The private secondary markets are less well-known than public markets. You might assume that means they’re less regulated too. But that’s not necessarily the case.
Private secondary transactions, such as buying and selling shares of pre-IPO companies, are subject to regulations by the U.S. Securities and Exchange Commission (SEC), just like transactions on public exchanges like the Nasdaq or New York Stock Exchange.
Regulations play a crucial role in ensuring transparency and managing risk for investors interested in tapping into the unique benefits of this emerging market.
There are many types of private secondary market transactions: private equity, venture capital, real estate, and more. Specific regulations may differ from trade to trade. But from a regulatory perspective, private securities can broadly be divided into two categories: restricted or not.
Restricted securities are not freely tradable, meaning that transactions involving them are subject to certain limitations. These securities include those issued in employee benefit plans under SEC Rule 701, or acquired in private placements under Rule 506(b), among others. This overview is for informational purposes only and should not be construed as legal advice. Investors should consult with their legal and compliance advisors regarding applicable requirements.
In other words, if a startup employee receives equity in the company as part of their compensation package, they can’t just resell it for cash to their interested uncle at Christmas dinner.
In order to trade their shares freely on the market, the employee would first have to register the securities with the SEC, or receive a valid exemption under Rule 144, such as holding the shares for a set amount of time, typically six months or one year.
These restrictions are put in place to prevent the immediate resale of shares from unregistered private placements. This helps make sure investors have adequate information before purchasing on the public market. It also aims to discourage insider trading by limiting when certain individuals can sell their holdings.
Some privately-issued securities, on the other hand, are not restricted; Regulation A offerings, for example. These offerings allow privately held companies to sell their shares to the public without going through the full registration process to complete an initial public offering (IPO).
In turn, these shareholders can sell their shares without being subject to a holding period, or needing to file additional paperwork with federal regulators.
The regulations don’t end with who can sell private securities. They extend to who can buy them too.
Several marketplaces have emerged to help make private secondary transactions more accessible than ever. Augment* facilitates pricing discovery, connections, and secure trades between buyers and sellers of pre-IPO shares.
However, these platforms are typically limited to accredited investors. In the US, individuals must qualify through financial criteria such as: net worth exceeding $1 million (excluding primary residence), either individually or with a spouse/spousal equivalent; annual income of $200,000 individually or $300,000 jointly for the past two years with a reasonable expectation of the same in the current year; or through professional qualifications including certain FINRA licenses, knowledgeable employees of private funds, or officers and directors of the issuing company. These requirements exist because private securities transactions require a sophisticated understanding of their unique risks.
Making money isn’t all about moving fast and breaking things. Regulations exist for a reason. They help reduce the risks inherent in the private secondary market — and ensure traders are well aware of the risks before participating.
Ultimately, without regulations, the private market wouldn’t be what it is: a regulated marketplace full of ample opportunities for investors in search of diversification.
*Securities transactions are executed on Augment Capital, LLC's ATS and offered through Augment Capital, LLC (member FINRA/SIPC).
Important Disclosures: Investing in private securities involves substantial risk, including the potential loss of principal. Private securities are typically illiquid, have limited pricing transparency, and often require longer holding periods. These investments are available exclusively to qualified accredited investors and offer no guarantee of returns. Additionally, past performance of private securities does not indicate or predict future results.