By Nick Lawler
In anticipation of the SEC’s final rulemaking on the JOBS Act, the hedge fund industry is preparing for what are expected to be landmark changes. With the elimination of the prohibition against general solicitation and advertising, hedge funds will now have the ability to openly communicate with investors and the broader public. But to what extent will these changes affect the way hedge funds currently do business? And who will these changes benefit?
The industry seems to have taken a wait-and-see approach since the President signed the Act into law in April. As expected by many, the SEC has shuffled its feet, missing the original ninety day deadline to finalize the rules, followed by an additional announcement that it would be accepting public comments for thirty days. During this time, we have yet to see Bridgewater Associates billboards in Times Square, or AQR Capital ads splashed on the back page of The Wall Street Journal, and still no D. E. Shaw Stadium, but will we ever? It is our belief that the titans of the industry won’t be changing their strategy any time soon; however new rules will create a huge opportunity for smaller funds to distinguish themselves from competitors by communicating more broadly.
Before diving into the benefits that the JOBS Act can provide smaller hedge funds, it is important to understand the issues raised by the Act’s supporters and the dissenters. On one side you have hedge fund industry groups, the HFA (Hedge Fund Association), MFA (Managed Funds Association), and AIMA (Alternative Investment Management Association), which adamantly support the elimination of the 80-year-old prohibition on advertising established by the Securities Act of 1933. Their overarching belief is that this will open the door for the industry to achieve greater understanding and transparency through increased communication.
On the other side, the investor protection agencies (Public Citizen, ProPublica, and Consumer Federation of America, etc.) take more of a glass half-empty view that by eliminating regulation, investors will be at greater risk of being defrauded. The rational response: investor fraud is nothing new. A money manager who is determined to break the law is more than likely going to find a way to do so. The Madoffs of the world will always be out there.
Like all issues, there is not a black and white solution. There has to be a middle ground between the hedge fund trade groups supporting an “open kimono” approach and the investor protection agencies screaming “investors are doomed.” The SEC must lay out a set of rules that eliminates the gray area in the law that many have cited as a detriment to funds over the years. By simply approving the proposed rules as is, after reviewing public comments, the SEC would have essentially delayed the process multiple times without truly benefitting anyone.
Hedge fund industry advocates have asked the SEC to provide further clarity on what firms must do to remain in compliance. In a letter to the SEC dated September 13, the HFA recommended that the SEC adopt a definitive “safe harbor” standard to help funds manage the process of verifying an investor’s accreditation. Others in the industry have suggested further guidance on how hedge funds report performance numbers. Should there be a benchmark or specific method for calculating historical returns? How will investors know what to believe in advertisements? Will the SEC restrict where funds can advertise?
In order for hedge funds to benefit from the JOBS Act they must know what they can and cannot do. Not only will this encourage funds to act, but it will also become the standard for what investors will come to expect. Mystique and secrecy are no longer an allure in the financial industry. Instead, investors want a proven investment strategy with historical returns, increased transparency and access to fund managers. Many of the large hedge funds understand this shift and that is why the institutional money continues to pile up for these managers. It is harder than ever for small hedge funds to attract institutional money, so many have continued to focus on high-net worth individuals and family offices, while trying to break through the institutional barrier.
The passage of the JOBS Act presents a new market opportunity for smaller funds to explore different avenues to get in front of accredited investors through targeted communications. While many of the large funds may be content with keeping the status quo, small hedge funds need to take advantage of the new rules and take a strategic approach to communications. In an industry where even the slightest advantage is cherished, every millisecond and opportunity matters.
In the post-JOBS Act world, small hedge funds should consider taking the following steps to reach investors and the broader public:
- Increase communication with the media – Funds should educate reporters through background meetings and by providing additional details on strategies, funds, and historical performance. The new rules will allow funds to proactively reach out to a broader audience and effectively increase transparency. In addition, funds should also continue to reactively manage false information and negative perceptions spread through the media.
- Participate in thought leadership conferences and investor events – Many managers have been hesitant to speak openly at thought leadership events because of the gray area in the law. If the SEC promulgates rules that ensure investors are accredited through a safe harbor, then managers and funds will feel a level of comfort and be more willing to speak at industry conferences, which will benefit the investment industry and the general public. Smaller funds will also benefit through an increased number of investor events that demonstrate the breadth and depth of senior management and potentially generate additional capital.
- Website development– The new rules should allow funds to move beyond the generic log-in pages and password protected websites that many firms currently have. Funds will finally be able to catch up with the times by building robust websites that will serve as an additional avenue to reach investors by highlighting firm objectives, senior management, investment strategies, funds’ performance, and news and events.
Will the benefits outweigh the negatives for the hedge fund industry as a whole? Only time will tell, but if small funds take the lead by increasing communications then investors should come to expect the same from large funds in due time. While the final rules have yet to be released, one thing is for certain, new regulations are forthcoming and small hedge funds need to embrace the changes and be prepared to take advantage of the new communications landscape.
Nick Lawler is an Account Supervisor at Intermarket Communications, a strategic communications and public relations agency that serves financial services firms.