TORONTO (Reuters) - The wild popularity of Facebook and other social media sites has spawned a cottage industry of con artists promising average investors a chance to cash in on the frenzy through shares in the companies ahead of their initial public offerings.
While the pre-IPO offerings may be real, investors must be aware that the people touting them may be frauds, the U.S. Financial Industry Regulatory Authority (FINRA) said on Tuesday.
“Investors need to understand that it’s extremely rare and extremely unlikely that the average Main Street investor will have access to these kinds of shares in social media companies, before those companies go public, if they ever go public,” said Gerri Walsh, FINRA’s vice-president for investor education.
A simple search of the Internet reveals YouTube videos telling investors how they can get in on the ground floor of exciting investment opportunities in social media companies, as well as blogs that are devoted to thinly traded, unregistered securities.
The touts aim to connect investment ideas to the buzz surrounding the concept of social media to lure unsuspecting investors in, said Walsh, whose agency is looking into potentially fraudulent schemes attached to social media.
In September, the U.S. Securities and Exchange commission settled a civil action against securities broker Randy Cho, who bilked investors out of nearly $10 million in pre-IPO scams involving well-known companies between 2001 and 2009.
Self-employed Cho was telling investors he worked for Goldman Sachs and had access to shares in companies like Google, Facebook, and Rosetta Stone, and that he would invest their collective funds in these companies ahead of their widely anticipated IPOs.
Cho spent the money on personal trades, personal expenses, and to feed a Ponzi scheme, paying old investors with money from new investors, according to the SEC.
Cho had to repay nearly $8 million and had to pay a penalty of $150,000. In December, U.S. federal prosecutors brought criminal charges against Cho, who operated in Chicago, Seattle, Boston and Newton, Massachusetts.
“With any startup company, early-stage investors that are putting their capital and their belief and trust into the company are exposing themselves to a great deal of loss,” said Walsh.
“The workers who often get stock options should the company ever go public, are putting in their sweat equity, so why would a stranger approach you, give you an opportunity to get in on this ground-floor investment — you need to ask, ‘why me?’”
She said con artists commonly manage to persuade investors to take part in their scams by dangling “phantom riches” — the promise of huge guaranteed returns for getting in on the ground floor.
FINRA recommends a few things investors can do to avoid cons: verify that the person touting the investment is licensed; look the person up on the Federal Bureau of Prisons Inmate Locator (here); Google them; and get a second opinion from a licensed investment professional or an attorney.
Separately, the SEC said on Tuesday it was reviewing the rules surrounding private securities trading and IPOs.
The move comes as the market for pre-IPO offerings by Wall Street banks and electronic markets for companies like Facebook and Twitter heats up.
In a high-profile example, Goldman Sachs had planned to offer both U.S. and foreign investors a chance to own shares in Facebook through private placements. Goldman later said it would not sell the shares to U.S. investors, citing the intense media coverage of the deal.
SEC Chairwoman Mary Schapiro said that Goldman feared the media attention might run afoul of rules that prohibit general solicitation to investors for private placements. When these rules were written, “nobody thought about media frenzy,” she said.
The review will look at the rules around when a company must go public and start filing periodic financial reports. It will also look the rules on private placements and how firms can qualify for exemptions from registering their securities offerings with regulators.
Additional reporting by Sarah Lynch in Washington