The Securities Exchange Commission today settled with Sand Hill Exchange over allegations that the start-up illegally offered complex derivative products to retail investors.
According to the SEC, the Silicon Valley-based exchange, launched at the end of 2014 by entrepreneurs Gerrit Hall and Elaine Ou, offered retail investors futures-like derivative contracts linked to pre-IPO tech companies.
The idea was to allow investors the ability to bet on valuations of private tech start-up firms prior to their expected IPOs or in the context of private rounds of funding. The exchange dubbed itself ‘the new Wall Street.’
“The Dodd-Frank Act prohibits security-based swaps from being offered in the darkness to retail investors, and we were able to act quickly before any losses materialized in this offering that occurred outside the proper regulatory framework,” Reid A. Muoio, Deputy Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, said in an agency release
The exchange agreed to cease and desist from committing future violations of securities laws and pay a US$20,000 fine, but did not admit any wrongdoing.
While the SEC only cited Dodd-Frank provisions in bringing allegations against the exchange and ultimately reaching settlement, legal experts say the firm was likely in violation of a raft of securities laws.
“They were probably breaking about 27 different rules. This would have been illegal even before Dodd-Frank,” said Steven Lofchie, partner at Cadwalader, Wickersham & Taft.
“To me this does not look like hardened criminal activity. It looks like a couple of tech guys came up with a neat idea, but they didn’t know that you can’t have neat ideas in the financial industry.”
Aside from the violation associated with offering complex derivatives to retail investors, the firm also never received regulatory approval for their contracts – a requisite for derivatives that reference private companies.
“Hall and Ou understood that they were buying and selling derivatives linked to the value of private companies, and Ou falsely claimed that they were in the process of seeking regulatory approval for Sand Hill’s contracts,” the SEC said in the release.
The SEC also referred to the exchange as “along the lines of a fantasy sports league,” and released an alert warning investors on its website.
The exchange was launched at a time when tech companies began discarding the traditional IPO process in favour of repeated rounds of private funding. It had sought to allow investors to use bitcoins to access its contracts,
The trend of so-called ‘unicorn’ start-ups – private companies that raise money at US$1bn-plus valuations – has made it harder for investors to access equity in some of the most promising tech companies. So far this year, only 10 tech IPOs have priced, compared to 55 in 2014, according to data from Renaissance Capital.
Among the companies listed for trading on Sand Hill Exchange were Uber, Snapchat, Fitbit and Pinterest.