SEC’s flawed protection

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A Securities and Exchange Commission ruling in July 2013 that allows hedge funds to advertise exposes flaws in how the agency protects consumers. Critics say the rule doesn’t protect investors from misleading claims that might be advertised. Further, SEC hasn’t devised penalties that specifically would address a hedge fund’s misleading advertising.

Hedge funds, like mutual funds, are managed portfolios but typically are aggressive in taking risks and employ tactics that mutual funds aren’t permitted to use. To invest in hedge funds, you must have an annual income of $200,000 or a net worth of $1 million. (At least 8.7 million households, or 7.4 percent of all households, meet these thresholds, according to SEC.) Theoretically, this is to protect investors who aren’t savvy. However, that’s at best a porous defense, because hedge funds that don’t advertise don’t have to verify investors’ financial status. The new rule does require hedge funds that advertise to verify investor qualifications, but SEC allows hedge funds to decide what counts constitutes proof. (In its final rule, SEC says no evidence exists that hedge funds were involved disproportionately in fraudulent activity.)

Regardless, wealth doesn’t equal intelligence, critics argue. “No one honestly believes that having an income of $200,000 ensures that someone is automatically financially sophisticated enough to understand the risks in these offerings or wealthy enough to withstand the potential losses,” says Barbara Roper of Consumer Federation of America. In other words, misleading advertising can fool anyone.