On Feb. 1 of this year, Bulldog Investors, its principal Phil Goldstein, and related individuals and entities filed a petition with the United States Supreme Court for a writ of certiorari; that is, they requested that the court take a (discretionary) appeal from a decision by the Supreme Judicial Court of Massachusetts.
The Justices meet on May 10, and they may on that day decide whether to grant that appeal. If they do, then we’ll no doubt witness a battle royale – an exchange of million-dollar briefs and overheated oral arguments – next session. The whole alternatives-investment world ought to be paying heed to this, because a victory by Massachusetts might make the always-tricky question of marketing hedge funds and related instruments a good deal trickier.
Facts of the Case
Meanwhile, as readers of AllAboutAlpha will surely remember, the Goldstein case has arisen because a Massachusetts regulation prohibits an issuer of unregistered securities sold only to sophisticated investors from running a website accessible to not-so-sophisticated folks, or from contacting them with emails in response to interest expressed via the website.
The Bulldog website at issue made materials available only to those visitors who clicked “I agree” to a disclaimer that indicated that its information “does not constitute solicitation as to any investment service or product and is not an invitation to subscribe for shares or units in any fund herein.”
In 2007, the Enforcement Section of the Securities Division, Secretary of the Commonwealth, filed a complaint alleging that Bulldog had been illegally “offering” unregistered securities to a Massachusetts resident. Bulldog responded that the regulatory scheme violates its rights under the first amendment to the US Constitution, as applied to the states by the due process clause of the 14th amendment.
The trial court upheld the law and regulation against Bulldog’s first amendment arguments, finding that (under the established Central Hudson test for “commercial speech”) the scheme was justified because it was narrowly tailored to the state’s interest in protecting the integrity of the capital markets. The Supreme Judicial Court agreed. It is the SJC decision that Bulldog wants SCOTUS to overturn.
What kind of speech was this? Some sorts of speech (such as speech inciting violence, or obscenities) receive no first amendment protection. There is no contention here, though, that Bulldog’s barks fall into any such utterly-unprotected category.
Other sorts of speech, specifically those that propose a commercial transaction, are aptly called “commercial speech” and exist on an “intermediate tier” legally. Such speech receives less than full free-speech protection from the federal courts, but more than none. It is less highly valued than art or a political speech, but more highly valued than criminal incitement.
So … was Bulldog engaged in commercial speech? You can argue that it was not, and that its speech deserves full (top tier) protection. In that case, the Massachusetts regulatory scheme as applied to Bulldog is doomed. On the other hand, the parameters of the category “commercial speech” are not very precise, so you can also make the argument that this is commercial speech, merely because the website and responsive email were in general part of an effort to stimulate public awareness of and interest in products for sale. After all, one of the key commercial speech cases involved a Tupperware Party. Surely not all statements made at the Tupperware party were in any direct sense offers to buy or sell Tupperware.
So consider this for purposes of discussion an intermediate-tier case. The speech the state proposes to ban or punish was not false or misleading. Under Central Hudson, the state then has to show that the censorious law is narrowly tailored to serve a substantial interest of the state. What substantial interest does this one serve?
Paternalism and SNL
The argument that unsophisticated investors are best kept in ignorance of what hedge funds are up to is not available, because the U.S. Supreme Court has rejected that paternalistic approach to carving out free speech exceptions at least since 1976. That year, in Va. Pharmacy Bd. V. Va. Consumer Council, the state of Virginia sought to justify a ban on advertising by pharmacists on the grounds that advertising could confuse the drug purchasing public. The high court stating as an axiom its view that “people will perceive their own best interests if only they are well enough informed, and that the best means to that end is to open the channels of communication, rather than to close them…. It is precisely this kind of choice, between the dangers of suppressing information, and the dangers of its misuse … that the First Amendment makes for us.”
So Massachusetts offered a different argument. It contended, and the SJC of that state agreed, that the statutory/regulatory scheme is “narrowly tailored” to the state’s interests because the ban “on general advertising of unregistered securities … provides a powerful incentive for issuers to register.” The “substantial interest” then, must be the goodness of registration.
This just sounds lame. Not only is it an indirect and not-especially-substantial sort of interest, it seems very implausible that this was what the legislature or the regulators ever had in mind. It smacks of the sort of rationale lawyers come up with when they are trying to fit an indefensible paternalistic regulation into a respectable constitutional frame.
The Commonwealth is coming out of this like a character on an old Saturday Night Live Skit, played by Jon Lovitz.
“No, no, no, we’re not trying to keep the public in ignorance. We’re trying to, ummm, create incentives, yeeeah, that’s the ticket … incentives to register. Yeeah.”