Is This Bulldog’s Bark Worse Than Its Bite?

Mar 20 2008 | 7:37am ET

By Lawrence Cohen -- It seems that Philip Goldstein wants his Bulldog Investors’ bark to be heard around the world.

Goldstein won the admiration of his hedge fund manager peers when he slew the dragon of adviser registration that the U.S. Securities and Exchange Commission imposed on the industry in 2006. He is challenging the SEC again. This time, Goldstein appears likely to sue the SEC over its prohibition against permitting unfettered access by the public to information on hedge fund Web sites. According to Goldstein, the SEC’s position infringes the First Amendment’s guarantee of freedom of speech.

Prompted by an investigation and enforcement action taken against him by the Massachusetts Attorney General for allowing Bulldog Investors’ private offering material to be accessible to potential public investors—Goldstein characterized the event as a "sting" operation and took his fund’s Web site offline as a result—he said that he intends to take the issue to federal court.

Current SEC policy reflects the agency's interpretation of the transaction exemption from registration of securities under the Securities Act of 1933, which prohibits public offerings of unregistered securities. The regulatory "quid-pro-quo" that has been accepted for decades requires that if an issuer does not want to go through the expense and disclosure requirements necessary to register with the SEC, it must limit its distribution activities to a private placement approach. That means, generally speaking, offering securities to a limited number of people who are personally known to the issuer or have demonstrated an appropriate level of investment experience and sophistication. The SEC promulgated Regulation D to provide a "safe harbor," with specific criteria for certain types of private placements. For example, in the case of offerings with unlimited dollar amounts, no more than 35 "non-accredited" investors are allowed to participate.

Goldstein first asked the SEC to respond to a "no enforcement action" letter on a highly expedited time frame. The SEC staff, not unexpectedly, declined to adjust its procedures. As he did when fighting the adviser registration rule, Goldstein decided to pursue his remedies through the judicial system. As of the date of this writing, a complaint has not yet been filed.

Goldstein is applying a rather novel strategy to attack the restrictions on public disclosure of the terms of a hedge fund offering—he is defending the right to do so on the grounds of free speech.  He noted recently that there is “significant uncertainty” regarding the legality of operating a Web site that affords full public access. He is arguing that the regulators should distinguish between a public offering that is undertaken without an effective SEC registration statement and the mere establishment of informative Web sites. Goldstein has been quoted as saying, “We [Bulldog Investors] believe that a ban on hedge fund Web sites and electronic communications with Web site users does not provide protection to investors, and the First Amendment applies to all Web sites and communications that provide truthful and no misleading information about products and services that may legally be sold to qualified persons including the Web sites of hedge funds.”

Over many decades, the federal courts have addressed the differences between “political” and “commercial” speech under the First Amendment, and while the protections for commercial speech have been broadened over the years, the rights enjoyed by those who communicate commercially-oriented messages are not equal to expressions that are political in nature. It will be hard to predict, but interesting to observe, whether the courts will be receptive to Goldstein’s argument that his freedom of speech is being denied. Ever colorful, Goldstein pointed out that the securities regulations equate his situation with that of pornography Web sites. 

It may be difficult to justify the reasons for refusing to allow a member of the public from simply logging onto a Web site and reading a disclosure document. After all, the important goal of federal and state securities regulators should be to prevent an issuer from accepting the subscription of an investor who is not qualified to participate and for whom the product is not suitable. The investor would always have the opportunity to pursue an action against the issuer for violations of fiduciary obligations, selling an unsuitable security, presenting material misinformation, lack of disclosure, and other actions that are based on fraudulent conduct. 

Goldstein will most certainly argue that his making available a Private Placement Memorandum or deal summary should be regarded as a protective right of free speech. The SEC may counter with the position that the courts have determined over decades of cases that the exemption from registration of securities for “transactions not involving a public offering” (under Section 4(2) of the Securities Act of 1933) requires that offerings of securities be made on a private, limited basis. Note that the safe-harbor under SEC Regulation D, Rule 506, has no limit on the number of accredited investors that may invest in an offering, subject to certain conditions. Is that safe harbor consistent with a prohibition on the use of a Web site as the medium for accessing the private placement document?

The tension between freedom of speech and non-public offerings may come down to a determination of the meaning of the term “offering.” Some would argue that the availability on a hedge fund’s Web site of a document that can be read by anyone constitutes a “public offering,” even if the Web site and/or document clearly states that investments may only be made by certain high-net worth, sophisticated investors after a detailed subscription agreement is signed, submitted to, reviewed, and accepted by the fund. Others might say that a more affirmative invitation or enticement is required on the Web site for the information displayed thereon to be considered an “offering.” Even if hedge fund access is held to be a public offering, can the traditional private placement restriction be tolerated in respect of the right of free speech? It may depend on whether the speech in question is found to be commercial in nature, which could be overshadowed by regulatory concerns, or whether it is granted the level of protection generally reserved for political speech.

Goldstein was successful in his last action against the SEC. We will have to wait and see if his dogged efforts persevere again.

Lawrence Cohen is a partner in the Corporate Department at Morrison Cohen LLP.  A former officer and compliance director of two major mutual fund groups, he concentrates his practice on securities transactional and regulatory matters.

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