SEC Eyes Pre-IPO Secondary Market Trades, IPO Governance

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By Che Odom

April 1 — The Securities and Exchange Commission is scrutinizing secondary market trades in companies, particularly startups, that linger in a pre-initial public offering stage, the head of the agency said.

In particular, the commission is focusing on the effect of valuations on pre-IPO secondary markets, SEC Chairman Mary Jo White said.

Companies that delay going public may grow rapidly, outstripping their internal controls and governance structures, creating risks that imperil investors, White said March 31 in a speech at Stanford Law School in California.

“The IPO process is not just about raising capital,” White said. “A public company commits to shed light on its operations and strengthen its controls and governance in ways not required of private companies.”

Dozens of companies have registered IPOs but haven't yet begun trading publicly . Many registered last year.

Only six companies have gone public since Jan. 1, which is the slowest start for IPOs in several years. The latest, by Maryland-based biotechnology research services company MaxCyte Inc., occurred March 29.

Some of those sitting aside may be looking for better, alternative forms of financing or waiting for their valuations to increase before pricing shares .

In the secondary market, early startup employees can sell stock to outside investors, who may not have sufficient information caused, in part, by insufficient controls, governance and disclosures, White said. This may help a company grow, but it also raises governance and internal control concerns for investors, she warned.

Federal Requirements

The federal securities laws and listing standards require public companies to comply with a range of rules designed to protect shareholders.

For example, public companies must form an audit committee, establish disclosure controls and procedures and create internal controls over financial reporting. The chief executive and chief financial officers must certify to the adequacy of those controls, and the company must be audited by a firm registered with the Public Company Accounting Oversight Board.

The longer a company waits to go public, the longer it may avoid those strictures, which may create an environment conducive for “errors and misconceptions of valuation,” amplified by derivative contracts that have emerged to trade interest in non-public companies, White said.

Such markets may have liquidity problems that hinder investors from selling their positions, she said.

Tech Sector Fraud

In the last wave of technology-sector IPOs in 2011 to 2014 that included Facebook Inc. and Twitter Inc., a secondary market was marred by unregistered broker-dealer activity, conflicts of interest, undisclosed compensation and fraudulent offers of pooled investment vehicles that “purported to hold pre-IPO stock,” White said.

For example, the SEC in 2014 charged a stock promoter with fraudulently raising nearly $3.5 million from investors purportedly to purchase Facebook and Twitter shares prior to their IPOs .

White had some suggestions for pre-IPO companies that she said would help safeguard the markets. For example, issuers registering IPOs could bring on board directors who can look critically at financial statements and provide oversight of internal controls, reporting and certifications to prepare for trading shares publicly.

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.

White isn't the only one calling on companies going public to pay heed to their governance structures. The Council of Institutional Investors—the largest association of institutional investors in the U.S.—last month urged companies to adopt fundamental governance best practices, including granting one vote for each share owned and holding annual elections for directors .

To contact the reporter on this story: Che Odom in Washington at

To contact the editor responsible for this story: Yin Wilczek at

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