Unicorns

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In the wake of a host of negative developments, Theranos Inc. is reportedly under investigation by the Department of Justice and the Securities and Exchange Commission.  The SEC and DOJ inquiries are likely to focus on whether Theranos misled investors about the state of its technology and operations.  Even beyond potential misrepresentation issues, we believe the SEC may also be focused on the adequacy of internal controls at privately-held companies, potentially viewing governance and control problems as contributing factors to other issues.

Theranos has also been dealing with issues raised by the FDA and the Centers for Medicare and Medicaid Services (CMS), including quality control concerns involving the company’s lab testing process.  The SEC may have parallel concerns about the company’s internal controls over financial reporting.  Under pressure to perform to the expectations of the company’s $9 billion valuation and to prove the viability of its signature technology, it is possible that enhancing internal controls may not have been the company’s top priority.

Private companies are still subject to SEC action for violations of the antifraud provisions, even though they are not typically subject to reporting and internal control requirements set out in the federal securities laws.  We believe the SEC may expand its footprint and focus on whether internal controls are adequate at rapidly-growing private companies. 

Partners Timothy W. Mungovan (co-head of Private Equity & Hedge Fund Litigation Group) and Christopher M. Wells (head of Hedge Funds Group)  have been invited to join a large collection of senior regulators at the Regulatory Compliance Association’s Enforcement, Compliance & Operations (ECO) 2016 Symposium.  The conference will take place on Tuesday May 17 at the Mandarin Oriental Hotel in New York City.

Tim will be chairing the session entitled: “Enforcement 2016 – New Priorities, Initiatives and Latest Developments.”

Chris will be chairing the panel entitled: “SEC Exam and NFA Audit Practice: 2016 Areas of Focus with Case Studies.”

SECAs we previously discussed, SEC Chair Mary Jo White recently delivered the keynote address at the Silicon Valley Initiative hosted by the SEC-Rock Center for Corporate Governance at Stanford University.   While the speech and its focus on unicorns attracted some initial media attention, the subsequent response has been surprisingly muted given that Chair White provided a number of regulatory signals not only to unicorns (and other investment-backed private companies) but also to the venture capital and private equity funds that invest in them.

SECOn March 31, 2016, SEC Chair Mary Jo White delivered the keynote address at the Silicon Valley Initiative hosted by the SEC-Rock Center for Corporate Governance at Stanford University.  A substantial portion of Chair White’s remarks focused on “unicorns,” or private start-up companies with valuations exceeding $1 billion.  Chair White’s comments reflect the SEC’s apparent focus on, and concerns with, unicorn companies.  Specifically, Chair White voiced concern over the accuracy of the financial information used to secure financing prior to an initial public offering (IPO), as well as the enterprise valuations which are calculated at or near unicorn levels.

This year, private investment funds are likely to face increased regulatory scrutiny and litigation risk. This is due to several market developments, including transparency and compliance initiatives of limited partners.

There are several areas that should be on every private fund sponsor’s list. Fees and expenses will continue to be…