The Securities and Exchange Commission on Wednesday lifted a decades-old rule that banned hedge funds and other alternative investment managers from marketing their products directly to consumers.
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Now hedge fund and private equity titans such as SAC Capital and Blackstone Group (NYSE:BX) will be able to reach out to potential investors through the customary marketing venues of television, billboards, print ads and the Internet.
The rule change also affects venture capital firms, allowing them to broadly solicit potential investment targets.
The idea behind dropping the ban is twofold: to open up more investment choices to American consumers of a certain income, and to expand funding opportunities for small businesses and start-ups seeking seed money from investors.
The ban was kept in place for decades as a means of protecting unsophisticated investors from getting skinned by savvy and sometimes unscrupulous financial professionals. Wealthy investors seeking alternative investment sources had to reach out on their own to high-end firms, and usually became aware of such sources through word of mouth.
SEC Chairman Mary Jo White, who took over the regulatory agency in April, made lifting the marketing ban a priority in an effort to comply with rules mandated by the Jumpstart Our Business Startups Act, passed by Congress last year to create jobs and help businesses raise capital.
“As we fulfill our mission to facilitate capital formation and maintain fair and efficient markets, the Commission must always focus on strong investor protections,” White said in a statement Wednesday. “We want this new market and the private markets in general to thrive in a safe and efficient manner, and these rules we adopt and propose are designed to facilitate that objective.”
The move, approved by SEC commissioners in a 4-1 vote, has been compared to the Supreme Court ruling in the late 1970s that allowed attorneys to advertise their wares for the first time. Advertising by law firms exploded following that ruling.
Similar to that shift, while hedge funds and other types of alternative investments will soon have wide marketing access, the content of their advertisements will be heavily regulated to ensure the information provided is accurate.
One thing that won’t change is the current restrictions on who can invest in high-risk/high return hedge funds. Investors will still have to make at least $200,000 a year and have a net value of $1 million, not including the value of their home. And the burden will be on them to prove they can meet those thresholds.
Marketing strategist Mark Macias, owner of Macias PR in New York, said hedge funds have a lot of catching up to do if they plan on competing with widely advertised mutual funds, all of which have a well-established Internet presence.
Few hedge funds have websites, Macias explained, due to concerns they will violate existing regulations against marketing directly to consumers.
“The majority of them will have to start from scratch,” he said. “They’re at a complete disadvantage at day one because most have zero online presence.”
Macias said the first group of investors likely to be targeted by hedge funds are professionals who have seen their incomes jump dramatically in recent years – lawyers, doctors, dentists, for example, whose incomes have rapidly jumped from five figures to mid-six figures as their businesses have expanded.
The fear is that many of these newly wealthy investors may not be ready to play in the heady world of hedge funds, where the rewards are great but the risks often even greater.
“There’s going to have to be a higher level of sophistication for these types of investors,” said Macias.
Jennifer Openshaw, president of Finect, a social media network that connects financial professionals on prominent social media sites such as LinkedIn (NYSE:LNKD), Facebook (NASDAQ:FB) and Twitter, supports lifting the ban but believes there should be stronger consumer safeguards put in place to protect investors.
In order to become accredited, the term used to describe eligibility for investing in hedge funds, Openshaw said the thresholds should be lifted to a minimum income of $400,000 and a net worth of $2.5 million.
Openshaw sees two problems with investors’ newly acquired access to “the rich or old boys networks” once the marketing ban is lifted.
“First there’s the assumption that because you accumulated wealth you know how to manage it… Second, your mom or dad – perhaps very unsophisticated -- could easily fall under the accredited investor definition. Say they just sold their Florida home and now have $1 million. Does this mean they should be investing in these more complicated investments? And do they know how to make those decisions?” she said.
Openshaw said a solution to easing the complexities inherent to more sophisticated investment vehicles is creating a uniform disclosure process for investment firms similar to the information regarding interest rates, fees and total costs now available to consumers seeking mortgages, credit cards and student loans.
“Investors, too, are entitled to similar treatment with alternative investments so they can evaluate possible gains and losses in volatile markets with their eyes wide open,” she said.
The rule becomes effective 60 days after publication in the Federal Register and then will undergo a 60-day public comment period following its publication.