S.E.C. Lifts Advertising Ban on Private Investments

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 a large swath of issuers raises 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 in the wake of 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 investment vehicles to the public. Restrictions remain on who can invest in hedge funds and private equity funds.

“This lifts the veil of secrecy with respect to private offerings while still maintaining limits on who can purchase them,” said Paul N. Roth, a lawyer at Schulte Roth & Zabel. “The new rules promote greater transparency, which is a good thing.”

Some regulators and consumer-protection groups disagree. 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 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.

Proponents of the rule argue that there are substantial limits on who can invest in these private offerings. Those who qualify â€" called “accredited investors” â€" 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.

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 have criticized the rule. On Wednesday, 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 of the eased restrictions, the S.E.C., led by its new chairwoman, Mary Jo White, also voted on Tuesday 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 historic investor-protection laws 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 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. Others, like Highbridge Capital Management funds, a unit of JPMorgan Chase, are arms of the big banks. The top players all have large compliance staffs and legal teams.

Similarly, private equity firms are no longer a small group of swashbuckling deal makers striking audacious takeovers using gobs of debt. Now, the world’s largest firms â€" the Blackstone Group, the Carlyle Group, Kohlberg Kravis Roberts and Apollo Global Management â€" are publicly traded on the New York Stock Exchange.

Even private placements, which are investments in privately held companies, have become more accessible to the public. In recent years, so-called secondary exchanges have developed on which trading in private companies takes place. Facebook was heavily traded in the private market before selling stock to the public last year. Today, shares of closely held social media companies like Twitter and SurveyMonkey change hands in online exchanges like SecondMarket. And small companies are looking to raise money through social media and other technology.

Though they garner far less publicity than splashy initial public offerings, private placements play as prominent a 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 some time 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 solicitations 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 roughly 7 percent â€" or 7.6 million households â€" are accredited investors, mass advertising through television or magazine 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.

Elise Walter, an S.E.C. commissioner who voted to eliminate the advertising ban, noted that the agency must still remain 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.