SEC commissioners voted 4-1 to invite public comment on a proposal for how to end decades of restrictions on the pursuit of investors by private funds and startups. The proposal is driven by a law that repealed a ban on pitching such investments to all but a select few investors, such as those accustomed to pumping cash into hedge funds.
“I recognize that there are very real concerns about the potential impact of lifting the ban on general solicitation,” SEC Chairman Mary Schapiro said before the vote. “While I believe it will be incredibly important for the commission to take a thorough look at the private placement market in the future, I think at this point it is appropriate that we undertake this more narrow mandate that Congress placed upon us.”
The Jumpstart Our Business Startups Act, signed into law by President Barack Obama in April, ended the ban as part of a wider effort to expand funding options for fledgling companies. The shift drew criticism from investor-protection groups and the mutual-fund industry, including the Washington-based Investment Company Institute, which have said that lifting the ban without restrictions may expose investors to misleading advertisements by some private funds.
“The greatest threat of all to investors and one that is expected to grow as a result of the JOBS Act involves private offerings,” Jack Herstein, president of the North American Securities Administrators Association, said in a conference call with reporters last week.
In the past, securities laws allowed firms to market non- publicly traded securities only to so-called accredited investors that they were familiar with, usually meaning frequent, wealthy investors. The solicitation rules were designed to protect retail investors from inappropriate risks.
Even as future offerings are marketed to the general public, the new rule would limit participants to those with more than $1 million in assets, excluding primary residences, or those earning more than $200,000 a year. The SEC’s proposal doesn’t include restrictions for how offers are advertised, nor does it establish a system for verifying accredited investors -- only that firms must take “reasonable steps” to check.
“These offerings are not for everyone and carry a very high degree of risk,” Lori Schock, the SEC’s director of investor education and advocacy, said in a June speech. “For every successful venture, there are more numerous failed ventures.”
Private offerings are the No. 1 fraud or scheme leading to enforcement actions and investigations, according to NASAA. The number of cases involving these types of investments jumped to 410 last year, according to preliminary data from the organization of state securities regulators. That’s a 60 percent increase from 2010.
The lift on the advertising ban will educate a broader group about the type of private offerings available, said Steven Nadel, a partner at the law firm of Seward & Kissel LLP in New York who specializes in hedge funds and other alternative investments.
“There’s plenty of wealthy Americans who may not be super sophisticated when it comes to investing in alternatives,” Nadel said in an interview before the meeting. “It will create more knowledge, more transparency, more understanding of the entire alternative industry.”
The SEC missed the law’s July implementation deadline, and the 30-day public comment period will delay new hedge-fund advertising practices even further.
“The 90-day deadline did not provide a realistic time frame for the drafting of a new rule, the preparation of an accompanying economic analysis, the proper review by the Commission, and an opportunity for public input,” John Nester, an SEC spokesman, said in a statement.