SEC Chair Mary Jo White outlined the opportunities, challenges and risks of “Silicon Valley” technology in the financial markets and urged entrepreneurs and issuers of private companies – particularly of “unicorns” (private start-up firms with valuations that exceed $1 billion) – to focus on investor interests.
Chair White examined the following challenges for new and evolving markets:
- Pre-IPO Financing: Chair White asserted that despite broad sophisticated investor awareness that the majority of pre-IPO companies fail, venture capital firms, private equity funds, smaller retail investors and the “next . . . student whose great idea needs funding” all equally lose when “participants choose – with eyes wide open – to invest in private companies at valuations that may be ethereal or over-inflated.” She called for vigilance of so called unicorns, by establishing robust internal controls and governance procedures to provide accurate disclosures of financial results.
- New Models of Capital Formation: Chair White declared that the SEC will hold brokers and funding portals responsible to be “bulwarks of investor protection” in securities-based crowdfunding that was recently introduced by Regulation Crowdfunding. She also emphasized that the SEC is counting on advisers as “gatekeepers” presenting information on the significant risks involved to make secondary market trading work fairly for investors. Although Chair White recognized that many secondary market participants may be “buy and hold” investors seeking exposure to late round pre-IPOs to profit from an eventual IPO or acquisition, she asked for regulators to scrutinize these emerging platforms to ensure they provide a functioning market that operates within the disclosed parameters.
- Financial Controls and Corporate Governance: Chair White noted a “current slow-down” in IPOs and that unicorns are staying private longer. She called on entrepreneurs and their advisers, venture capital and private equity investors as well as general industry leaders to request that private startups develop enhanced governance structures and internal control environments to match their respective size and impact.
- Fintech: Chair White highlighted that the SEC is exploring whether: (i) blockchain technology applications require registration under existing SEC regulatory regimes, such as those for transfer agents or clearing agencies; (ii) “robo-advisors” meet Investment Advisers Act obligations and their fiduciary duties when they solely provide automated advice; and (iii) online marketplace lending platforms provide adequate information to investors on offered securities and whether these offerings are registered or made using an exemption.
Chair White concluded by encouraging cooperation between the SEC and Silicon Valley.
Chair White delivered her remarks at the SEC-Rock Center for Corporate Governance speaker series, “The Silicon Valley Initiative: Protecting Investments in Pre-IPO Issuers.”
Lofchie Comment: While it is certainly appropriate for the SEC to concern itself with investment in private issuers, the SEC should also be concerned that the costs of the regulation that it imposes might discourage companies from going public. Put differently, the SEC should consider whether it is selling a “product” (access to the public capital markets and exchange liquidity) that is unattractive in light of its subsequent costs.
Congress should also be concerned about the deterrent costs of needless regulation. When issuers and investors see that the costs of going public include regulatory requirements such as those relating to “conflict minerals” or “compensation ratios” that have no reasonable benefit to either party, they may forsake liquidity for the sake of rationality.