8/29/12

Let the Scams Begin – SEC’s Proposed Rule on Private Offerings Encourages Risky Financial Industry Practices

Statement of Bartlett Naylor, Financial Policy Advocate, Public Citizen’s Congress Watch Division

If a proposal issued today by the Securities and Exchange Commission (SEC) is adopted, financial speculators looking to make a quick buck may soon be able to advertise high risk, shady deals to the public with the blessing of the federal government.

In the agency’s first rulemaking effort following the April 5th passage of the Jumpstart Our Business Startups Act (the misnamed JOBS Act), the SEC is failing to propose concrete solutions that would prevent average investors from being duped by hedge funds managers and other issuers of private securities.

Transactions involving private offerings already result in more enforcement actions and investigations than any other kind of financial transaction, according to the North American Securities Administrators Association. The number of actions grew to 410 in 2011, a 60 percent increase from 2010.

Private offerings are so risky that, to date, hedge funds and other firms could only offer these high-risk deals to proven, “sophisticated” investors, such as professional money managers with whom they have an ongoing business relationship. The JOBS Act permits advertising such deals to the public. 

One of the very few investor safeguards from Congress is the requirement that firms offering private securities have to take “reasonable steps” to ensure that the investor is sophisticated and has a net worth of $1 million or $200,000 in annual income.  Significantly, the SEC’s proposed rule fails to adequately define these “reasonable steps” a hedge fund is required to take before it can categorize a prospective client as sophisticated. This is a grave oversight.

SEC Commissioner Luis Aguilar opposed the proposed rule. But, while some of the other commissioners have acknowledged concerns about investor abuse, their sympathy won’t be able to restore a pillaged retirement fund after the fact.

The SEC will accept public comment for 30 days before finalizing the rule so there’s still time for them to do the right thing. We urge the SEC to rethink the final rule, and consider including more investor protections.