Hedge funds are one step closer to officially being permitted to advertise to the general public. The burning question, though, is whether that's cause for celebration or trepidation.
The Securities and Exchange Commission has recently put forth proposed rules that, if approved, would govern hedge fund advertising. The rules are a direct response to the JOBS Act, which contained a provision requiring that hedge funds, along with various other types of private offerings, be allowed to market their products to all types of investors.
Prior to the JOBS Act, hedge funds that took advantage of certain SEC registration exemptions were banned from engaging in general solicitations. But because of the bill, the question in front of the SEC is not whether such hedge funds will be allowed to undertake such advertisements. Rather, it is how to best regulate the advertisements once they are allowed.
Still, even though you'll soon be able to see the advertisements, most investors won't be allowed to invest in the products. The SEC is planning to require that funds previously subject to the ban employ "reasonable" safeguards to ensure that only "accredited" investors are allowed to buy in. An example of an accredited investor is an individual with a net worth of upwards of $1 million or an annual income north of $200,000.
Opponents of the SEC's plan, which include the mutual fund industry and consumer protection advocates, say the commission falls short of protecting against abuse. Barbara Roper, the director of investor protection at the Consumer Federation of America, concedes that the SEC is forced, as a result of the JOBS Act, to permit advertisements. But she faults the commission for failing to employ proper safeguards.
"The JOBS Act requires the SEC to lift this ban on general solicitation and advertising. So we accept that this is something that the SEC has to do," she says. "But we disagree with pretty much everything else about the way that they've handled it."
For starters, Roper worries that the proposed rules don't do enough to prevent unaccredited investors from finding their way into hedge funds that advertise. More significantly, she fears that investors at the lower end of the accreditation spectrum don't have the financial know-how necessary to invest in hedge funds, and she's concerned that fund providers will exploit that lack of sophistication.
Roper argues that the new rules would heap troubles onto an industry that has already had its fair share of problems. "You're fundamentally changing the ways that these [products] are sold in a market that already has some significant problems," she says. As such, she has suggested that the SEC raise the accreditation threshold.
On the other end of the debate, hedge fund providers have long argued that they have been unduly stifled by the solicitation ban. They maintain the requirement that they take steps to ensure that investors meet the accreditation standards is a sufficient check against the potential harms of allowing mass advertising.
One of the most vocal supporters of lifting the ban has been Phillip Goldstein, a co-founder of the hedge fund provider Bulldog Investors. Goldstein made a name for himself by defying regulators when he allowed unrestricted access to Bulldog's website rather than only permitting accredited investors to read about the company's offerings.
Massachusetts regulators fined Bulldog Investors in 2007, and a state judge upheld the penalty in 2009. At the time, Goldstein blasted the decision, arguing that individuals should be allowed to see promotional information about hedge funds even if they're not allowed to invest in them. "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?" he asked.
Goldstein's legal battle ended earlier this year when the Supreme Court declined to hear his case. That means that for the moment, Bulldog remains muzzled. But soon, when the SEC's rules are finalized, that will change.
Will the change, as Goldstein believes, harmlessly democratize access to information? Or will it, as Roper fears, open up a Pandora's box? You be the judge.