Thursday, September 29, 2005

Seeking Unlimited Success From Providing a Market for Restricted Stock - New York Times

JENNY ANDERSON - New York Times: "While there are markets to buy and sell everything from weather derivatives to sneakers, there has not been a market dedicated solely to trading restricted stock, a market estimated to be worth more than $1.2 trillion.

Restricted Stock Partners wants to change that.

The company has started the Restricted Securities Trading Network, a platform to trade securities known as restricted stock that are issued by companies in private, unregistered sales as part of compensation agreements, mergers or other corporate deals.

Currently, people who want to unload restricted stock generally go through brokers who offer a price based on what the bank sees as a fair value for the restricted stock. The new trading network will provide sellers with multiple buyers and competitive bidding, while continuing to operate with a private transaction regulatory framework required by the Securities and Exchange Commission.

Because the securities are unregistered, various restrictions and document requirements govern their sales, including the requirement that the buyer be an accredited investor who is buying the securities as an investment rather than just to flip for a profit. Brokers face restrictions on soliciting interest publicly. When banks, hedge funds and wealthy investors register as members of the network, they certify that they have met those requirements and they identify their areas of interest.

The idea was not born out of too many sellers but rather a fast-growing market of buyers. "It's the largest asset class without a developed secondary market," said Barry Silbert, the founder and chief executive of Restricted Stock Partners. "It's not a new or novel concept but the time is right because of the proliferation of hedge funds."

Not everyone thinks the market is a sure bet. Seth Merrin, the founder and chief executive of Liquidnet, an electronic and anonymous trading system for large blocks of stock, doubts that there is enough stock to be sold to create a viable market.

"My gut tells me it's not even close to building up the liquidity," Mr. Merrin said. "To me, I think this is a perfect example of where Wall Street can provide value."

A senior equities executive on Wall Street, who insisted on not being identified because his firm does not permit its executives to speak to the press, said: "It's not an innovation that needed to be done. Demand is being met by the marketplace."

Mr. Silbert is operating on the premise that there is an increasing amount of restricted stock in the market and that more people are willing to trade in it.

Companies issue restricted stock for a number of reasons, including compensation, in the form of private investments in public entities - known as Pipes - or in merger deals or as part of a corporate reorganization. When companies come out of bankruptcy, various stakeholders are often given restricted stock that they may want to offload. Venture capitalists often hold restricted stock in the companies in which they invest.

An increasing number of companies are replacing stock options with restricted stock because of new rules that will require companies to start expensing for stock options.

Because the securities are unregistered, it is unclear how big the market in restricted stock is. But the Depository Trust and Clearing Corporation, which maintains and transfers securities for member firms, estimated last year that it processed about $1.2 trillion in restricted securities, making it a conservative estimate.

Restricted Stock Partners says it will focus on restricted stock issued by small to midsize companies, making it potentially attractive to hedge funds trying to make money in less traded securities. The new trading network has signed up 125 members, representing banks, hedge funds and wealthy individuals, who collectively represent $50 billion in assets that can be invested. On average, the restricted stock transacted through the network ranges from $100,000 to $5 million with trading prices of $1 to $15.

Mr. Silbert, a former restructuring banker at Houlihan Lokey Howard & Zukin, founded his company in 2004 after ushering a number of companies through bankruptcy. As part of that process, a number of stakeholders - bondholders, vendors - ended up with sizable portions in a company they might not have intended to own.

The "network" is surprisingly low tech. People sit at a desk and negotiate with people who want to buy or sell restricted stock. While Mr. Silbert says he is in talks to make it electronic, for now it is a telephone business. The company charges 1 percent to 5 percent of the total transaction value and the trade usually takes one to two weeks, he said.

Hedge fund managers say the market provides opportunities to increase a fund's position in a company it likes, at a discount and in a private market. (Sales of restricted stock are done at a discount because the securities are not immediately liquid as they are restricted from entering the public market for a set period of time).

"There's a big advantage to buying big blocks in a private transaction rather than buying in the public market," said Daniel Warsh, a partner at the Chicago-based hedge fund Crestview Capital. "To purchase in the public market would take a very long time."

Still, Mr. Silbert is aiming high. "It's possible that restricted securities will become another widely accepted investment strategy like bank debt and high yield bonds," he said. "

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