SEC Votes to Ease 80-Year-Old Ban on Private-Investment Ads

Hedge funds and other companies seeking private investments will be allowed to advertise publicly for funding under a rule approved today by the U.S. Securities and Exchange Commission.
The rule, which passed by a 4-1 vote, is the first one mandated by last year’s Jumpstart Our Business Startups Act to be completed by the SEC. A deadline for the regulation set by Congress lapsed more than a year ago.
The rule will ease 80-year-old advertising restrictions intended to help ensure small investors aren’t lured into taking inappropriate risks. Under the measure, startups and other small companies would also be able to use advertising to raise unlimited amounts of money.
“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,” SEC Chairman Mary Jo White said. “This does not mean, however, that the commission should not take steps to pursue additional investor safeguards if and where such measures become needed.”
The rule affects how companies raise money through private offerings, which are exempt from requirements to publicly report financial statements. Private offers are restricted to investors with a net worth of at least $1 million excluding their primary residence, who are considered better positioned to take the risks of investing with less information.

Changes ‘Paradigm’

“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.”
Companies raised $899 billion through private offers last year, compared with $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.
“By allowing issuers to solicit to a broader group of potential investors, the SEC has today showed its commitment to democratizing the investing process and putting an end to yesterday’s ’old boy’ investor networks,” said Barry Silbert, founder and chief executive of SecondMarket Inc. a marketplace for private shares.

Enforcement Actions

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. 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 rule proved controversial at the five-member commission. Democratic Commissioner Luis A. Aguilar, who voted against the change, said it leaves investors unprotected against a greater risk of fraud.
“Without common-sense protections, general solicitation will prove be a great boon to the fraudster,” Aguilar said in a statement prepared for today’s meeting. “Experience tells us that this will lead to economic disaster for many investors.”
Fellow Democratic Commissioner Elisse B. Walter voted for the rule, saying the SEC will scrutinize how advertising is used and will pursue additional investor protections in a separate process.

Changes Recommended

An SEC advisory committee recommended in October that the commission rewrite the proposal to include new investor protections. Instead, the SEC lifted the advertising ban today and said it would pursue new regulations through another public-comment process.
The committee 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. About 7.4 percent of U.S. households meet the net-worth definition, according to the SEC.
Investor advocates such as the Consumer Federation of America expressed skepticism about whether the proposal will ever be adopted.
“This is a poor beginning to Chair White’s term as head of the agency, and it sends a disturbing message about the commission’s likely priorities under her leadership,” said Barbara Roper, director of investor protection for the Consumer Federation.

Two Methods

The SEC’s rule includes two methods for companies to verify a person is qualified to participate, while giving them flexibility to determine other ways. Companies can review federal-tax documents to check the income of the purchaser or get confirmation of a person’s income or wealth from a registered broker, investment adviser, licensed attorney or certified public accountant.
The limit to sell only to accredited investors explains why many hedge funds probably won’t respond 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

Operating companies and startups 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 deception, the commission approved, on a 3-2 vote, a proposal for new regulations that would allow better tracking of private offers and how advertising is used.
Republican SEC commissioners Troy A. Paredes and Daniel M. Gallagher said the proposal was unnecessary and would weigh down the private market for securities with costly new rules.
“The proposal, if adopted, would undermine the JOBS Act goal of spurring our economy and job creation,” Paredes said.
Under the proposal, companies raising money through advertised private offers would be required to file a statement, known as Form D, before and after the offer. Companies that failed to comply with the form requirements would be disqualified from conducting private offers for one year.
Form D data is used to evaluate the size of the private market and the types of investors who participate. The SEC knows some companies don’t file the required form but it can’t say what percentage don’t comply, SEC Chief Economist Craig M. Lewis said today.
The SEC also approved a rule that blocks felons and others found have violated securities-laws in marketing private offers, which are more lightly regulated than public offers of stock or debt.