Could Jobs Act Advertising Rules Make Securities Fraud Easier?
In an effort to create more jobs and boost the economy, the Jumpstart Our Business Startups Act (JOBS Act) was created to facilitate the funding of small business and start-ups by easing current securities regulations. Signed into law on April 5, 2012, by President Barack Obama, the JOBS Act is comprised of seven sections, or Titles, three of which went into effect immediately.
Two parts of the bill, Title II and Title III, have caused much debate among securities regulators and require significant changes As a securities attorney that represents investors in fraud claims, the significant change that concerns me is the lift on the 80-year old ban on advertising on private placements and hedge funds. I am all for job creation, but this lift could have disastrous effects on main street Americans.
Private placements and hedge funds are extremely complex and risky investments. The old rules were in place to limit the accessibility of these investments because, frankly, these investments are not appropriate for most investors. Lifting the ban on advertisements for these offerings will only increase the chances that unsophisticated investors will be lured into these products.
Under the old system, hedge funds and companies looking to raise money through a private placement were required to find investors by either working with qualified institutional investors or using a brokerage firm to help them find qualified investors. Although brokerage firms do fail to perform the appropriate due diligence on some offerings, including them in the process is vital to protecting investors from fraudulent offerings (particularly since hedge funds and private placements are an area that is not stringently regulated by the SEC). The lack of regulatory oversight on private placements and hedge funds was one of the main reasons why advertising was banned for these investments in the first place.
The new rules, however, will make it easier for fraudsters to directly solicit investments in hedge fund and private placement from potentially unqualified investors without that extra layer of protection that brokerage firms provided.
Brokerage firms and financial advisors have fiduciary duties to their clients to perform meaningful due diligence on any offering they recommend and to ensure that any recommendation made is appropriate in light of the client’s age, income, net worth, investment experience and investment objectives. Hedge funds and the companies raising money via private placements will not have a similar fiduciary relationship to those with whom they attempt to solicit and will not be required to make sure that investing in the particular offering is suitable in light of the investor’s age, investment experience, investment objective, and net worth.
If hedge funds and companies seeking to raise money via a private placement offering can advertise to raise funds, the only remaining restriction on who can invest appears to be Rule 506 which requires that an investor in these types of investments be an “accredited investor.” An individual is considered “accredited” if their net worth is greater than $1 million or if their yearly income exceeds $200,000. Not only is this bar not as high as when it was first implemented, but just because an investor may qualify as an accredited investor does not mean that a particular investment is suitable for that person or that the investor understands the risks and complexities of a particular investment.
My firm has represented countless “accredited investors” who had little understanding of what a private placement is or how risky and complex these types of investments truly are. Since accreditation is merely a measure of wealth and income, it should be apparent that accredited and sophisticated are not synonymous. Many people inherit money or stumble in to wealth that belies their particular sophistication.
The old rules were meant to protect those investors who were not sophisticated enough to protect themselves by requiring a brokerage firm to properly vet these investments and make suitability determinations. Without these restrictions, I am afraid it is open season on accredited but unsophisticated investors. It is apparent that the drafters of the JOBS Act sought to eliminate certain of the barriers to easier job creation, but at what cost? The main jobs this change will likely result in is in the field of securities law, because it is going to take a lot of attorneys to clean up the number of messes that the lifting on the advertisement ban will undoubtedly create.
D. Daxton White is the managing partner of The White Law Group, LLC, a national securities fraud, securities arbitration, and investor protection law firm. He has represented investors in virtually every U.S state and litigated over 500 FINRA arbitration claims. Find out more about White at www.WhiteSecuritiesLaw.com. He tweets at @SecuritiesAtty and can be found on Facebook here.
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