Free Speech Trumps SEC Advertising Ban
Wednesday was finally the day that the Securities and Exchange Commission — one year and three months after it was instructed to do so by the bipartisan Jumpstart Our Business Startups (JOBS) Act signed by President Obama — lifted the ban on advertising and communication to and from hedge funds and the private equity and venture capital community.
Lifting these archaic rules is a victory for entrepreneurs, all types of investors, and, most importantly, the First Amendment.
The SEC’s decades-old ban on “general solicitation” by vehicles serving wealthy “accredited investors” was wrong at the time, but is positively archaic today in the face of instant communication through the Internet and social networks. It is also paternalistic and anti-egalitarian.
Under this ban and state variants, the “99 percent” of Americans not wealthy enough to invest in a hedge fund or in venture capital were prevented from obtaining basic information about how these alternative investments work.
Similarly, budding entrepreneurs wishing to sell ideas to wealthy investors had to conduct whisper campaigns to find them to satisfy the SEC’ and state edicts that no ordinary investor hear this pitch — the rationale being that ordinary investing schlubs might so tempted that they would fudge their net worth to invest.
Allowing advertising and communication does not change the rules as to who can invest in hedge fund and venture capital. A series of policies, such as Regulation D, exempt securities offerings from many provisions of laws such as Sarbanes-Oxley and Dodd-Frank provided that only “accredited investors” — defined by the SEC as those with assets of more than $1 million (not including primary residence) or income exceeding $200,000 a year — participate in the offerings.
Whether the definition of “accredited investors” should be loosened so that more middle-class folks willing to take these risks should be able to, or whether we need much of the red tape of Dodd-Frank and Sarbanes-Oxley at all, is another debate that CEI vigorously participates in. But what is settled First Amendment law is that a government agency cannot ban advertising or communication about a product to the public simply because some members of the public are ineligible to purchase it.
As my Competitive Enterprise Institute colleague Hans Bader, our counsel for special projects, has written:
Thanks to the First Amendment, you can advertise a prescription drug even though most people don’t have a prescription for it, as the Supreme Court ruled in 1976. You can advertise liquor and guns, even if minors can’t buy them, and gambling. The First Amendment has been held by the courts to protect advertising of all these things.
Bader, along with scholars at the Cato Institute, had written an amicus brief last year on behalf of me and three financial writers that argued that a Massachusetts rule similar to the SEC ban limited our access to gain truthful information about hedge funds and venture capital for our research purposes.
Although the U.S. Supreme Court passed on taking the case — as it does with most petitions for cases it receives — it is almost certain the Court would eventually have thrown out this rule had the SEC not done it first. The hedge fund challenging this rule, Phillip Goldstein’s Bulldog Investors, was represented by the venerable Harvard Law academic Laurence Tribe, a principled liberal defender of the First Amendment.
The irony is that hedge funds and private equity firms are accused of not being transparent, but much of this is due to the government’s own rules that force them to keep mum. Now that they will be free to communicate to the public, ordinary investors and financial researchers will gain from their insights, which are often very valuable because they’re against the grain.
It was hedge fund managers such as Michael Bury, Charles Ledley, and James Mai, now celebrated by journalist Michael Lewis in the bestselling "The Big Short," who bet successfully against housing during the bubble.
Perhaps if the general solicitation ban hadn’t restricted their communication, more of the general public would have heard their insights and been able to better protect themselves from the crash to come.
All kinds of scary scenarios have been bandied about if hedge funds, venture capitalists, and others affected are suddenly allowed to speak freely. This was reportedly a factor in former SEC chairman Mary Schapiro’s delay of the rule way past Congress’ deadline, because she didn’t want to be tarnished with an “anti-investor legacy.” But she now has such a legacy precisely because she listened to scaremongers instead of advocates of economic freedom and the First Amendment.
The SEC still has all the authority it ever had to go after fraudulent and misleading speech in selling securities. And it should be noted that the general solicitation ban did nothing to prevent Bernie Madoff from peddling his fraudulent scam to “qualified” individual and institutional investors. With barriers to general communication lifted, there will be fewer shadows where fraudsters like Madoff can hide.
By making the lifting of this archaic ban one of her first priorities upon confirmation, new SEC chairman Mary Jo White — in at least one realm of securities regulation — has a pro-investor legacy that her predecessor will always lack.