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SEC Votes 4-1 To Require All Hedge Funds To Advertise On Dealbreaker

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We don't make the law, folks, we just help you follow it. Comply with your regulatory requirements right here.

Or I guess you could read Dan Primack's summary of the SEC's vote to allow general solicitations for private placements, but don't take him too seriously when he says "Issuers do not need to generally solicit. They may continue to do business the old way, which many of the top-performing fund managers are likely to do." You may not be absolutely required to advertise on Dealbreaker, technically speaking, but sources at the SEC assure me that it's sort of an informal best-practices requirement. Certainly the safer course is to buy a banner ad today.

One thing about the new rules is that they're not really rules about hedge funds. At their core, they let people with cockamamie money-making schemes publicly advertise to raise money from "accredited investors" - rich people - without going through the bother of SEC registration and being a public company. One particular category of cockamamie money-making scheme is running an investment fund exempt from the requirements of the Investment Company Act of 1940, but there's an infinity of other schemes. The SEC's vote comes too late for Great Idea Corp., which has already filed to go public, but presumably the next entrepreneur with a Great Idea and a burning desire not to tell his investors what it is will avail himself of the new general solicitation rules.

Also though: people with legitimate businesses? One way to think of the JOBS Act is to start from the idea that there are two separate capital markets: one for everyone, populated with public companies and mutual funds, and one limited to rich people, populated with hedge funds, private companies, and other unregistered investment opportunities that are lightly regulated in exchange for only being able to raise money from accredited investors.

The purpose of the JOBS Act is largely to improve the liquidity and robustness of the rich-people market: whereas pre-JOBS Act private companies couldn't generally solicit for investments, and were limited to 500 shareholders, now they can advertise freely and have up to 2,000 investors without going public. Those investors still need to be rich, though not that rich,1 but that is not a huge limitation, because rich people have most of the money.

This is good for the issuers - hedge funds and private equity funds but also just private companies of all sorts - that populate the rich-people markets. Those markets are mostly nicer for issuers. You don't need, just for instance, to publicly disclose material events. Or file audited financials. Or comply with stock exchange listing requirements that tend to encourage "good governance" and shareholder rights and discourage founder control. If you're an investment company, you've got much more leeway to use leverage and derivatives than do public mutual funds. It's a better life.

The tradeoff is that these markets are relatively illiquid, making it harder to raise money. I mean, not that hard, if you're following certain established pathways - GS partner to hedge fund manager, say, or 19-year-old vowel-averse Stanford student to venture-capital-funded tech startup - but there's certainly a who-you-know element. And the public solicitation rules drastically reduce that. The rules, and also the ecosystem of service providers who want a piece of the new paradigm: accreditation providers, crowdfunding goofballs, and Nasdaq Private Market, which "will offer a complete, end-to-end solution that will enable a private company to control the marketplace for its shares."

The upshot is that private companies can now raise money in almost-public offerings, and be listed and traded on the almost-Nasdaq. Sure, you can only raise money from rich people, but again: where else would you want to raise money? In exchange for this minor limitation, you get out of all the public-market rules and vagaries that come with actual public offerings and actual stock exchange listings. So why go public?

Is all this good for the rich people who'll now be targeted with these general solicitations? A lot of people - including SEC commissioner Luis Aguilar, who voted against the new rules - worry that widespread investment solicitations by unregulated companies will lead to fraud and, sure.2 Rich people (and especially lower-tier not-all-that-rich accredited investors) probably will be offered more fraudulent investments post-JOBS Act. The tradeoff is that they might also be offered more good investments: that, over time, the two-track markets might develop in such a way that really good viable businesses would prefer to exist perpetually on the Nasdaq Private Market or equivalents, sacrificing the dubious prestige of public-company-ness for more regulatory and governance flexibility.

Which makes a certain intuitive sense: generally rich people get to buy nicer things than poor people, right? Why should it be different for investments?

Anyway, that's a possibility. No one seems to believe it about the specific category of hedge funds, though? Generally speaking, well established successful hedge funds can raise all the money they need, and more, without public solicitation. Many - not all! but enough! - less-established hedge funds, particularly the ones accumulating AUM, tend to share a business model, with that model being roughly speaking charging higher fees for worse performance than their public-market competitors.3 So providing mildly rich investors more opportunities to invest in those hedge funds will tend to be bad for those investors ...

... is what some uncharitable people would say. Those people don't read Dealbreaker, though. Which is why it's the perfect place to run your ads.

U.S. SEC lifts longtime advertising ban for hedge funds, others [Reuters]
Hedge funds can now advertise. What it really means. [Fortune]

1.The rules are here; the key ones include, for people, either $1mm of non-house net worth or $200K ($300K for married couples) of annual income.

2.Though also, like:

  • if you're soliciting someone to invest in your fraud, you're probably not that concerned with SEC rules anyway, and
  • if you're worried about being defrauded you can always, y'know, not invest in cockamamie private schemes.

3.Which is true of many of the better established ones too. Why this is is an interesting question. I present three data points:

If my children’s experience is in any way representative, lemonade stands are joyfully embraced by adults but they don’t teach entrepreneurship. My kids’ clientele didn’t act like typical customers: They didn’t compare the price and quality of my kids’ lemonade to the price and quality of the lemonade being sold by other kids a few blocks over. They didn’t haggle. ... In their eagerness to help my daughters learn about private enterprise, they ironically undermined that lesson. Capitalism isn’t sentimental. It doesn’t coddle entrepreneurs. More businesses fail than survive. People think of lemonade stands as representative of pure enterprise, but in enthusiastically supporting them, they deny the true nature of our consumer culture, which rests on both the ideal and reality of competition and ruthlessness.

Something else was going on with my daughters’ customers, too. The sight of small children selling cups of lemonade stirred some sweet emotion in every adult who gladly handed over their dollar bills, from the local dry cleaner to the father driving his daughter home from summer camp. I couldn’t help but think that the pleasure they took in my children’s experience reflected wistfulness for their own lost youth.

If you understand how wrong that is, you understand the entirety of modern capitalism. Also consider Wally Weitz.