Pre-IPO Offerings—These Scammers Are Not Your Friends
It’s no secret that when a promising company emerges or an industry sector becomes “hot,” investors typically flock to get a piece of the action. But what happens when the company is privately held and investors can’t readily buy shares because the company has not conducted an initial public offering of its stock? Investor demand for shares of the private stock of high-profile social media companies—such as Facebook, Groupon, Twitter and Zynga—has been surging in recent months. These companies have millions of subscribers and have dramatically changed the way people interact. But social media has also become the latest hook on which con artists can hang a scam. In this case, fraudsters dangle the promise of wealth from the sale of “pre-IPO” shares.
For instance, in late December 2010, shortly after the Securities and Exchange Commission settled a civil action, federal prosecutors brought criminal charges against a self-employed securities trader who allegedly bilked more than 50 U.S. and foreign investors out of more than $9.6 million in a series of pre-IPO scams spanning an eight-year period. We are also aware of other potentially fraudulent schemes that have solicited potential victims by purporting to sell shares of Facebook.
FINRA is issuing this alert to warn investors about pre-IPO scams purporting to offer access to shares of Facebook and other popular, well known private companies.
Pre-IPO Speculation Always Risky, Can Be Illegal
In general, offerings of securities must either be registered with the SEC or meet an exemption under the federal securities laws—otherwise the offering is not legal. "Pre-IPO" speculation involves buying unregistered shares in a private company before the initial public offering of securities—and it can range from risky deals to outright frauds.
On the legitimate end of the spectrum, a company can sell its unregistered shares in private transactions (often called “private placements”), and such sales to investors are an essential source of capital for American business, particularly small firms. But these Investments can be fraught with risk—including the fact that you can’t be certain the company being touted will actually complete an IPO. This means you cannot be sure whether you will ever be able to sell the shares you purchased. Separately, the fair market value of your shares may be based solely on speculation. And privately purchased shares typically come with restrictions, such as lock-up periods that prevent you from selling your shares for up to a year even if the company goes public in the interim. In addition, for a private placement to be legal under the federal securities laws, the company and its promoters generally cannot advertise the offering or make solicitations to the general public. And these deals are typically open only to “accredited investors,” which includes individuals who have net worth of more than $1 million (excluding the value of their primary residence) or income of more than $200,000 in the current year and each of the preceding two years ($300,000 for couples).
On the other end of the spectrum, the unregistered shares offered to you could be part of a fraud. The company might not exist—or, if it does, the promoter might be offering shares he doesn’t have or that he acquired in a questionable transaction. The fraud could also involve misrepresentations about the company and its prospects, including the likelihood, timing and pricing of any potential IPO. In the criminal case mentioned above, the defendant falsely claimed that he had worked at Goldman Sachs, was a preferred client of the firm and had access to discounted, pre-IPO shares of such well-known companies as AOL, Google, Facebook and Rosetta Stone.
The bottom line is that many pre-IPO scams involve unlicensed individuals selling unregistered securities—that’s why it’s critical to check out both the promoter and the investment. And pre-IPO offerings that target the general public—especially those that are publicized through "spam" emails—often violate the federal securities laws.
Fraudsters would have investors believe that virtually anyone can get in on pre-IPO deals of small, little-known start-ups as well as those of large, popular companies. One sure-fire way to avoid being taken in by an unsolicited offer is to ignore it—regardless of how you heard about it. Someone claiming to have shares of Facebook or some other social networking company may very well be a paid promoter or, more likely, a con artist trying to take your hard-earned money.
Never rely solely on information contained in an unsolicited fax, email, text message, tweet or other format for social network communications—or in a blog post or online thread. To steer clear of potential scams, follow these tips.
If a Problem Occurs
If you believe you have been defrauded—or treated unfairly by a securities professional or firm—please send us a written complaint. And if you suspect that someone you know has been taken in by a scam, be sure to give us that tip. Here's how:
File a Complaint (for you)
Send a Tip (for others)
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