In a victor for Wall Street and a setback for investors, the Securities and Exchange Commission last week lifted an 80-year-old ban on advertising private-placement securities. Hedge funds, private-equity firms — and perhaps most dangerous of all, startup companies — now will be free to run advertising on television, the Internet, magazines and wherever else they wish, to attract new investors.
Free to run amok is more like it.
To be fair, the SEC had to lift the ban. Congress mandated it under the Jumpstart Our Business Startups Act.
At the same time, however, the SEC could have done much more to ensure that by allowing private placements to be advertised, it isn't inadvertently placing investors in harm's way.
In fact, at the same meeting where the advertising prohibition was repealed, SEC Chairman Mary Jo White introduced a separate regulatory proposal that would tighten the rules surrounding private-placement advertising.
Her proposal would bar felons from pitching certain private-placement deals. It would also require anyone advertising these investments to file a Form D 15 days before the offering instead of 15 days after.
It also would require issuers to increase the information that they would have to disclose, including a website address, background on the securities being offered, types of investors participating and the planned use of the proceeds from the offering.
Although we don't doubt Ms. White's sincerity, her proposal is problematic for at least two reasons.
First, there is no assurance that the other SEC members will go along with her proposal. In fact, two have already voiced objections.
Second, even if the proposal passes, it doesn't go far enough.
For example, it does nothing in terms of updating or amending the definition of an accredited investor. That is important because though these private placements can be advertised anywhere, only accredited investors can invest in them.
Right now, the SEC defines an accredited investor as one with an annual income of at least $200,000 or a net worth of $1 million, not including the value of his or her residence. This definition is woefully out-of-date and could include legions of retirees and pre-retirees who would be putting a lifetime of savings at risk if they were to bite at one of these advertisements for a private placement.
The SEC claims that under the Dodd-Frank financial reform law, it is precluded from increasing the income and net-worth guidelines for an accredited investor until next year. Fair enough, but how about amending the definition to address what is really critical: ascertaining that the investor has the financial sophistication to analyze the risks in private offerings?
And make no mistake about it — many private placements are inherently risky.
Just this past week, InvestmentNews reported that former baseball Major Leaguer and five-time all-star Mike Sweeney is suing his former broker and brokerage firm for putting $6.85 million of his money into 11 private-equity investments. Mr. Sweeney subsequently suffered losses of $4.9 million.
ACCREDITED BUT UNWARY
Under the SEC's definition, the former first baseman for the Kansas City Royals certainly was an accredited investor. But his lawyer claims that Mr. Sweeney was an unsophisticated investor who previously had nearly three-quarters of his holdings in municipal bonds.
No one knows for sure how intense the advertising climate is likely to become for private placements. One sector that seems to be champing at the bit is the many fledgling entrepreneurs who are looking at last year's legislation as a way to finance their startup ventures, no matter how risky or half-baked.
Financial advisers are going to have to become much more vigilant to make sure that their clients aren't buying a marketing pitch hook, line and sinker, and investing huge sums, only to regret it later. Due diligence will become more important than ever.
Meanwhile, the SEC should do everything it can to protect investors in this area, including moving Ms. White's proposal to fruition and re-examining ways to beef up the definition of an accredited investor. Millions, if not billions, of investor dollars could be at stake.
