Should the Securities and Exchange Commission Regulate Secondary Markets?

Secondary Market What issues does the secondary market face when it comes to IPOs? The Economic Times (TET) in India explains that when a company issues securities to the public for the initial time, it is offered in the primary market. However, once the IPO (initial public offering) has been offered, and the stock can be listed in the market, those securities are then traded in the secondary market (TET).

The main difference between the two markets is that when an investor puts down money for securities in the primary market, that investor deals directly with the company offering the IPO. But once the securities are in the secondary market, the investor buys them from "other investors willing to sell…" (TET). What can go wrong -- how can fraud occur in secondary markets? In Forbes, contributor J.J. Colao offers an example of what can go wrong or awry with secondary markets.

He notes that for many years secondary markets rose steadily, and "appeared to be welcomed by all the major players in the venture-backed startup community" (Colao, 2012).

Those who launch startups had "reliable means of selling stakes" in the startup well before an IPO was issued, and hence, they could keep control of the startup "…and shield them from the searing gaze of public markets longer…" But Tangent Capital's Bob Rice and August Capital's David Hornik have put forth "lengthy denunciations" of secondary markets because they insist that those involved in large private placements "…may get access to financial information under a non-disclosure agreement," and that is not fair to other investors (Colao, p. 3).

Basically they are talking about a lack of transparency. There is speculation that before Goldman Sachs raised $2 billion for Facebook in 2011, it got "…a peek at the company's user metrics and financials" (Colao, p. 3). In fact Goldman Sachs "doubled the amount of stock it sold on the day of the IPO" which coincided with a "selective disclosure of the company's second quarter results" (Colao, p. 3). This kind of "mischief" can and does occur in secondary markets, Colao explains.

As to how fraud can occur in secondary markets, Vivek Wadhwa writes in the Washington Post that the secondary markets' "bubble…represents a danger to America's leadership position in the technology sector" (Wadhwa, 2011). That bubble also brings a serious threat to the "culture of innovation that made Silicon Valley great" because secondary markets bring with them the possibility of generating "fraud on an Enron-like scale" (Wadhwa, p. 1).

Wadhwa goes on to explain that secondary markets are only available for "so-called accredited investors" (i.e., rich folks); the Securities and Exchange Commission requires a net worth of a million dollars or "income consistently exceeding $200,000 ($300,000 if married). The writer believes that the SEC is out of touch, because while millions of Americans qualify to buy in secondary markets, many don't know the difference between preferred and common stock. So people are jumping in but they are ignorant of the secondary market particulars.

And because of "minimum disclosure requirements" in the secondary marketplace, shares are "nothing more than a handshake and promise" (Wadhwa, p. 2). Because the SEC has mostly ignored the secondary market milieu, and doesn't police the markets, it opens the door for fraud. Without regulations, the secondary market floats freely and fiscal hanky-panky can take place.

What has happened following Facebook's IPO is that many of Facebook's top talent has "cashed out enough so they don't have to work anymore" and many of them are launching their own startups, which is perfectly.