Photo: Jim Migdal
Employees at hot Silicon Valley companies are once again getting rich selling stock.This time, they’re doing it even without their companies – Facebook, Groupon, Twitter and others – going public.
They are selling their stock on private secondary markets like SecondMarket and SharesPost – two new exchange/brokerage firms that have created a thriving market for hot private stocks.
The rise of the private markets is controversial. In addition to creating excitement about a new source of private-market liquidity, these markets have spawned concerns about “asymmetrical” information and insider trading as well-informed insiders dump their stock on clueless outsiders.
The markets have also given rise to an ecosystem of middlemen who facilitate private-market investing. Middlemen like Felix Investments, which send out letters to potential investors like this one, which was obtained by the Wall Street Journal:
If you do not own stock in Twitter already it is a must. If you already own Twitter you need to add to your position. There are two absolute must have positions – Facebook and Twitter! This is the first Twitter stock we or anyone else has had in the past six months and like Facebook it will continue to trade up in price rapidly!”
You can imagine why emails like this one worry people. In it, Felix Investments called the stocks of Twitter and Facebook “absolute must have positions” because… well, because Twitter and Facebook stocks were going up! Felix provides no details about the financial performance of Twitter and Facebook in this solicitation email – because it didn’t have any. The financial performance have not been publicly released.
In other words, even in the private markets, the stock-promotion game is already alive and well.
It used to be that employees at hot Silicon Valley companies could wait for the IPO and then just sell their stock on the pubic markets, where anybody with an E*Trade account could by their stake.
These days, since IPOs are so much rarer, former employees have to find “accredited investors” that the SEC will allow to buy stakes in private companies. The SEC has this rule because private companies, unlike public companies, don’t have to disclose their financials, and this can make them riskier investments. Accredited investors are individuals whose earned at least $200,000 the last two years, and expect similar income next year, too. They can be a married couple who combine to earn more than $300,000. The idea is that they understand and can afford the risk.
Because it would be difficult for some former employee of a hot Silicon Valley startup to find an “accredited” investor all on their own – and because private companies like Facebook and Twitter would like to remain under the SEC’s 500 shareholder limit for private companies – these employees are selling their stock to middlemen operating huge funds, of which “accredited” investors can own a stake.
This puts the onus on the the middlemen operating those funds to find investors willing to invest in fast-growing, speculative Silicon Valley companies that do not tell anybody how much money they have, are making, or plan to make in the future.
Perhaps the very most successful of these middlemen is a firm called Felix Investments – the firm that wrote the email you read before.
Felix Investments is run by a Wall Street veteran named Frank Mazzola, who works out of a shiny, glass skyscraper way downtown. Mazzola is bald, tanned, and a big smiler. On the phone, he sounds like a less cartoonish version of Vin Diesel in Boiler Room.
He won’t tell you this – the SEC forbids him too – but Mazzola runs at least two large and growing funds with large stakes in Facebook and Twitter.
He’s purchased stock from employees and investors in companies like Facebook, Twitter, and Groupon at least 70 times. Sixteen pre-IPO Google employees are investors in his funds. Prior to running Felix Investments as its CEO, Mazzola was a managing director at Advanced Equities. That stint didn’t go as well as he’d hoped, Mazzola told us on the phone.
Even as it aggressively makes former employees of hot startups rich, Felix Investments has, thanks to that email and others like it, developed a poor reputation in some quarters of Silicon Valley.
When former Twitter employee Alex Payne considered selling Twitter stock to Felix Investments, Silicon Valley’s top angel investor, Ron Conway, told Payne it was a mistake to sell to Felix because of its reputation. He told Payne that he should consider “his long term relationship with Twitter and the tech community” before completing the transaction.
Importantly, Conway’s view of Felix Investments is not unbiased. Through his Twitter fund, RC Chirp, he’s actually one of Felix’s competitors.
But Conway isn’t alone in his views, either. Several other sources complained to us about Felix Investments.
One source alleges that when Felix sells its own investors on Twitter and Facebook stock, it will, in the absence of real financials from the companies, produce revenue figures “in thin air.”
Mazzola calls this accusation “totally inaccurate.” He says Felix Investments will sometimes repeat to its clients what media outlets are reporting about the companies in which they are invested. “CNBC has numbers on Facebook all the time,” he says.
Besides, he adds: “Any numbers that [the media] published a year ago have been proven out, and maybe even look to be on the conservative.”
Several other sources alleged that, in violation of SEC rules, Felix Investments will solicit non-accredited investors with which it has no previous relationship and sell them very hard on private company stock using, in one source’s words, “used car salesman techniques.”
Remember that email with all the exclamation marks, describing Twitter and Facebook as ” two absolute must have positions”? It’s not the only example.
On its Web site, Felix Investments has the following text next to Facebook, Twitter, and LinkedIn logos:
“We offer our investors the opportunity to invest in companies that don’t want money, don’t need money, and won’t take money. This is when you want to invest!”
We don’t know if the email we started our story with was sent to an accredited or non-accredited investor.
Either way, it may violate SEC rule 15.c.2.11, which stipulates that a broker is not allowed to solicit interest in a company’s stock from investors unless the broker has access to that company’s balance sheet. Felix Investments does not have access to Twitter’s balance sheet.
When we read this email to Michigan law professor Adam Pritchard – one of the top securities law professors in the country and author of the authoritative text book, “Securities Regulation: The Essentials,” – Pritchard said, “That email sounds like a solicitation of interest to me. I don’t think it’s a judgement call. “
Mazzola says he did not personally write that email, but he doesn’t deny it came from Felix Investments.
Either way, the email doesn’t bother him, he says, noting that Twitter has gone from a $2 billion valuation to a $10 billion valuation since that email went out. “In that particular case the excitement was justified,” he says.
“Maybe from time to time individuals get very excited. You have to believe in the products you’re getting behind. If you don’t that would be a bigger issue,” he argues.
Others don’t share this view.
A source briefed on the compliance practices at SecondMarket, a Website that helps connect buyers and sellers of private company stock buyers and sellers, tells us that the language on Felix’s Web site and in the email produced above is the sort that resulted in SecondMarket banning Felix from its platform.
Mazolla says he’s never been informed of any such ban, and that it’s him that’s not doing business with them.
“I’m quite confident that if there was anything on their site that we wanted to buy, I would be able to do so. We don’t have to use middlemen. We hired a senior guy from SecondMarket last year.”
Pritchard says its likely that SecondMarket is being pro-active because “they don’t want to give the SEC ammunition to say that this market needs to be regulated.”
Pritchard says the SEC could respond to Felix Investment’s behaviour – if indeed it does amount to any violations – with a cease and desist or an injunctive action.
One question you might have about Felix Investment’s reputation and it’s alleged solicitation of interest is: So what?
Who cares if Felix Investments is sending out screamingly bullish emails about Facebook and Twitter?
So far, you might say, Silicon Valley employees and investors are getting rich and the “YOU MUST OWN TWITTER” email has been proven right. You might even pull up the incredible chart we’ve pasted below, which shows the prices at which “accredited” investors bought LinkedIn stock before it’s IPO, and the price at which they were able to sell after:
Try this: Felix Investments admits to telling its clients – and, allegedly, people who are not yet its clients – to buy stock in companies which they know very little about. While everything on the private market keeps going up, that may seem something less that crazy.
But there is no “new normal” and eventually, one of these companies is going to do much worse than anybody on the outside could have expected.
And that’s when proverbial “mum and pop” investors who bought in on screaming emails and then lost everything will come back with their lawyers. And they’ll go after anybody who had any part in the whole mess.
Correction: An earlier version of this post said Alex Payne sold his stock to Felix Investments. Payne did not, though he says Felix has approached him several times.
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