SEC official says FTX failure shows need for private placement reform

A US financial regulator has urged better disclosures for investors who buy company stock through private placements, citing the collapsed cryptocurrency exchange FTX as an example of the dangers of opaque offerings.

Private placements are sales of equity outside of public markets. US rules largely limit offerings to so-called accredited investors who are thought to have the financial resources and savvy to assess deals that come with less information than public issues.

Caroline Crenshaw, a commissioner of the Securities and Exchange Commission, said in a speech on Monday that an exemption from extensive disclosure that was carved out for smaller businesses had come to be used by larger companies including “unicorns”, or private issuers valued at more than $1bn.

Likening ballooning private markets to the children’s book The Very Hungry Caterpillar, Crenshaw said: “[P]rivate companies now have access to increasing amounts of private capital, inflating their sizes and significance to investors and our economy, and all without the concomitant safeguards built into the public markets.”

Crenshaw cited as examples of companies providing inadequate disclosures FTX, the failed blood-testing start-up Theranos and WeWork, the office leasing company.

FTX filed for bankruptcy in November and its former chief executive is under indictment for fraud. Despite having sophisticated investors including Sequoia Capital and the Ontario Teachers’ Pension Plan, Crenshaw said FTX’s bankruptcy filings revealed it “didn’t even maintain an accurate list of its bank accounts or account signatories”.

“Crypto really does add an element to this,” Crenshaw said in an interview.

A Democratic member of the SEC, Crenshaw suggested broadening disclosure requirements when using the private placement exemption to include the size of the issuer in terms of assets, employees and investors; its financial state and revenues; as well as the size and nature of the transaction. Turning Crenshaw’s ideas into policy would require support from a majority of the five-member SEC commission.

During her speech she showed a six-page form the SEC requires for private placements sold to an unlimited number of accredited investors, which largely contained check-the-box questions. She held it up alongside the 173-page form required for public offerings.

Crenshaw warned that an “unintended and perverse consequence” of the wide use of the SEC exemption for private placements “may actually be hurting small businesses it was designed to help” as capital flowing to large players tends to be “locked up” because of private markets’ illiquidity.

She recommended a “two-tiered” disclosure system that would require more information from larger private issuers and deals, similar to the scaled framework that operates in public markets.

Crenshaw also urged a reassessment of what constitutes “accredited investors”, arguing that they should have access to more information regardless of earnings or level of wealth. “[T]he de facto presumption that accredited investors need no disclosure isn’t panning out.”