SEC disclosure 

The SEC has very specific rules that limit what a company can say, either about itself or about the securities it’s selling, when it’s in the process of issuing stocks or bonds.

The securities of some companies aren’t subject to general SEC oversight,  either because the firms are tiny or the securities are being sold only to a small group of supposedly savvy buyers.  In such cases, the SEC rules have been, basically, that the firm can say nothing publicly.  In particular, the issuing company can’t solicit interest from the general public or advertise its offerings in ways the general public might see–like in newspapers or on the internet.

a rule change

That changed last year when Congress passed the JOBS (Jumpstart Our Business Startups) Act.  This legislation requires the SEC to take back the regulations that bar solicitation and advertising by issuers of non-regulated securities.  Mary Shapiro, former head of the SEC, decided this was a bad idea and didn’t comply.  The current chairman, Mary Jo White, has followed the Congressional directive and removed them.

Yes, Ms. White had no legal choice…

…but is this a good idea?

At first blush, it would seem that it isn’t.  After all, the consensus is that the JOBS Act, by eliminating the requirement for many issuers to offer audited financial statements to potential buyers, is an open invitation to fraud.

Washington is the same crew that repealed the Glass-Steagall Act in the late 1990s, allowing commercial banks to reenter businesses they helped cause the Great Depression with–and which they promptly used to help cause the Great Recession that we’re still digging ourselves out of.

In this case, the glaring issue is that there’s lots of evidence that significant numbers of hedge funds misstate in their marketing materials their investment performance, their professional qualifications and the size of their assets under management.  It doesn’t take a genius to guess what side of the ledger the misstatements fall on.  (Search PSI for my posts on hedge funds.  If you read one, maybe it should be about an NYU study.)

Why would hedge funds change their stripes when selling to a much wider group of individual investors.

accredited investors

Yes, issuers are supposed to sell the bulk of their offerings to “accredited” investors.  But that only means that buyers are supposed to have either:

–net worth of at least $1 million, excluding the value of a primary residence, or

–income of $200,000 in each of the past two years, with prospects of the same in the current year ($300,000 for couples).

That doesn’t mean they know anything about finance.

maybe it is

But there may be a method to the apparent madness.

Ms. White seems to be drawing a sharp distinction between the character of the buyer of a private offering (supposedly sophisticated parties, who are outside SEC purview) and the disclosure materials relating to it.

Because the offering documents have so far been disseminated only to qualified buyers, the SEC had no say over their accuracy. That was up to the buyer to judge.  Now, thanks to the JOBS Act, these materials can be disseminated to everybody, whether “accredited” or not.  The issuer subsequently screens potential buyers to ensure they meet the accreditation criteria before he allows them to purchase.

The SEC is asserting that the wider dissemination gives the agency jurisdiction over the accuracy of the materials.  It is preparing rules it intends to have issuers of private securities follow.

It may turn out that the JOBS Act has accidentally given the SEC another weapon in addition to prosecution for illegal insider trading in its fight to clean up the hedge fund industry.