Hedge Fund Advertising Turns Into A First Amendment Issue

Phillip Goldstein is at it again. The guy who single-handedly vacated the SEC’s hedge fund regulation rule has now threatened to sue his arch nemesis if it doesn’t lift its ban on hedge fund advertising immediately. According to Investment News,

Mr. Goldstein, principal of Bulldog Investors LLC in Saddle Brook, N.J., gave the SEC an ultimatum: Either issue him a no-action response by last Friday, allowing him to open his hedge fund website to the public, or he would file suit and let the courts determine if the securities laws violate the First Amendment.

According to the website Archive.org, which copies websites from across the Internet for historical posterity, the Bulldog Investors website has been in cryogenic suspension since the beginning of last year when the Massachusetts Secretary of the Commonwealth William Galvin accused Goldstein of providing fund information to a non-qualified investor (for the record, he says it was a "sting" operation). Since then the firm’s website has read simply “Site is currently being updated. Please check back soon. Thank you.” But Archive.org also shows what the site looked like before the latest brouhaha developed. While it’s not immediately clear if this archived version of the website contains the information that raised the ire of the SEC, its existence alone raises certain questions about the ability of the SEC to effectively control information in the Internet age.

In any case, Goldstein’s argument seems to be based on the delineation between the freedom of “political speech” and the freedom of “commercial speech” under the U.S. Constitution. As you might guess, “political speech” (a.k.a. “non-commercial speech”) is more protected than “commercial speech”. But the problem is that these terms have never been adequately defined. As a result, different courts have issues different rulings over the years.

As some legal commentators have suggested, the distinction between commercial speech and non-commercial speech is somewhat artificial and “contrived“. This is particularly true in the hedge fund industry where products are each so unique (idiosyncratic) that to describe a particular product is to necessarily describe a unique and specific economic phenomenon. In other words, it is often impossible to disentangle the fundamental economic argument (deserving constitutional protection) from the commercial one (which has been viewed by the courts as less deserving of protection).

This is especially evident to us at AllAboutAlpha.com when we cover academic papers that advocate a specific investment strategy (or, for that matter, debunk a certain investment strategy in favor of something else). While academic ideas are protected, the dissemination of the very same ideas in the context of a commercial proposition seems to be off limits. This is particularly confusing as the worlds of academia and finance begin to converge in the form of quantitative hedge funds.

Many US readers (and those simply trying to market their funds in the US) have contacted us over the past year to express an opinion in private that their compliance departments wouldn’t allow them to express in public. Some of the people who provide those comments to us are well known writers/researchers whose unexpressed opinions are thoughtful and useful commentary on the particular issues of interest.

While some of this is a result of a strategic decision to keep quiet about a particular strategy, much of it is a result of regulatory and legal concerns. In fact, HedgeWorld gives us some insight into the origin of these concerns in this piece:

…’The current [SEC] rule is difficult to work with,’ said David Nissenbaum, a partner at law firm Schulte Roth & Zabel LLP, acknowledging that because it gives lawyers little guidance, they usually advise clients to say as little as possible. ‘It would be a good thing if there were more information and access should not have to be limited.’

Those who are able to speak freely on these pages write about the academic and economic rationale underpinning various hedge fund strategies - while attempting to steer clear of advocating any particular product (other than to cite them as anecdotal evidence of a broader trend). This is a sometimes a tough balancing act. But it would be made a lot easier if they didn’t have to think twice before expressing their views in an open and frank manner for fear of being accused of “marketing to the public”.