The NASPP Blog

The latest in a long series of SEC enforcement initiatives seemed to arrive last week when both the SEC’s Chair and its Enforcement Director, while visiting Silicon Valley and San Francisco, appeared to deliver a unified message that law firm Fenwick summarized in a publication titled “Securities Enforcement Alert: SEC Increases Scrutiny of “Unicorns” and Other Private Companies and Secondary Market Trading of Pre-IPO Shares” as:  “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.”

It appears to be a growing concern of the SEC’s that private companies may be lacking in sound corporate governance policies, practices and internal controls. Enforcement Director Andrew Ceresney 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. This has the makings of a new wave of scrutiny and enforcement actions focused on private company governance.

Secondary Market Focus

The Fenwick memo also described comments made by Chair White suggesting there is concern around secondary market trading of pre-IPO shares. It also captured detail shared by enforcement chief Ceresney:

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.

Mitigation

While this new wave of enforcement focus may not apply specifically to public companies, I can still think of scenarios where private company actions could still have a ripple effect. Take M&A activity, for example. A public company acquires a private company that has historically shown poor governance practices. Later, those practices become the target of a shareholder lawsuit. Fenwick offered some suggestions to private companies to aid in evaluating their practices and help stand up to a potential SEC investigation.

• 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.
• 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.

This is likely not the last word we’ve heard on this topic.

-Jenn