Companies can get big without going public. The number of U.S. listed companies is down by half, and the last few years have seen more capital raised on the private side than on the public side. Despite this well-documented shift to raising capital privately, public companies are still the focus of securities law and enforcement. A major exception is that anti-fraud provisions apply to all companies, public or private. My article Private Company Fraud examines the SEC’s securities fraud actions against private companies – including unicorns – as a way of analyzing information loss from the shift to private capital.

The key securities fraud provisions apply broadly to all companies, whether private or public. In particular, Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 contain a broad prohibition on the use of “any manipulative or deceptive device … in connection with the purchase or sale of any security.” Moreover, the SEC’s anti-fraud power against private companies is useful in the context of garden-variety fraud, where one shady character moves money around entities, some of which are private.

The more important category when thinking about the shift towards raising money privately is that of companies like Theranos or Zenefits. In what came to be called the SEC’s Silicon Valley Initiative, the SEC announced in 2016 that it was turning its attention to Silicon Valley startups. Then-Chair Mary Jo White declared that “It is axiomatic that all private and public securities transactions, no matter the sophistication of the parties, must be free from fraud” and that “we must be vigorous in ferreting out and punishing wrongdoers wherever they operate.” Law firms warned that unicorns were newly in the SEC’s “line of sight.”

Are unicorns really in the SEC’s “line of sight”? The short answer is that the number of SEC unicorn enforcement actions is very low. My article provides a chart of the SEC’s securities fraud actions against private companies from SEC FY 2016 to FY 2019, highlighting the actions against unicorns, but also providing the broader context of enforcement actions against private companies of various sorts. A few themes emerge from the SEC’s attention to the newly private universe of big companies: the unicorn-plus size of some of the companies; actions that protect employee-investors; and the presence in some cases of a private secondary market.

Although anti-fraud provisions reach both private and public companies, something is lost in the move to private capital. In particular, the anti-fraud regulatory tool is unaccompanied by mandatory disclosure and information from the market and the price, affecting the ability to detect and punish fraud. The shift to private capital can be seen as a shift from a disclosure ecosystem with a range of regulatory tools to a low-information regime where the only regulatory tool is anti-fraud.

The information gap between public and private companies means that it is important to pay attention to, and even cultivate, information sources that continue to be available when companies are private. Informational substitutes are needed in this world where the companies being policed are not public companies. The article concludes by putting forward one prescription to address the loss of information needed for detection and anti-fraud enforcement. It advocates an extension of whistleblower protections from the currently different treatment of employees of public and private companies.

This article’s look at the SEC’s unicorn enforcement is one piece of an emerging legal literature that addresses the gap between U.S. regulatory structures and the world of startups, tech unicorns, private secondary markets, and other innovations – good and bad – that reflect a fundamental shift in how businesses raise money.

This post comes to us from Professor Verity Winship at the University of Illinois College of Law. It is based on her recent article, “Private Company Fraud,” available here.