The SEC recently adopted a rule that overturned an 80 year ban that will now allow hedge funds to advertise publicly, well kind of, for the first time. The rule, which passed by a 4-1 vote, came about because of initiatives from the Jumpstart Our Business Startups Act to be completed by the SEC.
Much fanfare has been made about how this will open the flood gates for fund raising from the masses. Some in the media have even suggested that we might start to hear hedge fund ads on the radio or see hedge fund billboards.
While the specifics of the rule change do provide more flexibility with regards to hedge fund advertising they do not completely remove them. Funds must still make efforts to verify that a person is an accredited investor. This is a bit of a paradox, because certain reports suggest that this will increase hedge fund marketing towards the retail market, but many in the retail market would not necessarily meet the accredited investor hurdle. Perhaps the theory is that those funds with lower minimums seeking wealthy individuals will be able to have success in raising capital via broader more traditional marketing efforts.
Continuing this line of thinking, many in the hedge fund community, at least those looking to raise capital or start new funds, likely welcome the rule change due to the increase in the flexibility in marketing it provides them. Their zeal may only be matched by the deluge of marketing and advertising professionals who are now seeing a new channel of potential business open up. However, the question must be asked as to whether this will have any real material effect on fund raising efforts?
For starters, many established large hedge funds may not want to pro-actively put themselves in the spotlight. Additionally, many hedge funds build their businesses around institutional capital. This can be from endowments and foundations, pension funds and sovereign funds and the like. While these types of institutional clients typically read the papers and may be subjected to advertising, they typically are first introduced to managers in a number of different ways that don’t necessary interact with the traditional type of advertising that the recent rule changes influence. One such method is via industry conferences – the recent rule doesn’t really effect this sector at all. Another method that used to be more popular but has perhaps waned slightly is the traditional capital introduction services – once again the rule has no comment on this.
Yet another common method used to locate hedge funds by these institutions are traditional investment consultants. These investment consulting firm’s typically assist institutions in crafting searches and locating managers which are attractive from an investment perspective. The hedge funds typically get on the consultants radar by reporting into industry performance databases, applying directly to be listed in consultant databases and through many of the traditional institutional industry channels such as industry conferences and events.
In the past, certain traditional investment consultants may have recommended hedge funds to large institutional investors making broad marketing claims related to the fund managers they recommend or the due diligence that the consultant themselves had performed on the fund manager. For an example of litigation surrounding these issues see South Cherry Street, LLC v. Hennessee Group LLC.
This is not to fault the investment consulting industry, which provides a valuable service to many institutional clients. Rather it is to highlight that the SEC is missing the boat with regards to taking the opportunity to establish effective due diligence and transparency standards around both hedge funds directly, and more appropriate to this discussion, those that promote and recommend hedge funds such as traditional investment consultants. Such regulations would likely be more impactful in influencing the largest hedge fund investor groups (i.e. – institutions) rather than the smaller retail marketplace.
The new SEC rule changes will likely result in smaller start up funds seeking to raise capital from the retail market. Inevitably some fraudsters will use these more lax restrictions to raise money through now more available retail channels, and catch those who are perhaps most vulnerable to fraud in the retail market, unaware. Perhaps these same individual investors would be better served, if the SEC focused instead on enhancing protections around the pension funds of those same individual investors via more stringent due diligence requirements, as opposed to just easing the restrictions on funds that attempt to market to them directly.