Private companies are not held to the same SEC requirements as publicly traded companies.
However, this does not mean they are exempt from SEC regulations. The SEC can and does regulate privately held companies, including taking action against private companies found not to be in compliance with SEC regulations.
Introduction to SEC Regulation of Private Companies
The SEC regulates securities, protects investors and goes after entities that are found to have violated laws. While much of the SEC's oversight is of publicly traded companies, the agency also makes sure that private companies play by the rules.
For example, federal securities laws require that any security sold first be registered with the SEC, unless it happens to be exempt. A public company selling a security would need to register that security with the SEC.
SEC rules also cover what is referred to as an offer of securities. Even something as simple as posting to social media about ways to invest in a private company could be construed as offering securities. For this reason, private companies need to be aware of key SEC regulations that apply to them and follow the requirements or risk fines and penalties if they are found noncompliant.
Key SEC Regulations Applicable to Private Companies
Companies are required to file financial reports with the SEC if they have $10 million or more in assets, or if the number of common shareholders exceeds 500. A private company that meets this threshold must file quarterly and annual reports, along with other financial disclosures.
There is a special form known as Form 10 that a public company must file when it first crosses this threshold.
As part of its mission to protect investors, the SEC requires companies to be truthful in what they disclose to investors. Both private and public companies are held to truthful disclosure and anti-fraud provisions that fall under provisions of the Securities Exchange Act.
From a legal and compliance perspective, private companies need to understand what information they are required to disclose to the SEC. Then they need to make the appropriate filings in a timely manner.
While annual and quarterly reports are tied to the calendar year, some forms like the Form 10 are triggered by a qualifying incident, such as exceeding $10 million in assets. Private company financial reporting software is essential for organizing and preparing this financial information and making SEC filings.
While private funds are not required to register with the SEC, private fund advisers do need to register. The size of the funds being managed and the type of activity play a role in determining what data the adviser needs to provide.
The SEC is always changing and updating rules. A new rule could come into play that affects public company reporting requirements, so it is important to stay up to date on regulations.
Compliance and Legal Implications for Private Companies
Let's look at what compliance means in this context, including legal ramifications of noncompliance with the Securities Exchange Act or the Investment Advisers Act.
If a company is not in compliance with registration requirements under the Securities Act, its investors may exercise their right of recession. The company would need to return the investors' original investment plus interest. If a company used the money to fund operations, this could create a severe financial hardship. If a company has a history of noncompliance, it may struggle to attract financing moving forward.
Savvy investors want to avoid potential legal headaches. Many insist that companies guarantee their past compliance with securities law, such as through documentation or a lawyer's attestation. Entities that do not comply with regulations risk civil or criminal lawsuits.
One example from recent history is when the SEC charged the CEO and former President of Theranos with fraud. The now-disgraced CEO and President were convicted on multiple counts and are currently in prison.
While the Theranos case may be an extreme example of private companies running into trouble with the SEC, the point stands. Private companies must understand what SEC regulations affect them, then comply — or face trouble.
Investment and Capital Raising Under SEC Regulations
Companies can raise capital through private placements. While Regulation D of the Securities Act exempts this private funding from public registration, there are rules around raising capital that private companies must adhere to.
These include:
- Rule 506(b), which allows companies to raise capital without announcing it publicly, yet limits this fundraising to accredited investors and up to 35 non-accredited investors
- Rule 506(c), which allows companies to raise unlimited funds from a widespread pool of investors, provided they verify those investors are accredited
- Rule 10b-5, which requires truthful disclosures
- "Bad actor" provisions, which prohibit anyone with court injunctions, specific criminal convictions or regulatory issues from investing in a private fund
- Form D: Within 15 days of their first securities sale, companies must file Form D with the SEC
Regulation D allows companies to raise greater amounts of capital with less of a regulatory burden than they would otherwise be subject to. Lower regulations create a more efficient process for the company, which saves money.
Crowdfunding is another option for a private company to raise capital. The SEC limits companies to a maximum of $5 million in crowdfunding money in a 12-month period. The crowdfunding campaign must take place in a funding portal that is a registered intermediary, such as a broker- dealer.
Navigating SEC Compliance: A Checklist for Private Companies
This comprehensive SEC compliance checklist can help private companies stay on top of regulations that impact them as well as filing deadlines and triggers.
- Identify relevant exemptions: Regulation D, Regulation Crowdfunding and other SEC rules have special exemptions that may affect a public company or private company. Companies should review these rules with counsel to identify any exemptions that affect them.
- Understand which forms are needed: Which forms companies need to file depends on their chosen path for raising funds, among other variables mentioned above. Companies must get clear on which forms they need to file and when to stay in compliance with SEC regulations.
- Follow investor disclosure rules: Anti-fraud and truthful disclosures regulations mandate privately held companies to clearly disclose financial information and potential risks to investors.
- Verify investor accreditation: Companies must make sure that investors meet criteria outlined in Rule 506(b) and 506(c).
- Keep documentation: Companies need to document investor communications, disclosures, and transactions in case they are called upon to prove regulatory adherence.
- Conduct compliance audience: By performing internal audits, companies can ensure they are in compliance.
The SEC is increasingly focused on private companies, making sure they keep up with all required filings. In addition to this checklist, companies need legal advisors who can ensure compliance and keep executives notified of any changes that may impact them.
While private companies may not be experts in federal securities law, they cannot use "I didn't know" as an excuse for not complying. Maintaining SEC compliance is an ongoing process that requires diligent effort. Companies must also make sure they have the right software in place to prepare and submit needed SEC filings in a timely manner.
DFIN provides industry-leading financial reporting software trusted by public and private companies. Our signature products support every phase of the corporate lifecycle, from M&A deals to IPO launches to private funds that need a trustworthy solution for their financial reporting requirements. Discover what sets DFIN's products apart from the rest.
