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A growing secondary market for shares trading has accelerated in the past year, with online private shares exchanges such as SharesPost Inc., SecondMarket Inc., and Xpert Financial Inc. emerging from the tumultuous wake of the financial crisis. While the advent of private trading has enabled companies, mainly in the technology industry, to raise funds without filing for an initial public offering, the majority of investors, those with less than $1 million in net worth, are prohibited from trading on these exchanges. Critics argue that the emergence of this secondary market requires fresh regulatory scrutiny to protect investors and the non-investing public.

For the secondary markets to thrive, regulations need to be in place to restrain excessive risk-taking while protecting even the most sophisticated buyers. The central premise in support of increased regulation is that even sophisticated investors need relevant data such as revenue, cash flow and debt obligations, which private companies aren’t required under securities laws to disclose as long as they have less than 500 shareholders. New York-based SecondMarket stated that the SEC has requested information on investment funds that are pooling together shares of companies like Facebook.

The significance of this emerging industry remains mired in debate. Emerging companies have discovered a lucrative way to raise funds for their expansion without having to go the IPO-route, while investors can buy shares that may multiply exponentially upon exit or an eventual IPO, leading to returns that will likely exceed any result by an ordinary investor post-IPO. This disparity is what the SEC may also be looking to reconcile. A parallel investor market created out of pooled funds to maintain less than 500 shareholders may be viewed as markedly different from venture capitalists investing in specific companies they have become intimately familiar with. Securitization of such investment vehicles may lead to additional regulatory issues, particularly in the derivatives market.

While nascent, this secondary investor market has gained in popularity as an alternative means to invest in emerging companies. Investors are looking for higher returns on their investment after a dry recessionary period where initial public offerings were sluggish at best and the Dow Jones Industrial Average and Standard Poor’s 500 Index witnessed tepid growth.  In the U.S. IPO market, 2010 saw over 100 deals priced, compared with 64 for 2009 and only 48 in 2008. Charging 3% per transaction, the shares exchanges are looking to secure over $200 million in sales in 2011. Facebook Inc., Linkedin and Zynga Game Network Inc. are leading the charge, although there are dozens, if not hundreds of internet companies whose shares are being traded on the exchanges.

Investors are increasingly looking to take advantage of new investment opportunities. As the market will inevitably grow beyond the internet economy, fresh regulatory supervision will provide the necessary compliance for the market to grow and sustain to the benefit of investors and the public.

- Sheheryar T. Sardar, Esq.

sardar@sardarlawfirm.com