The Securities and Exchange Commission (SEC) is an independent government regulatory agency established in 1934. Its primary objectives are to protect investors and to regulate the securities markets. For companies seeking to go public, the SEC requires securities to be registered before they can be sold to public investors. The SEC also helps prevent insider trading, accounting fraud, and misleading information in companies’ financials.
Five Commissioners oversee all SEC activities. The U.S. President appoints new Commissioners after each Commissioner’s five-year term expires. Each commissioner must be approved by the U.S. Senate. To maintain non-partisanship, only three of the five members can be of the same political party. Thus, the SEC has the authority and discretion to enforce U.S. securities laws. This article discusses the divisions of the SEC and the forms required for publicly traded companies.
Divisions within the SEC
Division of Corporation Finance
The SEC’s corporate finance division “seeks to ensure that investors are provided with material information in order to make informed investment decisions, both when a company initially offers its securities to the public and on an ongoing basis as it continues to give information to the marketplace” (SEC). This division at the SEC may also provide companies with assistance in interpreting the rules and recommend modifications to rules based on companies’ inquiries and questions.
The division’s filing review process monitors the disclosures and accounting requirements of public companies. This practice is intended to prevent fraud and instill more confidence in the public markets.
However, this review process does not guarantee that the disclosures are accurate. Rather, the responsibility for each company’s financial disclosures is with the company itself.
Division of Enforcement
The SEC’s enforcement division conducts investigations into violations of federal securities laws—and makes recommendations to the Commission as to whether to sue companies for these violations. When the Commission files civil lawsuits, it is represented by lawyers in the division of enforcement, and seeks injunctions, which are orders to prevent future violations against securities laws. Under these civil suits, the courts may award monetary penalties and the disgorgement of illegal profits. Disgorgement, the remedy prescribed by section 16 of the Securities Exchange Act of 1934, means companies that profit from illegal activities must pay those profits back to discourage illegal behavior and to put investors negatively affected back in the position that they would have been but for the illegal activity. The Commission may also bar or suspend individuals from acting as corporate officers or directors again. These actions brought against companies show the importance of hiring qualified accountants and lawyers to mitigate the risks of lawsuits from the SEC.
The Commission is not authorized to act on behalf of individual investors. This means that individual investors are not represented by the Commission, but it does always seek to restore harmed investors through disgorgement and penalties.
The enforcement division also issues subpoenas, gathers evidence, and takes testimonies from companies and individuals potentially in violation of securities laws. In 2020, the enforcement division filed 715 enforcement actions, which is down from 862 enforcement actions in 2019. The commission attributes the decline in actions to the COVID environment, which made it more difficult to gather evidence and take live testimony.
In 2020, the enforcement division’s actions received $3.589 billion in disgorgement and $1.091 billion in other penalties imposed. Roughly 32% of the standalone enforcement actions filed by the SEC pertain to security offerings, while the other actions involve insider trading, market manipulations, or the Foreign Corrupt Practices Act, to name a few. For a full list of all the actions filed by the SEC, see the SEC’s disclosures here.
Division of Economic and Risk Analysis
The SEC’s division of economic and risk analysis (DERA) was created in 2009 to assist “the Commission in its efforts to identify, analyze, and respond to economic and market issues, including those related to new financial products, investment and trading strategies, systemic risk, and fraud. DERA’s data analytics work develops a variety of financial and market data-analysis tools, supplies economic statistics, and promotes data standards.” Through the use of data analysis tools, the SEC has become very efficient at spotting areas to investigate.
If the price suddenly drops after an initial public offering, the SEC investigates for fraud or failure to disclose material information on its S-1. When the price immediately drops within the first few hours of trading, the SEC is quick to scour the financial and non-financial disclosures looking for what made the price drop. On occasion, when a price drops significantly after an initial listing, the SEC discovers that there were material misstatements that negatively affected the price of the securities.
Division of Examinations
The SEC’s Division of Examinations—formerly known as Office of Compliance Inspections and Examinations (OCIE)—conducts the SEC’s National Exam Program. “The results of the Division's examinations are used by the SEC to inform rule-making initiatives, identify and monitor risks, improve industry practices and pursue misconduct.”
The Division interacts with market participants by conducting on-site exams. These exams provide reliable information to assist the SEC in fulfilling its mission. This division reports its findings and other statistics; see this link to view its 2021 findings. For example, in its most recent yearly report, the Division of Examinations disclosed the following milestones: the division’s work resulted in firms returning over $32 million to investors; the exams found and notified hundreds of firms about their failure to timely file a Form CRS, which is the form required between brokers and advisers; the division also verified the accuracy of over 4.8 million investor accounts, which totaled over $3.4 trillion in assets. In short, the work of the SEC’s Division of Examinations is crucial to identifying risks and fixing them through direct communication with financial market players.
Division of Investment Management
The Division of Investment Management “oversees mutual funds and other investment products and services that investors may use to help them buy a home, send kids to college, or prepare for retirement.” This division has its main responsibility in administering the Investment Company Act of 1940 and Investment Advisers Act of 1940, each of which develop regulatory policy for investment companies.
Division of Trading and Markets
The Division of Trading and Markets provides oversight of some of the major securities market participants. Some of these participants include various securities exchanges, Financial Industry Regulatory Authority (FInRA), the Municipal Securities Rulemaking Board (MSRB), and clearing agencies that help facilitate trades, to name a few.
These are the six divisions at the SEC. Each strives to effectively communicate with the other divisions to optimize efficiency and results. The following sections describe some important SEC filings relevant to the capital markets in general—and to IPOs in particular.
Forms & Statements within the SEC
Draft Registration Statement (DRS)
The Draft Registration Statement (DRS) allows for Emerging Growth Companies (EGCs) and other companies to submit IPO paperwork to the SEC privately without immediate public disclosure. This allows companies to work through some of the disclosures and SEC feedback before the public is aware of the company’s intent to go public. This nonpublic, confidential process effectively allows the company to use the experience and resources of the SEC to gauge how ready it is for the IPO process without signaling to the public that it is going public. Once a company would like to make its intentions to go public known, it must register with the SEC by filing the publicly available Form S-1.
For U.S. companies trying to go public, filing Form S-1 with the SEC is required. Form S-1 is the initial registration form that the aspiring public company uses to show how it will use the capital proceeds from the public offering and give a prospectus of the security offering intended. The form S-1 requires both non-financial disclosures (as set out in Regulation S-K) and financial statement disclosures (as set out in Regulation S-X).
Once the S-1 has been filed with the SEC, this document is publicly stored in the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. This system is where any public company’s S-1 and other quarterly or annual reports are found.
The benefit of filing the registration statement with the SEC is the confidence it can give to companies prior to doing roadshows. Exposure to securities liability often arises during a company’s IPO roadshow because investors rely on statements or information gathered from the roadshows. By filing with the SEC prior to doing roadshows, the company may mitigate some of its securities exposure.
Similar to the form S-1 is the form S-3, which is used when a company seeks to raise capital in a secondary offering after the IPO has already occurred. The S-3 is a simplified form of registering securities with the SEC. However, to qualify to file the form S-3, the company must meet certain dividend, debt, and reporting deadline requirements (i.e., the company has already been filing with the SEC for 12 months).
The SEC charges fees to companies that register their securities. As of October 1, 2021, the fees required are set at $92.70 per million dollars of the proposed maximum aggregate offering price of the securities.
The S-8 is used to register securities with the SEC for a company’s employee compensation plan such as incentive plans, profit-sharing, bonuses, or options. One main purpose of the S-8 is to prevent the illegal offerings of securities.
The 10-K is a report required by the SEC for public companies to be filed within 60 to 90 days of the end of the fiscal year. Arguably, the 10-K is the most important document an investor can study to understand a company’s operations. The SEC requires various sections to be included on this form. First, the business section describes the company’s operations, products, and services. Next, the company must include any risk factors, followed by its recent years’ selected financial data. The Management’s Discussion and Analysis (MD&A) is where the company can explain its most recent financial information with words. Finally, the 10-K includes a company’s financial statements: the income statement, balance sheet, and statement of cash flows.
The 10-Q is similar to the 10-K except for these two main differences: (1) the 10-Q includes quarterly information, as opposed to annual data in the 10-K, and (2) the 10-Q must be only reviewed, as opposed to being audited by an auditing firm as is required with a 10-K. The SEC requires that public corporations file this form 10-Q for the first, second, and third fiscal quarters. The 10-K serves as the fourth quarter and yearly information.
The 8-K is another form required by the SEC. This form serves as an announcement to investors about special events they should be made aware of. Generally, this is required to be filed with the SEC within four days of the event transpiring. Some of the events that require 8-K disclosure are acquisitions, bankruptcies, corporate restructuring, changes in material obligations, and more. Regulation Fair Disclosure (Regulation FD) governs what kinds of disclosures are required and how to appropriately file the form to avoid penalties. A problem that could arise from not filing form 8-K in a timely manner is insider trading accusations. Reviewing 8-K filings is beneficial to investors as this allows them to keep tabs on public companies without information about significant changes being filtered by the news or other media.
Forms 3, 4, & 5
Forms 3, 4, and 5 are required to be filed with the SEC for publicly traded companies. These forms are specifically designed for company officers, directors, or those who hold more than 10% of any security class of the company for which they are employed (as the SEC defines Section 16 Officers). This often includes the board of directors, executives, and more. The purpose of these forms is for investors to see the equity stakes of the company’s often-primary decision makers.
Form 3 discloses new insider’s ownership in the company’s securities. Form 3 is required within ten days after one becomes an insider (i.e., one is hired or promoted to a company officer or director).
Form 4 is used for when an insider completes a securities transaction such as any option awards, the sale of securities, or equity swaps. The price and quantity of shares that are transacted are also disclosed on this form. Form 4 must be filed within two business days after the transaction date to comply with the SEC regulations.
Form 5 is required only when an officer either fails to report earlier transactions on Forms 3, 4, or some allowable exemption. For example, a form 4 filing is not required when an insider transacts in less than $10,000 in six months, but a form 5 filing is required. This form is usually due 45 days after the company’s fiscal year end.
The proxy statement, or form DEF 14A, is used to prepare shareholders at the company’s annual meeting as required under Section 14(a) of the Securities Exchange Act of 1934. The proxy statement is one way that the public is made aware of things such as executives’ compensation, business relationships and conflicts of interests, the audit firm and fees, and any other information pertaining to the voting topics during the shareholder meetings.
Private Company Interactions
In the past couple of decades, the number of unicorn companies has been increasing. A unicorn company is any private company valued at $1 billion or more. The SEC is currently working to require more disclosures for these huge private companies given their impact on private investors and the economy in general. At least one SEC Commissioner, Allison Lee, is working to require more private company disclosures to be filed with the agency. This push is at its initial stage and will surely get pushback from private companies in Silicon Valley, Silicon Slopes, and other tech hubs, given the heavy reliance on private funding with no desire to disclose more than necessary as a privately held company.
Some economists are worried that the costs of going public are being outweighed by the benefits of private funding. This is evidenced by the fact that there are currently 959 private companies valued at more than $1 billion, which is up from 513 at the end of 2020. Thus, private financing is skyrocketing because it is much easier to raise equity capital privately rather than going public due to the SEC’s stringent standards.
The Costs and Benefits of Going Public
Some people argue that the requirements for going public should be loosened by the SEC to allow more emerging growth companies to go public with less strict restrictions. These same people are saying that this is what causes an IPO to be nothing more than an exit opportunity for founders; otherwise, the owners will seek private funding due to the cost and burdens of going public following the SEC’s rules.
On the other hand, there are tremendous benefits to going public. The work required to go public (and maintain good standing with the SEC) is the price paid to achieve the benefits of being publicly traded. Some of those benefits include the huge amount of cash the company can receive instantly, the public awareness and brand building post-IPO, a bigger valuation than if privately held, the ability to attract better talent, and more. So, even though it is hard to achieve the milestone of being a publicly traded company given the SEC’s strict guidelines, the payoff is well-worth the costs for many companies as evidenced by the growing number of IPOs in recent years.
The SEC is designed to protect the capital markets and has successfully prevented fraud and shielded investors from false company disclosures. Although the registration process takes a lot of work and plenty of disclosures, the work of the SEC increases investor confidence in publicly traded companies in the United States.