Hedge funds and other companies seeking private investments would be freed to advertise publicly for funding under a rule set for a vote Wednesday by the U.S. Securities and Exchange Commission.
The rule is the first of those required by last year’s Jumpstart Our Business Startups Act to be approved by the SEC, the vote coming more than a year after a deadline set by Congress.
The rule would lift an 80-year-old regulatory practice that has restricted advertising outside of a public offering in an effort to protect small investors from inappropriate risks. Under the new rule, startups and other small companies would also be able to use advertising to raise unlimited amounts of money.
“It changes the whole paradigm of who you can talk to,” said Brian J. Lane, a former division director at the SEC and now a partner at Gibson, Dunn & Crutcher LLP in Washington. “Hedge funds will benefit because they have the most restrictions on their ability to communicate more broadly about different funds coming to market.”
The rule affects how companies raise money through so- called “private offerings,” which are exempt from requirements to publicly report financial statements. Private offers are restricted to wealthier investors, who are considered better positioned to understand the risks of investing with less information.
Companies raised $899 billion through private offers last year, compared to $228 billion through registered sales of stock and $976 billion through sales of public debt, according to the SEC. Firms raising capital through private offers decide what information to share with investors.
State securities regulators say private offers were the most common product leading to enforcement actions in 2011. The North American Securities Administrators Association protested the SEC’s plan for lifting the advertising ban after it was proposed in August 2012. The state regulators said the SEC’s plan failed to provide guidance to companies about appropriate advertising and didn’t include any investor protections.
The proposal also divided the five-member commission. Two Republican commissioners have said the proposed rule should be completed as written. Democratic Commissioner Luis A. Aguilar said in April that a rewrite is needed because last year’s proposal resulted from an “aggressive effort to exclude pro- investor initiatives.”
An SEC advisory committee recommended in October that the commission rewrite the proposal while seeking to insure better compliance with a required form that tracks the initial offer. The committee also said the SEC should restrict the number of people eligible to invest by refining the definition of an “accredited investor,” or those considered rich enough to understand the risks and withstand an adverse outcome.
The limit to sell only to accredited investors explains why many hedge funds probably won’t respond to the rule change by taking out print and television ads seeking new investors, said David S. Guin, a partner at Withers Bergman LLP whose clients include hedge funds.
Instead, the rule may free up hedge fund managers to communicate more freely at conferences and to offer more information about fund performance on their websites, Guin said in a phone interview.
“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.
Operating companies also will be able to advertise for investors after the ban is lifted. They’ll benefit because they’ll be able to reach “a much broader audience than they would be able to with their own contacts,” Guin said.
In an effort to address questions about fraud, the SEC also will vote on a new proposal that seeks to monitor how advertising is used and whether it is contributing to more fraud.
The SEC’s meeting notice didn’t disclose details of the proposal, but the document states the commission will consider changes to a rule that holds investment companies accountable for their sales literature. Investor advocates such as the Consumer Federation of America have expressed skepticism about whether the proposal will ever be adopted.
A third rule scheduled for a vote today would block felons and others found culpable of securities-law violations from marketing private offers, which are more lightly regulated than public offers of stock or debt.
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