July 22, 2013 Updated: July 22, 2013 at 4:05 pm
Coming this fall: advertisements pitching the opportunity to buy into hedge funds, private equity funds or early-stage companies.
The Securities and Exchange Commission lifted this month a Depression-era ban against private companies advertising the sale of securities that don't have to be registered with regulators. That rule had been put in place to protect investors because such securities are considered a riskier investment.
Many entrepreneurs and young companies hailed the regulatory move, which will allow them to raise capital by pitching private offerings through tweets, email, print ads or other outlets.
"It's fantastic," said Adam Lehman, president of Lotame, a data management company in Columbia, Md., that has raised several rounds of venture capital. The old rules, he said, "have been completely out of date and impractical."
But consumer advocates, and even some entrepreneurs, are concerned that some investors won't fully understand the risks of investing in these private offerings and get burned. Or worse, advocates warn, investors might fall for schemes by con artists posing as entrepreneurs.
Melanie Senter Lubin, Maryland's securities commissioner, warned that con artists may use the news of the SEC changes to immediately start advertising bogus securities to consumers.
Under the SEC rules, companies raising capital through ads can only sell securities to investors with a certain amount of assets or income, a sign that individuals are sophisticated enough to know what they are getting into - or at least can weather a loss.
The regulations are likely to take effect in September.
The SEC's move is the result of the Jumpstart Our Business Startups - or JOBS - Act, a bipartisan law passed last year aimed at loosening restrictions for businesses raising capital. The hope is that these companies will use the money to create jobs.
Eventually, the SEC is expected to issue regulations allowing even small investors to buy a stake in a private company through so-called crowdfunding. But for now, these latest SEC rules deal with only high-net-worth individuals.
Businesses will be able to advertise private offerings to the general public, although they are supposed to take "reasonable steps" to ensure that only "accredited" investors participate. Accredited investors must have a net worth of more than $1 million, excluding a primary residence; or an annual income of more than $200,000 if they're single and $300,000 if they've been married the past two years and expected to maintain that income level.
The new rules will level the playing field for investors, said Lotame's Lehman. Today, well-established institutional investors are in the loop about which private companies are raising money, he said. But accredited individual investors don't necessarily have access to that information.
"There are very few channels that you can get good information about private investment opportunities," Lehman said.
Lehman said this means of raising capital will likely be used by early-stage companies seeking their initial rounds of financing. "If we were starting the company again, it's absolutely something we would look at," he said.
Jason Hardebeck, executive director of the Greater Baltimore Technology Council, favors the new rules, saying young companies could attract investors who have been sitting on the sidelines.
But Hardebeck worries that many investors will be disappointed, not fully understanding the investments or how difficult it may be to resell them because they aren't sold on public markets. And once an investor is burned, he said, "you lose them forever."
Entrepreneurs and consumer advocates agree that being accredited doesn't guarantee individuals are sophisticated investors who understand the risks with young companies.
"Most startup companies fail. There is a reason they aren't public companies yet," said Barbara Roper, director of investor protection with the Consumer Federation of America. They don't meet the standards for a public company, including independent boards and audited financial statements, she said.
The new SEC rules offer some investor protections, but they don't go far enough, Roper said.
For instance, the SEC said that "bad actors" - including felons convicted of a crime involving the sale of securities - won't be able to participate in these securities offerings. But that's only if those disqualifying acts occur after the new rules take effect. If crimes or other prohibited acts happened earlier, the information only has to be disclosed to investors.
"Who writes a rule that weak?" Roper said. "It boggles the mind."