Although it is not always appreciated or taken into account, the fact is that executives of private companies can be held liable for statements or other actions made in violation of the federal securities laws. One very recent and high-profile example where this happened involved the SEC enforcement action (and subsequent criminal proceedings) involving the high-profile medical testing company Theranos. Recent SEC and Department of Justice actions involving an Indiana-based company underscores the fact that private companies can draw the attention of federal securities regulator, and that it is not just high profile Silicon Valley firms that are potentially at risk.
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Though a Private Company, Uber Hit With Securities Class Action Lawsuit
The news late last week that London’s transport authority had stripped ride-hailing firm Uber of its ride-hire license on the grounds that it was “unfit to operate” in the U.K. capital was merely the latest blow to the company, following a string of scandals, probes, and damaging revelations. Now the company – which, despite its enormous size, is still a privately held firm — has been hit with a federal court securities class action lawsuit, the most recent instance where one of the high-flying “unicorn” companies has been hit with a securities fraud lawsuit after a decline in fortune. The new lawsuit has a number of interesting features, discussed below.
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D&O Insurance is Important for Private Companies, Too
Executives at companies whose securities are publicly traded typically don’t need to be persuaded that their company needs D&O insurance. They understand that the exposures public companies face make D&O insurance indispensable. However, the view of some private company managers may be different, particularly for officials at companies whose shares are very closely held. These company officials may believe their company has little risk of getting hit with a D&O lawsuit and as a result conclude that they don’t need D&O insurance. However, the reality is that D&O insurance is an indispensable part of every company’s risk management arsenal, whether or not a company’s shares are listed.
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The Liability Exposures of Directors and Officers of Pre-IPO Companies
When private companies are on track toward a planned IPO, much of the focus and attention is on readying the company for the burdens and responsibilities it will face as a public company. Among other things, this also means a focus on the potential liability exposures for the company and its directors and offices once the company goes public. Until the company actually completes its planned offering, however, it is still a private company — albeit one with a heightened set of risk exposures because of the company’s pre-IPO activities. If the planned IPO never happens, the company and its senior officials sometimes face liability claims arising from pre-IPO activities. A recent complaint filed in the Northern District of California against the former directors and officers of a pre-IPO company that ultimately went bankrupt illustrates the kind of claims pre-IPO companies and their executives can face. Pre-IPO companies’ liability exposures have important implications for the companies’ D&O insurance programs, as discussed below.
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Supreme Court Asked to Clarify Private Company’s Federal Securities Law Stock Purchase Disclosure Duties
In the D&O insurance world, private company liabilities, exposures, and insurance are viewed as categorically distinct from public company liabilities, exposures, and insurance. There are completely separate and distinct insurance policy forms for each of the two categories of companies. In this traditional view, one of the key distinctions between two kinds of companies is the potential liability of public companies and their directors and officers under the federal securities laws. However, it has recently become apparent to me that this perceived difference between the two categories of companies may be less distinct than I had perceived. For example, as I noted in a recent post, the SEC has recently made it clear it is watching private companies, and is particularly concerned with so-called “unicorns” (private start-up firms with valuations greater than $1 billion).
This issue of the potential private company liabilities under the federal securities laws came up again for me recently when I read about a petition for a writ of certiorari that a securities claim plaintiff has filed in the U.S. Supreme Court. As discussed in a June 8, 2016 post on Jim Hamilton’s World of Securities Litigation (here), the petition asks the Court to address the question whether a privately held corporation trading in its own stock has an Exchange Act duty to disclose all material information or abstain from trading. As discussed below, the petition and the underlying claim raise important questions about the potential liabilities of private companies under the federal securities laws. The May 31, 2016 cert petition in the case of Fried v. Stiefel Laboratories, Inc. can be found here.
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Theranos, the SEC, and the Enforcement of the Securities Laws Against Private Companies
In a speech last month, SEC Chair Mary Jo White signaled that the agency was going to be paying closer attention to private companies, particularly so-called “unicorns” – that is, the private venture-backed start-ups with valuations over $1 billion (as I discussed in a recent post). In her speech, White highlighted the concerns that can surround companies with these kinds of lofty valuations, noting that “the concern is whether the prestige associated with reaching a sky-high valuation fast drives companies to appear more valuable than they actually are.” It wasn’t clear at the time exactly what the agency’s scrutiny of these private companies might mean, but recent news involving the high-flying start-up company Theranos shows what White had in mind. The developments involving Theranos, in turn, raise the question of whether other high-flying privately held companies might also face scrutiny, as well.
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