On March 31, 2016, US Securities and Exchange Commission (SEC) Chair Mary Jo White delivered a keynote address at the SEC-Rock Center for Corporate Governance indicating that the SEC is increasing its focus on large private companies valued at more than $1 billion—commonly referred to in market parlance as “unicorns.”
White began her keynote by acknowledging that the initial public offering (IPO) and private financing landscapes have shifted, as more companies than in the past have decided to remain private longer. In fact, the first quarter of 2016 has been the least active three months for IPOs since 2009. White reiterated that the SEC’s “core mission” is to protect investors, and that private companies and entrepreneurs should not shirk their responsibility to be candid and fair to shareholders, regardless of whether that responsibility is required by federal securities laws or their fiduciary duty under state laws.
White then suggested that the same obligations required of public companies—including “transparency with investors, controls on financial reporting [and] strong corporate governance”—have applicability to private companies, and especially to unicorns. Although White noted that “sophisticated investors do not need the protections offered by the . . . provisions of the 1933 Securities Act,” she went on to state that the real “losers” when private companies fail are “[n]ot just the VC and private equity funds, but also smaller retail investors and the next Stanford student whose great idea needs funding, but investors are unwilling to take a bet on her because they were burned last time.” Her concern is that the prestige and allure of achieving high valuations, combined with the lack of legally mandated internal controls and governance procedures for private companies, such as unicorns, which in years past probably would have been subject to the regulations that apply to public companies, will have a downstream effect on retail investors (which often invest via mutual funds or other vehicles with exposure to private companies) and on employees of private companies (who often receive stock and options as a material portion of their overall compensation).
Despite these concerns, many private companies that have weighed the costs and benefits are reluctant to go public in the current financial and regulatory environment. According to White, these companies are not just foregoing public capital, they also are foregoing the process by which private companies become “public,” and with that a commitment to shed light on their operations and strengthen their controls and governance. She further believes that companies should be “maturing” their governance structures and internal controls to “match their size and market impact,” even though such efforts are not currently required by law.
The key takeaway from White’s speech is that private companies that are on a trajectory to become “unicorns,” or that have already reached that status, should plan well in advance to adopt some or all of the measures that a private company typically adopts before going public. Such measures may include the following:
- Establishing committees, such as audit, nominating and compensation committees (to the extent not already formed), and holding regular meetings
- Adding independent directors to the board and committees (that meet Sarbanes-Oxley Act requirements)
- Adopting a written code of business conduct and ethics for directors, officers and employees, and implementing a whistleblower program
- Reviewing the company’s legal structure and amending the company’s charter documents
- Establishing enhanced disclosure controls and controls over financial reporting
- Having a PCAOB-registered accounting firm perform annual audits and prepare financial statements in accordance with US GAAP
- Preparing interim financials on a similar timetable to the ongoing disclosures required of public companies
- Identifying, evaluating and possibly terminating transactions between the company and related parties
- Reviewing compensation to directors and officers and implementing new equity/incentive compensation plan(s)
- Purchasing directors’ and officers’ liability insurance (if not in place) or reviewing the existing policy
Implementing these kinds of measures early will help instill the kind of discipline and corporate culture that are the hallmarks of being public, and potentially will help companies avoid the kind of pitfalls that can result in SEC enforcement actions or shareholder litigation down the road. Moreover, by acting like a public company, a company is better positioned to react to improving market conditions when IPO windows open up.