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Coming to a TV near you: Ads for hedge funds
Some pros and cons of this brave new world
 
The $2 trillion hedge fund industry could soon be a regular on your TV screen.
The $2 trillion hedge fund industry could soon be a regular on your TV screen. Shutterstock

In a couple weeks, the $2 trillion hedge fund industry will be allowed to advertise and market its products for the first time in 80 years, a change that's attracting a mixed bag of reactions.

The shift is part of Congress' Jumpstart Our Business Startups (JOBS) Act, a set of reforms primarily aimed at making it easier for small companies to raise money. However, the changes will also apply to private-equity funds and hedge funds, which are not usually known for being hard up for cash.

Hedge funds, aggressively managed funds that require enormous initial minimum investments, have since 1933 been barred not just from advertising, but from doing or saying anything publicly that could be construed as an attempt to raise money.

The new rules will loosen those restrictions, allowing hedge funds to use marketing tactics like mass mailings, cold calling, and television ads. However, hedge funds can still only accept money from "accredited" investors, meaning rich people who make $200,000 a year or more, or have a net worth of more than $1 million excluding a family home.

A few pros and cons of the new rules:

Pro: Advertising could demystify hedge funds
The rule that prevented hedge funds from talking in public arguably kept the entire industry shrouded in secrecy. "By allowing hedge funds and private-equity funds to benefit from the JOBS Act’s advertising provisions, the government will allow the funds to provide more information to would-be investors," says Timothy Spangler in The New Yorker.

These funds are often described as shadowy and secretive partly because of the ban on advertising, which prevented them from openly discussing their investment activities with the media and the public. Lawyers for these funds historically advised their clients that any decision to speak with journalists or publish information about their activities could be misconstrued by the S.E.C. and the courts as an illegal "general solicitation" for their funds.

By including hedge funds and private-equity funds as beneficiaries of the JOBS Act, Obama has signalled that you have less to fear from a vampire if you can actually see him. [The New Yorker]

Pro: Hedge funds can grease the wheels of capitalism
While some claim hedge funds are for suckers, others say attracting more money to the funds through advertising could boost market activity. "Hedge funds provide much needed liquidity to financial markets by actively buying and selling stocks and bonds, which gives would-be investors confidence that, when they eventually want to liquidate a holding, the prices and volumes in the market will permit them to do so," says Spangler. "Without that confidence, many investors would be reluctant to participate in I.P.O.s, for example."

Con: Vulnerable investors could be targeted
The most successful hedge funds are doing just fine without advertising. Which means the underperforming funds will probably make the most noise, attracting vulnerable investors, says Simon Johnson at Bloomberg Businessweek.

In September, the last month for which data are available, funds in the top 10 percent as measured by investment returns picked up an additional $10 billion to manage. The bottom 10 percent had an outflow of $6.4 billion.

It isn’t hard to see what lifting the ad ban might lead to: Underperformers will flog their funds on the airwaves, on websites, and in the pages of the financial press, aiming at unsophisticated investors eager to get the same fabulous returns as the Wall Street elite. [Bloomberg Businessweek]

Con: Frauds will be able to advertise alongside legitimate funds
By allowing hedge funds to market, Bernie Madoff-types might follow, which poses a huge risk to investors. Securities and Exchange Commissioner Luis Aguilar shared his dissent on the SEC website, saying:

[G]eneral solicitation provides fraudsters with key advantages over legitimate capital raisers: For one thing, the scam artist does not feel compelled to tell the truth — but can make the sales pitch as compelling as imagination permits. For another, unlike real investment funds and companies raising money for a legitimate purpose, the Ponzi-schemer only cares about raking in as much money as possible, and has an unlimited number of shares to sell. Thus, without common sense protections, general solicitation will prove be a great boon to the fraudster. Experience tells us that this will lead to economic disaster for many investors. [SEC]

 
Carmel Lobello is the business editor at TheWeek.com. Previously, she was an editor at DeathandTaxesMag.com.

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