United States: Securities Enforcement Alert: SEC Increases Scrutiny Of "Unicorns" And Other Private Companies And Secondary Market Trading Of Pre-IPO Shares

Urges Private Companies To Adopt Enhanced Controls Long Before IPO

In an unprecedented one-day blitz, the Chair of the Securities and Exchange Commission was joined by the SEC Enforcement Director in events in Silicon Valley and San Francisco on March 31 focused on one message:  the SEC is closely watching the conduct of private companies as well as emerging platforms that trade in private company securities, and will bring enforcement cases as needed to protect investors. Dubbed the "Silicon Valley Initiative," the senior officials emphasized that although the SEC wants to encourage capital formation for innovative Bay Area companies, because they play such a critical role in our economy and our markets, the SEC expects even private companies to embrace and demonstrate sound corporate governance.

Financial Controls and Corporate Governance

At an informal morning reception sponsored by Women In Securities (WISe), co-founded by Fenwick's Susan Muck, SEC Chair Mary Jo White emphasized that private companies who reach a certain size and maturity are not immune from SEC scrutiny or shareholder complaints. Chair White reminded her listeners that private companies are subject to Exchange Act Section 10(b) and Rule 10b-5 and owe fiduciary duties to shareholders. Chair White recommended that private companies take steps to enhance internal controls and governance procedures.

Later that evening in a speech at Stanford Law School, Chair White proposed questions that directors, officers, advisors and pre-IPO companies should be asking themselves:

  • Does your board include outsiders with public company or large company experience?
  • Do you have board members with regulatory and financial experience?
  • Does your board have expertise in the industry so that you can analyze different viewpoints and spot critical issues?
  • Is the company run and governed for the benefit of all of its investors?

As an illustration, Chair White noted the case of Marrone Bio Innovations, Inc. Charges were brought against the company and one of its former executives in February 2016 for inflating financial results in order to meet its projections during its first year as a public company.  This occurred, Chair White said, "[b]ecause, in part, of insufficient internal controls" that allowed the executive to direct subordinates to obtain false documents and intentionally ship the wrong product in order to book sales.

Enforcement Director Andrew Ceresney, participating in a panel after the Chair's remarks at Stanford, emphasized that companies "can't simply just turn on effective controls" once they become public; instead companies need to develop such controls while they are still private.

Secondary Market Trading

In addition to internal controls and corporate governance, Chair White noted that the SEC was also focused on the secondary market for trading pre-IPO shares.  The SEC's core mission is to protect investors, including employees of private companies or other shareholders who hold what may be illiquid shares.  In fact, the SEC already has brought at least one case alleging that a private company and its CEO defrauded shareholders—some of whom had been employees—by failing to disclose material information as part of a share buy-back.

In particular, enforcement chief Ceresney singled out the SEC's concern about trading platforms that enable investors to purchase derivative interests in private shares. He noted that this new model has arisen because companies have restricted the transfer of shares, leading to employees and others retaining the shares themselves but selling an economic interest in the shares or promising to deliver shares after a liquidity event. Ceresney noted that, depending on the structure of the deals, such transactions may be securities-based swaps which are most likely illegal if sold to retail investors under SEC rules passed in the wake of Dodd-Frank. Last year, the SEC brought its first enforcement case under these rules against a Silicon-Valley start-up who was offering investors swap contracts based on the value of pre-IPO shares.

These comments appear to herald what may be the beginning of increased scrutiny as the SEC turns its attention to private companies. In an April 1 news article in The Recorder, Fenwick's Mike Dicke noted the fear that the SEC will attempt to use the proliferation of secondary market trading in pre-IPO shares as "a hook to more closely police private companies." Despite arguments that most transactions in Silicon Valley involve sophisticated parties on both sides who understand the risks, Director Ceresney stated that the SEC's mission includes protecting even sophisticated investors, and pointed to a danger that investors broadly will lose faith in the markets if the SEC fails to prosecute fraud or misstatements involving securities transactions, in whatever sectors those transgressions occur.

Suggestions for What Private Companies and their Boards Should Be Doing Now:

In the wake of the SEC's increasing scrutiny, private companies should consider doing the following:

  • Develop written and enforceable compliance policies and procedures over financial reporting, disclosure, compensation (including the granting of equity-based compensation), cybersecurity, insider trading, and policies designed to prevent violations of the Foreign Corrupt Practices Act (if the company does business overseas).
  • Develop a whistleblower program that provides an avenue for employees and consultants to bring issues to the attention of senior management and the Board. As public companies have learned, if employees do not feel they have an effective way to bring concerns to senior leadership, employees will instead bring those concerns to the government. As the SEC increases its interest in the affairs of private companies, whistleblowers are likely to avail themselves of the SEC whistleblower process, thereby potentially triggering an SEC inquiry.
  • If their shares trade in the secondary market, companies should develop procedures to monitor and review company disclosures or other publicly available information that may impact trading, as well as monitoring what material, nonpublic information is available to directors, employees and others who may be selling shares in the secondary market.
  • Boards should consider meeting with experienced regulatory counsel on a regular basis—as public companies do—to keep abreast of current issues and best practices. In addition to the inherent benefits of having improved corporate governance, should regulators undertake an investigation, it is important to be able to show that the Board and the company are sophisticated and have heeded the SEC's recommendation to adopt improved internal controls.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Events from this Firm
2 Oct 2018, Webinar, California, United States

This CLE webinar will offer suggestions to litigators to help them comply with the new GDPR during e-discovery.

10 Oct 2018, Webinar, California, United States

For the past years, 3D printing has significantly revolutionized the business industry as it provides innovations and improvement to pre-existing processes.

16 Oct 2018, Other, California, United States

This highly interactive colloquium will provide a deep understanding and practical advice regarding major e-discovery challenges facing organizations t​oday.

Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions