Was the Exchange Act Redundant? The Questionable Legality of an SEC Commissioner’s Unicorn Reform Proposal

The rise of private markets and the proliferation of “unicorns” (private startup companies valued at $1 billion or more) has diminished the SEC’s power and reach. Back in 2021, the agency signaled a plan to reassert itself by forcing unicorns to go public. But the plan fizzled; its legality was called into question and key proponents departed without taking action.

Now the regulator has a new strategy, and it is scheduled to be the main topic for discussion at Thursday’s meeting of the SEC’s Investor Advisory Committee.

In January, Commissioner Caroline Crenshaw proposed a mandatory periodic disclosure regime for unicorns.  She would have the agency revise Regulation D to require these companies “to engage independent auditors and . . . to provide prospective and committed investors with financial statements audited in accordance with GAAS, along with auditor opinion letters, confirming the adequacy of the company’s internal controls over financial reporting.”  These disclosures would be required both at the time of the Regulation D offering and on an “ongoing” basis afterwards. Commissioner Jaime Lizárraga appeared to endorse this proposal in April.

But, once again, the latest unicorn crackdown plan faces some serious legal obstacles. In a new paper, I argue that the SEC lacks legal authority to impose ongoing disclosure obligations on unicorns and that, if adopted, the proposal would likely be struck down by a court.

The requirement that companies make ongoing periodic disclosures comes from the second of the New Deal era securities laws: the Securities Exchange Act of 1934. An earlier statute, the Securities Act of 1933, had broken ground by imposing one-time disclosure obligations on companies offering securities to the public. But, as former Commissioner Allison Herren Lee has explained, “Congress saw that a one-time obligation to file information was insufficient, and a year later it passed the Securities Exchange Act of 1934 to, among other things, create ongoing periodic reporting obligations.”

Commissioner Crenshaw’s proposal implies the ’34 Act was legally redundant – that the government already had legal authority to require ongoing disclosures.

Under the ’33 Act, any company offering securities must either register or qualify under a statutory exemption. Section 4(a)(2) exempts transactions “not involving any public offering,” and Regulation D is a regulatory safe harbor companies can rely on to meet that statutory exemption.

By proposing to condition the Regulation D safe harbor on private companies committing to making ongoing disclosures, Crenshaw turns the regime  inside out – reading elephant-sized ’34-Act authorities into the mousehole of the ’33 Act private offering exemption. Crenshaw essentially reimagines the core of the Exchange Act of 1934 – an iconic New Deal regulatory statute – as legally unnecessary and irrelevant. It seems unlikely that a court would go along with such interpretive revisionism.

Crenshaw also obliterates a foundational distinction drawn by these two statutes: public companies must make ongoing periodic disclosures; private ones don’t. The ’34 Act (as amended) specifically enumerates three ways a company may trigger its ongoing disclosure obligations: listing on a national securities exchange (12(a)), exceeding specified thresholds with regard to assets and shareholder base (12(g)), and making a public offering under the Securities Act (15(d)). Crenshaw wants to impose the same periodic reporting obligations on companies that, by definition, haven’t met any of those triggers. Again, it seems doubtful that a court would go along.

Conditioning disclosure on issuer size, as Crenshaw proposes, is also legally suspect. For one thing, any new regulatory issuer-size trigger for periodic disclosures would seem to impermissibly end-run the statutory issuer-size triggers that Congress wrote into Section 12(g) of the Exchange Act.

Crenshaw’s proposal also would directly contradict Congress’ 2012 decision to exempt “emerging growth companies” (issuers with less than $1 billion in revenues) from the requirement that companies include, along with their disclosures, a report by the firm’s auditor attesting to and reporting on management’s assessment of its internal controls for financial reporting. Crenshaw would require many of these companies to make precisely the disclosures that Congress had explicitly excused them from making.

It might be argued that the SEC has broader interpretive license in this context because Rule 506 is merely an optional regulatory safe harbor not a prescriptive rule. But Rule 506 is not a pure safe harbor but rather, in part, a congressionally designated regime for allocating a Constitutional benefit: federal preemption of state law. Under Securities Act Section 18(b)(4)(F), offerings under Rule 506 are exempt from state blue sky laws, whereas offerings under the underlying statutory exemption Section 4(a)(2) are not. If anything, the SEC should have less interpretive license to set the contours of Rule 506, not more.

In sum, for the second time in two years, an SEC commissioner has proposed to fundamentally redraw the lines between public and private companies. And for the second time in two years, that proposal appears to fall outside of the SEC’s legal authority.

This post comes to us from Professor Alexander I. Platt at the University of Kansas School of Law. It is based on his new paper, “(More) Legal Guardrails for a Unicorn Crackdown,” forthcoming in the New York University Law Review Online and available here.