The SEC’s reformed Marketing Rule (Rule 206(4)-1) went into effect on November 4, 2022. Despite a lengthy lead time up to the compliance date, many registered investment advisers risk noncompliance as they continue to adjust internal processes.
SEC exam priorities
Firms still finalizing their revised policies and procedures at least know what to expect when it comes to future SEC exams. On September 19, 2022, the SEC published a risk alert on the new Marketing Rule, stating the Commission will perform a broad review for compliance with the Marketing Rule, including to determine whether advisers:
- Have implemented written policies and procedures designed to avoid regulatory violations, including with the Marketing Rule;
- Have a reasonable basis for believing they are able to substantiate material statements of fact in ads;
- Are complying with performance advertising requirements; and
- Are complying with the amended Books and Records Rule.
The new SEC Marketing Rule
The SEC replaced the advertising and cash solicitation rules (Rules 206(4)-1 and 206(4)-3) with one Marketing Rule.
Below is an overview of some of the most significant changes.
An expanded definition of an advertisement
The SEC redefined an advertisement under Rule 206(4)-1, giving it two parts, and communications that fall under either part are considered to be an advertisement. The first part includes communications that offer the adviser’s services to prospective clients or private fund investors or offer new services to current clients or investors. That said, this first part has several exclusions, including most one-on-one communications. The second part includes communications by placement agents, endorsements, and testimonials for which a third party receives compensation directly or indirectly from the adviser.
7 General prohibitions
As of November 4, investment adviser advertisements may not:
- Include any untrue statement of a material fact or omit material facts necessary to make the statements not misleading;
- Include a material statement of fact for which the adviser does not have a reasonable basis;
- Include information that would reasonably be likely to cause a client or prospect to draw an untrue or misleading inference concerning a material fact;
- Discuss potential benefits to clients or fund investors related to the adviser’s services or operations without providing fair and balanced treatment of any material risks or material limitations associated with those benefits;
- Include reference to specific investment advice provided by the adviser where such advice is not presented in a fair and balanced manner;
- Include or exclude performance results, or present performance time periods, in a way that is not fair and balanced; or
- Be otherwise materially misleading.
Testimonial and endorsement rules
Advisers may use testimonials and endorsements if they meet several requirements. A testimonial is a statement by a current client or investor in a private fund that:
- Discusses the client’s or investor’s experience with the adviser;
- Solicits current or prospective clients or investors to be a client or investor in a private fund of the adviser; or
- Refers current or prospective clients or investors to be a client or investor in a private fund of the adviser.
An endorsement is any statement by someone other than a current client or investor in a private fund of the investment adviser that:
- Indicates support of the adviser or describes that person’s experience with the adviser;
- Solicits current or prospective clients or investors to be a client or an investor in a private fund of the adviser; or
- Refers current or prospective clients or investors to be a client or an investor in a private fund of the adviser.
Advertisements must clearly and prominently disclose whether the person giving the testimonial or endorsement is a client and whether the adviser directly or indirectly provided compensation for the testimonial or endorsement. Advisers must also make disclosures regarding compensation and conflicts of interest.
Oversight and written agreement
The adviser must oversee compliance with the Marketing Rule and enter into a written agreement with any party providing an endorsement or testimonial, with some exceptions.
An adviser may not compensate anyone for a testimonial or endorsement if it knows, or reasonably should know, that the person (or its related entities or representatives) is ineligible due to a disqualifying SEC action or event, such as certain court convictions or the SEC suspending or barring the person from acting in any capacity under federal securities laws.
Third-party rating rules
Advisers may include a third-party rating in an advertisement if the adviser reasonably believes the survey was structured to allow favorable and unfavorable responses and was not designed to produce predetermined results. The adviser must also disclose the third party that calculated the rating, the date the rating was given and period it was based on, and any compensation directly or indirectly provided.
Performance information in advertisements
The Marketing Rule provides additional requirements and restrictions for the presentation of performance information in advertisements.
The Marketing Rule prohibits all advertisements from including:
- Any presentation of gross performance unless they also present net performance with at least equal prominence for the same time periods and using the same methodology;
- Any performance results, unless they are provided for several specific time periods (one, five, or 10 years) or are the results for private funds;
- Any statement that the SEC has approved or reviewed a calculation or presentation of performance results;
- Related performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those in the advertisement;
- Performance results of a subset of investments extracted from a portfolio, unless the advertisement provides or offers to provide the performance results of the total portfolio;
- Hypothetical performance, unless the adviser implements policies and procedures reasonably designed to ensure the performance is relevant to the likely financial situation and investment objectives of the intended audience and provides sufficient information for the audience to understand the criteria, underlying assumptions, risks, and limitations of the hypothetical; and
- Predecessor performance, unless there is a sufficient similarity with regard to the personnel and accounts between the predecessor and advertising advisers and all relevant accounts are advertised unless the exclusion of any account would not result in materially higher performance. The adviser must include all relevant disclosures in the advertisement.
Revised Books and Records Rule
The SEC updated the Books and Records Rule (Rule 204-2). Advisers must preserve several types of information and documentation, including copies of their advertisements, records of their intended audiences for hypotheticals or performance information, and documentation substantiating their reasonable bases for believing any testimonials, endorsements, or third-party ratings comply with the Marketing Rule.
Updated Form ADV
In connection with the new Marketing Rule, the SEC revised Form ADV requiring advisers to give more information about their marketing activities.
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