Nearly three years into a regulatory dispute, a recent ruling on a lawsuit has left the muzzle in place around hedge fund provider Bulldog Investors. In a decision late last month, Massachusetts Superior Court Judge Judith Fabricant upheld a long-standing rule that effectively prohibits hedge funds from advertising to the public.
Bulldog principal Phillip Goldstein, who filed the suit after being cited for not restricting access to his website, calls the verdict an affront to free speech. "The rationale for the ruling is that people who are not wealthy should not be entitled to get information about a product that they may not be able to buy," he says. "What if [the government] said that you couldn't even get a brochure about a Rolls-Royce because you couldn't afford the Rolls-Royce?"
But Brian McNiff, a spokesperson for Massachusetts Secretary of State William Galvin, says the case was never about free speech. Instead, he says it was the "protection of investors" that was at stake.
The case began in early 2007 when Galvin fined the New Jersey-based Bulldog Investors for the contents of the company's website. Since virtually all hedge funds are private offerings, they can escape most government regulations, but the flip side of that arrangement is that they are barred from many forms of promotion. In particular, the Securities Act of 1933 limits "general solicitation or general advertising" to registered public offerings.
The idea behind the restriction is to ensure that companies that advertise offer potential investors a complete and accurate view of their holdings and performance. A common manifestation of this requirement is the prospectus that such companies must make public. The advertising rule also gives companies an incentive to register, thereby allowing the government to enforce its disclosure standards. "It follows that the ban on general solicitation of unregistered securities effectively promotes registration, which, in turn, effectively serves the state interest in market integrity," according to Fabricant's decision.
Hedge funds could circumvent the rule by going public, but the idea is almost universally unpalatable to managers, who prefer the flexibility afforded to them by their private status. As a result, the practical implication of the rules is that hedge funds can advertise only to qualified parties, or those who are wealthy enough to meet the minimum-investment requirements that the funds impose. On the Internet, one way for funds to do that is to make their sites password protected.
But in challenging Galvin's fine, Goldstein argued that the free flow of information should trump the restrictions, particularly if the advertisements present accurate information. "There was not one iota of skepticism toward the government's ban on truthful speech," he says of the ruling.
Still, not everyone in the hedge fund industry is jumping to his defense. Chris McHugh, the chief financial officer of the Massachusetts-based hedge fund New Generation Advisors, calls the restrictions sensible. "If you're running a hedge fund . . . you shouldn't be advertising to the average man in the street," he says. "Our libertarian streak tells us that everyone should know everything, but in all honesty, this business is a little risky, and it's probably good that the government restricts who gets peddled the [information]."
McHugh also notes that since hedge funds draw their investments from high-wealth investors, they don't need to use grass-roots advertising. "We can find people to invest, and it's not like we're missing a lot by not reaching low-income households," he says.
Meanwhile, for his part, Goldstein has said he will appeal the ruling in the hope of repeating his 2006 victory over Galvin. In that case, Goldstein blocked the implementation of a rule requiring hedge funds to register with the Securities and Exchange Commission.