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US regulators plan to increase the transparency of business practices at large private companies by pushing for stricter disclosure rules. The U.S. Securities and Exchange Commission (SEC) is preparing new rules. They would apply to private U.S. companies with value of at least $1 billion.

These so-called unicorns often raise money from private fundraising rounds. Investors who fund promising startups in private capital markets are typically venture capital firms, large asset management firms, and wealthy individuals.

SEC Touts Benefits of Increased Transparency

Regulators cite investor protection as one of the main reasons large private companies should increase disclosure. They believe that heightened disclosure standards would promote transparency and enable investors to make better informed investment decisions.

SEC Commissioner Allison Lee believes this effort has significant implications. “When they’re big firms, they can have a huge impact on thousands of people’s lives with absolutely no visibility for investors, employees and their unions, regulators, or the public. I’m not interested in forcing medium- and small-sized companies into the reporting regime.”

How Publicly Listed Companies Provide Disclosures

Publicly listed companies on the New York Stock Exchange or Nasdaq face regular disclosure requirements. They must file periodic reports such as Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q. These reports disclose their latest financial and operational performance to investors. They are also subject to other SEC filing requirements. For example, suppose a publicly listed company enters a material contract or completes an acquisition. It must disclose the details of the agreement on a Form 8-K. The reports are accessible to anyone online.

Some disclosure obligations stem from the 2002 Sarbanes-Oxley Act. This Act passed in the wake of several high-profile accounting scandals including Enron and WorldCom.

The initial public offering (IPOs) market is hot. Overall, 2021 marked one of its strongest years in history. Global IPO activity was up 64% from last year. Some notable multibillion companies that went public in 2021 included Robinhood Financial, Bumble, Roblox, Rivian, and Coinbase. However, many large startups valued at over $1 billion have chosen to remain private companies. Accordingly, they are not subject to the SEC disclosure rules that apply to public companies.

Unlike private capital markets, public capital markets involve the participation of many individual investors who trade in relatively small amounts. Investment opportunity access in private markets is not directly available to many retail investors. These investment opportunities are the province of accredited investors. These investors must have an annual income of at least $200,000 or a net worth of $1 million or more.

How Private Fundraising Rounds Can Affect Average Americans

Although most retail investors do not directly invest in private fundraising rounds of fast-growing unicorns, many mutual funds and pension plans do. Thus, as holders of the savings and retirement assets of many Americans, their money is indirectly invested into large private companies. Some SEC regulation proponentsargue these private companies could present undisclosed investment risks due to lack of transparency. As a result, they could put the savings of many average Americans at risk.

In 2021, many privately held unicorn startups raised record amounts of venture capital funding. According to Pitchbook data, investors placed over $300 billion across approximately 17,000 deals, nearly double the amount in 2020. There was also an uptick in the valuations of companies across all investment stages.

Critics Argue New SEC Rules Cause Unnecessary Burdens

Critics argue that more regulatory burdens on private companies could increase the cost of doing business. As a result, these costs could be passed to customers in the form of more expensive products and services.

“We caution the SEC from putting additional and unnecessary burdens on privately held companies that could have unintended consequences,” said Bobby Franklin, the head of the National Venture Capital Association. “This segment of the U.S. economy has driven innovation and delivered new products and services that have been very beneficial during the pandemic.”

The SEC is a five-member board of Commissioners. The President of the United States appoints them. Each commissioner serves a five-year term. Not all the SEC Commissioners are enthusiastic about new disclosure rules for private unicorns. Hester Pierce and Elad Roisman, both Republicans, issued a joint statement that expressed their opposition to the new rules. “Lowering these thresholds may both contradict the express will of Congress and potentially undermine our mission to facilitate capital formation,” they said.

There are also concerns from large private companies that disclosure of sensitive information could give their competitors too much insight into their business strategy. “Generally speaking, these companies don’t want to give out much information,” commented Nicholas Economides, an economics professor at NYU’s Stern School of Business. “Rightly or wrongly, they are concerned that their business plans are going to become known, and they want to keep those secrets.”

Precise rules for heightened disclosure by privately held unicorns are still being formulated. It seems likely the SEC will require financial data and other information to be shared in a controlled manner. It will be important for regulators to find a balance between promoting information transparency without hindering business innovation.