SEC Could Pull More ‘Unicorns’ Into Public Reporting Regime

The U.S. Securities and Exchange Commission could compel more large private companies to comply with public reporting requirements to bolster transparency.

Driving the news: Companies have various reasons for wanting to stay private longer, including the fact that activist shareholders expect results on a quarterly basis, which can hinder long-term strategic planning. Entering the SEC’s reporting system also opens a company’s disclosures to the plaintiffs bar, potentially inviting litigation.


The U.S. Securities and Exchange Commission could compel more large private companies to comply with public reporting requirements in order to bolster transparency, potentially inviting resistance from so-called unicorns objecting to greater oversight.

The SEC’s current regulatory agenda indicates it is considering a proposal to amend how “shareholders of record” are defined under Section 12(g) of the Securities Exchange Act of 1934. Any change to existing criteria could be significant, because that provision of securities law triggers when companies must begin filing public disclosures regardless of whether they plan to conduct an initial public offering.

Morrison & Foerster LLP partner David Lynn said if rules around unicorns — or private startups valued at $1 billion or more — become more stringent, then a “pretty significant number of companies would have to rethink their approach going forward.”

“It changes the landscape of how they finance themselves and how they would structure their ownership,” said Lynn, a former counsel at the SEC’s Division of Corporation Finance, which reviews corporate disclosures for accuracy and materiality.

One scenario is that private companies could go public sooner, either through a direct listing or traditional IPO. Otherwise, “they’ll have the burdens of reporting under the Exchange Act without the upside of having their securities being publicly traded,” said K&L Gates LLP partner David Bartz, who works in the firm’s corporate practice.

Private companies disclose little information regarding their operations and financial conditions compared with their public counterparts. Public companies also have to abide by additional rules regarding accounting procedures and corporate governance.

As the ranks of unicorns have swelled in recent years — venture capital database CB Insights lists 986 unicorns worldwide — so have concerns that a large swath of companies with vast economic impact are operating without public oversight.

SEC Commissioner Allison Herren Lee raised transparency concerns in a speech in October in which she called for updating how shareholders of record are counted for public reporting purposes, expressing worry that much of the American economy is “going dark.”

“It’s time for us to reassess what it means to be a holder of record under Section 12(g),” Lee, one of the three Democrats in the majority on the SEC, said at the time.

Potential new SEC rules would add to the agency’s broader efforts to increase scrutiny of private markets under Chair Gary Gensler. On Wednesday, the SEC proposed rules that would beef up disclosures for hedge funds and private equity funds.

The SEC declined to comment on how it may propose to change Section 12(g) rules beyond a brief description listed on its regulatory agenda, which indicates the agency could propose amendments to the shareholder of record definition by October.

As it stands now, companies with 2,000 shareholders of record, with certain conditions, must register with the SEC and submit periodic filings applicable to public companies.

This threshold had stood at 500 shareholders dating back to 1964, when Congress created Section 12(g) of the Exchange Act aiming to ensure that companies would enter the SEC’s reporting system once their assets and investor base grew to a certain size.

The Jumpstart Our Business Startups Act of 2012 quadrupled that minimum to 2,000 shareholders, part of a larger legislation designed to stimulate IPOs and private capital raising. The bill effectively provided companies the flexibility to stay private longer.

The SEC is powerless to revise statutory thresholds enacted by Congress. But the agency can revisit its rules determining how shareholders of record are determined, which has become a sticking point.

Stock ownership of public companies now are often held in “street name,” by a broker rather than the beneficial owner. This enables brokers to keep electronic records of ownership, allowing for faster trading as it reduces reliance on paper certificates.

Thousands of shareholders can be covered under one “street name,” which one securities law professor said creates a misleading picture of a company’s investor base.

“This belies reality, and it is also contrary to investors’ best interests,” said Marc Steinberg, Radford professor of law at Southern Methodist University. “The reason is the lack of disclosure in the marketplace. Simply, this is not what Congress could have intended when it adopted the statute in 1964.”

Steinberg said nothing requires the SEC to count shareholders of record under “street name,” though that has been the practice for decades. In her speech, Lee of the SEC noted that the agency has the authority to require companies to look deeper to count beneficial owners.

It’s not fully certain to what extent investor records of private companies are held under “street name,” though Lee called on the SEC to further study the matter.

The SEC can also opt to count investors that participate in private investment vehicles known as feeder funds on an individual rather than collective basis. The agency could likewise count individually the number of investors in a venture capital fund, which could push companies closer to the 2,000-shareholder threshold that triggers public reporting.

If such options are pursued, one attorney said companies seeking to avoid inadvertently becoming a reporting company may respond by limiting the pool of their investors.

“It opens the door and shifts the scales in favor of wealthy individual investors who are capable of writing larger checks and only representing one shareholder on their cap table,” said K&L Gates partner Matthew Miller, who represents private investors.

Companies have various reasons for wanting to stay private longer, including the fact that activist shareholders expect results on a quarterly basis, which can hinder long-term strategic planning. Entering the SEC’s reporting system also opens a company’s disclosures to the plaintiffs bar, potentially inviting litigation.

Morrison & Foerster’s Lynn added that companies may also fear that disclosure requirements could be “used as a way to shame companies” into taking some sort of action, be it on climate change or other hot-button social issues.

In her speech last fall, Lee said employees who depend on stock compensation would benefit from more disclosure from large private companies. She also noted that labor unions bargaining for worker rights may want a clearer picture of a company’s finances.

While it’s unclear what an SEC proposal may look like, advocates for venture-backed companies are concerned about potential new rules. The National Venture Capital Association contends that such companies have delivered immense value to the public, including helping to mitigate effects of the coronavirus pandemic through innovation.

“We are concerned that unnecessary regulation of this vibrant sector will hamper entrepreneurship when jobs and technological leadership are needed,” National Venture Capital Association general counsel Jeff Farrah said in a statement to Law360. “Instead, the SEC should focus on making the public markets more inviting to high-growth companies as all stakeholders have a strong interest in more American public companies.”

If the SEC does proceed, support is likely not to be unanimous. Republican SEC Commissioners Hester Peirce and Elad Roisman, who recently left the agency, expressed concern last month that the SEC could counter the JOBS Act, which sought to provide private companies greater flexibility in deciding if and when to go public.

SMU’s Steinberg noted that private companies have additional tools to reduce their shareholder count if they want to avoid tripping over a minimum threshold, including reverse stock splits or tender offers by which they repurchase shares from investors.

“It’s not as if companies today are stuck with going public if they’re over this number,” Steinberg said. “There are internal corporate governance procedures that can be used to enable the company to stay private.”

Read more at: https://www.law360.com/articles/1459446/sec-could-pull-more-unicorns-into-public-reporting-regime?copied=1

Jeff Farrah served as General Counsel at NVCA, where he advocates before Congress, the White House, and agencies for pro-entrepreneurship policies and leads in-house legal matters for the association. He loves working at the intersection of venture, public policy, and the law. Jeff served as Treasurer of VenturePAC, the political action committee of NVCA.