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SEC Hedge Fund Proposal to Solicit Average Investors, Possibly Benefitting Startups

Meyer Wilson

Hedge Funds Would Be Cleared to Solicit Average Investors Under SEC Proposal

Hedge funds may soon be able to solicit investments from average investors through wide advertising campaigns, if a new rule proposed by the SEC passes. The proposal, which comes out of The Jumpstart Our Business Startups Act, would lift the current ban on general solicitation for private offerings and allow firms to solicit investments via a variety of media, including TV, the Internet, radio, billboards, and telemarketer calls.

Though advocates for lifting the ban say it will expand funding options for start-ups, its overall effect (if passed) will be to decrease investor protections that help prevent unscrupulous marketing practices and investment fraud.

Under current rules, financial firms are only allowed to market non-publically traded securities to “accredited investors” with whom they have existing relationships. These rules were designed to protect everyday investors from marketing materials and sales pitches that promote exceptionally complicated and/or risky products, which the average investor may not understand.

“I recognize that there are very real concerns about the potential impact of lifting the ban on general solicitation,” said SEC Chairman Mary Schapiro. “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.”

Schapiro’s recommendation to lift the ban, however, goes against the warnings of the SEC’s own director of investor education and advocacy: “These offerings [private funds and hedge funds] are not for everyone and carry a very high degree of risk,” said the SEC’s Lori Schock, in a June speech. “For every successful venture, there are more numerous failed ventures.”

Unfortunately, she’s right.

Hedge funds and private offerings are risky and complicated.

They're also the number one investment products pushed by fraudsters and con artists. And, there's no expectation for that to change.

“This is a huge disappointment,” Barbara Roper, director of investor protection for the Washington-based Consumer Federation of America, told Bloomberg reporters. “It appears that none of the investor protections that we or others have advocated are included in this proposal … Unsophisticated investors will be inundated with offers of inappropriate investments sold through misleading advertisements. Fraud will surge in a market already ripe with problems.”

Let’s hope the public comment period changes the Commissioners’ minds.