Advertising Private Investments
On Monday, another provision of the Jumpstart Our Business Startups (JOBS) Act will go into effect. Under rules promulgated by the SEC, all sorts of advisors will for the first time be able to advertise in order to raise private capital. This means that anyone trying raise capital to invest in private equity, real estate, or a hedge fund will be able solicit investors through mass solicitations. The new law does not expand the definition of eligible investors. They must still be accredited (have a large enough net worth), or with respect to a small group of potential investors, have the requisite experience.
The new rule will not have any appreciable impact on most of the funds raised by money managers, especially those connected to Wall Street. Most private capital is raised through relationships with endowments, family offices, retirement funds, wealthy Wall Street executives, and consultants. For example, Richard Schimel is launching a new hedge fund a mere nine months after shuttering Black Diamond, the fund caught up in insider trading. As Reuters explains, “Schimel has been making the rounds on Wall Street and beyond to raise money. . .” Mr. Schimel is following the well-worn fund raising path that works for the established part of the industry.
The law will enable all sorts of would-be money managers to solicit investment far beyond their circle of friends and business contacts. With mass solicitation as a marketing tool, the amount of fraud is going to rise. Simply type “investment fraud” into a Google news search and you’ll come up with an endless list of cases, and these are only the frauds that at some stage of regulatory review or part of a criminal case. These cases are mere kindling for the forest fire of fraud that will burn once mass solicitation is possible. The SEC, which processes private placement, already receives about 31,000 private filings (Regulation D) per year. The agency is going to be overwhelmed with filings.
In trying to get ahead of the advertising provision, the SEC has proposed changes to Regulation D. For example, the SEC will now require those filings to be made 15 days before a money manager begins to solicit instead of 15 days after the sale. The SEC will also require the manager to submit information about the offering and solicitation materials. Failure to comply with these requirements will result in a one-year ban on soliciting, and the SEC’s antifraud provision will apply to the advertising materials. The investment and business communities are strongly opposed to these new requirements.
It’s important to understand that the SEC is not a substantive regulator. The agency doesn’t opine on the soundness of an investment or the adequacy of the investment’s legal structure. Rather, it is in the business of speed bumps and sunshine. In other words, the SEC role is about process and disclosure. It can tell money managers what they have to file and what they have to reveal. And if something goes wrong, the SEC can bring a civil action. Of course, once a fraud occurs, the damage has been done, and investors typically don’t recover any money.
I agree with critics that the SEC’s additional filing requirements will be burdensome for some issuers. However, I don’t think the SEC has much choice. The agency lost about $100 million from its budget as a result of sequester and has a long list of regulations that it needs to promulgate as a result of Dodd-Frank. Thus, its ability to stand up for investors is already compromised. The SEC has to put in at least a few speed bumps if we’re to going to have any hope of reducing the huge wave of dubious investment schemes that will be spawned by the advertising rule.