Earlier this month, the SEC and the former CEO of Jumio — a defunct, privately held mobile payments verification startup — agreed to settle fraud charges related to the overstatement of revenue. Executives of private companies should regard the case, and other recent ones like it, as warnings.

Nicolas Morgan

According to the SEC, the ex-CEO, Daniel Mattes, personally prepared false financial statements that overstated the company’s revenue by more than 10 times, while hiding the truth from its board of directors and counsel. He allegedly did so in order to sell his own private shares of the company to other investors at inflated prices.

Mattes agreed to pay disgorgement of more than $14.5 million plus interest, as well as a civil penalty for a total settlement of more than $16.7 million, without admitting or denying the allegations against him.

Some may be surprised to hear that the SEC stepped in with an enforcement action in response to a strictly private transaction. But the dealings of private companies and their executives have become an area of increased focus for the commission, and the trend shows little sign of slowing down.

Just over three years ago, former SEC chair Mary Jo White delivered a speech in Silicon Valley warning that “being a private company comes with serious obligations to investors and the markets.” She said the commission was concerned with and monitoring private companies, particularly with respect to their reporting to actual and potential investors.

White’s words have rung true, as the SEC has pursued a number of enforcement actions against both individuals and private companies related to purported fraud, even after White’s tenure at the SEC ended. Examples:

• In October 2017, Zenefits and its co-founder, Parker Conrad, settled SEC charges related to allegations that Conrad and the company misled Series B and Series C investors about the company’s health insurance broker licensing compliance, failing to disclose violations in several states.
• In March 2018, Credit Karma settled charges that it had unlawfully issued stock options to employees without providing appropriate financial information or risk disclosures.
• The same month, the SEC filed charges against Theranos, its now-infamous founder, Elizabeth Holmes, and its former president, Ramesh “Sunny” Balwani, related to false product claims and overstated financial expectations. Holmes and Theranos settled with the SEC on the date the charges were made public; Balwani’s case is still pending.

Brian Kaewert

While it’s easy to assume that the SEC’s focus is fixed on publicly traded companies, by now it’s clear that this sort of enforcement action against private companies is no passing fad. The SEC can and will continue to pursue these actions against any companies and individuals who defraud investors.

Investors too are taking note of private company disclosures. Just last week, two separate class-action complaints were filed against Lyft, alleging that the company was “overhyped” and exaggerating its market position prior to going public.

While the company is now publicly traded, both of the lawsuits focus on the company’s disclosures (or lack thereof) while it was still privately held. The irked investors pointed to Lyft’s post-IPO price drop as evidence that the company’s pre-IPO statements did not offer a full picture.

Officers and employees of privately held corporations, particularly those at startups with high valuations and an eye toward a public offering, would be wise to heed the lessons from the SEC’s recent private company enforcement actions and investors’ suits related to statements by private companies.

While there is frequently pressure on executives to make their company look as enticing as possible to investors, it’s important to remain honest and realistic when discussing the company with potential investors, both regarding its products and services and executives’ financial expectations.

Overly optimistic projections that aren’t based on realistic expectations may lead to serious consequences down the road.

Nicolas Morgan is a partner and Brian Kaewert an associate at law firm Paul Hastings LLC.