Speaking last week at the SEC’s and Rock Center’s Silicon Valley Initiative at Stanford Law School, SEC Chair Mary Jo White cautioned Silicon Valley’s start-up companies regarding their potential lack of internal controls. In particular, she warned that unicorns—nonpublic start-up companies valued north of one billion dollars—may warrant special scrutiny into whether their corporate governance and investor disclosures are keeping pace with their growing valuations. Ms. White repeatedly warned that the prestige of obtaining “unicorn” status may drive companies to inflate their valuations.
Although unicorns are private companies not subject to public company disclosure rules, they are subject to the general anti-fraud laws under the Securities Exchange Act of 1934 (Section 10(b) and Rule 10b-5), which apply to all companies. As the primary watchdog, the SEC is monitoring unicorns to ensure that private investors and company employees who are often primarily paid in stock and options are receiving accurate and complete information. Chair White maintained that the risk of distortion and inaccuracy in unicorns’ financial statements could be greater than in public companies due to their rapid growth that may outpace internal controls. White advised unicorns to boost internal controls to ensure compliance with securities regulations even if not planning for an imminent initial public offering.
Chair White’s comments were challenged by some, including Mark Cuban, for failing to provide any clear guidance or rules for companies to follow. In an appearance on CNBC, Mr. Cuban stated: “There’s no clarity and where there’s no clarity and no certainty on what to do in response to the SEC, you get people doing nothing or people avoiding going public or doing anything to avoid dealing with the SEC. And that’s a real problem for up and coming companies and it’s a problem for the economy as well.”
What do Ms. White’s comments mean for Silicon Valley and venture-financed companies generally? Unicorns (and baby unicorns) should know that the SEC may monitor the information disseminated to investors regardless of their non-public company status. As venture-funded companies continue to grow, expand their workforce, and recruit more capital and investors, they should continue to monitor and improve their corporate governance and internal controls so they do not run afoul of the SEC. Of course, the SEC is principally focused on disclosures, so they should always pay particular attention to the disclosures made to investors and employees about financial results and corporate valuation. They should ensure that the data underlying their valuations is subject to rigorous internal controls that evolve to meet the needs of a growing enterprise and changing business models, and include appropriate cautionary information about the uncertainties inherent in their financial projections and resulting valuations.