Has Blogging Become the New Insider Trading?
“People think there is a distinction between how an major investor can talk about a public company versus a private company,” said Ralph Ferrara, former General Counsel for the SEC. “But if you read the law carefully, you see that everything that you can do wrong when combining a public company with the media applies to investments in private companies as well.”
Michael Arrington wanted to have it all. The editor-in-chief of TechCrunch, the nation’s most powerful tech blog, had, except for a brief hiatus, invested his own money in the companies he covered. The move always prompted a bit of grumbling in the blogosphere, but nothing he couldn’t handle.
Then Mr. Arrington decided to go bigger. He tapped Silicon Valley’s royalty to raise a $10 million pool he dubbed CrunchFund.
According to sources familiar with the fund, it was only after these commitments were made that Mr. Arrington approached his corporate overlords at AOL to inform them of his plans. Initially upper management was nervous about the potential conflict of interest. Mr. Arrington was, after all, running the crown jewel of AOL’s new journalistic empire. “He explained to them that this was nothing unusual, and pointed out that Om Malik works for True Ventures and runs GigaOm,” the source said.
The answer seemed to satisfy AOL, which gave Mr. Arrington its blessing…and an additional $10 million in corporate cash to invest. When CrunchFund became public just before Labor Day, however, the result was a media firestorm. Mr. Arrington was fired (twice) and quit (once), before eventually parting ways with TechCrunch on an amicable note. It all made for great theater—but it also signaled that something significant was happening. The increasingly incestuous relationship between investors in private technology companies and the new media publishers who cover them had become to big to ignore.
Anyone watching the industry closely could see this conflict coming. TechCrunch, GigaOm, Business Insider and yes, Betabeat, are all backed to some extent by venture funds or individuals who also invest in the companies the blogs cover (BetaBeat is owned in part by Josh Kushner of Thrive Capital). All maintain rules about disclosure when writing about companies their own backers fund, but no marriage of media and money is ever completely cut-and- dry.
In January, for example, Reid Hoffman of Greylock Parnters, which invested in Mr. Arrington’s new CrunchFund, took advantage of Mr. Arrington’s soap box with a long “guest post” for TechCrunch explaining why his firm had chosen to invest in the controversial daily deal giant Groupon.
“It takes a lot of conviction in the future of a business to pull out your checkbook when the pre-money valuation has this many zeroes,” intoned Mr. Hoffman, laying out his justification for TechCrunch readers, as well as, no doubt, the powerful limited partners who back Greylock.
Investors like Greylock typically have access to a company’s financials before committing to new funding. But there was little mention of accounting in this post. Instead Mr. Hoffman cited Groupon’s smart use of data and its sense of humor as the basis for his confidence that the company would emerge as the leader in capturing the $100 billion local advertising market. Less than five months after his post, Groupon filed for an IPO.
There was no mention in Mr. Hoffman’s item of the fact that Groupon was bleeding red ink—losing, depending on who’s accounting you prefer, anywhere between $100 and $400 million last year. He did note Groupon’s staggering growth, but neglected to touch on the corresponding explosion in hiring the company oversaw. Last week Groupon’s sales force filed a class action lawsuit alleging the company had failed to pay them millions in overtime. On the website Glass Door, a forum that allows workers to comment anonymously about their employers, members of the sales force described a boiler room atmosphere were employees were afraid to take bathroom breaks and cried at their desks.
What is Mr. Hoffman’s responsibility, if any, to investors who may decide to put money into Groupon based on his post? The conventional wisdom holds that rules governing how investors can use the media vary depending on whether a company is private or public. In the latter instance, the SEC has strict guidelines governing how the financial health of a company is represented to the public by insiders.
But the landscape is evolving rapidly. The emergence of robust secondary markets like SharePost and SecondMarket, which allow investors to purchase shares in private companies like Facebook, Twitter and Groupon, means thousands of smaller investors—with access to far less information than VC insiders—are getting in on the action. In theory, some may well have purchased shares in Groupon before their S-1 revealed their precarious financial situation—possibly after reading Mr. Hoffman’s endorsement.
“People think there is a distinction between how an major investor can talk about a public company versus a private company,” Ralph Ferrara, former General Counsel for the SEC, told Betabeat. “But if you read the law carefully, you see that everything that you can do wrong when combining a public company with the media applies to investments in private companies as well.”
Betabeat reached out several times to Greylock Partners for comment, but so far has received no reply.
According to Mr. Ferrara, there is a provision of the Securities and Exchange Act of 1934—often overlooked and typically unappreciated by investors and the lawyers who represent them—which that applies not only to public companies but to private securities as well: Section 10 b-5. Mr. Ferrara explained, “When an investor or insider is engaged in an omission which proves to be a deception, and the result of that was a financial loss to another investor, a case for fraud can be made.”
On Monday Mr. Arrington kicked off the TechCrunch Disrupt Conference, an extremely lucrative three-day orgy of back-slapping bonhomie between the TechCrunch editorial team and the companies they cover. Mr. Arrington began by announcing that he was stepping down, but he made no apologies for the conflict that caused his resignation. In fact he wore a T-shirt that read “unpaid blogger”—a middle finger to Arianna Huffington, and a play on the fact that while he had officially resigned, he has every intention of continuing to write about the companies he invests in.
For the first event of the conference, Mr. Arrington sat down for a friendly “fireside chat” with Greylock’s Reid Hoffman.
“I love the shirt,” said Mr. Hoffman.
“You can buy one on Zaarly, or not on Zaarly, dammit,” Mr. Arrington blustered, before adding jokingly, “I already said something I shouldn’t have about a company I invested in.”
Talk quickly turned to Mr. Arrington’s own drama. “I don’t have any doubts about TechCrunch, or your integrity,” Mr. Hoffman said seriously.
“But do you think all the drama around me hurts the companies?” said Mr. Arrington, the brazen provocateur suddenly concerned about media attention. “That worries me sometimes.”
Mr. Arrington began to needle Mr. Hoffman about what deals he was in. “As an investor, you really shouldn’t be talking about this stuff,” Mr. Hoffman warned, squirming a bit in his chair in front of a thousand journalists and industry insiders.
“All I want to say is, nicely done,” concluded Mr. Arrington. “You’ve got to get me in on some of these deals.”
“Likewise,” said Mr. Hoffman. And with that, it was back to business as usual.