Silicon Valley Must Corral Its `Unicorns,' SEC's White SaysBy and
Regulator advises tech startups to match growth with caution
SEC chief warns against pressures that can inflate valuations
The head of the U.S. Securities and Exchange Commission ventured deep into Silicon Valley Thursday to warn the tech community and its investors to be wary of unicorns.
Mary Jo White, speaking at Stanford Law School in California, was referring not to the mythical horse-like creature but to non-public startups valued at more than $1 billion. Such firms may warrant special scrutiny into whether their internal controls and investor protections are keeping pace with their growth, she said.
“They do not appear to be an endangered species,” White said in remarks prepared for a conference on protecting investments in non-public firms. “The concern is whether the prestige associated with reaching a sky-high valuation fast drives companies to try to appear more valuable that they actually are.”
“There is a worry that the tail might wag the horn,” she said, triggering waves of laughter from the 300-person audience packed into Paul Best Hall.
The concerns are timely ones, given the string of startups that have lost value on the private markets during the past year, a number that now stands at 58 according to the Downround Tracker by research firm CB Insights.
That decline, along with the failure of widely traded mutual funds to agree on what shares in a startup are worth, highlight the imprecise and subjective art of private valuation.
In one example, five mutual funds holding Dropbox shares valued it differently on 16 different occasions, according to Bloomberg’s analysis of securities filings. In December, the gap was acute, with T. Rowe Price valuing shares at $9.40 and Hartford Financial Services Group valuing them 62 percent higher, at $15.20 a share.
Founders and advisers of fast-growing startups should consider questions such as whether their boards have expanded beyond entrepreneurs and original investors, whether they have brought in sufficient regulatory expertise and whether their leadership includes outsiders with public-company experience, White said. Those thinking about initial public offerings should bolster internal controls, reporting and certifications to get ready, she said.
White sounded a note of caution over the secondary market in which early startup employees can sell stock to outside investors, saying that “errors or misconceptions in valuation” could be amplified by derivative contracts that have emerged to trade interest in non-public companies. Such markets may have liquidity problems that hinder investors from selling their positions, she said.
The SEC’s crowdfunding rule, which allows general investors easier ways to put money into non-public companies, becomes effective in May. The new funding portals associated with such investing will be closely monitored by the SEC with “rigorous inspections and examinations,” White said.
White also said the agency is closely monitoring how loans arranged by online marketplace companies are packaged and sold to investors. Investors who purchase bonds backed by these loans should receive adequate disclosures about the platform’s lending models and who the borrowers are, she said.
“As investors are attracted by potentially higher yielding but riskier marketplace loans as an investment strategy, information about the borrower’s ability to repay the loan underlying the investment is critical,” she said. “Innovation in finance is welcome, but it must be built upon the disclosure of material information.”
So-called peer-to-peer lenders use online platforms to directly connect borrowers with lenders, often at cheaper rates than those available at banks and offering better returns. The higher yields have drawn interest from Wall Street, with asset managers, hedge funds, and banks buying or bundling the loans into bonds that can be sold to investors. As the market has grown, so have concerns over early signs of deterioration and questions about whether they are riskier than more traditional forms of credit.
In a panel discussion following White’s address, SEC Enforcement Division director Andrew Ceresney said the agency was keeping an eye on Silicon Valley. Ceresney, who’s based in Washington, said he has visited the region three times in the past four months and has another trip planned for May.
"You can’t say we don’t focus on the West Coast. Not that you want us to, but we are," he told the panel, which included venture firm Kleiner Perkins Caufield & Byers, law firm Wilson Sonsini Goodrich & Rosati, data company Splunk Inc. and the founder of news site The Information.
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