By Cyrus Sanati, contributor
FORTUNE — Private equity doesn’t have to be so private anymore. Buried deep in the recently passed JOBS Act bill is a provision that lifts the old Depression-era ban on advertising unregistered private placements to the general public. That means it will be possible for hedge funds and private equity firms to take out full-page ads in newspapers, purchase radio spots or even buy commercial time on television. President Obama is expected to sign the bill Thursday.
Wall Street may be elated now, but the industry may come to regret this fundamental shift in their business. While the change is expected to make it easier to market private placements, it also drops the mystique of exclusivity the industry has used to draw in high net worth clients. The change also raises the bar on disclosures as funds will now be able to talk publicly about their investment returns and strategies, forcing a new level of openness in the industry that many managers may find uncomfortable. And most troubling, the lifting of the veil exposes the industry to fraudsters looking to cash in on the public’s naiveté on alternative investments.
The JOBS Act, which stands for Jumpstart Our Business Startups, was sold to the American public as a bill that would help small businesses grow and create jobs. In reality, the bill is really a series of regulatory rollbacks that mostly benefit Wall Street and Sandhill Road and does little, if anything, to help Mom and Pop startups hoping to make it big on Main Street.
At the heart of the legislation is a series of provisions that would make it easier for small startup companies and investment firms to either go public or remain private entities. Venture capital and private equity funds win here as they will be able to have more control over when and how they can take their small portfolio companies public.
But it isn’t just the small Internet startup flavor of the month that will benefit here. The legislation would also eliminate the ban on the public solicitation of private offerings under Regulation D of the Securities Act of 1933. The law, put in place in the wake of the 1929 stock market crash, forced investment vehicles to register with the Securities and Exchange Commission, who would make sure that the firms were following the law and operating above board. The law also extended to private equity and private debt offerings.
Investment firms that wanted to avoid SEC oversight, and all the red tape that comes with it, could only do so by limiting their investor base to those deemed by the regulators to be rich and sophisticated enough to take the risk. Today, an accredited investor is a person with at least $1 million in net worth, excluding the value of their primary residence. Investment firms, like pension funds, that want to invest in such a firm could only do so if they have assets of at least $5 million.
The JOBS Act keeps in place the accreditation rules but lifts the ban on advertising. This will have a profound impact on the way Wall Street can market its services and lifts the veil from a corner of the market that has essentially worked in the shadows for decades. Hedge funds will now be able to have flashy websites and brag all they want about their performance in public. Broker dealers at investment banks can now openly pitch a private equity firm’s latest fund to their rolodex of high net worth clients, complete with lunch and glossy pamphlets.
But is this really a good thing for the private investment industry? For many high net worth investors and large investing funds, especially sovereign wealth funds, being invested in the “right” private equity or hedge fund is as important as being a member of the “right” country club or sending their kids to the “right” schools. The exclusivity and mystique surrounding private investment vehicles has arguably been one of their greatest selling points as it made investors believe they were a part of something that was “better” than the mutual funds and other investment vehicles open to the general public. The potential mass marketing of private investments vehicles could see some high net worth investors looking elsewhere for alpha on the grounds that all the common money flooding the space could somehow hurt fund performance.
To be sure, there will be funds that try to maintain their low profile and retain their high-rolling clients, but the vast majority of funds, mostly smaller and less established funds, will happily use advertising to gain more investors. This could rattle the more traditional funds and could force them to advertise to protect their investor base from flying the coup to more successful funds. Eventually, the whole industry, save a few shut-ins, will likely turn to Madison Avenue to stay competitive.
But perhaps the worst impact advertising could have on the industry would be an increase in investment fraud. By soliciting people directly, private funds and offerings can now lure investors who the government may label as “accredited,” but who really have little financial education. Before it was hard to attract the elderly widow or the busy doctor, but advertising changes all that.
Many advocate groups, including the North American Securities Administrators Association and AARP, oppose the lifting of the advertising ban on concerns that it could increase investment fraud. The Consumer Federation of America said in a statement last month that removing the ban on advertising would make a “mockery” of the concept of a private offering and “create an opportunity for fraud on a mass scale.”
President Obama is scheduled to sign the JOBS Act into law this week. It is still unclear what impact all these changes will have on the industry – both good and bad. The SEC will soon be tasked with writing new rules to enforce the law, a process that could take months or even a year. But once the ink dries, don’t be surprised to see some spam in your inbox from the likes of hedge fund mavens John Paulson or Ken Griffin asking for your help in raising a new investment fund – in Nigeria.