SEC keeps a close eye on direct secondaries

The US Securities and Exchange Commission (SEC) Chair Mary Jo White sees risks in investing in direct secondaries for both institutional and individual investors, according to a keynote session at the Annual Securities Regulation Institute meeting she spoke at last month.

“Secondary liquidity for investors on the private side is something that our advisory committees, the Commission, lots of folks are attending to,” she said, referring to the transaction of privately held shares in start-ups.

As venture capital-backed start-ups are staying private longer and postponing their initial public offerings, sometimes indefinitely, the need to provide liquidity to existing shareholders is increasing. This is particularly so for early angel and venture capital investors and employees who want to cash out.

To facilitate these direct secondaries transactions, several companies have created technology platforms, such as SecondMarket which was purchased last year by Nasdaq Private Market.

“Technology has made it possible to bring buyers and sellers together on various kinds of alternative trading platforms,” White said, adding that such exchanges aimed at increasing liquidity “have not yet worked that well”.

One of the main causes of concern is around valuations of private companies. How transparent are sellers in direct secondaries and are potential buyers sufficiently well equipped to invest?

Whether buyers are institutional or individual investors, they do not always have access to all the necessary information to make a purchase, according to the SEC chair.

White noted that those involved in late-stage, pre-IPO transactions are typically sophisticated institutional investors “who ought to know the right questions to ask and have the leverage to be able to get the information that they need”, to properly conduct their due diligence.

When it comes to private companies, no matter how sophisticated an investor is, accessing accurate valuation information can be difficult.

So-called unicorns have also attracted interest from retail investors who “may get very excited from an article or a blog and invest their money, and so you worry about them not getting sufficient or accurate information,” White added. “Anytime you have that kind of excitement in a space, it can attract fraudsters.”