The move is part of a broadening probe by the U.S. agency, still at an early stage, of the thriving bazaar that has sprung up largely beyond the reach of regulators and traditional securities firms. Trades handled by SecondMarket Inc., SharesPost Inc. and other market makers specializing in privately held shares are conveying eye-popping valuations on some companies while disclosing little about their financial results.

Such market makers connect holders of private-company stock, often former employees, with potential buyers. But SEC officials are concerned that the middleman role could cause conflicts of interest, especially given the challenges of ascribing a fair value to privately traded shares, according to a person familiar with the situation.

SEC officials also believe some of the firms promoting stock-trading in private companies should be registered as broker-dealer operations but aren’t, according to people familiar with the matter. Licensed securities firms are subject to oversight and inspection by the Financial Industry Regulatory Authority and the SEC.

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But the current market tempts VCs to change the game plan by buying shares of late-stage Web companies wherever they can find them–from start-ups directly or from employees and previous investors.

VCs didn’t start the fire; folks like Yuri Milner from Digital Sky Technologies (Facebook, Zynga, Groupon) and private company marketplaces that help stave off IPOs, like SecondMarket and SharesPost, did.

But these new Web giants’ valuations just keep going up. Think Facebook’s valuation was bloated at $50 billion? After seeing huge demand at that price, a month later, the company is exploring selling employee shares at a $60 billion valuation.

Watching those numbers rise so quickly makes VCs lose their hang-ups about price and just want to get in on the hotness.

Kleiner Perkins is reportedly buying $38 million worth of Facebook shares from existing shareholders at a $52 billion valuation, according to VentureWire. Meanwhile, Andreessen Horowitz bought $80 million worth of Twitter shares on the secondary market, after not participating in the company’s recent $200 million funding round, led by Kleiner Perkins.

Both those firms, along with Battery Ventures and Greylock Partners, also invested in Groupon’s last huge round, after the daily deal site walked away from talks of a $6 billion buyout by Google.

It’s not just the big names doing such deals. Venture capitalists were the buyers in more than 40 percent of transactions on SecondMarket in the fourth quarter of 2011.

VC activity easily outpaced other buyers, which were individuals, hedge funds, mutual funds, secondary funds and asset managers.

According to SecondMarket Head of Public Affairs Mark Murphy, VCs representing the largest percentage of buyers is a recent trend that started in the third quarter of 2010.

This comes at a time when raising money for a VC firm is tougher than ever.

What are VCs buying on SecondMarket? Facebook accounts for the single largest portion of transactions, at 39 percent. After that are LinkedIn, Etsy, Chegg, Epocrates, Silver Spring Networks, CafePress and Reply, and some other companies that declined to be named.

SecondMarket does not share pricing or volume stats or trends, except to say it sold $157.8 million worth of stock in the fourth quarter, up from $75 million in the third quarter.

Some VCs are steering clear of secondary markets and late-stage deals. Redpoint’s Geoff Yang was willing to go on the record about it in a recent interview. “What do venture capitalists know about being a momentum hedge fund?” he said.

It’s not just proven hits big enough for the secondary markets that are attracting funding interest. Everyone is still eager to find the next Groupon or Zynga. The Q&A site Quora, led by former Facebook CTO Adam D’Angelo, raised $11 million at a valuation of $86 million last year before it had even launched to the public. After success with early adopters, the start-up is now fending off offers of much more money than that.

So there’s pressure to either get in very early, or get in late if you can, because the time in between is fleeting.

VCs are also actively trying to get more involved in seed funding deals. For instance, Google Ventures recently set up its Startup Lab to attract early-stage companies where it charges them $5 per month for office space (see our video tour). And just this morning, NetworkEffect covered how VCs are actually more active than angels on the early-stage investment matchmaking service AngelList.

Look instead on the market’s margins, where a new set of tech companies is racing to attract public investors before the warm, buzzy feeling wears off.

That’s where a curious document was released Friday afternoon: The initial-public-offering papers for a company called Skullcandy, Inc., issued by top-tier underwriters at Bank of America-Merrill Lynch and Morgan Stanley.

You probably try to avoid things called Skullcandy. Your kids think otherwise. Lately, they may have been pestering you for a pair of Skullcandy headphones for their iPhones. These headphones are typically stamped with bright colors and large skulls, presumably to enhance parental annoyance.

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But besides valuations, perhaps a more severe symptom of a brewing bubble is the recklessness by which venture capitalists are making their investment decisions.

Speaking Wednesday at the Digital Hollywood conference in New York, Venrock’s David Pakman tossed out an observation that makes the investment game sound like the Wild West.

“We are seeing what I would call bad behavior with investors looking at these hot spaces,” Pakman said, speaking specifically about ventures in social media and mobile. “Deals are getting done with little to no due diligence.”

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Here’s a deal we can confirm: AOL is buying Web video start-up 5Min Media.

The price for the deal is between $50 million and $65 million, sources close to the situation said. AOL (AOL) plans to announce the deal Tuesday morning. UPDATE: Here’s the press release.

5Min has raised some $13 million in three years, and last spring CEO Ran Harnevo told me he was being offered the chance to raise more money at very attractive valuations.

The deal is at least part of AOL’s secret video strategy–the one that CEO Tim Armstrong acknowledged, but wouldn’t disclose–earlier this month.

5Min is a video middleman: It takes video clips that other people make and distributes them to other people’s Web sites. It says it has a library of 200,000 clips that generate 110 million views a month across 800 partner sites.

The videos come from people you’ve never heard of, and those you have, including CBS (CBS), Hearst and Scripps Networks. 5Min isn’t focused on getting the clips on Google’s (GOOG) YouTube–it’s trying to strike deals with conventional publishers that don’t have video, but would like some.

I don’t know whether 5Min’s deals allow it to retain distribution rights if it gets acquired, but I’m guessing that they do. Otherwise, 5Min is a much less attractive acquisition.

But in any case, you can see how the company would fit together with StudioNow, the video-creation platform AOL bought for $36.5 million earlier this year.

The first deal gives AOL a way to make lots of videos at low cost; the second gives it the ability to distribute those clips widely. At the right price, it’s not a head-scratcher.

No comment from AOL. I’ve left messages for Harnevo, who can be seen in the video below:

According to a new survey from law firm Fenwick & West, the terms of venture financing in the first quarter of 2009 were heavily dominated by “down” rounds–industry jargon for saying that companies are getting much lower valuations than they previously commanded. Down rounds exceeded “up” rounds by 46 to 25 percent, with 29 percent flat, notes the survey. That’s the first time since the fourth quarter of 2003 that down rounds have outweighed up rounds.

That’s bad news for existing venture investors in a startup, whose piece of the company is devalued. It’s also bad news for startups, which are worth less than they once thought.

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That’s not great, but it’s a marked improvement from the 2.77 the Index registered in the fourth quarter–its lowest point in five years. Why the sudden change? “While concern over the state of the national and global economy and financial system remains, a sense of foreboding appears to be giving way to an expectation of eventual, if slow, recovery in the high-growth venture environment,” Mark Cannice, the author of the survey explains. “This mustard seed of hope appears to be taking sprout among a majority of the venture capitalist respondents who provided their insight to the March 2009 survey. And it is nurtured by venture capitalists’ faith in the resilience of entrepreneurs to build efficient enterprises with disruptive solutions, more modest expectations for growth and valuations, and the early stages of a stabilization in the financial system.”

In short, no reason at all. The economy is still deteriorating, perhaps less quickly than it has been, but deteriorating nonetheless. And venture investment is still declining. But there’s a sense that things are going to get better. And they surely will. Certainly, it’s not too difficult to do better than no IPOs two quarters running. And, as Sandy Miller of Institutional Venture Partners reasons, an economic environment like the one we’re in often gives rise to disruptive new technologies. “While the environment seems gloomy with no end in sight we need to remember that some of the best companies have been founded and built during bleak times,” he said. True entrepreneurs will continue to find ways of moving their ideas forward. From a venture investor standpoint 2009 and 2010 should be an attractive environment for new investments though there will be little liquidity for existing investments.”

As Sequoia Capital partner Michael Moritz often notes, the best time to invest is often “when people are cowering under their desks.”

[Image Credit: VC Wear]

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