Federal regulators on Wednesday lifted an 80-year-old ban on advertising by hedge funds, buyout firms and start-up companies seeking capital, a move that will fundamentally change the way that many issuers raise money in the private marketplace.
The Securities and Exchange Commission voted to approve a rule that Congress included in last year’s Jumpstart Our Business Startups Act, a law meant to help bolster small businesses and create jobs after the financial crisis.
The move allows start-ups and small businesses to use advertising to raise money through private offerings. Hedge funds and buyout firms, whose investment vehicles fall under regulations for private offerings, will also be able to promote their products to the general public, though restrictions remain on who can invest in them.
Some regulators, lawmakers and consumer protection groups faulted the S.E.C.’s decision. Luis A. Aguilar, the lone dissenter among the S.E.C.’s five commissioners, called the adoption of the rule reckless. He said it was being approved without appropriate investor safeguards and worried that it would lead to abuse. “The record is clear that general solicitation will make fraud easier by allowing fraudsters to cast a wider net for victims,” Mr. Aguilar said.
Senator Carl M. Levin, the Michigan Democrat who has pushed for greater regulation of Wall Street, criticized the rule and the S.E.C.’s new chairwoman, Mary Jo White. “Proceeding today with this flawed rule will ultimately damage the investing public and investor confidence in U.S. markets,” Mr. Levin said in a statement. “I am disappointed that Mary Jo White, who knows what it’s like to combat financial fraud, let this rule go with so few investor protections.”
Proponents of the rule argue that there still are substantial limits on who can invest in these private offerings. Those who qualify — called “accredited investors” — must have a net worth of at least $1 million, excluding their primary residence, or annual income of more than $200,000 in each of the previous two years.
Yet, opponents contend that there are lax safeguards for verifying that investors are accredited. The regulation dictates that the company or fund raising money have a reasonable basis to conclude that the investor is qualified and includes various verification methods, including reviewing tax returns.
Several state securities regulators also denounced the rule. The Arkansas securities commissioner, A. Heath Abshure, said that the S.E.C., in allowing small, speculative companies and high-risk hedge funds to raise money through public advertising, had failed to ensure the integrity of the market. “You can’t just open the door of a new way of offering securities without ensuring the integrity of the market,” Mr. Abshure said. “And the idea that the accredited investor is a sophisticated investor is ridiculous.”
As part of its effort to guard against potential abuse, the S.E.C. also voted on Wednesday to bar felons and other “bad actors” convicted of securities fraud from raising money through private offerings.
Supporters of the rule said that it helps bring securities regulations in line with modern financial markets. The advertising ban on private offerings was adopted in 1933 as part of a series of investor protection laws enacted during the Great Depression. Today, hedge funds, private equity and private offerings, once exclusively the domain of large pension funds and wealthy families; have become far more accessible and visible to the investing public.
“There is a larger and deeper investor base, a bigger and more diverse pool of issuers, and a proliferation of technologies that allow information to be conveyed across the globe nearly instantaneously,” said Matthew E. Kaplan, a partner at the law firm Debevoise & Plimpton. “Those factors underpinned the general consensus that it was time to consider updating rules that many viewed as being a bit long in the tooth.”
Hedge fund managers were once small, niche players in the financial markets and rarely sought publicity. Today, many of them grant interview requests, make frequent television appearances and lecture at conferences. Some large ones, like Och-Ziff Capital Management, are publicly traded companies.
Similarly, several of the world’s largest private equity firms, including the Blackstone Group and Kohlberg Kravis Roberts, are publicly traded on the New York Stock Exchange. Even investing in privately held companies has become more accessible to the public. In recent years, so-called secondary exchanges like Second Market have developed on which trading in private company’s takes place. And small companies are looking to raise money through social media and other technology.
Though they get far less publicity than splashy initial public offerings, private placements play a prominent role in the financial markets. The amount of money raised through private offerings in 2011 was about $900 billion, compared with about $1.2 trillion in public stock offerings and debt deals.
The ban on advertising will officially end sometime later this year, after a 60-day waiting period. The rule will require hedge funds and companies that use general advertising to notify the S.E.C. 15 days before the solicitation begins.
But most hedge fund and private equity lawyers said that they did not expect the airwaves to be filled with hedge fund ads promoting their superior risk-adjusted returns. Because only about 7 percent — or 7.6 million households — are accredited investors, mass advertising through television or magazines makes little economic sense for most funds.
“It’s likely that the new rules will take some time to pick up much momentum, and that there will only be a handful of pioneer-types at first who will look to dip their toes in the advertising waters,” said Steven B. Nadel, a lawyer at Seward & Kissel.
Elisse B. Walter, an S.E.C. commissioner who voted to eliminate the advertising ban, noted that the agency must continue to be vigilant in monitoring whether the looser regulations and increased advertising put investors at greater risk.
“It’s important that investors have confidence that the market for private investments has not turned into the Wild West,” she said.
S.E.C. Lifts Advertising Ban on Private Investments