Investment pitches by entrepreneurs and hedge funds may get a higher public profile on television, through social media and even at sporting events following the lifting of an 80-year-old rule by U.S. securities regulators.
While yesterday’s vote by the Securities and Exchange Commission to end a ban on advertising for private offerings isn’t expected to spark an immediate deluge of mass-media marketing, funds will feel pressure to promote investments as competitors take advantage of the new freedom, according to securities lawyers. Some may experiment with low-cost venues such as social media while others may sponsor sporting events that attract wealthy investors.
“It’s at the very top end, like Bridgewater, and D.E. Shaw, and Blackstone, and also the funds with $50 million, the guys who know they have to get bigger to survive,” said Jay Gould, head of the investment funds practice at Pillsbury Winthrop Shaw Pittman LLP. “Those are the two groups that are most excited about the rule change.”
The SEC action was required under a law passed last year by Congress, which agreed with arguments from technology entrepreneurs and venture capitalists that the general solicitation ban was written for a different era of investing. Private offers have outgrown public sales of stock, raising $903 billion in 2012, according to the SEC.
Under the old rule, hedge-fund managers were inhibited from talking about specific funds at seminars and to the media, out of fear their remarks would be interpreted as advertising. Now firms such as BlackRock Inc. (BLK) and JPMorgan Chase & Co. (JPM) that offer hedge funds, private equity and other alternatives will benefit because they already market to retail investors and can provide information about more products.
“It’s a sensible and balanced approach. They’re not giving up investor protections, but they’re looking at a more modern view for general solicitation,” said Barbara Novick, vice chairman at New York-based BlackRock, the world’s largest asset manager. “To say that people can’t even put information out there just doesn’t make sense in the modern world.”
The lifting of restrictions on media interviews, putting information on websites and appearing at conferences will first be used to help build brand awareness, Steven B. Nadel, a lawyer at Seward & Kissel LLP in New York, predicted.
“They’ll take baby steps by first appearing on business news networks and industry conferences, and we’ll probably see fewer password-protected websites than we do now,” said Nadel, whose clients include hedge funds. “We could even see funds do things like sponsor polo events in the Hamptons.”
Under the rule, private funds and other companies are still restricted to selling to “accredited investors,” or those considered rich enough to withstand an adverse outcome. The law defines accredited investors as having annual income of at least $200,000 or a net worth of at least $1 million excluding their primary residence.
The limit to sell only to accredited investors explains why many hedge funds probably won’t respond by taking out print and television ads seeking new clients, said David S. Guin, a partner at Withers Bergman LLP whose clients include hedge funds.
“You wouldn’t expect the type of person who is typically sought as an investor to be investing off of an ad in a newspaper or magazine,” Guin said.
The Hedge Fund Association said the new rules will increase transparency, facilitate capital formation and enhance capital markets.
“Though the HFA views this development as generally positive, we await publication of the new rules to determine whether particular requirements impose an unnecessary burden on our members,” the trade group said in a statement.
The hedge-fund business has been “uniquely entrepreneurial, in part due to its lightly regulated and private structure,” Charles Stucke, senior managing director of asset manager Guggenheim Partners LLC, said in an e-mailed statement. “Hopefully, the industry can maintain its entrepreneurial spirit through these and other regulatory changes which benefit larger firms. It may take smaller, niche names, which often outperform due to their ability to be nimble, longer to catch up.”
The freedom to advertise will take the muzzle off startups, which are expected to respond by using websites and industry conferences to announce their need for funding, said Alex Mittal, founder and CEO of FundersClub Inc., which invests in early-stage companies and operates an online fundraising platform.
The SEC could help investors sort through the higher level of “noise” by requiring companies to provide information that will allow the regulator to better surveil the market for fraud, Mittal said in a phone interview.
“If you think of a private company’s stock or a startup’s stock as one of its products, it seems reasonable to think they should be able to market that,” Mittal said. It also seems reasonable that the SEC ought to ensure “the investors are protected in this new landscape.”
Some investor advocates say advertising will lure small investors into risky bets and complain the rule didn’t include any protections. State securities regulators say private offers were the most common product leading to enforcement actions in 2011.
“The record is clear that general solicitation will make fraud easier by allowing fraudsters to cast a wider net for victims,” said SEC Commissioner Luis A. Aguilar, who cast the lone vote against the rule. “Experience tells us that this will lead to economic disaster for many investors.”
An SEC advisory committee recommended in October that the commission rewrite the proposal to include new requirements on the use of advertising. Instead, the SEC lifted the advertising ban and said it would pursue new rules through another rulemaking process.
The SEC started that process by approving, on a 3-2 vote, a proposal for new regulations that would allow better tracking of private offers and how advertising is used. Two Republican commissioners, Troy A. Paredes and Daniel M. Gallagher, voted against the measure, saying it would weigh down the private market with costly new rules.
SEC Chairman Mary Jo White said the agency recognizes the worries about fraud and will monitor the market for more signs of it. In the meantime, she said, the regulator was compelled to move forward and lift the ban.
“Given the explicit language of the JOBS Act as well as the statutory deadline which passed last July, the commission should act without any further delay,” White said. “This does not mean, however, that the commission should not take steps to pursue additional investor safeguards if and where such measures become needed.”
Investor advocates such as the Consumer Federation of America expressed skepticism about whether the proposal will ever be adopted.
“This is a poor beginning to Chair White’s term as head of the agency, and it sends a disturbing message about the commission’s likely priorities under her leadership,” said Barbara Roper, director of investor protection for the Consumer Federation.
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