The Securities and Exchange Commission voted Wednesday to allow hedge funds and other private firms to raise money by advertising to the public for the first time in decades, a dramatic loosening of the rules governing the investing landscape.
Currently, firms that issue private stock are allowed to solicit only wealthy individuals, who can presumably withstand potential losses. But by October, hedge funds and others will be able to advertise to the masses via e-mail, billboards or even Facebook — expanding their reach to a much wider circle of potential investors.
The commission voted 4 to 1 in favor of the rule. The lone holdout was commissioner Luis Aguilar, a Democrat who has long argued that lifting the advertising ban would unduly expose unsophisticated investors to fraud, a sentiment echoed by many investor advocates Wednesday. Those advocates worry that investors faced with high-pressure sales tactics will be unable to distinguish between legitimate offers and schemes.
The business community, on the other hand, said the new mass-marketing rule is a long overdue update to a 1930s regulation that has thwarted entrepreneurship and kept many investors in the dark about promising opportunities.
Congress directed the SEC to lift the advertising ban as part of broader bipartisan measure known as the Jobs Act, which aims to make it easier for small firms to grow, raise money and hire workers. Since the measure was enacted more than a year ago, the SEC has struggled to strike a balance between the business community’s desire for more capital and the need for investor protections. The commission has been blasted by some lawmakers for dragging its feet.
SEC Chairman Mary Jo White said Wednesday that the commission needs to act on Congress’s mandate. “This does not mean, however, that the commission should not take steps to pursue additional investor safeguards,” she said.
To that end, the agency unanimously adopted another rule Wednesday that will restrict the ability of firms associated with felons and other “bad actors” from taking advantage of the new advertising rules. That provision will also go into effect by October.
In addition, the commission approved a proposal that would require firms that solicit the public to disclose more information about themselves and notify the SEC in advance of a solicitation. It’s unclear when, or whether, that plan will be finalized.
The commission’s two Republican members — Troy Paredes and Daniel Gallagher — voted against it, arguing that the proposal would add to the regulatory burdens that small firms already face as they try to raise money.
Barbara Roper of the Consumer Federation of America said the “bad actors” restrictions and investor-protection proposals are “little more than empty gestures” that do not even begin to tackle the most pressing concerns of investor advocates. “The SEC is going to throw open the door to the mass marketing of so-called private offerings and never get around to market rules to protect investors,” Roper said.
For Roper and others, the biggest concern is the definition of an “accredited investor.”
Under the new rule, the SEC will allow firms to advertise to whomever they want. But only accredited investors with a certain net worth or income will be allowed to make a purchase.
But the net-worth and income thresholds have not been adjusted for inflation since 1982, and Congress has barred the SEC from making immediate adjustments.
Investor advocates say the thresholds are far too low. Anyone with a net worth of more than $1 million (with or without a spouse) or an income exceeding $200,000 (or $300,000 with a spouse) would qualify as accredited. A person’s primary residence is not part of the net-worth calculation because of a recent change in law.
It will be up to the firms to take “reasonable steps” to verify that investors are accredited.
The industry said lifting the advertising ban makes sense. In the age of the Internet and social media, it is of little use to limit who should know about private offerings; far more important, the industry said, is to restrict who can buy them.
Barbara Novick, a vice chairman at BlackRock, said concerns about scams can be addressed through existing anti-fraud laws and laws that govern oversight of the securities industry.
Potential investors are not likely to be deluged with advertisements, in part because firms don’t want to waste money trying to reach people who are not qualified buyers, Novick said. Instead, she expects firms to take advantage of the new rule by posting information on their Web sites, or speaking freely about their products at conferences, or responding to questions about their products — all things they could not do with the solicitation ban in place.
“The [advertising ban] didn’t reflect the times we live in,” Novick said.