By Tim Husson, PhD
The Jumpstart Our Business Startups (JOBS) Act (PDF) that was enacted this past April was ostensibly designed to increase investment opportunities by relaxing certain regulatory requirements on small businesses. There are several excellent reviews of the provisions of the JOBS Act, which not surprisingly is a lengthy and impenetrable document, and there has been considerable debate between proponents, who argue that increased investment opportunities can help support new business ventures and create jobs, and critics, who worry that the reduced regulatory requirements may remove important investor protections.
The Wall Street Journal's Andrew Ackerman has called attention to one provision of the Act (section 201(a)) which repeals a ban on certain advertising for what are known as private placement investments. Private placements are usually equity interests in small companies or business ventures, and are loosely regulated by the SEC because their shares are not publicly traded or available to investors through brokers. Private placements can only be sold to wealthy ('accredited') investors, and until the JOBS Act, could not be 'generally solicited', meaning advertised publicly, according to section 230.502(c) of Title 17 of the Code of Federal Regulations.
The reason the ban on solicitations existed was because of the highly speculative nature of many private placement investments. For example, many private placements are oil and gas exploration projects that have limited probability of success. Other private placements are special purpose vehicles for highly complex derivatives transactions. Because private placements have effectively no regulatory requirements, their disclosures to investors can be insufficient, incomplete, or even misleading. Perhaps the most well known private placement investments are hedge funds, who may stand to benefit from being able to more widely solicit new investors.
At SLCG, we have seen numerous instances of misrepresented or unsuitable private placement investments, including hedge funds. As the JOBS Act will soon allow these firms to advertise publicly, we hope investors and their investment advisors realize that private placements are risky and speculative, and should only be considered with caution and proper due diligence. We feel that general solicitation of private placements is similar in many respects to advertising for prescription drugs--just because a particular drug has a flashy ad does not make it appropriate for all patients. Likewise, just because a private placement has an attractive marketing pitch does not make it appropriate for all investors.
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