The SEC is considering imposing additional oversight over large privately held companies by overhauling Rule 506 of Reg D, which would include a series of changes, most significantly a requirement that unicorns provide audited financial statements to investors.
In a recent speech at the Securities Regulation Institute, SEC Commissioner Caroline Crenshaw said that changes were necessary because the existing regulations were outdated and didn’t keep up with the fast-growing private markets. She said that Rule 506 of Reg D has allowed “unicorns”, those private issuers valued in excess of one billion dollars, to raise capital without going public.
“Private securities offerings have grown at a significantly faster rate than public offerings,” said Crenshaw. “Companies that contemplate going public are now waiting much longer to do so. Others are choosing not to go public at all. Companies no longer need to go public to raise enormous amounts of capital.”
Codified in 1982, Reg D was intended to facilitate access to capital by small businesses. Under Rule 506, large private issuers are allowed to raise unlimited capital from an unlimited number of accredited investors, if the companies satisfy certain requirements.
When the term “unicorn” was coined in 2013, there were 43 unicorns. Today the number stands at 1,205. Crenshaw cited SEC data showing that for the 12-month period from July 1, 2021 through June 30, 2022, exempt private offerings accounted for approximately $4.45 trillion in capital raising. For that same time period, publicly raised funds accounted for approximately $1.23 trillion.
“And, relevant here, these unicorns have consistently relied on Rule 506 of Reg D to raise billions of dollars in U.S. capital,” she told her audience. “Make no mistake, Reg D has helped pave the way for the advent of the unicorn. Private companies now have access to increasing amounts of private capital, inflating their sizes and significance to investors and our economy, and all without the concomitant safeguards built into the public markets.
In addition to requiring audited financial statements, Crenshaw suggested that new regulation could require that Form D be filed prior to the time any solicitation is made, instead of 15 days after the first sale of securities in the offering.
The commissioner suggested adopting a two-tiered framework, similar to what’s mandated under Reg A, which has two separate levels of disclosure requirements based on the amount of capital raised. Both Tier 1 and Tier 2 issuers must file an offering circular, and must file two years of financial statements. Tier 2 offerings, which are for larger raises, additionally are required to disclose financial statements audited in accordance with GAAS by an independent accountant. They also must file annual, semiannual, current and special financial reports with the Commission.
In the wake of the bankruptcy of crypto exchange FTX and failures in other digital assets, Senators Elizabeth Warren of Massachusetts and Ron Wyden of Oregon are calling on the PCAOB to provide more scrutiny over the PCAOB-registered auditors who audit the cryptocurrency industry.
In a recent letter to PCAOB Chair Erica Williams, the Senators underscored “the need for the Public Company Accounting Oversight Board to act to ensure accountability.”
Though FTX was privately held, as are many other crypto companies, the Senators argued that PCAOB rules require that if a PCAOB-registered firm is performing an audit, it must follow the same standards it applies to audits of a publicly traded company. “In connection with the preparation or issuance of any audit report, a registered public accounting firm and its associated persons shall comply with all applicable auditing standards adopted by the Board. This rule is clearly not restricted solely to public companies.”
Meanwhile, the SEC has stepped up scrutiny. Offerings either have been delayed or outright cancelled, as the SEC has failed to grant the necessary approvals to go public amid increased scrutiny over crypto filings, reported the Wall Street Journal.
The Journal cites instances of crypto-focused firms that have been delayed by repeated rounds of questions from SEC staff. SEC accountants and lawyers have been asking companies for more detailed information about financial disclosures, legal risks, and the impact of market disruption on their businesses. One firm reported responding to more than 10 letters from the SEC over the course of a year, compared to one to three letters in a typical filing.
“The flurry of [SEC] actions came after years of slow-moving investigations and debate in Washington over how to best handle the fast-growing industry. Some observers detected a shift in officials tone after the collapse of the FTX crypto exchange, which strengthened the hand of politicians and regulators calling for tougher enforcement,” reports the Journal.
“It certainly feels, from an industry perspective, like there’s a crypto carpet bombing going on right now,” said Kristin Smith, CEO of industry group Blockchain Association.
China Tells its Companies to Leave Big 4s
Despite last Fall’s historic agreement that allowed PCAOB inspectors to have full access to the audit work papers of China-based companies listed on US exchanges, China is urging those state-owned companies to not renew relationships with Big 4 international accounting firms when contracts run out.
Bloomberg News is reporting that China’s continued concerns about data security prompted its Ministry of Finance to give new guidance to some state-owned companies to hire local Chinese or Hong Kong accountants instead.
Bloomberg’s sources noted that in addition to concerns over China’s data security, the move was meant to bolster the local accounting industry. Chinese regulators for years have been urging state-backed companies to use local auditors, but “recently re-emphasized that companies should use other auditors than the Big Four”, according to Bloomberg.
No deadline has been set for the exit out of the Big 4s, but it’s anticipated that changes may occur gradually as contracts expire. The Chinese Ministry reported that the Big 4 earned approximately US $3 billion from Chinese clients in 2021.
When PCAOB auditors in December completed their first ever on-site work paper inspection of some of the biggest Chinese companies, the move was hailed as a breakthrough after decades of resistance from Beijing.
Since then, several of the largest state-owned companies began voluntarily delisting from US exchanges.
Since September 2022, when the PCAOB started its inspection process in Hong Kong, about 60 Hong Kong-listed companies with Chinese headquarters, both state-owned and private, changed auditors.
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