Hedge-Fund Ad Rule Said by SEC’s Walter to Boost Fraud Risk

A regulation letting hedge funds advertise for investors could force the U.S. Securities and Exchange Commission to expand enforcement activity to guard against fraud, SEC Commissioner Elisse B. Walter said today.

Investor-protection concerns caused the SEC to miss a congressional deadline for finishing the rule called for in last year’s Jumpstart Our Business Startups Act, Walter said in testimony at a House Financial Services subcommittee hearing.

“We would have to expend examination and enforcement resources that we would not otherwise have to,” she said in addressing questions about why commissioners didn’t accelerate work on the measure as some SEC staff members suggested. The agency needed to analyze questions raised by investor advocates, said Walter, who served as SEC chairman from December until Mary Jo White took the helm this month.

The SEC issued a proposal to lift the ban on hedge-fund advertising in August, four months after the JOBS Act became law. Debate over how to proceed sparked conflict between Mary Schapiro, who stepped down as chairman in December, and Commissioner Daniel M. Gallagher, who said he was furious that Schapiro changed her mind about the process.

House Republicans, including Representative Patrick McHenry of North Carolina, used the hearing to question whether the SEC could enforce the ban on advertising after missing a 90-day deadline set by Congress to lift it.

Lost Authority

“It would appear to me that, with this change, the SEC lost its authority to enforce the ban on general solicitation,” McHenry said.

Lawmakers pointed to e-mails, obtained from the SEC, that showed its lawyers considered accelerating the rule because of concern their authority to enforce the ban would expire “on day 91.” The ban remains in effect until the SEC passes a regulation lifting it, Walter said.

“There was a concern that a court or other tribunal might not be willing to impose relief because of the congressional policy,” Walter told the committee.

The SEC needed longer than 90 days to explore concerns raised by outside groups, Walter said. The commission could have been sued for failing to conduct necessary analysis if it had proceeded, Walter said.

“Our mandate is to lift the ban and also to consider investor protection,” Walter said. “That made it more complicated than it seemed on its face.”

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