The explosive growth of private markets, and other thoughts on the SEC Commissioner Lee’s remarks

I’m glad people are reading some of my musings here. As Securities and Exchange Commission Commissioner Alison Hearn Lee She gave her remarks at the annual Securities and Exchange Commission (SEC Speaks) conference. Oct 12 – Focusing on the rapid growth of private markets Oct 21St century and the impact of this growth on investors and the economy in general – it was a vindicating moment for me as I wrote about a number of issues that were addressed.

As it turns out, I wasn’t just a proverbial high-beam flash in vain. As you all know, I often examine how legal and regulatory structures affect my Shift in US stocks from public markets to private markets. I have been – and remain concerned – about the growing lack of transparency in the private equity markets.

Commissioner Lee noted that the private market is growing rapidly, and acknowledged that it may be time for Congress and the Commission to scrutinize the problems and consider action to address this low transparency without stifling economic growth.

Before considering what we should do about this situation, let’s remember three critical factors: the nature of the companies involved here, the number of investors, shareholders and stakeholders they have, and perhaps most importantly, the way federal securities laws view these actors.

Companies grow in size and frequency with More than 70% of the new capital is raised privately The number of unicorns alone ranges from 40 to . nearly 900 In less than eight years. As these companies grow, so does the number of their employees, investors, shareholders and stakeholders.

Unicorns: a common rarity

As unicorns are increasing in frequency and size, their impact andTransformative influences on our way of life“It’s starting to grow too. However, as I rightly acknowledge, these companies are under no obligation to provide virtually any information to the public at large about their activities, current financial condition or operational capabilities.

Despite the fact that these Companies represent over $3 trillion in valueIt operates largely outside the scope of the disclosures we have come to expect from some of the world’s largest companies. Some unicorns exceed the market capitalization of publicly traded companies without being subject to the same rules.

How to lose money faster than a minute in New York

It is the shareholders, current and future, who invest in these companies that bear the greatest risk of lack of transparency. For those with a few hundred million, you can simply buy a seat on the board of directors to ensure access to information. National Venture Capital Association model investor rights agreement Even indicates it. They can also negotiate strict refund rights or anti-mitigation provisions.

in my paper Alternative venture capitalI am discussing the growing number of players who are willing and able to invest this type of money. Mutual funds, sovereign wealth funds, private equity funds, corporate and hybrid venture capital are all jumping over each other to invest in these companies.

With less access to information for the public, board seats or large investments used to secure the information are the only way, bringing the investment closer to a high-stakes game of musical chairs. This game is moving into the public domain as an increasing amount of capital that is run here comes Indirect public investment through the savings and retirement assets of millions of Americans.

But for us pure humans who do not even have money to play the game, the lack of information becomes more difficult. As I argued in my paper about unicorn stock optionsThe largest group of shareholders at risk here are corporate employees themselves. Stock grants are a common place in unicorns. But the staff who greet them are left in the dark when they buy, their condition, and when they decide to leave. As she told me in her remarks:Quitting smoking can become an investment decision to be made in the dark. “

Employees as investors

Unicorns stay private longer for various reasons, including to avoid public disclosures that could reveal their true financial conditions and fair market value, including to their own employees. As the commissioner correctly pointed out to me, the staff”Investors in these markets who have a lot at stake and sometimes little or no negotiating power to obtain the required information. ”

In the past, before the Jobs Act, employees were protected as an investor group under our securities laws. Startups need to count employees as investors and disclose material information accordingly. The Jobs Act changed thatLeaving employees weak in their positions as investors and minority shareholders in their companies. Employees are left subject to the discretion of the majority of the shareholders, founders, and legal counsel of their companies.

Unicorns are notorious for their exaggerated ratings. If you want to know more, see the work Journal and Strabolife on this. Employees are not privy to confidential information, including financial statements, shareholder lists, and other material non-public documents. Many unicorn companies leave employees holding tens of millions of dollars of illiquid stock at the mercy of the majority of shareholders, without access to detailed financial statements and adequate disclosures of risks and prospects to help guide their investment decisions.

Move Goalpost

Federal securities laws are supposed to be designed with ultimate faltering wires to address this lack of transparency when it becomes too much of a problem for many people. However, the rules continued to change to bring this flight cord back. Section 12(g) of Law 33 Corporations are required to comply with periodic disclosure rules if they have 2,000 registered shareholders and at least $10 million (not billion) in assets.

Employees receiving equity grants are no longer considered investors, and the number of shareholders that necessitate some public reporting is now set at 2,000. While this may seem like a low threshold, keep in mind that the maximum number of this number has been increased from 500 to 2,000 in 2012 Just as unicorns were discovered and equity ownership in the United States increasingly shifted to indirect corporate ownership.

This has allowed companies to remain dark indefinitely as they grow and leave smaller minority shareholders in the dark. While there is a minimum if shareholders are unaccredited, the Securities and Exchange Commission has moved frequently in the past several years to Facilitate qualification as an approved investor, which causes the tripping wire to move further.

Shine a light in the dark

I call for stronger disclosures by these unicorn companies to shareholders than to their employees regarding the company’s financial position and corporate governance structure. Such disclosures will allow these employees to not make investment decisions in the dark, precise purpose of our securities laws.

On the other end of the spectrum, Many lawyers by industry They advocate eliminating any financial statement disclosures, and instead provide fair market value statements to shareholders once a year. If you want to learn more about the different methods of detection, check this out my paper work Yifat Aran.

Commissioner Lee and I both agree that it is also time for the Securities and Exchange Commission to consider reexamining the way shareholders are classified as registered shareholders. You have joined us Association of Securities Administrators of North AmericaAcademics like Ann Lipton The current SEC Corporate Finance Director Renee Jones, And Former Supreme Education Council President Mary Shapiro.

Although this discussion has only just begun, I am glad to have found someone leading us with lit lights in the darkness of the private market. I may simply have to keep flashing my high beams of light to ensure more lights are still on.

If you have any comments, suggestions or feedback, please send them to my research assistant John Livingston john.livingstone@case.edu or me anat.beck@case.edu.

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