SEC Lifts Advertising Ban on Securities Firms

Equity funds now able to engage in mass advertising

In just a few days, the ban that prevents private equity funds from marketing directly to the public will be lifted. A recent review by Michelle Park of Crain’s Cleveland Business examines what this might mean for various private equity and venture capital funds and their future customers.

SEC Lifts Advertising Ban

It’s a ban that has kept them tight-lipped for decades. But, thanks to a vote last month, hedge funds, private equity funds and other issuers of certain securities soon can advertise their fundraising efforts to the masses.

The ban lifts Sept. 23, 2013, and attorney Howard Bobrow expects some funds to jump into action that very day.

“Maybe not a commercial for a venture capital fund or a private equity fund, (but) I do think we will see webinars or things on the Internet that you could not have done before go live on that date as if a starting gun went off,” said Mr. Bobrow, a business and finance practice partner in the Cleveland office of the Taft law firm.

“There are people who are very interested in being first,” he said.

One of them is Charles Stack, CEO and founder of Cleveland startup business accelerator FlashStarts, Inc.

“I’ve been chipper since the 10th,” Mr. Stack said, referring to the July 10 vote by the Securities and Exchange Commission (SEC) to lift the prohibition against general solicitation and general advertising in certain offerings.

FlashStarts raises money to invest in the startups it incubates, and upon seeing the SEC’s decision moved the date of its “demo day”—at which ten startups will make presentations about their products and businesses—to September 23 from August 27. That way, Mr. Stack said, FlashStarts can expand the audience of customers and investors to whom its startups can make their pitches.

Companies seeking to raise money through the sale of securities have had two choices: register their offerings with the SEC, or rely on an exemption from registration. Most exemptions prohibit companies from engaging in general solicitation or general advertising related to their offerings.

That prohibition has meant those raising money in an unregistered offering have had to do business the “old-fashioned” way—asking someone to introduce you to someone he or she knows who might want to hear about your investment opportunity, said David St. Pierre, co-founder and president of real estate private equity firm Legacy Capital Partners in Lyndhurst.

Following a directive of the federal Jumpstart Our Business Startups Act, or the JOBS Act passed in April 2012, the SEC last month in a 4-1 vote eliminated the ban on promoting these investment opportunities.
From Mr. Stack’s perspective, it’s a positive change.

“It is going to be great for capitalism because it allows the money to flow as smoothly as information does today,” he said. “While money can be wired at the speed of light, getting investments in any way (other) than manually, in smoky rooms, was left behind. It’s as if the whole 20th century bypassed the fundraising industry. So now, it’s being brought into the present.”

Law Firms Show the Way

Many startup companies attempting to raise capital had pushed for this change, arguing the ban on general advertising impinged on their ability to access capital, Mr. Bobrow said.

He expects change to unfold in the way attorney advertising did following a 1977 U.S. Supreme Court case that made it legal for lawyers to advertise. Today, he said there’s “an onslaught of advertising by lawyers.”

“I think we are going to see things we have never seen before,” Mr. Bobrow said. “We’ll start out seeing buttoned-down and conservative advertisements, talking about performance, talking about traditional things you would see in a business plan or investor presentation. But then I think you will see things that are off the wall, that are funny; that are attention-grabbing.”

John M. Mueller, who founded his own private equity fund, Partners Private Equity LLC, earlier this year, seems to reflect what Mr. Bobrow expects early on. Mr. Mueller wrote in an email, “… A professional, understated advertising campaign could make sense to reach (investors) in our fundraising efforts.”

Still, not everyone accustomed to raising money privately expects to spread the word.

A spokesman with the region’s most prolific dealmaker, The Riverside Co., says the Cleveland private equity firm has no plans to advertise to the masses, in large part because its press releases and participation in industry conferences are aimed at finding investment opportunities, not investors.

“Our model is predicated on approaching large pension funds, endowments, funds of funds, in an effort to attract many millions of dollars,” Graham Hearns said. “[We’re] not necessarily looking to appeal to individual prospective investors who might be looking to commit a few thousand dollars.”

Riverside’s position doesn’t surprise Mr. Bobrow. He expects funds that raise their capital from high-net-worth individuals and wealthy families to advertise the most. He also predicts smaller, younger funds and established operating companies in need of cash to use advertising to cast a wider net.

That’s not to say Mr. Hearns doesn’t see any benefit in the ban’s end for Riverside, which raises funds ranging from $200 million to more than $1 billion.

“I think the lifting of the ban allows groups like Riverside and other private equity firms in Northeast Ohio and across the country to sleep a little bit easier at night,” he said. “We’ve always run the risk of one of our colleagues accidently saying something on some panel at some conference in some part of the world on the topic of fundraising that could jeopardize our entire fundraising cycle. The flexibility in the rules now allows us to take a deeper breath in participation at panels, in interactions with journalists.”

Those who violate the long-time prohibition on general solicitation and advertising face a range of penalties for doing so, according to Mr. Bobrow. They include a mandatory suspension of fundraising, losing the exemption that allows the raising of a fund that’s unregistered with the SEC (which effectively terminates the fundraising), and civil and criminal penalties.

Minuses with the Pluses

Though there are potential benefits to general advertising by private equity and hedge funds, there also are risks and limitations, local fund managers and advisers say.  One is accepting so-called “hot money” from investors who are chasing the performance a firm may have advertised but who might remove their money if it doesn’t happen.  Another downside is exposing to too many eyes the strategies that differentiate a fund.

“It’s not like you want to be out there barking at the moon what your secret is,” said John Micklitsch, senior vice president and director of the private client group of Ancora Advisors LLC, a Beachwood registered investment adviser with more than $150 million under management in three hedge funds.

“When you find these inefficiencies that you are successfully exploiting … to the benefit of your investors, it’s not as though you want to broadcast what those inefficiencies are to the general public so that others can replicate what you’re doing and, over time, remove those inefficiencies from the market,” Mr. Micklitsch said.

Fund managers say general advertising also opens the possibility that less sophisticated investors will end up investing in opportunities that are far more risky and illiquid than they knew.

“Who verifies them (investors)? It’s the managers’ job to verify them,” said Wade Massad, co-managing partner of Cleveland Capital Management, a hedge fund in Rocky River. “You could see less sophisticated investors getting information on the web or through advertising that may be from funds or guys who are raising capital who have very speculative investments.”

For its part, Cleveland Capital Management, after September 23, plans to augment the information on its website, which offers little more than contact information now, Mr. Massad said. He expects to provide a more detailed description of the firm’s investment process and investment examples.

Shouts from the Valley

The lifting of the ban on general solicitation and advertising does not affect other securities laws. Those who want to conduct offerings without the use of general solicitation and advertising may continue to do so and are not subject to a new rule to take “reasonable” steps to verify that investors are accredited investors, or those with a certain net worth or income.

That verification requirement has riled the Angel Capital Association, which argued in a July 16 statement that it will result in many angel investors refusing to invest, hurting startups’ access to capital.

“Not a single angel [investor] I have spoken with is willing to provide personal financial information to an issuer who is asking them for investment,” said the organization’s executive director, Marianne Hudson. “This violation of privacy is untenable … This would be like having your bank demand to know your net worth before you could open a bank account to put money in, or the stock market demanding to know your net income before you can trade securities.”

The raised bar for verifying investors’ qualifications, Mr. Bobrow said, may drive a “whole new stand-alone industry.” FlashStarts’ Mr. Stack sure hopes so. One of the startups he’s incubating, Crowdentials, is in the business of certifying investors’ accredited status.

“We’re sitting pretty, with one of our companies that is perfectly poised to benefit from this change,” Mr. Stack said.

The ban’s end, advisers predict, will produce job opportunities.  This includes employment for branding experts, who might be hired to freshen logos and related materials before firms go to market.  It also benefits web developers, whom companies might hire to spruce up websites that, until now, stored most of their investment information behind firewalls.

Mr. Stack said he believes the ability to solicit and advertise generally is particularly significant for Ohio and Cleveland.

“It’s probably oddly much less significant to Silicon Valley than it is to Cuyahoga Valley,” Mr. Stack said. The capital flowing into this region, he said, “should increase dramatically as companies are able to solicit investment as far as they can shout.”

“There’s a lot of money in the world and a lot of great ideas, and this will dramatically encourage their ability to get together.”

Michelle Park is a writer/editor with Crain’s Cleveland Business,   www.crainscleveland.com.  You can reach Michelle at:  mpark@crain.com.

This article originally appeared on the Crain Cleveland Business website, August 23, 2013.