Private Equity Advertising
When I first began my career in online marketing and public relations, one of my first clients was a start-up private equity fund management company focusing investments in NNN leased real estate nationally. The challenge was to attract investors and to network in the industry without ever mentioning the fund or any aspect thereof. My focus was simply to establish presence and legitimacy for the infant fund management company online without any direct or even indirect marketing. While the fund is now thriving, the ban on advertising made it a difficult task to attract new investors in the beginning. However, a recent ruling by the SEC will change the marketing atmosphere of the industry.
A few days ago I had the opportunity to contribute my opinions in an article by Susan Lyon of NerdWallet.com about the recent ruling of the U.S. Securities and Exchange Commission (SEC) to change Rule 506 now allowing hedge funds and other alternative investments to publicly advertise. This ruling was part of its first actions in implementing the JOBS Act, passed in 2012.
A prohibition against advertising risky alternative-investments, those exempt from the requirement to make public financial statements, had been in place for 80 years, since the Great Depression, in an effort to protect small, potentially naïve investors. This restriction had not only applied to advertising, but also to any discussion or activity that could be interpreted as solicitation to raise money, such as talking about the content of an alternative investment fund, and how it was doing.
With the changes, officially called “Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 114A Offerings”, companies can now advertise for security offerings by any means – for example, on the internet – as long as the sales are made only to accredited investors.
Companies engaging in advertising will have to ensure that they are taking reasonable steps to make sure that buyers are indeed accredited investors, as they are presumably able to make educated decisions on risk. The SEC provides some guidance on what would be considered reasonable steps:
- Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
- Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
There are a variety of opinions on how this change will impact both start-ups and investors. Proponents of the change see it as an opportunity for start-ups to expand their network of investors through increasing the visibility of companies looking for capital. It should be easier for investment companies to direct wealthy clients to hedge funds, bringing in new cash. However, some are concerned that the process of taking the reasonable steps to ensure investors are accredited will result in additional burdensome work that new companies may have difficult complying with, and that the steps themselves are guidance only, leaving room for possible misinterpretation and potential enforcement issues with the SEC.
Perhaps the biggest concern is how vulnerable investors will be to solicitation and advertising in general. Will those who don’t qualify as accredited investors be bombarded with ads for funds they can never invest in? Will potential investors take on increasing risk without the protections previously provided? SEC Commissioner Luis Aguilar dissented on the decision to lift the advertising ban, arguing that it would “come at the expense of investors and place investors at greater risk.” With the greater use of online media, reaching a larger group of unsophisticated potential investors could bring problems. Jennifer Openshaw, president of Finect, an online network for the financial industry, said the SEC’s lifting of the advertising restriction should be followed by strong investor protections.
I personally feel the ability to advertise will be a welcomed improvement to the private equity community. Allowing these funds to compete with fewer impediments is in the best interest of our country’s economy. Investors must remain diligent when deciding where to invest, however they may now have exposure to many more options than they ever had before.