On July 10th, the U.S. Securities and Exchange Commission (SEC) voted to lift the ban on solicitation for hedge funds and other accredited investor financial services. To some industry and advising professionals, this was a terrible idea that opens the door to fraud and other financial swindling (the SEC’s current commissioner is of this opinion). In contrast to these paternalistic individuals, others viewed the SEC vote as a move in the right direction, allowing more investment to flow towards profitable investments (putting aside the whole freedom from government regulation issue).
The question here is: how will the elimination of the general solicitation ban affect the nature of the hedge fund industry and the economy at large? Among the many potential benefits and challenges now before the hedge fund industry, here are three.
The first is that competitors within the hedge fund industry must now compete with each other in the semi-marketing arena, in addition to the traditional word-of-mouth and referral networks. This is already happening in a way, but not in the manner in which it will occur now. Even though the situations are generally different, hedge fund industry executives will likely be stealing some marketing professionals from some big mutual fund companies in order to compete with each other for the accredited investors’ business.
The second is challenge is that, presuming a greater amount of cash inflow, the industry may become even more like the mutual fund industry, and thereby lose some of its appeal to the accredited investor. This isn’t just theory. Accredited investors are looking for alternatives to the low cost options they already have, and if hedge funds, in general, become less different, the accredited investor may move his money to a lower cost alternative. Interestingly, up until now it has been the mutual fund industry trying to mimic the hedge fund industry, using such strategies as the well-known “hedged mutual fund” or employing futures and forward contracts to minimize risk. With the recent SEC decision, the roles may end up being somewhat reversed. With this background in mind, it’s not a given that the answer to the encroachment from the mutual fund industry on what has traditionally been hedge fund territory is for the hedge fund industry to become more like the mutual fund industry. It could go the other way – only time will tell.
The third challenge is that the SEC decision didn’t actually reduce any regulatory burden, at least when it comes to form-filing and the like. Instead, the SEC, at least as of now (there’s a 60-day comment period on this), expanded the regulatory burden associated with Regulation D. Isn’t it interesting that, on the same day when many were cheering the decreased liability risk associated with the general solicitation ban, regulators found a way to increase the regulatory burden somewhere else?
Overall, the SEC’s incredibly slow implementation of the Jumpstart Our Business Startup Act is finally rolling. Depending upon how onerous the final rules connected with the lifting of the ban are, the recent changes could provide a much needed boost to many sectors of the financial industry, with the hedge fund industry a potentially big winner (in addition to the investors). The changes do pose some challenges as well, at least when it comes to marketing strategy, regulatory burden, and return maximization.