The Securities and Exchange Commission (SEC) does not monitor just publicly traded companies. It also looks at the dealings of some private companies, often to the surprise of their owners and executives.
Reasons for SEC scrutiny
The SEC’s mission is to protect the public as well as the integrity of the financial markets. That mission extends to not only public companies but also private companies that may be acquired by a public company or that are large enough to consider an initial public offering (IPO).
Ultimately, whether a private company attracts regulatory scrutiny depends on its disclosures regarding current and projected financial performance. Therefore, private companies must walk a fine line between 1) enticing would-be investors with attractive financial projections and 2) painting an overly optimistic picture that is unhinged from reality.
Interest in private company activities
Increasingly, the SEC has unleashed enforcement actions and investors have filed lawsuits related to allegedly misleading or erroneous statements made by private (or formerly private) companies. So, companies contemplating an IPO or a merger with a public company should begin developing their approach to SEC compliance as soon as possible.
The risk of attracting the attention of the SEC is particularly concerning if there is a secondary market for your company’s pre-IPO shares. These are known as “security-based swaps” for purposes of SEC regulation. If the swaps are available to retail investors who do not meet the criteria of an “eligible contract participant” under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the securities must follow specific rules, including the existence of a registration statement and the ability to trade on a national securities exchange.
Additionally, the Financial Accounting Standards Board (FASB) recently-proposed Accounting Standards Update No. 2019-600, Disclosure Improvements — Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative. The updated FASB guidance, which would apply to both public and private entities, would better sync U.S. Generally Accepted Accounting Principles with the SEC’s updated disclosure requirements.
Proactive compliance
It takes time to create and deploy an effective corporate governance program that complies with the SEC rules. Start the process by determining whether retail investors participate in trading that raises your company’s compliance risk. Pay close attention to every financial disclosure and the publicly available information that may affect trading. This effort also should include keeping track of material, nonpublic information available to insiders who may sell shares in the secondary market.
Next, create and deploy policies regarding how your company compiles its financial reports. Implement tools and procedures designed to prevent financial crime — such as internal fraud, bribery, and corruption — and ensure compliance with SEC regulations. For example, you might consider setting up an anonymous whistleblower hotline for employees to report concerns regarding the company’s activities.
We can help
Companies on their way to becoming public represent a small, but growing, segment of the SEC’s enforcement activity. Protect your company against unwanted scrutiny by learning and complying with the SEC’s financial reporting rules and regulations.
Contact us to get a comprehensive assessment of your private company’s corporate governance practices. Now is the time to shore them up, rather than waiting for an IPO or a merger with a public company.