The Securities and Exchange Commission today approved an end to a long-standing rule that barred hedge funds and private investment groups from advertising to seek capital from the public. Here's what went mostly unnoticed: The SEC also missed an opportunity to protect smaller investors by updating who counts as rich.
The agency really had no choice about ending the rule after Congress last year passed the Jumpstart Our Business Startups Act, or JOBS Act, a law designed to make it easier for companies to raise capital, spur the economy and create jobs.
The 80-year-old ad ban placed limits on how certain funds could solicit money from the general public for "private placements" -- investment arrangements that are exempt from SEC registration rules and their accompanying financial disclosures. This market already is huge and will no doubt grow larger. As Bloomberg News reported, companies and funds raised $899 billion through private placements last year, almost four times more than they raised through registered sales of stock.
Because firms seeking money through private offerings can choose what information they disclose to investors, it shouldn't be a surprise that this market is where state securities regulators say they bring the most enforcement actions. The ad ban dated to the 1930s and was included in the nation's first securities laws for an obvious reason: Solicitations for private placements was an area of widespread abuse in the run-up to the stock-market crash of 1929.
Although the SEC had to end the ban, it didn't have to leave intact outdated standards outlining which investors would be allowed to put money into private placements. For individuals, such "accredited investors" are still defined as those with annual incomes of $200,000 ($300,000 for a couple) and a net worth of $1 million. To its credit, the agency two years ago decided to exclude a primary residence from the net worth calculation.
The idea is that accredited investors are sophisticated enough to make wise financial decisions and have the wherewithal to be able to withstand losses.
This would be fine if these figures had any relationship to someone's investment savvy or ability to absorb a major loss. But they don't, at least not anymore.
Here's why. Those thresholds were set in 1982, when $200,000 was worth a lot more than it is today. Thanks to inflation, you would need to make almost $500,000 a year to have the same standard of living.
Because the SEC chose not to update its accredited-investor benchmarks, the potential market for private placements is as much as 20 times larger than it was three decades ago. So don't be surprised if hedges funds and their ilk raise a lot more money through private placements and create many more unhappy investors in the process.
(James Greiff is a member of Bloomberg View's editorial board. Follow him on Twitter.)