potentially profitable "social networking" class and investors are hoping to get in early on the next Google (NASDAQ:GOOG). One problem though: many of the investors haven't seen the financial health of these companies. It's not surprising then that the Securities and Exchange Commission (SEC), as reported by the New York Times, has expressed interest in looking into the secondary market trading. As the valuations for the social media companies are reminiscent of the internet bubble pricing, there is much concern that investors are grabbing onto something they know very little about. Private companies aren't required to disclose their financial statements. As the trading has become more liquid, with investment companies reaching out to private investors in their attempt to pool money, the non-disclosure has become a growing concern.

Current regulations appear to treat these "blind pools" more liberally. As long as a fund has less than 500 investors, there's no need to disclose anything to the public. Each blind pool could technically have hundreds of investors. With Facebook specifically, however, as the blind pools have become an effective way to raise significant capital, the regulators are concerned that the number of actual investors could be in a much higher range than anything they've seen before. The SEC's reasons are unknown, but if regulations change, the situation could have a significant impact on secondary markets and blind pools in general.

My opinion is that the secondary markets have traditionally been a unique trading exchange for illiquid trading. With investors pouring in capital into these markets, the trades have become extremely crowded. If blind pools are a loophole to avoid the 500 shareholder measures, then clearly there should be more regulations in place to protect the investors. I was shocked to see the Facebook valuation reach $56 billion. Apparently I wasn't alone.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.