The Securities and Exchange Commission is taking heat for a proposed rule that would allow issuers of private securities, such as hedge funds, to advertise their offerings and solicit the public.
The agency last week voted to put the proposal out for comment.
The controversial rule change is mandated under the Jumpstart Our Business Startups Act. Once enacted, the revised rule will affect private securities that are exempt from registration under SEC Rule 506 of Regulation D and sold only to accredited investors.
The Investment Company Institute, whose mutual fund members worry about competition from hedge funds, blasted the proposal immediately.
”We are keenly disappointed ... that the commission apparently has not included ... investor protection measures in the proposal, beyond those few specifically mandated by the JOBS Act,” ICI chief executive Paul Schott Stevens said in a statement.
“Misleading advertisements by private funds have the potential to confuse investors in funds of all types, he said.
HUGE MARKET TO BE TAPPED
The market in private securities is huge. Last year, more than $1 trillion was raised via private offerings, topping the $984 billion raked in by registered offerings, according to the SEC.
Todd Ganos, owner of Integrated Wealth Counsel LLC, which manages about $250 million in assets, doesn't see a problem with allowing hedge funds to advertise.
“We're not going to see ... a situation of prisoners running the prison” once hedge funds can advertise, he said.
“Reg D Rule 506 is only one of several regulations and rules that privately offered funds have to comply with,” Mr. Ganos said. For example, hedge funds that want to charge a performance fee must limit sales to investors whose net worth exceeds that specified under Rule 506, he said.
“The advertising I don't view as a negative,” said Lynne Kinney, a principal in the CKW Financial Group, which has about $700 million under management.
The accredited-investor standards provide safeguards, “and our clients are already aware of hedge funds,” so seeing more information about them shouldn't hurt, she said.
In fact, the major issue in the run-up to the SEC's action last week was what method issuers of private securities should use to verify that investors are accredited. Under Reg D, accredited investors must have a net worth of more than $1 million, or $200,000 in annual income ($300,000 if filing jointly with a spouse).
HONOR SYSTEM
Issuers want to continue using signed statements from investors attesting that they meet those standards. State securities regulators, who contend that relaxing Reg D standards would lead to more fraud, want the SEC to require further substantiation of financial status, such as tax and income records.
The commission chose to punt on proposing specific verification methods. Overly prescriptive methods “would be impractical and potentially ineffective,” it said in its rule release.
Instead, the SEC said, issuers should consider the type of purchaser and what they know about them, how the investor was solicited and the terms of the offering, such as minimum investment.
The SEC initially had planned to move directly to implement the rules last month. But Chairman Mary Schapiro backtracked on that idea after state regulators and investor groups complained about not having the normal 30-day comment period.
Still, the lack of specific verification procedures looks like a victory for the
hedge fund industry and other issuers.
“We are pleased with what seems like a practical approach by the SEC staff to verification — that is, the recognition that this may be a facts-and-circumstances-based approach,” said Anna Pinedo, a partner at Morrison & Foerster LLP, who works with issuers.
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