Ad proposal fuels debate on alternatives regulation

Alternative investments are getting hot. And the debate over their regulation is getting even hotter.

The Managed Funds Association in Washington this month is planning to ask the Securities and Exchange Commission to allow advertising for private-placement funds such as hedge funds, venture capital funds, private-equity funds and managed futures.

The association, which represents hedge funds and managed-futures marketers, has not formally filed a request, but the idea has set alarm bells ringing at the Investment Company Institute in Washington.

Restricted advertising is intended “to limit investors’ participation in hedge funds and other unregulated pools to highly sophisticated individuals,” says John Collins, a spokesman for the ICI, which represents mutual funds.

“We think that allowing hedge funds to advertise could be confusing to investors in general,” he adds.

Protection

The issue of regulation of alternative investments strikes a chord in the financial services industry, because few restrictions currently apply to alternative investments.

The concern is that investors can get burn by buying unregulated investments that are marketed and sold to an unwary public. Currently, the only real protection for investors is through restricted advertising, and income and asset screening.

“When you make a private offering, there are long-standing commission positions out there that you can’t do any advertising or engage in any kind of general solicitation,” according to Paul Roye, the current head of the SEC’s division of investment management.

The SEC also limits investor participation with its income and asset requirement. Investors must have $1 million in net worth and have earned $250,000 in each of the last two years ($200,000 if the investor is single).

However, those asset and income thresholds have remained the same for a decade and need review, says Mercer Bullard, founder and CEO of Fund Democracy LLC, a mutual fund shareholder advocacy group in Chevy Chase, Md.

A presidential working group appointed after the much publicized 1998 collapse of Greenwich, Conn., hedge fund Long-Term Capital Management LP found that more disclosure by hedge funds was needed. But so far, no regulatory proposal to that end has gained major support on Capitol Hill.

“At least to date, the [SEC] staff focus on alternative investments has not been one that is structural,” comments Mr. Roye’s predecessor, Barry Barbash.

The SEC is concentrating on ensuring that alternative investments such as hedge funds don’t violate existing regulations, says Mr. Barbash, now a partner in Washington with the New York law firm Shearman & Sterling.

Meanwhile, the mutual fund industry is on the offensive. ICI president Matthew Fink has said that he opposes “mass advertising of risky pools that are unsuitable for all average investors” and called for more disclosure by hedge funds.

Mr. Fink made the call in March at the Mutual Funds and Investment Management Conference in Palm Desert, Calif.

Patrick McCarty, general counsel to the MFA, says that it “does not want to market hedge funds to the retail masses,” adding that the ads would specify that the investments are restricted to accredited investors.

He says that the proposed “plain-vanilla” ads identify the issuer, give the type of offering, the minimum investment price, the investment strategy and contact details.

Mr. McCarty adds that the proposed ads have been endorsed by the North American Securities Administrators Association and 31 states.

The industry’s attempts to get advertising restrictions removed may be hampered by the fact that the SEC in recent months has brought a number cases accusing hedge fund managers of stealing from their funds.

But alternative investments have been relatively unscathed from a regulatory perspective in the wake of the Long-Term Capital debacle.

Private-placement funds have little regulation, except for general anti-fraud regulation. They are not required to register with the SEC or to disclose their portfolio contents.

They can engage in leverage and short-selling tactics, and can concentrate their portfolios.

Mr. Bullard says the alternative-investment area needs closer regulation to protect unwary investors.