SEC Votes In Favor Of Advertising For Hedge Funds, Startup Companies

Michael Teague  |

A major change to the way that hedge funds do business is coming down the pipe in about 60 days from now.

In a 4 to 1 vote, the Securities and Exchange Commission decided on Wednesday to lift the ban on hedge funds and other private equity firms advertising their investments to the general public. The change in regulation resulted from the Jumpstart Our Business Startups, or JOBS Act, legislation passed last year, and would also exempt fledgling companies from having to abide by the SEC’s rules on reporting.

The one dissenting voice among SEC commissioners, Luis Aguilar, cast his vote against the removal of the 80-year old prohibition due to concerns about the increased potential for fraud that many fear would be the result. In particular, Aguilar objected to the lack of consumer protections in the new rule that could result in less affluent investors becoming tricked into investments that they will ultimately be unable to afford.

Hedge funds are only allowed to sell securities to clients who meet strict standards. Individuals are required to have a net worth of over $1 million, or an annual income of over $200,000 in the two most recent years, which constitutes some 7 percent of the populace.

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But this first implementation of the JOBS Act legislation would also permit startups to access larger amounts of cash by making direct appeals to the public. While hedge funds have qualification requirements that are inherently prohibitive for the vast majority of Americans, there is a great deal of concern about the potential for fraud that could result from allowing advertising on the part of small, unknown companies.

Proponents of the change have portrayed the new rule as a means of “democratizing” investment, and have apparently taken comfort in the SEC’s promises to watch the effects of this type of advertising, and how it is being used by different actors.

The commission has said it would work out the details about regulating the process after taking public commentary into consideration, and to this end also voted 3-2 in favor of a proposal that will allow for the monitoring of both the advertisements, as well as the private offers that are received as a result. Companies who seek to raise capital via advertising will be required to file both before investments are accepted, as well as after they have been received, and felons as well as others convicted of violating securities laws will be barred from the process altogether.

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