SEC Rule Regarding Hedge Fund Advertising Could Increase Investment Fraud

Investors may begin to see more advertisements for risky hedge funds and other private placement investments. The SEC has changed an 80-year-old rule that banned advertising for private securities offerings. While some technology entrepreneurs and venture capitalists have argued that the nearly century-old advertising ban stifled the ability of start-ups to raise money, opening the floodgates for private securities offering advertising could result in a significant rise in investment fraud cases.

Under the rule, private investments still can be sold only to "accredited investors," or those considered wealthy enough to withstand investment losses. The law defines accredited investors as having annual income of at least $200,000 or a net worth of at least $1 million excluding their primary residence. Unfortunately, even with these limitations, many brokers subject an unsuitably large percentage of accredited investors' total net worth to the risks of private placement investments. And permitting advertising to the general public likely will result in even more investors unwittingly buying investments that are too risky for them. Moreover, private placements often are subject to lower regulatory scrutiny and, therefore, are subject to a greater likelihood of fraud.

Given these increased risks associated with private placements, advertising (and ultimately selling) hedge funds and other private placements to the general public most likely will expose more and more investors to the massive investment losses that can happen with private placements. We recognize that laws and regulations must change with the times, but we just do not see how exposing more investors to massive investment risk is a good thing.

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