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Q&A with Troy Paredes: How the SEC Regulates Silicon Valley (Part 2)

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Shriram Bhashyam   April 13, 2017

The change in administrations at the White House has multifold ramifications for startups. Important among those areas is the Securities and Exchange Commission’s (“SEC”) posture towards Silicon Valley and how that agenda may shift under incoming Chair Jay Clayton. We’ve tapped friend of EquityZen, and former Commissioner at the SEC, Troy A. Paredes to shed some light. You can read Part 1 here.



Shri Bhashyam: I’m glad you raised your views on where regulation needs to go.​ Under most recent SEC Chair Mary Jo White, it seemed the drumbeat had grown steadily. It started with Theranos, and then Chair White gave a friendly warning of sorts to Silicon Valley, and then controversies at Hampton Creek and Lending Club came to light, and finally some shareholder lawsuits. How would you contrast a prospective SEC agenda under Chair Jay Clayton (assuming he is confirmed) to that of most recent Chair Mary Jo White?

Troy A. Paredes: SEC Chairs (as well as Commissioners) take enforcement very seriously, even if they have different ways of going about it.  Each and every part of the SEC’s mission – protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation – requires the regulator to identify misconduct and hold wrongdoers accountable. 

In an environment where there often is a lot of disagreement, one item stands out to me for the bi-partisan support it gets – namely, there is widespread agreement that the SEC should use data and technology as part of its examinations, inspections, and enforcement.  Data analytics has become an important part of how the SEC goes after fraud and manipulation.  I expect that to continue, regardless of the SEC’s political makeup.  It will be particularly interesting to see how things like artificial intelligence and machine learning end up factoring in.

Stepping back a bit, I expect this SEC to focus on economic growth by taking sensible steps to make it easier for companies to raise capital – in other words, by giving new life to the SEC’s capital formation mission.  It will take some time to see which exact rules and regulations may be up for reform.  But generally speaking, I think the effort should include a “retrospective” review that evaluates whether and how the regulatory regime has proven too costly and burdensome, working against the best interests of both companies and investors. 

SB: What will the change in administrations mean generally for financial regulation?

TAP: One place to look is the President’s recent Executive Order on Core Principles for Regulating the United States Financial System.  In short, I think attention be will paid to how regulation, notwithstanding the best of intentions, can end up being counterproductive, disadvantaging our markets, companies, investors, and taxpayers.  Cost-benefit analysis and data-based regulatory decision making can help ensure that we do more good than harm.  I advocated for both during my time at the SEC.

SB: What are some big regulatory topics fintech firms should pay attention to in 2017?

TAP: Across our economy – indeed, across our lives – technology will continue to give us new opportunities and new ways of doing things faster and cheaper.  That’s good.  At the same time, precisely because it can be disruptive, innovation can cause dislocations as machines and software are used instead of people to do certain jobs.  We need to take seriously the difficulties people face when they are displaced by technology, even as we appreciate the new jobs that technology creates.

As for fintech specifically, I think we’re still in the early days, with much more ahead of us.  Part of what lies ahead is how regulators respond.  Financial regulators, including the SEC, have been paying more-and-more attention to how fintech affects how parties transact, how capital flows, how advice is given, how trading occurs, how markets are interconnected, and how personal information is vulnerable.  While regulators welcome innovation and the choice, competition, and cost-savings it spawns, they still have to ask a simple question:  Do we need to adapt our rules and regulations to account for the changes fintech is bringing about?  The SEC, for example, held a roundtable on this very question last year.  That was just the beginning of the SEC’s focus, not the end of it.  Fortunately, the predilection isn’t necessarily for more regulation.  In the minds of many, rules and regulations should be updated to facilitate innovation – 21st century regulation for 21st century technology.

In addition, regulators are themselves users of fintech.  Financial regulators will increasingly use technology – algorithms, machine learning, artificial intelligence – to detect misconduct and to develop their enforcement actions.   For those the regulators regulate, then, technology should become a more robust part of their compliance programs.  Traditional written policies and procedures soon will not be enough.  This is the fast-growing field of regtech.  I encourage companies to get on board by evaluating how they can take advantage of technology to bolster compliance.  

Troy A. Paredes is the founder of Paredes Strategies LLC and is a Senior Advisor at CamberView Partners, LLC.  From 2008-2013, Paredes was a Commissioner of the U.S. Securities and Exchange Commission, having been appointed by President George W. Bush.  Paredes advises companies on financial regulation, corporate governance, compliance, political risk, and government investigations.  Before becoming a Commissioner, Paredes was a professor of law at Washington University in St. Louis.  Currently, he is a Distinguished Scholar in Residence at NYU School of Law and a Lecturer on Law at Harvard Law School.  And he is the co-host of a fintech podcast called “Appetite for Disruption.”


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Q&A with Troy Paredes: How the SEC Regulates Silicon Valley (Part 1)

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Shriram Bhashyam   April 05, 2017

The change in administrations at the White House has multifold ramifications for startups. Important among those areas is the Securities and Exchange Commission’s (“SEC”) posture towards Silicon Valley and how that agenda may shift under incoming Chair Jay Clayton. We’ve tapped friend of EquityZen, and former Commissioner at the SEC, Troy A. Paredes to shed some light.



Shri Bhashyam: There has been an uptick in media attention and shareholder lawsuits related to possible securities fraud at big, later stage (“Unicorn”) startups, such as Theranos and Hampton Creek  (whose investigations by the SEC and Department of Justice were recently dropped). First, what are the main legal issues underlying these controversies?

Troy A. Paredes: The typical securities fraud case, whether it is brought by investors or the government, alleges that there was a material misstatement or omission – in other words, that information provided to investors was wrong in an important way.  Investors need accurate information to make informed decisions; they can’t be misled.  So protecting investors from fraud is key.  That’s true whether investors are investing in private companies or public ones.  At the same time, there’s a difference between fraud, on the one hand, and things simply not going as well as expected at a company, on the other.  Indeed, courts have consistently cautioned against so-called “fraud by hindsight” – a caution that matters a lot for startups and other emerging companies for which there often are genuinely high hopes that just don’t pan out.

SB: To what extent can startups rely on the fact that the investors coming in to their funding rounds are sophisticated folks or entities who can fend for themselves?

TAP: Routinely, private securities offerings are limited to “accredited investors” – certain institutional investors and people who meet income or wealth qualifications under SEC Regulation D. The idea is that if the investors buying into an offering can “fend for themselves,” then the government is justified in easing up on its regulation.  In practice, this means that a valid private placement under Reg D doesn’t have to meet the many Securities Act requirements that a public offering does.  Along these lines, two points are worth noting. 

First, even when a company raises money only from accredited investors, the company is still subject to the antifraud provisions of the federal securities laws.  Reg D may exempt a company from having to file a registration statement with the SEC, but it does not exempt a company from Rule 10b-5 prohibiting fraud. 

Second, the SEC has been reconsidering the definition of accredited investor, which has been on the books for years.  I’d like to see the definition modernized to help startups and other early-stage companies more easily raise the capital they need to grow and prosper.  Furthermore, if you’re not “accredited,” the law effectively puts you on the outside looking in when it comes to getting in on the ground floor, to mix my metaphors.  So changing the definition of accredited investor to give more investors more opportunity to invest in emerging companies can be good for investors too.  People who today don’t qualify as “accredited” but who would under an updated definition – if the SEC ends up adopting one – would have more freedom in deciding for themselves how to invest since private offerings would be more open to them.  That said, there are no guarantees when investing, and the chance to earn outsize returns can come with the potential to lose a lot.

SB: Are there any common threads among the Unicorn stories that are tied to securities fraud?

TAP: Compliance has to be taken seriously.  Integrating compliance, along with reputational risk, into a firm’s overall risk management framework can help ensure that it’s front-and-center.  Even for a startup, let alone a Unicorn, you should have good governance and sound controls.

That said, one size doesn’t fit all.  Policy makers should avoid over-regulating new and emerging companies.  In fact, what we need to do is continue promoting small business capital formation.  The reason is simple: entrepreneurs help drive economic growth and job creation.  Their ideas lead to breakthroughs that make our lives better.  That’s why I focused on helping small business when I was in government, including by supporting the JOBS Act.  While we’re at it, we should also adopt common-sense reforms to spur the IPO market.

Troy A. Paredes is the founder of Paredes Strategies LLC and is a Senior Advisor at CamberView Partners, LLC.  From 2008-2013, Paredes was a Commissioner of the U.S. Securities and Exchange Commission, having been appointed by President George W. Bush.  Paredes advises companies on financial regulation, corporate governance, compliance, political risk, and government investigations.  Before becoming a Commissioner, Paredes was a professor of law at Washington University in St. Louis.  Currently, he is a Distinguished Scholar in Residence at NYU School of Law and a Lecturer on Law at Harvard Law School.  And he is the co-host of a fintech podcast called “Appetite for Disruption.”

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SEC Voices Concern about "Eye-Popping" Startup Valuations

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Shriram Bhashyam   April 04, 2016


I recently wrote an article for TechCrunch analyzing a speech given by SEC Chair Mary Jo White in Silicon Valley. This is a positive development towards the evolution of transparent, deep, and orderly private secondary markets. As always, we at EquityZen seek to keep our community informed of relevant updates. 

Consider it an early warning, or maybe a gentle reminder from your friendly securities regulator. Securities and Exchange Commission (“SEC”) Chair Mary Jo White came to the heart of Silicon Valley to deliver a speech at Stanford University’s Rock Center for Corporate Governance on March 31, 2016, which touched on a variety of topics but was rather forthright in addressing startup valuations. Management and boards at late stage, or pre-IPO, companies are on notice that the SEC is paying attention to the late stage financing arena, and should look internally to ensure that corporate governance and financial controls are befitting their scale, and should also ensure the accuracy of the disclosures they make when raising funds.

Job number one of the SEC is investor protection. Viewed through this lens, it makes sense that the SEC would start paying attention to what’s going on in the world of Unicorns and their “eye-popping”, as Chair White put it, valuations. To be fair, late stage financing occurs in the private markets, where the players are sophisticated and typically understand the risks associated with growth stage investing. However, these financings are still subject to basic securities laws requirements, including the accuracy of information provided to prospective investors in these companies, which Chair White openly questioned. She was concerned that the motivations to achieve a high valuation may lead to impropriety in disclosures. Chair White noted, “In the Unicorn context, there is a worry that the tail may wag the horn, so to speak, on valuation disclosures. The concern is whether the prestige associated with reaching a sky high valuation fast drives companies to try to appear more valuable than they actually are.” It’s well-known in Silicon Valley that valuation itself has become a KPI, whether for noble reasons (recruiting talent) or not (valuation as vanity metric).  Chair White wondered aloud “… whether the publicity and pressure to achieve the Unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems.” The SEC has now reminded companies that these motivations and pressures do not excuse bending the rules by inaccurately reflecting company performance. 

Further, the SEC is keenly aware that the risk of inaccuracy is increased at startups because they tend to have looser internal controls than their public counterparts (Zenefits is the glaring example here). Accordingly, Chair White stressed the importance of financial controls and corporate governance at pre-IPO companies...

Continue reading at TechCrunch.
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