The Federal Bar Association’s annual kick-off event – “Views from the Top” – provides the white collar criminal defense bar an invaluable preview of the enforcement priorities of the Department of Justice, the U.S. Attorney’s Office for the Northern District of California, and the Securities and Exchange Commission.  Yet one preview that should be of particular interest to local companies stood out – the typically opaque pre-IPO space should expect heightened scrutiny by the SEC.

SEC Regional Director Jina Choi announced that the San Francisco Regional Office (which has enforcement jurisdiction not only over Silicon Valley but the western United States generally) will carefully examine pre-IPO companies as they raise capital, as well as scrutinize brokers who purport to sell pre-IPO shares in secondary markets and other investment advisors who pitch funds populated with pre-IPO companies.

The maxim that sophisticated investors can protect themselves in private markets has long shielded private securities transactions from the same rigorous disclosure requirements applicable to public companies.  But the SEC has apparently taken note that this “caveat emptor” mentality may bring inadequate investor protection in the pre-IPO landscape.  The rise of “unicorns” (typically private start-ups with valuations that exceed $1 billion), equity-based employee compensation predicated on (perhaps overly optimistic) valuations, the emergence of sophisticated secondary markets for the sale of private securities, and brokers and investment professionals operating in this murky space have fundamentally challenged many of the assumptions regarding fairness and market transparency in Silicon Valley.  Moreover, with the convergence of a general slowdown in the IPO market and the increasing popularity of the SEC’s whistleblower bounty for reporting violations of the securities laws, the pre-IPO space may be the locus of the next perfect storm for SEC enforcement in 2016.

Pre-IPO companies will need to bring renewed rigor to their existing internal controls and compliance programs and be mindful that representations to employees and private investors will likely be treated with the same scrutiny often associated with public companies speaking to the market.  Given the bellwether nature of Silicon Valley and that the SF Regional Office’s position on the cutting edge of the SEC’s enforcement agenda, Director Choi’s remarks likely foreshadow SEC enforcement priorities at a national level.