SEC likely doesn't have authority to enact new regulations on 'unicorns,' law professor writes

LAWRENCE — Not long ago, private startup companies that hit a billion-dollar valuation before going public were rare enough to earn the nickname unicorns. Now that there are more than 1,000 such companies, the Securities and Exchange Commission is weighing new regulations designed to force them to go public and take on the obligations that come with that status. A University of Kansas researcher has just published an article identifying a fundamental obstacle for this regulatory agenda: the law.

A private company is not required to disclose information to investors in the same manner as public companies do. In the past, when companies hit a certain magnitude, they would go public, begin making periodic disclosures to investors and come under the full jurisdiction of the federal securities laws and the SEC. But now, companies can raise enormous amounts of capital and employ thousands of people worldwide, all while remaining private. Under Chair Gary Gensler, there has been increasing talk from the SEC that it will enact new ways to force such companies into the light. Policymakers, legal researchers and others have all tended to assume the SEC has the necessary authority to do this.

Alexander Platt, associate professor of law at KU, has published an article challenging this view. He examined the governing law and said that any effort to redraw the lines between public and private companies most likely would need to come from Congress.

“The SEC wants to reassert its authority over this rapidly expanding area of the market, which has slipped away from its control over the last decade,” Platt said. “Law professors have been extremely worried about the expansion of private markets and have generally assumed the SEC has the authority to act to reassert its jurisdiction without getting new authorization from Congress.”

Platt’s article, available on SSRN and forthcoming in the Michigan Law Review Online, identifies the limits on the SEC’s authority. His analysis focuses on Exchange Act Section 12(g), which requires companies to go public when they have more than 2,000 shareholders “of record.” The 2,000 shareholder limit does not operate as a meaningful constraint because a single “record” shareholder may be composed of tens, hundreds or thousands of real human investors. The SEC’s planned proposal is to look through the record holders to the beneficial investors behind them for purposes of section 12(g). For instance, instead of counting a venture capital fund investor as one holder of record, as it would be under current rules, the SEC’s proposal may require counting up all of the fund’s investors – and perhaps all of their investors as well. In this way, the SEC would ensure that companies hit the 2,000 shareholder limit much earlier in their corporate lives and thus would be forced to go public.

But, while Section 12(g) is an important tool for the SEC, Platt said it likely doesn’t give the agency the authority to do this.

“My point in this paper is to set aside the questions about the wisdom of this policy change and ask a classic lawyerly question: ‘Can they do this?’ As I show, there is good reason to think not. If the SEC moves forward with this rule, it could be struck down by the courts,” he said.

Platt explores the legislative history of the JOBS Act of 2012, which raised the shareholder limit from 500 to 2,000. During debate in Congress, Democratic senators and congressional representatives tried four times to add an amendment to the bill that would have expressly given the SEC authority to look through to beneficial owners – and Congress four times rejected these efforts. Courts would be unlikely to override Congress’ decision not to authorize the SEC to do so, he wrote.

Additionally, changes to the line between public and private markets that happened in 1933 and 1964 were made by Congress and that authority has not been handed over to an agency such as the SEC, Platt wrote.

For the changes in public and private regulation to happen, the SEC would first need to make an official proposal, which would then go through a notice and comment period, Platt wrote. If it were then made official, it would likely face legal challenges in appeals court that the agency holds the authority to change oversight in the proposed manner.

Platt previously practiced as a litigator in Washington, D.C., in securities regulation cases, and he clerked for the U.S. Court of Appeals for the D.C. Circuit, which would likely hear any legal challenge to this regulation.

“Any fundamental redrawing of the boundary between public and private markets will likely have to come from Congress – just as it did in 1933 and 1964,” he wrote.

Top image: Unicorn tapestry, unknown author, Wikimedia Commons.

Right photo: Alex Platt, KU associate professor of law. Credit: KU Law.