SEC chair blasts Silicon Valley for its hokey valuations

That unicorn look suspiciously like a horse with a rubber horn, says Mary Jo White

The chair of the US Securities and Exchange Commission (SEC) has given Silicon Valley a poke in the eye concerning its over-valuation of tech stocks.

Speaking at Stanford University in the heart of Silicon Valley, Mary Jo White warned that the federal regulator did not look kindly on the wild – and wildly inaccurate – self-valuations of startups.

In particular she took a shot at so-called "unicorns" – companies valued at over $1bn – whose numbers have exploded in recent years following questionable valuations pushed by investors who stand to gain from over-inflating a company's value.

Said White: "A current feature of the pre-IPO financing market that puts these questions in sharp relief is one that has gathered considerable attention recently – unicorns ... By one count, there are nearly 150 unicorns worldwide, many based here in Silicon Valley. And, they do not appear to be an endangered species."

This issue had become "a topic of concern," she noted. "Beyond the hype and the headlines, our collective challenge is to look past the eye-popping valuations and carefully examine the implications of this trend for investors, including employees of these companies, who are typically paid, in part, in stock and options."

Disruption

Don't imagine you get to ignore the laws of the land just because Marc Andreessen says you're disrupting things, she warned.

"At the SEC, the questions we are asking do not fundamentally differ from the questions we ask about all transactions. They include whether the information supplied to investors is accurate and complete – that is, whether it accurately reflects the performance and prospects of the company."

She also made it clear that if people get hurt by buying into dodgy valuations, the SEC is not afraid to go back and find those responsible.

"Those involved in advising, investing and nurturing unicorns, there is an important related question: how do $1 billion valuations affect all of the relevant investors – both those investing in the unicorn round, and those that came before and after, whether in private or public transactions?"

White then goes on to make the same point in a number of different ways. Another example: "Being a private company obviously does not mean that you can disregard the interests of investors. Indeed, being a private company comes with serious obligations to investors and the markets."

She also gave a coded warning to anyone who imagines they can escape sanction by drawing up clever, complex agreements or claiming that tech valuations are a different animal: "It is axiomatic that all private and public securities transactions, no matter the sophistication of the parties, must be free from fraud."

Tech companies shouldn't imagine that just because they are not public entities, they can ignore corporate norms.

"There are several governance implications for the longer pre-IPO lifecycle," she said.

"The IPO process is not just about raising capital. A public company commits to shed light on its operations and strengthen its controls and governance in ways not required of private companies. The securities laws and relevant listing standards, for example, require a company to form an audit committee; it must establish disclosure controls and procedures and create internal controls over financial reporting; the CEO and CFO must certify to the adequacy of those controls; and the company must be audited by a PCAOB-registered firm."

Crowdfunding and fintech

It's not just unicorns that the SEC is keeping an eye on either, she noted. Crowdfunding is a remarkable new way to raise money, but it still operates under SEC rules and if people abuse them they can expect to have federal investigators come knocking.

"While we have our eye on unicorns because of their outsized impact on our markets and investors, our primary focus is obviously much broader. One key and current area of focus for us at the SEC is on the three new methods that have recently been created by our rules for capital raising under the JOBS Act – Rule 506(c) of Regulation D (permitting general solicitation), Regulation A+, and Regulation Crowdfunding."

She noted: "In contrast to the institutional investors that have typically been involved in the capital raising that has created unicorns, these capital formation tools can be used to, and in certain cases are expected to, raise money from retail investors. So it should come as no surprise that we are closely looking at not only how well these tools are working for companies seeking to raise capital, but also how well they are protecting investors."

And she drew special attention to "fintech" – startups that are targeting the financial markets.

"Innovations in digital finance, many of which originated in Silicon Valley, have the potential to transform how our markets operate in virtually every respect – from streamlined market operations to more affordable ways to raise capital and advise clients," she led in, before warning that blockchain, automated investment advice and marketplace lending were very firmly in the SEC's sights.

On blockchain: "One key regulatory issue is whether blockchain applications require registration under existing Commission regulatory regimes."

On "robo-advisors": "In this area, the key questions are focused on whether and how a firm meets its Advisers Act obligations, as well as its fiduciary duties, when it provides only or primarily automated advice."

And on marketplace lending: "The SEC evaluates these platforms through the lens of the federal securities laws – that is, are they offering securities and, if they are, are the offerings registered or made using an exemption. We are also concerned about the adequacy of the information received by investors in registered offerings."

Is that a gun or are you just pleased to... oh, it's a gun

While the speech did provide occasional preambles and praise for the innovative work that Silicon Valley carries out, the message was very, very clear – and not one that VCs would have been excited to hear: the SEC is watching. Don't imagine you are exempt from the normal rules.

As White herself summed up: "I challenge you to meet your responsibilities to investors with the same vigor you search for the next 'new unicorn'." ®

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