Industry unveils game plan: It wants to run tombstone ads

Hedge funds want to plant a tombstone – literally – on federal rules prohibiting them from advertising.

The Managed Funds Association says it will ask the Securities and Exchange Commission in the “next few weeks” to permit bare-bones “tombstone” ads in publications.

“We’re going to send a letter to the SEC that asks them to make some changes,” says Patrick McCarty, general counsel of the Washington-based trade group.

new details

If approved, the move will mark a radical advance in the marketing and sale of unregulated investments, which have soared in popularity following the stock market’s volatile decline last year.

Although the association in June expressed its intention to seek an end to the ban (InvestmentNews, June 11), this is the first time the details have been made public.

Needless to say, banks, investment advisers and mutual funds already are gunning for the proposal.

“Hedge funds are risky investments,” says Mark Hurley, chairman and chief executive officer of Undiscovered Managers LLC, a Dallas firm that manages $500 million in mutual funds and private accounts.

“These are not products that should be sold on a general solicitation basis,” he says.

The move also comes at a time when the SEC is warning pension funds to be wary about their increasing use of hedge funds.

Details, details

The spectrum of alternative investments includes managed futures, venture capital and other investments that do not have to be registered as securities with the SEC. The deals are typically packaged as limited partnerships.

Under the MFA’s proposal, the partnerships would be able to use tombstone ads limited to the name and location of the company, its investment objective, the minimum share price and how to get additional information.

No performance information would be included, and the ad would specify that the investment is open only to “accredited” investors – those with $200,000 in annual income and at least $1 million in investible assets.

As a trade-off for the privilege of advertising, Mr. McCarty says, his organization is willing to give up an exception in current regulations that allows participation by a maximum of 35 “retail” investors – people with less income.

Since retail investors would not be able to invest in the private placements, the offerings would not be public offerings, which must be registered with the SEC, Mr. McCarty argues.

“If you say it’s only available to a certain class of people, that doesn’t seem to be a public offering,” he says. “Who gets harmed by reading a tombstone?”

who benefits?

Ron Geffner, a member of New York law firm Sadis & Goldberg LLC, says the proposal “benefits the small- to mid-cap managers that do not have the shelf space to have assets directed to them by brokerage firms or other professionals.”

Mr. Geffner, a former SEC enforcement attorney who now works with many startup hedge funds, says it would also help investors find out about smaller hedge funds that are not well represented and require lower minimum investments than established hedge funds.

On the other hand, Mr. Geffner says “anyone who either has significant wealth or market savvy already is in contact with market managers and already has the pipelines established to come into contact with the small- to mid-tier managers.”

“This is really only bringing in investors who otherwise either did not have the sophistication or predisposed thought to investing in a hedge fund … You could be now attracting lesser-quality investors,” he warns.

Paul Roye, director of the SEC’s division of investment management, is less than enthusiastic about the rise of hedge funds as “the new craze in the pension world.”

In a July 17 speech in Santa Fe, N.M., Mr. Roye noted that hedge funds have grown by 13% annually over the last five years. The trend has pumped $400 billion into 6,000 hedge funds worldwide.

He noted that the money comes increasingly from pension funds driven to boost returns by the difficult market over the past year.

“High debt and secrecy have become parts of the hedge fund culture … This can make it easier for a hedge fund manager to engage in fraud.” He cited recent enforcement cases brought by the SEC against hedge funds.

Mr. Roye declined to comment on the Managed Fund Association’s planned request.

The mutual fund industry firmly opposes any type of advertising for hedge funds and other alternative investments, and wants more restrictions on them.

Investment advisers, who are increasingly interested in using hedge funds to boost sagging mutual fund performance, do not appear to be enthused about the idea either.

“This is a clever way to go to the end user to try to sell the fund itself. This is like me out advertising some prescription drug without a prescription,” says Mr. Hurley.

Private-placement issuers normally find high-net-worth clients by paying fees to big investment banking firms.