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News February 5, 2007 Issue

Massachusetts Securities Regulator Sues Phillip Goldstein

What goes around comes around.

Last week, the Massachusetts Securities Division, headed by William Galvin, sued hedge fund manager Phillip Goldstein.

In its January 31 complaint against Goldstein, his advisory firm, Bulldog Investors, and other related persons, the state regulator alleged that materials posted on Goldsteinís website constituted a general solicitation and, therefore, his hedge funds were not eligible to rely on the SECís Reg. D exemption for private offerings. Consequently, said the state, the funds could not rely on the Massachusetts private offering exemption, which keys off of Reg. D. Putting icing on the cake, the state alleged that Goldstein solicited a Massachusetts resident to invest in unregistered securities.

Goldsteinís problems originated in private litigation between Goldstein and RHR Hospitality and Real Estate Fund, a closed-end fund. Goldstein had been gobbling up shares of the fund in the hope that he would be able to convert it to an open-end fund. However, the fundís trust agreement generally provided that no person or group of persons acting together could own more than 9.8 percent of RHRís outstanding shares. "We didnít know that," Goldstein told IM Insight. "I went over." According to RHR, Goldstein acquired approximately 14 percent of its outstanding shares. So the fund sued Goldstein in Massachusetts state court.

Thatís where things got interesting. The RHR fund is based in Newton, Massachusetts. But Goldstein is based out of New York and New Jersey. Goldstein promptly filed a motion to dismiss RHRís suit, saying the court lacked jurisdiction over him personally.

RHR countered by saying the court did, in fact, have jurisdiction. To support its claim, it filed an affidavit signed by one Brendan Hickey, a resident of Quincy, Massachusetts. Hickey had visited Goldsteinís website and requested information about Bulldog Investors and the firmís hedge funds. In response, a Goldstein employee e-mailed various fund materials to him. That, claimed RHR, demonstrated that Goldstein had the requisite contacts in Massachusetts.

Interestingly, one of RHRís outside lawyers is named Robert Hickey. We wondered if there was any familial relationship between Brendan Hickey, the website visitor, and Robert Hickey, the RHR lawyer. So we asked.

"No relation," Robert Hickey told us.

In any event, a copy of Brendan Hickeyís affidavit managed to find its way over to the Massachusetts Securities Division.

"Next thing I know, I get a letter from the State of Massachusetts," Goldstein recalled. The regulatorís January 19 letter expressed concern that his website, www.bulldoginvestors.com, was not in compliance with Reg. D. Rule 506ís prohibition against general solicitation or general advertising. The regulator asked Goldstein to provide "a detailed explanation of the Massachusetts exemption being relied upon by Bulldog [and its funds] for offers of those funds in Massachusetts."

Goldstein quickly shot back a reply, claiming that none of his funds rely on any exemption to solicit investors in Massachusetts, because, he said, none of his funds solicit investors in Massachusetts "or anywhere else." Goldstein pointed out that he did not direct traffic to his website or promote it in any way. Moreover, he noted that to go beyond the websiteís welcoming screen, visitors were required to acknowledge that they had read "an explicit statement that the information on the site is not a solicitation."

Goldstein urged the Massachusetts Securities Division to look into Brendan Hickeyís visit to the bar association. "It would be a particularly egregious Ö for a lawyer representing one party in a civil lawsuit to cause a misleading complaint to be filed in order to gain leverage over an opposing party," he said.

A week later, the Massachusetts Securities Division sued Goldstein for offering unregistered securities in Massachusetts.

Letís take a closer look at Goldsteinís website. Itís shut down now, with a "Please check back soon" message on it. But we can get a pretty good idea of what the site looked like based on a January 24 "cached" version of the website still available via Google.

Visitors to www.bulldoginvestors.com were greeted with a welcome screen. To get past it, a visitor would have to click on an acknowledgement that he or she had read a disclaimer that the material on the site was being made available for information purposes only and "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."

At that point, the visitor could view most of the website, which, according to the Massachusetts regulator, contained "general advertising and offering materials." IM Insight found no evidence that any private placement memoranda or other formal offering documents were available on the public section of the website. However, we did find some fund-specific information: Under a tab labeled "Our Services," we found short descriptions of Bulldogís "three distinct investment vehicles." For example, the "Income Plus Fund" is described as a "low-risk fund that primarily invests in undervalued income-producing closed-end funds, real estate investment trusts, and other investments. [The Fund] attempts to product better current returns with less risk than is achievable in the bond markets." At the bottom of the website, we found a link to a printable brochure that contained a similar discussion of the various Bulldog hedge funds.

It appears that only one portion of the website, labeled "Fund Info," was password protected. That section apparently contained fund performance data. To obtain access to that section, a visitor was required to complete a "Registration Form," which requested the visitorís name, address, telephone number, fax number, and e-mail address. However, the registration form did not ask for information about a visitorís financial sophistication. Upon completing the form, the visitor received a user name and password.

According to the Massachusetts Securities Division, after Brendan Hickey filled out the registration form, he received several documents via e-mail that contained fund-specific information, including fund performance and a quarterly letter to investors. At no point, it seems, was Hickey asked about his personal financial circumstances. (We note that the investor letter contained a number of classic Goldstein-isms, such as the following: "We donít need a nanny regulator to tell us right from wrong.")

Nannies or not, the Massachusetts regulators were not pleased. Goldsteinís website, they said, had "no meaningful restriction on access to the advertising or offering materials based upon a prospective investorís state of residence, investment sophistication, or financial background." They noted that the "usual manner" in which hedge funds post materials on a website is to make the site password protected, they said, "so that only those prospective investors that the issuer has determined are properly accredited or sophisticated can access the advertising and offering materials."

Goldsteinís disclaimer that his website did not constitute a solicitation is not "an appropriate or adequate control over a publicly accessible website that displays advertising and/or offering materials for securities," said the regulator. There is no exemption in Massachusetts "based on a disclaimer stating that the materials are not an offer or solicitation," it said.

So what does Goldstein think about all this? Clearly, he is not pleased with Brendan Hickeyís visit to his website, which he described as entrapment. "We were the victims," he said. "We were defrauded." In fact, Goldstein analogized Hickeyís visit to the "pretexting" authorized by Hewlitt-Packardís board of directors.

He also questioned why the Massachusetts Securities Division felt compelled to sue him, rather than point him in the right direction. "They brought out a machete to cut a twig." Goldstein said he did not feel strongly about the website and would have been happy to make any changes that the regulators had requested.

Goldstein also pointed out that ironic fact that the Massachusetts Securities Division has now posted the very same hedge fund materials Goldstein was supposed to have password protected on the regulatorís very own public website.

However, for now, at least, heís not planning to fight back. "Iím going to try to settle," Goldstein said. "Iím not nuts." As long as the regulators donít ask for an "unreasonable" amount, he added.

Meanwhile, there may be another shoe to drop. In its complaint, the Massachusetts Securities Division flatly asserts that Goldsteinís conduct ran afoul of SEC rules: "The conduct of Respondents Ö constitutes the offer or sale of securities by general solicitation or general advertising in violation of Section 506(b)(1) and Section 502(c) of Regulation D of the Securities Act of 1933."

Will the SEC let that slide, or will we see SEC v. Goldstein (as opposed to Goldstein v. SEC) in the next few weeks?

Stay tuned.