One of the many ironies faced by the “opaque” hedge fund industry is the fact that its opacity is often not voluntary. Rather, it is often thrust upon hedge funds by the very party tending to capitalize most on public scorn for hedge funds: politicians. (See related AAA post about politicos and transparency.) As those with the sometimes thankless task of marketing hedge funds know, it is forbidden in the United States to communicate information about unregistered investment products, such as hedge funds and private equity funds, to those who are unqualified to ultimately purchase such a product. In other words, not only is it forbidden to sell a hedge fund to an unqualified investor (read: an Average Joe like your humble scribe), but it is, in fact, illegal to even speak about said hedge fund. (Side note: see this AAA post for a study showing the United States as one of the most restrictive countries in the world to communicate about hedge funds). As you might imagine, this has raised the ire of free speech advocates.
One of those advocates is the US-based Electronic Frontier Foundation, which just dove into the ongoing melee between hedge fund manager Phil Goldstein and his arch-nemesis Massachusetts Secretary of State William Galvin. Students of the hedge fund industry need no introduction to Goldstein. As we reported in 2008, Goldstein was hauled onto the carpet by the State of Massachusetts for allegedly allowing an unqualified investor, a Massachusetts resident, to receive information about his fund. Again, not to invest in the fund, but simply to receive information about it.
Goldstein’s Bulldog Investors argued that, on First Amendment grounds, anyone should be allowed to simply read information about his activities. But the courts invoked a series of cases illustrating that so-called “commercial speech” did not enjoy the same protections as regular free speech. The video of Bulldog’s appeal beats any courtroom drama and is available here.
The bulldog that keeps on biting
Fast forward to today and the case was being appealed in front of the Massachusetts Supreme Court. Goldstein again argues that information regarding his investment strategy should be protected under the First Amendment to the US Constitution that protects free speech.
Apparently, it can be tough to introduce any new arguments during an appeal like this. But there is one angle to this case that is new. The Electronic Frontier Foundation has assembled a group of individuals that have no “commercial” interest in the case but whose rights will nonetheless be impacted by the court’s ruling. The small group of journalists, academics and students (collectively, amicus curiae or “friend of the court”) described the collateral damage that would result from the continued suppression of such “free speech”.
One of those amici is also an amicus of AllAboutAlpha.comae: Deirdre Brennan, the publisher of the excellent alternative investment website FINalternatives. As you will see below, Brennan did a favor for journalists around the globe by advocating for the free flow of information regarding the hedge fund industry.
Journalists are “sophisticated” though not usually that wealthy
We have it on good authority that some financial journalists may have been checking the “qualified investor” box on hedge fund websites just to gain access to the same information that flows freely among the ranks of the wealthy. Aside from being forced to lie about their own net worth, these journalists know that only their wealthiest readers are actually able to expand their knowledge of certain topics by visiting a hedge fund’s website (lest they too are forced to lie about their net worth).
While the motivations behind the academics, students, and free speech advocates are somewhat prosaic, the Amicus Brief clearly lays out Brennan’s rationale for adding a journalist’s voice to the growing chorus:
“In her experience, hedge funds are of the hardest areas of the financial industry to cover because managers fear being prosecuted for soliciting if they provide information to the press. She believes that freeing hedge fund managers from the solicitation ban will allow the industry to more readily emerge from the shadows and educate the public as to what hedge funds actually do and will not have a detrimental effect on our society or investment community. Instead she believes that removing the ban of truthful information published by hedge funds would expose the industry to disinfecting sunlight.”
The Brief steers well clear of the right for those with a potential commercial interest in the hedge fund to receive information about it; that angle is covered by the appellant itself – Goldstein’s Bulldog Investors, which argues that the information communicated was not solely commercial anyway. Instead, it covers only those “interested in obtaining unfettered access to non-misleading information published by issuers of unregistered securities for academic, journalistic, or other non-investment reasons.”
The catch: How would you provide such “unfettered” information only to those (significant and ubiquitous) categories of readers? Clearly, to do so would necessarily make that information available to the public at large.
Brennan and her fellow amici argue that speech should be either fully protected, e.g. political views, or fully banned, e.g. yelling “fire!” in a theater, but that you shouldn’t allow some speech to be free for some people and banned for others. The Brief points out that currently, you aren’t allowed to access information from an issuer of securities even though that very same information may be accessed freely from a non-issuer of securities. (Hence the dearth of commercial research on these pages vs. the relatively surfeit of academic research.)
Conversely, wealthy investors are currently allowed to access certain information even those that very same information cannot be accessed by the relatively poor unwashed masses with journalists being chief among them (we can say with considerable experience). The Brief points out that picking and choosing who can communicate and who can read the very same information “violates the First Amendment requirement of strict speaker – and listener – neutrality.”
While one could argue that the information contained on a hedge fund website or in a hedge fund newsletter is “commercial” in nature (and therefore doesn’t fall under the aegis of the First Amendment), the Amici in this case argue that such information is not “solely” commercial. After all, it could be used to write an article for a website like AllAboutAlpha.com or FINalternatives, so not for “commercial” purposes. (Note: Just because a website might aim to generate revenue, the Brief argues that this motivation doesn’t count and the speech can still be considered “non-commercial”.)
According to the Brief, even the U.S. Supreme Court has acknowledged how difficult it is for issuers to parse “commercial” from “non-commercial” speech:
“Here, the regulatory definition of ‘offer’ is far too broad and vague to clearly define the kinds of speech that receive less robust First Amendment protection. Issuers cannot easily determine whether their speech will be treated by regulators as ‘offers’ or ‘solicitation of offer to buy.’…The uncertainty faced by speakers, and the discretion possessed by regulators results in the self-censorship that the First Amendment…seeks to combat.”
“Commercial speech” is sometimes banned in order to protect the consumer from harm “that flows from false or misleading information” according to the Brief. But when the truthfulness of the information is never in question, the Brief argues that this argument is a red herring.
Incentive to Register
The Brief goes on accuse the SEC of using the ban on communicating to non-qualified investors as a ruse designed solely to get hedge funds to register. Since the information Bulldog tried to communicate was “truthful, non-misleading and unrelated to any unlawful transaction” the only thing that stands between the “speaker” and the “listener” is the speaker’s regulatory status – proving that “the sole purpose and function of the ban is as an incentive to register” according to the Brief. (Note: Where the Amicus Brief refers to “registration”, it is referring to the registration of the fund/security itself, not the advisor managing it.)
In 2007, we noted that it was once illegal for beer companies to list the alcohol content on their labels in the United States. Apparently, regulators were concerned that allowing this might spark an arms race and, before you know it, we’d all be drinking malt liquor for breakfast. By doing so, the government intervened between the “speaker” (the beer company) and the “listener” (the consumer) and installed paternal and rather misguided policy to protect consumers. The irony is that in many countries the labeling of alcohol content is considered to be in the public’s interest, not against it – that it is better to let the speaker and the audience communicate directly.
Similarly, the Amicus Brief on the Goldstein appeal argues that:
“First Amendment precedent makes clear that there is a strong “presumption that the speaker and the audience, not the Government, should be left to assess the value of accurate and non-misleading information about lawful conduct.”
The Amicus Brief also argued that the trial court (whose decision the amici believe should be reversed) was wrong to agree that restricting communications actually preserved the “integrity of capital markets.” Instead, it says, the ban does not achieve this and causes unintended collateral damage by denying academics and journalists access to this information. Further, the Brief questions why such information that is allegedly “harmful” is then allowed to flow freely to sophisticated investors – and from registered hedge funds to the general public. Clearly such information is not inherently “harmful”, and therefore should not be summarily banned.
A “Last Resort”?
In conclusion the Amicus Brief cites a precedent case where the courts argued:
“If the First Amendment means anything, it means that regulating speech must be a last – not first – resort. Yet here it seems to have been the first strategy the government thought to try.”
Clearly, banning the free flow of information between hedge funds and the general public was not the “last resort” in protecting the proper functioning of capital markets. When the government targeted Bulldog back in 2007, it had several other strategies in its quiver – not the least of which was the nuclear solution: rewriting the law to require all hedge funds to register. But although hedge fund advisors will soon be required to register, most are unlikely to suddenly turn their unregistered hedge funds into registered hedged mutual funds. As a result, the hedge fund industry will be watching the latest Goldstein appeal closely to see if the last-minute pleas from a small group of journalists, academics and students will change the hedge fund industry as we know it.