One misperception I often encounter among private companies is that the rules don’t apply to them. And by “rules,” I’m referring to just about everything from tax and accounting to securities laws. A recent SEC enforcement action, however, highlights that even private companies can be the subject of SEC scrutiny.

Securities Laws: They’re not Just for Public Companies

“It would look really bad to have my 2 sons award me a whole bunch of additional stock right before a sale of the company at a stock price many times the price used to calculate my stock.” – Charles Stiefel, CEO of Stiefel Labs, in email to his sons (Stiefel and his sons were the only members of the compensation committee).

Really?  Ya think?

The SEC complaint alleges that Stiefel Laboratories, a small family-owned business, undervalued its stock when buying stock back from employee shareholders and failed to disclose information to employees that would have alerted them to the fact that the price they were receiving was too low. At the time of the buybacks, the company had received purchase offers based on valuations of the company’s preferred stock that were 50% to sometimes 300% higher than the price offered to employees.

The company employed a third-party accountant to value their stock, but failed to disclose numerous key facts to the accountant, including that management was actively shopping the company for sale. The company also represented to employees that it would remain privately-held, so employees had no expectation that there would be any opportunity to sell their stock other than through the company buyback program, and the company misrepresented how the stock was valued.

The SEC is seeking disgorgement of profits, civil monetary penalties, and to bar Charles Stiefel, the CEO, from serving as an officer or director of a public company.

The Enforcement Process

The company was acquired by GlaxoSmithKline in 2009. Now, I know what you are thinking: “If the company doesn’t exist anymore, how can the SEC pursue an enforcement action against it.” I’ll admit it, I was wondering that as well. Alan Dye explained to me that when a company acquires another company, it also acquires all of that company’s liabilities, including, apparently liabilities that haven’t even come to light at the time of the acquisition. So the SEC will pursue GlaxoSmithKline in the matter. If, as part of the merger agreement, GlaxoSmithKline received representations and warranties from the folks in control of Stiefel (i.e., Charles Stiefel and other officers) that there were no violations of law and the SEC successfully proves that there was a violation of law (thus making the representations false), then GlaxoSmithKline can sue the folks that made those representations for damages.

Employees that sold their stock back to Stiefel at the depressed prices can also sue for damages, unless the SEC recovers those damages for them through disgorgement.

Don’t Cheat, Don’t Lie, Pay Attention

The first lesson here is that even private companies must comply with securities laws and can be subject to SEC enforcement. The action demonstrates how important it is for private companies to obtain qualified and accurate valuations of their stock and that they inform the practitioners performing the valuations of all relevant facts. Finally, the action demonstrates that it is important for private companies to be honest with employees about the company’s business strategy, particularly to the extent that this strategy impacts the value of the company’s stock and employees’ investment decisions.  Companies that aren’t prepared to be honest with employees about valuation and strategy should probably stick to cash-based compensation.

And for acquirers of private companies, part of your due diligence should include reviewing the company’s stock valuations for reasonableness. Seems like maybe GlaxoSmithKline should have noticed that Stiefel’s valuations were significantly lower than Glaxo’s own valuation of the company.

20th Annual NASPP Conference in New Orleans
I’m excited to announce that the 20th Annual NASPP Conference will be in New Orleans from October 8-11, 2012. New Orleans is always a fabulous location for us and this year’s event is sure to be fantastic.  Look for information on early-bird registration later this week and submit your speaking proposal by March 2.

NASPP followers on Twitter and Facebook knew the dates and location of the Conference last Friday.  Follow the NASPP on Facebook and Twitter to make sure you don’t miss our next big announcement.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara