Online Exchange Fined for Illegal Swap Sales

Two entrepreneurs ran an unregistered securities exchange that sold derivatives linked to the liquidity events and value of private companies.
Matthew HellerJune 17, 2015

A Silicon Valley startup that touts itself as “The New Wall Street” has been sanctioned by regulators for illegally selling security-based swaps contracts linked to the perceived value of unlisted pre-IPO companies.

In an administrative complaint filed Wednesday, the U.S. Securities and Exchange Commission said Sand Hill Exchange violated the Dodd-Frank Act by selling the derivatives to retail investors on an unregistered securities exchange and without the required registration statements.

Sand Hill was founded in August by two young entrepreneurs, Gerrit Hall and Elaine Ou, as an online platform for “fantasy” investing. In February, they began offering and selling derivatives linked to liquidity events and the value of private companies and their securities. Some users funded accounts with dollars, others with bitcoins.

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After the SEC began an investigation, the exchange ceased operating in April. To settle the SEC’s charges, Sand Hill agreed to pay a $20,000 fine.

“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 a news release.

“We will continue to scrutinize this space for companies circumventing the law to offer security-based swaps without the safeguards provided to retail investors,” he added.

According to the SEC, about 83 individuals bought and sold contracts related to 60 private companies on the Sand Hill exchange. If a company experienced a liquidity event — such as an IPO, merger, or dissolution — the contract buyer would at that time receive one dollar for every $1 billion that the company was valued at, as determined by Sand Hill.

The private companies listed on the Sand Hill website included Uber, Pinterest, Snapchat, and Coinbase.

“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.