Do Some Securities Laws Violate The Right To Free Speech?

Feb 14 2011 | 12:23pm ET

By Mikhail Iliev, Who's In My Fund? -- A riveting case is soon to end its four-year journey through the Massachusetts courts, but outside of an AllAboutAlpha op-ed here or a Wall Street Journal op-ed there nobody seems to be noticing.

In a case filed in 2007, hedge fund Bulldog Investors claimed the securities laws prevented its managers from sharing fund information with regular folks.

At the same time, the laws allowed anybody else who wasn’t a Bulldog manager to share the information with anybody, including regular folks. They also allowed rich and sophisticated people to get the same information without restrictions.

This, the fund said, violated its First Amendment right to speak freely.

Now journalists, scholars and others not party to the dispute have filed an amici curiae, or friends-of-the-court, brief in agreement.

We join their voices and urge lawmakers to fix the securities laws.

Case History

For a year and a half, Bulldog’s website provided practically any visitor with true and non misleading information on its investment strategy, the backgrounds of its managers, its performance and recent successes.

In early 2007, the Massachusetts Securities Commission shut down the website. Because its website was open to anybody, the commission claimed, Bulldog was engaged in an illegal attempt to sell interests in its funds to the public.

Bulldog sued the commission saying shutting down the site violated Bulldog’s right to free speech.

The trial court found there was no free speech violation and the dispute is now in front of the Massachusetts Supreme Court on appeal.

Prior free speech decisions and the case history indicate that the state’s supreme court will likely agree with the lower court and find no First Amendment violation. 

It shouldn’t.

And the amici brief shows a compelling reason why.

General Solicitation Rules Violate Free Speech

If you are the government, how do you allow willing investors to buy shares in companies while protecting them from being sent to the cleaners by crooked companies? One way is to learn everything about every investment and then tell people exactly where they should invest. This is government paternalism, of course -- thoroughly un-American and unwieldy, to boot. So, authorities took another way.

They told investors: You can buy whatever you want.

They told companies: You can sell whatever you want, but only if you sell it to the rich and the sophisticated. If you want to sell to everybody, including poor unsophisticated widows and orphans, you have to register with us and discuss specific detailed information about the investments.

The thought here was the rich need less government intervention -- they could, and should, fend for themselves.

So, the government stays out of private decisions and it also provides protection to the masses. Everybody is happy.

Enter free speech.

To attract investors, hedge funds such as Bulldog like to talk about their business or themselves and thus engage in a type of speech the law calls “general solicitation.”

To protect the masses, the government makes funds register and structure their speech in very specific ways before they are allowed to engage in general solicitation.

So the government is restricting speech. And if the speech is anything like that in the Bulldog case, then the government is restricting speech that is true and non-misleading.

That alone must be unconstitutional, right? It could be, and maybe it should be, but interestingly it hasn’t been. Courts think of this sort of talk as “commercial speech” designed to lead investors to buy a share in the company. So they consider it second rate and not nearly as valuable as, say, political speech. 

Which is why even true and not misleading speech may be restricted if it serves to protect the widows and the orphans.

Of course, hedge funds can simply not engage in “general solicitation” and so avoid the restrictions. The problem is the law does not define “general solicitation” so nobody quite knows exactly what kind of speech is or isn’t part of it.

Hedge fund managers may think of all sorts of things to say about their fund or themselves. Sometimes such speech sounds like a direct offer to the listener to buy a piece of their fund -- a classic case of commercial speech worthy of restriction.

Mostly, though, managers like to discuss investment performance, investment strategy or their experience, in a general way without offering anything for sale.

Are all these instances of “general solicitation”? Would managers discuss their business for purposes unrelated a sale of fund shares?

Sure. They may be talking to a curious journalist preparing an informative article or a scholar writing a comparative study. Students or bloggers may also be interested in knowing about them.

Is all this crass commercial speech designed to rob the widows and orphans? Where is the dividing line?

There is no line. That’s what the SEC, and its relatives at the Massachusetts Commission, are telling Bulldog and every other company out there.

The way regulators have come to interpret the term, anything you say on a forum open to anyone that the government thinks creates interest in you means you are engaging in general solicitation. You never know, an unsuspecting poor orphan might hear you and go for broke.

Now, Bulldog didn’t tell anybody to buy its shares, but it did speak at length about its performance and its managers. And the way the website worked, practically everybody could hear.

So, yes a down-on-her-luck widow might conceivably see the data and might even want to buy a share. So what? The vast majority of down-on-her-luck widows wouldn’t. The vast majority of everybody wouldn’t. And journalists, scholars, students or bloggers wouldn’t even want to.

Every day, people hear about things they can’t afford or are not smart enough to understand, but they don’t rush to bet the farm on them. Why should we risk chilling truthful, non-misleading speech to protect the rare poor lunatic? Why should we be barred when we want to hear anything about hedge funds? Barring us when we wave our money wanting a piece of them should be enough restriction. There is no reason for a non-paternalistic government to restrict us any earlier than the point of sale.

If that wasn’t enough, the general solicitation rules are also schizophrenic. They stop Bulldog from providing the public with the fund’s data, its investment specs so to speak, but let anybody other than the fund do it without restriction. This is like stopping the salesman at the Ferrari dealership from showing you specs about their cars but letting bloggers post them on the internet.

It is clear the rules are flawed, and it’s not just us saying it.

Practitioners say it. “That part of the securities laws doesn’t make much sense and should be changed,” Adam Gale, a private fund expert at Chadbourne Parke, told Who’s In My Fund?

The American Bar Association has said it. The SEC's own annual forum on Small Business Capital Formation says it and has for years tried to do something about it.

It’s time lawmakers heard us and moved to narrow the scope of general solicitation.

Protecting widows and orphans is great, but not at the expense of our right to free speech.

Mikhail Iliev is a contributing editor of Who's In My Fund?, a site which groups hedge fund investors by investment, allowing them to communicate directly and discretely with each other in a secure environment and share news and opinion on their investments. Mikhail practiced law for 11 years as an associate at Dewey LeBoeuf, LLP and as Senior Vice President at KBC Financial Products. He has extensive experience in the field of securities law and private investments and has advised clients on financing and offering matters for domestic and offshore funds, mergers and acquisitions and securities regulation. He is also a visiting professor at Segal Graduate School of Business in Vancouver, Canada where he has taught courses on securities regulation and ethics.


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