WASHINGTON — For the first time, hedge funds will be allowed to advertise to the general public under a rule adopted Wednesday by federal regulators.
The Securities and Exchange Commission voted 4-1 to lift a decades-old ban that prevents hedge funds, private equity firms and other private investment managers from marketing their products to a wide audience.
Hedge funds are still allowed to sell securities only to an exclusive group of investors: those with a net worth of at least $1 million excluding their primary residence, or annual income of more than $200,000 (or over $300,000 with a spouse) in each of the two most recent years. About 7.4 percent of U.S. households have a net worth of $1 million or more.
The change, which takes effect in about 60 days, was mandated by legislation enacted last year. The law also makes it easier for small startup companies to raise capital without having to comply immediately with SEC reporting rules.
Hedge funds are investment pools that use complex trades to seek big returns. They command trillions of dollars in assets. The ban on general advertising has been in effect since 1933, during the Great Depression.
Companies and funds must verify that investors meet the financial requirements for the investments. And the SEC adopted a rule that bars convicted felons and individuals sanctioned by federal or state securities and banking regulators from participating in offerings.
Investor advocates have expressed concern that allowing hedge funds and similar investments to advertise could increase the potential for fraud.
It “will make fraud easier by allowing fraudsters to cast a wider net for victims,” Commissioner Luis Aguilar said at the meeting. He was the only commissioner to dissent.
To address the concerns, the SEC proposed to monitor the advertising and collect data on how it affects the market for private securities offerings.
On a 3-2 vote, the SEC advanced a separate rule that would require companies selling shares of hedge funds or other private investments to notify the agency 15 days before a sale and also after the sale is completed. Companies and funds also would have to provide detailed information about the types of investors who purchased the shares and how their financial qualifications were verified.
Republican Commissioners Troy Paredes and Daniel Gallagher voted against the proposal requiring advance notice of a sale and new information. The public has 60 days to comment on it. After that, the agency can take it up for a final vote.
The lifting of the advertising ban will weaken investor protections, said Sen. Carl Levin, D-Mich., who heads a Senate subcommittee that has investigated financial industry misconduct.
The SEC rule “puts essentially no effective limitations on the types or forms of advertising that can be used to promote high-risk investments, exposing unsuspecting investors to potentially misleading claims they will be unable to evaluate,” Levin said in a statement.
An association representing state securities regulators also said it was disappointed that the SEC allowed advertising to proceed before installing investor safeguards.
The head of SecondMarket, a private stock exchange on which shares of privately held companies are traded, called the SEC’s action “an important step forward in bringing today’s regulations into the 21st century.”
“After today, a much deeper, broader group of (qualified) investors will have the opportunity to hear about — and potentially invest in — private companies and funds,” said SecondMarket CEO Barry Silbert.