Once upon a time, a successful startup that was reaching a certain maturity would sell securities on the stock exchange to ordinary investors, possibly listed on a national stock exchange and assuming the privileges and obligations of a public company under the federal regulations on securities.
The times have changed. Startups that are successful today are now able to grow big enough without public capital markets. Not so long ago, a private company valued at over $ 1 billion was rare enough to earn the unicorn moniker. Now, more than 800 companies to qualify.
Lawyers are worried. A recent wave of academic papers shows that, because unicorns are not constrained by the institutional and regulatory forces that keep public enterprises online, they are particularly prone to risky and illegal activities that harm investors, employees, consumers and society in general.
The proposed solution, of course, is to put these forces on the unicorns. More precisely, the researchers propose obligatory IPO, considerably enlarged disclosure obligations, regulatory changes aimed at significantly increasing secondary market trading unicorn actions, expanded whistleblower protection for unicorn employees and stepped up Application of the Securities and Exchange Commission against large private companies.
This position also gained ground outside of the ivory tower. A leader of this intellectual movement recently appointed director of the SECs of Corporation Finance division. Big changes could happen soon.
In a new paper Titled Unicorniphobia (forthcoming in Harvard Business Law Review), I challenge this suddenly dominant view that unicorns are especially dangerous and should be tamed with bold new securities regulations. I raise three main objections.
First, pushing unicorns towards public enterprise status may not help and may in fact make problems worse. According to the vast academic literature on stock market myopia or stock market short-termism, it is public company managers who have particularly dangerous incentives to take excessive leverage and risk; under-investing in compliance; sacrifice product quality and safety; reduce R&D and other forms of business investment; degrade the environment; and engage in accounting fraud and other professional misconduct, among others.
The dangerous incentives that produce this parade of horrific results would arise from a constellation of market, institutional, cultural and regulatory characteristics that operate distinctly on Public corporations, not unicorns, including executive pay tied to short-term stock performance, the pressure to hit quarterly profit projections (aka quarterly capitalism), and the lingering threat (and the occasional reality) of an attack by hedge fund activists. As far as this literature is correct, the proposed unicorn reforms would simply amount to forcing companies to abandon one set of supposedly dangerous incentives for another.
Second, supporters of the new unicorn regulations are relying on a rhetorical sleight of hand. To show that unicorns present unique dangers, these advocates rely heavily on anecdotes and case studies of well-known bad unicorns, especially the Uber and Theranos cases, in their articles. Yet the authors make little or no attempt to show how their proposed reforms would have alleviated any significant harm caused by either of these companies, a highly questionable proposition, as I show in detail. in my paper.
Take Theranos, whose founder and CEO Elizabeth Holmes is currently on trial for criminal fraud and, if convicted, faces a sentence of up to 20 years in federal prison. Would any of the proposed securities regulatory reforms likely have made a positive difference in this case? Allegations that Holmes and others have lied extensively to the media, doctors, patients, regulators, investors, business partners and even their own board of directors make it hard to believe they would have been more truthful if they had been forced to make additional disclosures about the securities. .
As for the proposal to improve the trading of Licorne shares in order to encourage short sellers and market analysts to detect potential fraud, the fact is that these market participants already had the ability and incentive to make these plays against Theranos indirectly by taking a short position in its public company partners like Walgreens, or a long position in its public company competitors, like LabCorp and Quest Diagnostics. They failed to do so. Proposals to expand whistleblower protections and SEC enforcement in this area also seem unlikely to have made a difference.
Finally, the proposed reforms risk doing more harm than good. Today, successful unicorns benefit not only their investors and leaders, but also their employees, consumers and society in general. And they do this precisely because of the characteristics of the current regulations that are now on the regulatory chopping block. Changing this regime as proposed in these documents would jeopardize these benefits and could therefore do more harm than good.
Consider a company that has recently generated a huge social benefit: Moderna. Before going public in December 2018, Moderna was a secret, controversial, and overcrowded biotech unicorn with no single product on the market (or even in Phase 3 clinical trials), hardly any peer-reviewed scientific publications, a story turnover among scientific staff, a CEO with a penchant for exaggerated statements about the company’s potential and a toxic work culture.
Had these proposed new securities regulations been in place during the teenage years of Modernas companies, it is entirely plausible that they would have significantly disrupted the development of the company. In fact, Moderna might not have been able to develop its highly effective COVID-19 vaccine as quickly as it did. Our response to the coronavirus pandemic has benefited, in part, from our current approach to regulating unicorn securities.
Moderna’s lessons also focus on efforts to use securities regulation to combat climate change. According to a recent report, 43 unicorns operate in climate technology, developing products and services designed to mitigate or adapt to global climate change. These businesses are risky. Their technologies can fail; most likely will be. Some challenge well-established incumbent companies that have powerful incentives to do whatever it takes to resist the competitive threat. Some may be trying to change the preferences and behaviors of established consumers. And they all face an uncertain regulatory environment, varying widely between and within jurisdictions.
Like other unicorns, they can have very powerful founding CEOs who are demanding, irresponsible, or messianic. They may also have core investors who don’t fully understand the science behind their products, are denied access to core information, and push the company to take risks to achieve astronomical results.
And yet, one or more of these companies can represent an important resource for our society in the face of disruptions linked to climate change. As policymakers and academics explore how securities regulation can be used to combat climate change, they should not overlook the potentially important role that regulation of unicorns can play.
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