Caveat Investor: SEC Says Hedge Funds Can Advertise to Everyone

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Who wants to invest like a millionaire?

Lots of people, potentially, which is why SEC commissioner Luis Aguilar voted on Wednesday against a rule that will allow hedge funds and other companies looking for private investments to advertise to the general public. The change, Aguilar said, "will make fraud easier by allowing fraudsters to cast a wider net for victims."

Aguilar was the lone commissioner to vote no; the measure passed 4-1, lifting an 80-year-old restriction intended to prevent ordinary investors from being persuaded to take risks with their money that they can't afford.

Since the private offerings of hedge funds and startups seeking investments are exempt from public financial reporting requirements, these opportunities are restricted to wealthy investors -- those with at least $1 million in assets in addition to their primary residence, or an annual income of $200,000 (or $300,000 with a spouse) for the previous two years. (About 7.4 percent of U.S. households have a net worth of $1 million or more, the AP reports.) Such high-net-worth individuals are thought to be better able to handle the risk of more opaque and aggressive investments, and currently they're the only ones that issuers of private stock are allowed to solicit.

By October, that restriction will lift, enabling hedge funds and others to spread the word about their offerings however they like. But the rule about about who can invest in such companies will remain the same. And since the responsibility for vetting investors falls on hedge funds themselves, it's possible that far-reaching ads in print and online, or high-pressure sales tactics, could be used by mini-Madoffs to ensnare less savvy investors in fraudulent schemes. This has been Aguilar's concern, "a sentiment echoed by many investor advocates Wednesday," The Washington Post reports.

The change was mandated by the Jumpstart Our Business Startups (JOBS) Act of 2012, a bipartisan attempt to promote small business funding by loosening certain securities regulations. The SEC missed Congress's deadline to approve the regulation by more than a year; according to Bloomberg, Chairman Mary Jo White mentioned both the law and the timing as factors compelling the commission to approve the new rule now, despite concerns like Aguilar's:

"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. This does not mean, however, that the commission should not take steps to pursue additional investor safeguards if and where such measures become needed."

It seems that such steps might be rather modest: according to the AP, "the SEC proposed to monitor the advertising and collect data on how it affects the market for private securities offerings." This was good enough for Aguilar's fellow Democratic commissioner Elisse B. Walter, who voted in favor.

Advocates of the new rule say the old advertising restriction was badly outdated, having been enacted during the Great Depression, and caused many investors to miss opportunities. One businessman involved in the private share marketplace told Bloomberg that "the SEC has today showed its commitment to democratizing the investing process and putting an end to yesterday's 'old boy' investor networks."

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But those without a financial interest in increased private stock ownership have been more critical. In October, Bloomberg reports, an SEC advisory committee recommended that the proposed rule be written to include new investor protections, which did not happen. Specifically, the committee suggested revising the definition of "accredited investor" in order to reduce the number of people eligible to invest. And the North American Securities Administrators Association protested the SEC's proposed lifting of the ad ban after it was presented for public comment in August. According to state regulators, private offers were the leading cause of enforcement actions in 2011.

Wednesday's news was greeted with widespread derision on Twitter, as the trending hashtag #hedgefundslogans quickly became a vehicle for jokes about high fees, low returns, and carried-interest compensation. And Bloomberg Businessweek's July 11 cover story, "Hedge Funds Are for Suckers," comes with an illustration that has to be seen to be believed: a visual pun that turns "performance" into a double entendre, impugning the manhood of fund managers. As Dealbreaker's Matt Levine observes, with a cover like that, BBW seems unlikely to see much of the upcoming hedge fund advertising action.
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