Just prior to the new year, the SEC finalized significant changes to rules and forms governing advertising and cash solicitations under the Investment Advisers Act (“IAA”). In the original proposal, introduced more than a year ago (see previous Bates coverage), the SEC sought comment on the first significant changes to investment adviser marketing rules in decades. On December 22, 2020, the Commission issued the new final rule, which replaces both the prior Advertising Rule and Cash Solicitation Rule with a single, broad, “modernized” marketing rule. The new rule also amends investment adviser registration Form ADV and the books and records rule to reflect the related changes. In an accompanying fact sheet, the SEC stated that the Division of Investment Management staff will withdraw previously issued guidance and no-action letters related to the advertising and cash solicitation rules, as those “no longer apply” under the new final rule. Here are some highlights.
Key provisions of the new final marketing rule include the introduction of a definition of the term “advertisement,” prohibitions on numerous advertising practices, strict limitations on the use of testimonials and endorsements, required disclosures and criteria for the use of third-party ratings, and general prohibitions and conditions on the use of performance results or hypothetical performance information. New compliance requirements under corresponding amendments to Form ADV require advisers to provide additional information on their marketing practices to “help facilitate the Commission’s inspection and enforcement capabilities.”
Advertisements
Under the new rule, the definition of “advertisement” includes any direct or indirect communication by investment advisers offering new or additional services to prospective clients, existing clients or private fund investors. (Among a number of exclusions, one notable change from the original proposal is the exclusion of most one-on-one communications under this part of the definition.) The new advertisement definition also covers any compensated endorsement or testimonial provided either directly or indirectly. These two definitional “prongs” largely “capture” the communications covered by the precursor advertising and cash solicitation rules.
Marketing Practices
In general, the marketing rule prohibits practices that result in untrue or misleading statements of material fact. Specifically, these practices include communicating information (i) that may be untrue or misleading (including by omission); (ii) where an adviser does not have a reasonable basis for—and would not be able to substantiate—the information communicated; (iii) concerning potential benefits without communicating material risks or other limitations; and (iv) that is not presented in a fair and balanced manner (e.g., performance results).
CONTACT BATES COMPLIANCE TODAY FOR HELP NAVIGATING AND IMPLEMENTING THE NEW RULE.
Use of Testimonials and Endorsements
The marketing rule imposes disclosure, oversight and disqualification limitations on the use of testimonials and endorsements. To use testimonials, an adviser must disclose whether the endorser is a client or investor, is compensated or has some other conflict of interest. Further, to use testimonials, the adviser must oversee compliance with the rule and “enter into a written agreement with promoters, subject to certain allowances and conditions,” for example, where the promoter is an affiliate or receives de minimis compensation. (Notably, a broker-dealer acting as an endorser could be exempt from the disclosure requirements for a recommendation subject to Regulation Best Interest). Finally, the marketing rule generally disqualifies ineligible persons from acting in a testimonial capacity.
Third-Party Ratings
Disclosures and satisfaction of set criteria are also required under the marketing rule before third-party ratings can be used in an advertisement. The advisor must disclose the identity of the third party, the date and time period of the rating, and direct or indirect compensation by the adviser to the third party. An adviser must have a reasonable basis for believing that the rating was unbiased and not created in such a way as to produce a predetermined result.
Performance Information
Further to the goal of prohibiting misleading information in advertisements, the SEC provided specific requirements on performance information before it can be used. These include prohibitions against the use of information: (i) on gross performance without inclusion of net performance data; (ii) on performance results, without including specific time periods; (iii) suggesting that the SEC reviewed or approved of the advertised performance results; (iv) related to performance results, without inclusion of all related portfolios, and extracted performance results without the results of the entire portfolio; (v) on any hypothetical performance unless the adviser, among other requirements, discloses the criteria used and assumptions made in calculating the hypothetical performance, as well as its risks and limitations; and (vi) on the use of predecessor performance unless the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser were substantially similar and that any advertisement include all relevant disclosures.
The marketing rule and related books, records and Form ADV amendments will be effective 60 days after publication in the Federal Register. Because of the scope and complexity of the rule changes, the SEC has set an 18-month transition period for compliance.
The marketing rule was intended to address technological advances including social media and mobile communications under a principles-based approach to supervision and regulation. In this way, the rule is an attempt to strike a balance encouraging the use of electronic media for adviser marketing purposes, while protecting retail investors from the higher risks of fraud associated with it.
The new marketing rule imposes considerable oversight, recordkeeping and disclosure requirements on investment advisers. The SEC stated it expects that “100 percent” of investment advisers will be involved in activity regulated by the marketing rule. That will require substantial modifications to compliance programs across the industry. Notwithstanding the long compliance transition period, advisers will need to review their current advertising and solicitation policies, make adjustments to their performance presentations and disclosures, ensure effective supervision and set in place new policies and procedures for testimonials and endorsements.
Bates Compliance provides tailored compliance consulting solutions to financial services clients. In anticipation of the compliance transition for the new marketing rule, Bates has formed a team to address investment adviser concern and support efforts to conform oversight, recordkeeping and disclosure requirements under the new rule.
Our compliance team includes senior compliance staff and former regulators, with expertise in the development of policies, procedures, supervisory and compliance processes and best practices to enhance compliance and supervisory systems.
For more information, please contact:
Hank Sanchez, Managing Director – hsanchez@batesgroup.com
Linda Shirkey, Managing Director – lshirkey@batesgroup.com
David Birnbaum, Managing Director – dbirnbaum@batesgroup.com
Rory O’Connor, Director – roconnor@batesgroup.com
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