MODERNIZED SEC MARKETING RULES FOR INVESTMENT ADVISERS

Alert on Investment Funds and Asset Management

In order to enhance the regulation with regards to promotion and sales practices of investment advisers, last December 22, 2020 the U.S. SEC issued changes (final ruling) to Rule 206(4)-1 which is governed by the Investment Advisers Act of 1940 (aka the Advisers Act). As it is still a necessity under many circumstances, the Rule 206(4)-1 was still considered as the first antifraud provision of the SEC that governs the activities of investment advisers.

The SEC voted to amend the existing version of the Advertising Rule (Rule 206(4)-1) and the Solicitation Rule (Rule 206(4)-3) to create one SEC “Marketing Rule”, in light of the essence to keep up with evolving marketing tactics resulting to the technological advances within the financial marketplace.

In addition to withdrawing dozens of SEC staff no-action letters interpreting the existing advertising and solicitation rules in conjunction with the new SEC Marketing Rule, the Commission will also implement new marketing rules. Investment advisers will need to comply with the SEC Marketing Rule, which will combine principal-based prohibitions with prescriptive requirements for certain content. These no-action letters have set a framework for compliance in the SEC Marketing Rule, which has already been in place for decades.

After 60 days once the Marketing Rule was published in the Federal Register then it will take effect. During the 18-month transition period following the effective date, investment advisers subject to the rule have the option of switching their practices fully to compliance with the final rule.

It is important that investment advisers will note some changes from the current SEC guidelines as they are recently governed by the solicitation and advertising rules. Despite relaxing some restrictions regarding marketing materials, the final rule has imposed several new requirements. Following are a few points I would like to highlight about the final rule.

  • A new Marketing Rule will govern activities that currently fall under the advertising rule and the solicitation rule.
  • Even if fund interests are distributed by a placement agent or another intermediary, investment advisers must ensure that their marketing activities comply with the Marketing Rule.
  • By a more flexible set of rules, there will no longer be any per se restrictions on advertising content under the current rule, and it explicitly permits third-party ratings and testimonials that reference past advertising campaigns.
  • Advisers may compensate third parties for their testimonials and endorsements if they are considered advertisements.
  • Conditions must be met for the use of hypertext links and layered disclosures.
  • However, despite its many unique prescriptive provisions, the Marketing Rule offers a standardized, regulations-based approach to performance marketing that is comparable in many ways to the existing system.
  • Unlike the proposed amendments to the advertising rule made by the SEC in 2019, the final rule does not require corporate employees to obtain pre approval from clients and prospects prior to communicating with them.
  • Despite the final rule’s idea of protecting both sophisticated institutional investors and unsophisticated retail investors, among other recipients of investment performance communications. The final rule, however, includes some exceptions to protect private fund investors.
  • Marketers are not required to disclose individually tailored communications with prospective investors, unless there is a hypothetical element of performance at the time of communication.

A brief description of the final rule is presented in this client alert, in addition to an explanation of some of the issues the rule addresses. The SEC Marketing Rule and its impact on the asset management industry are both complex and will require supplemental alerts in the coming months, with MAH Advising publishing supplemental alerts centered to specific elements of the Marketing Rule and their impact among various market players.

TABLE OF CONTENTS

I. Defining “Advertisement

A. Proposition One – Advertisements

B. Proposition Two – Paid Endorsements and Testimonials

II. Prohibitions in General

III. Endorsements and Testimonials

A. Requirements for Disclosure

B. Ineligibility for Misconduct Offenders

C. Exceptions

IV. Ratings from Third Parties

V. Information on Performance

VI. Portability of Performance

VII. Form ADV Amendments

VIII. Documentation

IX. Letters of No Action Issued by the SEC Staff

X. Compliance Dates and Transition Period

Marketing Rule FAQs

I. Defining “Advertisement

In order to understand the requirements of the SEC Marketing Rule, one must understand the definition of an “advertisement.” Investment advisers are required by the Advisers Act to communicate with investors, however, only advertisements made by registered investment advisers, or those who need to be registered at SEC, must conform to the regulations.

As a response to multiple comments expressing concern about the definition of “advertisement” in the proposed regulation, by narrowing the definition, the SEC eliminated the term “advertisement,” which included most communications with existing clients, stating in the adopting release that it is “intended to include forms of communication that are typically categorized as advertising.” 

It still remains quite broad when it comes to the definition of “advertising”. “Advertising” is conceptually defined in two prongs in the Marketing Rule. Investment adviser advertising falls under the first prong, while compensated testimonials and endorsements fall, and under the second prong, currently treated as solicitations due to the content of paid testimonials and endorsements.

  • Proposition One – Advertisements

In its first prong, the definition of an “advertisement” includes:

“any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance, that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser[.]”

The first prong of the definition of “advertising” includes a few categories of communications which receive special consideration.

  • Live, extemporaneous, oral communication. The definition of advertisement does not include live, immediate, oral communications, whether broadcast or not. As an exception,  speeches, prepared remarks, or other written materials distributed during a presentation, such as scripts, slides, or printed documents, are not included as advertisements if they otherwise qualify. Unlike live, extemporaneous, written communications, like texts or electronic chats, the exclusion is not applicable to these types of communications.
  • Filings and Notices. Notices and filings that are required under applicable statutes will not be regarded as advertisements, provided that the information contains the information required by the filing or notice. In an instance, an advertisement won’t be information that reasonably complies with Form CRS or Form ADV Part 2. The Marketing Rule would still apply to information in an adviser’s regulatory filing that is not reasonably intended to fulfill his or her obligations as described therein and otherwise could be considered advertising.
  • Performance Hypothesis. Advertising is not considered advertising if the presentation of hypothetical performance is: (i) based on a client’s request, or (ii) presented to an investor in a private fund dialogue. In addition to one-on-one communications with prospective advisory clients, all other communications offering investment advisory services are deemed advertisements as defined by the Marketing Rule.

Funds held Privately. The final rule includes communication to “investors in a private fund” in what is considered advertising. Private funds are defined as issuers who would be investment companies if the Investment Company Act of 1940, as amended, did not contain sections 3(c)(1) or 3(c)(7) that define them as such. As a technical matter, private fund investors are not considered to be clients of investment advisers, and the specific advertising regulations do not apply in this situation, but securities law requirements apply to private fund advisers when communicating with them, and the SEC frequently refers to the advertising rule when deciding if communications with private investors constitute misleading statements. 

By definition, advertisements are classified as antifraud communications with private fund investors, so that the specific anti-fraud provisions of the Marketing Rule apply to them. In general, objectives, the material terms, and risks contained in a private placement memorandum (PPM) would not constitute an advertisement; however, if the content is furthered by marketing the investment advisor’s services, that would constitute an advertisement.

A collective investment fund, which relies on section 3(c)(11), was excluded from the marketing rule because they communicate with investors and prospective investors without relying on sections 3(c)(1) or 3(c)(7).

Social media and Content from Third Parties. Advertising is any form of communication from an adviser, whether direct or indirect. The meaning is that if an advisor distributes a communication on behalf of another, then it generally counts as an “advertisement”. According to the Adopting Release, advisors’ endorsement, approval, or involvement in the preparation of third-party information on company websites may be considered indirect “advertising,” if they endorse, approve, or have any other relationship with the information. When a third-party website provides information on performance for an ad, the adviser will be attributed with the content of that website and responsible for that content in the same manner as if the adviser had actually written it. As an adviser, however, you are not considered to be involved in advertising preparation if you revise a third-party communication using objective, predetermined criteria that are not biased in your favor or against you.

  • Proposition Two – Paid Endorsements and Testimonials 

Advertising includes the following as well as the second prong:

“any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly, but does not include any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication[.]”

As part of this prong, the existing solicitation rule is applied to solicitation activities. In words, testimonials are statements from current investors or clients about their experiences with the advisers, while endorsements are statements by individuals who are not current clients or investors and express support, a recommendation of the adviser, approval, or describe the adviser’s expertise. In addition, testimonials and endorsements are statements regarding expertise and capabilities of an  investment adviser regulation matters, as well as statements regarding such capabilities, expertise, or qualities outside of investment advisory services when they reflect such attributes in relation to the investment adviser regulation matters.

Whether direct compensation is provided or indirect payment is a fact-dependent issue. Indirect benefits include, for instance, entertainment and gifts, fees rebates, and other forms of indirect rewards, as long as these forms of rewards are intended to encourage positive remarks about an investment adviser, despite the employee’s monthly bonus and salary for any investment adviser’s activity, administrative, support, clerical or functions alike, in exchange for testimonials or endorsements, compensation is not considered. It was noted in the SEC’s Adopting Release that the term “indirect compensation”, which is open to broad interpretation, was not defined.

It is important to note that the second prong of advertising definition includes private in-person communications and spontaneous, oral communications, live, as opposed to the first prong.

FAQs about “Advertisement” and Its Definition

  • An investment adviser’s “advertisements” are defined as “any direct or indirect communication” in the final rule. What about the communication that was prepared by or distributed by intermediaries (e.g., agents, solicitors)?
  • What is the responsibility of an investment adviser to market a fund released by a fund-of-funds sponsor (or one of the feeder funds)?
  • How can an investment adviser avoid communications posted on the personal social media accounts of an investment adviser’s associated persons being attributed to the investment adviser for purposes of the Marketing Rule?
  • When will an investment adviser attribute the third-party content of a website?
  • What is deemed a “one-to-one presentation” under the Marketing Rule? In some circumstances, may an investment adviser include hypothetical performance information in one-on-one presentations or integrate them into presentations specifically designed for clients or private fund investors?
  • In the final rule, does brand content or whitepaper count as advertisements?
  • Are communications to existing clients or existing investors in private funds considered to be advertisements? Would a prospective investor or client subsequently receive the communication from the investment adviser?
  • For purposes of the second prong of the “advertising” definition, would a website maintained by a lead-generation company or an adviser referral network be considered paid endorsements?

II. Prohibitions in General

To prevent fraudulent, deceptive, or manipulative practices, the SEC Marketing Rule replaces the existing advertising rule’s four prescriptive prohibitions with seven concepts-based prohibited practices. According to a general prohibition, an advertisement cannot:

1. The statement must include any untrue facts, or leave out a necessary term, so as to be clear and not misleading in light of its circumstances.

Example: Incentives to arrange for an investor to be referred to an investment adviser when such investors are not clients or investors in the adviser’s private funds.

2. The statement must not contain any material claim in relation to any fact that a lawyer believes he will be unable to provide evidence for if demanded by the SEC.

Example: Insufficient record of or access to a benchmark securities index that helps substantiate a statement as to the performance of securities markets in a particular region. 

3. If the information contains a reasonable probability of leading to an unfair or misleading conclusion about a material fact concerning the investment adviser, it should be included.

Example: An advertisement that contains a series of literal statements that are all accurate, but that together convey an incorrect or misleading impression about the investment adviser.

4. The investment advisor should explain any potential gains associated with or arising from the method of any investment adviser regulation matters or services, including any risks and limitations associated with those benefits, without putting the potential benefits in a negative light.

Example: Including a hyperlink to a second page that explains all material risks and limitations on a webpage, instead of only advertising profitable investments.

5. Whenever an investment adviser provides specific advice and is not presented in a fairly balanced and honest manner, include a reference to the specific advice.

Example: Advertisements that describe investment advice in the past with insufficient information to evaluate the advice’s value (e.g., a “thought piece” that suggests specific investments following a significant economic event but does not explain the underlying circumstances, for example, the market’s circumstances and necessary investment restrictions).

6. Achieving an unbalanced presentation of performance metrics, or considering periods of performance unfairly.

Example: Those advertisements that offer added information for an investor to evaluate the performance of a product (e.g., information regarding the market conditions at the time, any unforeseen circumstances, or any other significant factors that affected the performance).

7. In the event of a material misrepresentation.

Example: Adverts that contain pertinent information but use font sizes that are too small for understanding.

An analysis of the “Circumstances and Facts.” A description of the general prohibitions listed above must be interpreted in light of the relevant facts and circumstances of each advertisement, including whether certain information is presented fairly and balanced. Investment advisers should be conscious of the sophistication of their clients, including whether they are retail or institutional investors. As an example, a communication targeting a retail investor and containing past investment adviser regulation matters may require additional disclosure to emphasize that past performance is no guarantee of future performance; similarly, a communication targeted to a complex institutional investment may not require as much disclosure. The SEC emphasized that its recent no-action letters from previous recommendations can be helpful to investment advisers in making fair and balanced judgments about communications, but they’re not the only way to satisfy this standard. Investment advisers will benefit from a greater degree of flexibility these standards provide as they can tailor advertisements based on a specific investment adviser regulation matters and marketing goals.

Provisions that have Practical Implications. As with the proposed rule, the final rule does not place burdensome requirements on pre-use and approval procedures, but advisers need to put in place policies and regulations that are reasonably designed to prevent violations of the Advisers Act, whether committed by the adviser or any of its supervised persons. In addition, a financial adviser must have the reasonable belief that material facts can be substantiated upon a request of the SEC. In addition, according to the Adopting Release, the Board will be taking the position that an investment adviser that does not have a reasonable basis to believe that it can provide substantiation on demand does not possess reasonable principles of investment practice. In this regard, investment advisers have a responsibility to develop and implement guidelines for documenting the sources of material facts contained in advertisements and for making reasonable efforts to verify them.

The Adopting Release facilitates the use of layers of information in support of the modernization of registered fund prospectus disclosures and shareholder reporting. While hyperlinked or other layers of disclosure are not directly addressed within the rule, in the Adopting Release, the SEC specifies that certain conditions should be met before hyperlinked or other layers of disclosure are permitted. Generally, hyperlinks cannot be used to present information in a prominent and easy-to-read manner, and each disclosure layer of a statement should be transparent and up-to-date without referring to other disclosure layers.

FAQs about Prohibitions in General

  • Investment advisers are only allowed to make material statements of fact in advertisements if they believe they can substantiate them upon request by the SEC. With regard to material statements of fact, how can investment advisers demonstrate the requirement of “reasonable basis”?
  • Does the Marketing Rule allow case studies?
  • Using balanced and fair timeframes of performance is the goal of an investment adviser, how can they achieve this?
  • The Marketing Rule requires disclosure by investment advisers. But how can that be achieved?
  • Is it prohibited for an adviser to include a testimonial in an advertisement if it is likely to lead to an inference or inference that is misleading or untrue regarding a material fact regarding the investment adviser?

III. Endorsements and Testimonials

SEC Marketing Rule permits disclosures and conditions regarding endorsements and testimonials that are more flexible than current advertising rules. In part because of this integration of many elements of the solicitation rule when it comes to marketing rule by treating paid marketers as endorsements and testimonials, there are still a number of specific requirements that must be met for the use of testimonials. Moreover, the new Marketing Rule extends the recent solicitation rule’s scope to include payments other than cash.

A. Requirements for Disclosure

Disclosures of Importance. According to the SEC Marketing Rule, an adviser must provide a clear and prominent disclosure of the following when disclosing a testimonial or endorsement, or reasonably believe that the person providing the testimonial or endorsement will disclose the following:

  • Client or investor testimonials were given by current clients and endorsements were given by persons other than clients or investors;
  • Payments for testimonials or endorsements, if applicable, were made in cash or non-cash;
  • The adviser should disclose any material conflict of interest that may arise because of the adviser’s relationship with the person who is giving the testimonial or endorsement.

Disclosures of Other Information. In addition to requiring disclosures of testimonials and endorsements, the Marketing Rule also requires the adviser to disclose certain information to clients and prospects:

  • Details of any compensation agreement, including an explanation of how the person will be compensated directly or indirectly for their testimony or endorsement; and
  • In the event of material dilution of interests arising from the relationship between the adviser and the endorser and/or compensation arrangements with that endorser should be disclosed.

The Compliance and Oversight of Advisers. In accordance with the Marketing Rule, advisers must oversee and comply with testimonials and endorsements, including uncompensated testimonials. A marketing adviser must, in particular, possess the following:

  • It must be in accordance with the rule to believe that a testimonial or endorsement is accurate;
  • When the adviser provides compensation for testimonials and endorsements above US$1,000 over a 12-month period (written agreement requirement), the adviser must have a written agreement with the person giving a compensated testimonial or endorsement which sets out the scope of the agreed-upon activities and terms of compensation.

B. Ineligibility for Misconduct Offenders

An adviser, under the SEC Marketing Rule, may not compensate anyone, indirectly or directly, for an endorsement or testimonial if an investment adviser knows, or reasonably ought to know, in the disqualification provision, which is when a testimonial or endorsement is disseminated, the person giving it is an ineligible person. A testimonial or endorsement that is uncompensated is not disqualified.

Inferred eligibility for the marketing rule is if the individual has been issued an SEC opinion or order disqualifying them from acting as an investor pursuant to federal securities laws or has had other disqualifying circumstances occur, under the SEC Marketing Rule. 

A person is deemed ineligible if he or she is a manager, officer, director, general partner, manager or employee of that person. According to the SEC Marketing Rule, all “disqualifying events” are looked back on for a ten-year period, which coincides with the forms used for disciplinary disclosure.

C. Exceptions

There are some exceptions to the requirements that may otherwise apply to endorsements and testimonials under the Marketing Rule:

Compensation De Minimis. In addition, endorsements and testimonials distributed for no payment or for small compensation (i.e. $1000 or less per year) are not subject to disqualification for ineligible persons and to the written agreement requirement. These communications are however still subject to general adviser oversight requirements and disclosure requirements under the rule.

Employees of Affiliates. In the case of testimonials or endorsements from an advisor’s employees or affiliates, neither disclosure rules nor written agreement requirements apply, but the adviser will be subject to general oversight and disqualification requirements. Whenever a testimonial or endorsement is disseminated, the client or investor must be aware of or informed of the adviser’s affiliation with such person, and such person’s status must be documented.

Broker-Dealer Registered Brokers. In addition to meeting the requirements of Section 15(b) of the Securities Exchange Act of 1934 (Exchange Act), a testimonial or endorsement by a broker or dealer is not required to meet any of the following requirements.

  • The requirements of disclosure for endorsements or testimonials if they are recommendations subject to Regulation Best Interests;
  • “Other disclosures” requirements in the event that the endorsement or testimonial is provided to a person that is not a retail customer (as that term is defined in Regulation Best Interest); and
  • If the dealer or broker has not been disqualified by the Exchange Act, the disqualification provision applies.
  • Regulation D Rule 506(d) Covered Persons. Similarly, a person whose endorsement or testimonial is covered by Rule 506(d) of the Securities Act that is associated with a Rule 506 transaction in a way that is not disqualifying is not disqualified under that rule. 

This will have the practical effect that non-broker/dealer placement agents, that includes the banks, as well as other service providers such as the family offices and registered investment advisers, are not required to comply with two different disqualification criteria while private funds are being recommended as outlined in Rule 506 of Regulation D.

FAQs about Endorsements and Testimonials

  • What are the differences between current promoters and solicitors as governed by the Marketing Rule?
  • How do you define “clear and prominent” when it comes to disclosures? The Marketing Rule requires investment advisers to make prominent disclosures. Can they utilize hyperlinks to those disclosures?
  • Are there any terms and conditions that an investment adviser must agree to with a promoter? What changes will need to be made to current solicitation agreements?
  • What is the level of diligence that a marketing rule compliance expert must demonstrate to satisfy that an endorsement or testimonial meets the requirements for its compliance?
  • Investing advisers will need to perform what degree of diligence to ensure that a potential solicitor or promoter is not disqualified?
  • Are investment advisers mandated to monitor compensated promoters’ eligibility in regard to websites posts that remain on the web for an extended period of time under the Marketing Rule?
  • In a one-on-one presentation, could a compensated endorsement or testimonial from a firm’s employee be considered advertising?

IV. Ratings from Third Parties

Third-party ratings are prohibited from appearing in advertisements, save for certain prohibitions and conditions in the Marketing Regulation. Those who are not related to the consultant and who offer independent ratings and rankings of the consultant in the normal course of business are defined as third-parties for the Marketing Rule.

A third-party rating in an advertisement may not be included by an investment adviser unless the adviser complies with the Marketing Rule’s general prohibitions and conditions.

  • It is reasonable to believe that any survey or questionnaire devised for the purpose of preparing the third-party rating is designed or prepared so that it is equally easy for a participant to respond in a favorable or unfavorable way (due diligence requirement);
  • Provides clear and prominent disclosure, or reasonable grounds to believe the third-party rating does:
  • The date, as well as the period of time that was considered in determining the rating;
  • Names of the third parties who tabulated and created the ratings; and
  • The adviser may have received compensation directly or indirectly if he obtained or used the third-party ratings.

FAQs about Ratings on Third-Parties

  • In what way can an adviser determine that a third-party rating is not predetermined by the questions or survey used?
  • Even with the three public disclosures outlined above, would a third-party rating still be in violation of the Marketing Rule?

V. Information on Performance

According to the SEC, there is a heightened risk that financial results may be misrepresented because of the Marketing Rule. Unlike the proposal, the SEC Marketing Rule does not distinguish between performance advertisements for retail investors and non-retail investors, meaning there are specific performance guidelines basically meant to protect the unsophisticated retail investor that must appear in sophisticated institution-targeted advertisements.

The Marketing Rule specifically prohibits the following in advertisements:

  • Results presented on a gross basis (which includes extracted performance results as well as hypothetical results) unless the advertisement includes net performance data (i) to the same degree as gross performance data, and present it in a format for comparison ; and (ii) calculated using the same method, return, and timeframe as gross performance data;
  • Except for the performance that are for one-, five- or ten-year periods or are for private funds, any performance results;
  • The SEC has approved or reviewed the presentation or calculation of performance results in any way, whether implied or explicit;
  • A comparison between the performance of similar or comparable portfolios to those offered in the advertisement, unless the comparison includes all portfolios with investment policies, objectives, and strategies equivalent to those offered in the advertisement;
  • Unless the advertisement offers or provides the performance results of the total portfolio from which the performance was extracted, it can only relate to a subset of investments from a portfolio (also referred to as a “carve out” or “segmented” performance);
  • Performance predicted by the adviser, except if:
  • Adopts and implements policies and procedures to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience;
  • Ensures that the intended audience is provided with sufficient information in order to understand the underlying assumptions and criteria used to calculate such hypothetical performance; and
  • Provides (or offers to provide, in the case of a private fund audience) sufficient information to help the intended audience understand the risks and limitations associated with using hypothetical performance as a basis for investment decisions.

FAQs about Hypothetical Performance

  • In what way should an investment advisor assess whether hypothetical performance matches the likely financial situation and investment goals of the target audience?
  • Is the Marketing Rule in line with the classification of investment analysis performance as “hypothetical performance”?
  • Under the Marketing Rule, are target performances considered hypothetical results?

FAQs about Net Performance

  • In general, how should net performance be calculated according to the Marketing Rule?
  • Are model fees applicable to the Marketing Rule calculation of net performance?

FAQs about Carve-Outs and Extracted Performances

  • Does a carve-out performance have to be disclosed under the Marketing Rule?

FAQs about Performance

  • If an investment adviser manages other funds with a similar strategy, will the related performance requirement prevent the adviser from displaying a single fund track record?
  • To determine if an investment product is relevant to related performance, refer to what constitutes a “related portfolio”?

FAQs about Performance Timeframes

  • Is it possible to advertise performance results outside of the one-, five-, and ten-year time periods required?

VI. Portability of Performance

Latest advertising regulations do not address the transferability of performance when an investment professional moves to a new investment adviser, and historically, the SEC staff addressed this issue through a series of no-action letters. SEC adopted fourth explicit requirement for presentation of predecessor investment performance in advertisements in the Marketing Rule, which codified these positions for the first time.

  • In accordance with the Marketing Rule, an advertisement can only mention a previous firm’s performance if:
  • Manage accounts at the advertising adviser; basically responsible for delivering previous performance results;
  • There were enough similarities between the accounts managed at the predecessor investment adviser and those at the advertising investment advisor to provide clients and investors with relevant performance information;
  • If the account had been handled similarly, it would not have resulted in a materially higher result, and the presentation of results for the required one-, five-, and ten-year periods would not have been altered;
  • Ensure all relevant disclosures are clearly and prominently listed in the advertisement, including the fact that the performance data was derived from accounts that were managed by another organization.

Additionally, the Marketing Rule also applies to the presentment of prior firm performance, including those provisions that prohibit unfair and unbalanced presentation of performance.

In addition to maintaining all written communications pertaining to predecessor performance, advisers are now obliged to keep all records of performance presentation. Furthermore, the SEC Marketing Rule states that an adviser must possess a reasonable basis to believe that statements of fact appearing in an advertisement will be substantiated (upon demand from the SEC). Consequently, advisers who wish to present their firm’s performance must be in possession of all the original records needed to substantiate the claims. However, the SEC explicitly declined to provide additional flexibility despite acknowledging advisers have a hard time complying with these requirements through the Adopting Release

FAQs about Portability

  • Who are the people primarily responsible for the achievement of previous performance results for an investment adviser?
  • Would it be appropriate to include an account presentative of a previous employer as part of the performance review?
  • Does the investment adviser have access to audit or verification statements that verify past firm performance?
  • Can third-party ratings, endorsements, and specialized investment advice be transferred from one platform to another?

VII. Form ADV Amendments

The SEC also approved amendments to Part 1A of Form ADV that add a new subsection L titled “Marketing Activities”, which requires advisers to answer “Yes/No” inquiries with regards to the marketing practices or activities in which they are involved. This Form ADV amendment was adopted on the basis that it will improve the flow of data to enable SEC staff to conduct their enforcement and examination activities.

As part of this new rule, new Item 5.L will require advisers to state whether they include specific investment advice, performance results, endorsements, testimonials, third-party ratings, and (again in contrast to the proposal rule) hypothetical performance and predecessor performance in their advertisements. The advisers that use endorsements or testimonials, or ratings from third parties to advertise must disclose whether they have received any compensation in exchange for the use of those testimonials, endorsements, or ratings.

FAQs about Form ADV amendments

  • Item 5.L requires investment advisers to update their information when it becomes necessary?

VIII. Documentation

As part of the SEC’s adoption of the marketing rule, Rule 204-2 under the Advisers Act (the recordkeeping rule) was also amended to reflect the changes. For oral advertisements, as well as oral testimonials and endorsements, investment advisers must keep records of all “advertisements” they make and disseminate. Under the new requirement, advisers will be required to maintain advertisements sent to more than one person, instead of just advertisements sent to 10 or more people. It was stated that the enhancements to recordkeeping are intended to assist in the examination and enforcement work of the SEC.

The Marketing Rule also calls for advisers to maintain the following records:

  • Material used or disclosed in oral advertisements in written or recorded form;
  • Any written communications about the return or performance of a particular portfolio;
  • Documents necessary to calculate or justify portfolio performance or rate of return, such as accounts, books, and internal working papers;
  • Documents that illustrate hypothetical performance must include the following supporting documentation: copies of the information provided or offered in accordance with the hypothetical performance section of the Marketing Rule;
  • To keep the records of communications which relates to the performance of the predecessor;
  • As outlined in the Marketing Rule, documents stating what the “intended audience” is, as in the case of hypothetical results and a model fee;
  • Documentation relating to an adviser’s assessment that a testimonial or endorsement meets the Marketing Rule and a third-party rating meets the Due Diligence required by the Marketing Rule; and
  • Any questionnaires or surveys used by a third party to prepare a rating are disclosed in advertisements.

FAQs about Documentation

  • Email advertisements are often sent by investment advisers. How can email archives be used for compliance with recordkeeping regulations?

IX. Letters of No Action Issued by the SEC Staff

As part of its marketing rule, the SEC staff will withdraw all no-action letters pertaining to solicitation and advertising rules and all other guidance related to such rules. This list of withdrawn guidance and no-action letters will be published on the SEC’s website along with the compliance date.

Therefore, investment advisers have 18 months to improve their marketing practices and reduce the likelihood of relying on no-action relief that has been replaced by the Marketing Rule and to take steps to adjust their solicitation and advertising practices to comply with the Marketing Rule. As noted in the Adopting Release, investment advisers may remain guided by no-action letters issued by the SEC that are not compliant with the Marketing Rule following the effective date of the Marketing Rule.

FAQs about Letters of No Action Issued by the SEC Staff

  • When should a marketing rule-compliant investment adviser move away from the current no-action relief and adopt the current Marketing Rule?
  • In what cases will letters of non-action be withdrawn?
  • Would the SEC be willing to formally withdraw recent guidance and no-action relief related to both activities that fall within and outside of the scope of the Marketing Rule? What about the use of related performance for registered funds?

X. Compliance Dates and Transition Period 

Upon publication in the Federal Register, the Marketing Rule is effective 60 days after publication. Between the effective date of the rule and the compliance date, there is an 18-month transition period, which means ads that run between the effective date and the compliance date will need to comply with the final rules. A transition period of 18 months will also apply to the amendments to the recordkeeping rule. 

After the effective date, and prior to the compliance date, the SEC staff is likely to permit early adoption, but it will likely require full compliance with the Marketing Rule by investment advisers. An approach similar to this would be in keeping with other recent rule changes, preventing investment advisers from cherry-picking portions of solicitation and advertising rules or the Marketing Rule to suit their own needs. The marketing rule will require considerable effort on the part of many investment advisors. In light of the fact that the Marketing Rule now encompasses marketing activities and solicitation practices, new policies must be written to address existing policies.

FAQs about Compliance Dates and Transition Period

  • What are the disadvantages of implementing the Marketing Rule before it becomes effective?

Marketing Rule FAQs

In the Adopting Release, the SEC discusses the Marketing Rule and provides answers to the following frequently asked questions (FAQs). SEC or its staff have not provided or conveyed any legal advice in these answers, which are only for informational purposes. Unless otherwise noted, these FAQs only reflect the most recent update.

“Advertisement” and Its Definition

1. An investment adviser’s “advertisements” are defined as “any direct or indirect communication” in the final rule. What about the communication that was prepared by or distributed by intermediaries (e.g., agents, solicitors)?

It is permissible for an advertisement to constitute an “indirect communication” if it is both developed and disseminated by an investment adviser without actual dissemination or preparation on their part. As an example of indirect communication, the materials shared with intermediaries are cited by investment advisers in the Adopting Release (including consultants and funds of funds) when this material is intended to be made available to third parties. Investment advisers can also be considered to be advertisers within an intermediary’s communication when they contributed to or authorized the communication regarding the investment adviser regulation matters or services.

However, even if advisers aren’t required to supervise intermediaries, they are still subject to the Marketing Rule and must oversee advertising credited to them to make sure they comply with it, regardless of whether the adviser played a direct or an implicit role in its creation or dissemination. It is not necessary that the material be attributed to an investment adviser if the adviser is active in creating the material. The investment adviser will not be responsible for any changes made to the marketing piece by an intermediary not accepting the investment adviser’s comments, or the intermediary making unauthorized modifications to the marketing piece without its consent.

2. What is the responsibility of an investment adviser to market a fund released by a fund-of-funds sponsor (or one of the feeder funds)?

Marketing materials provided by a fund adviser to a fund sponsor (as part of a feeder fund structure) are responsible for the sponsor distributing their materials with the adviser’s permission. As a result, an investment adviser won’t be liable for materials distributed to a fund-of-funds sponsor, should the sponsor disseminate them to third parties without the investment adviser’s permission. It does not matter if the advisor anticipated that the sponsor would redistribute the materials if the sponsor made unauthorized changes to the materials before disseminating them.

3. How can an investment adviser avoid communications posted on the personal social media accounts of an investment adviser’s associated persons being attributed to the investment adviser for purposes of the Marketing Rule?

For investment advisers, the SEC indicated in the Adopting Release, they should adopt and implement procedures and policies reasonably aimed at preventing advisory services regarding securities from being marketed on social media accounts of an associated person. If an investment adviser doesn’t outright prohibit social media communication, the SEC indicated in its Adopting Release that attestation or training may be considered for such communications, as well as monitoring content that is publicly available on the investment adviser’s social media profiles.

4. When will an investment adviser attribute the third-party content of a website?

It depends on the facts and circumstances of the adviser’s involvement in posts posted by third parties on a website or social media pages if the adviser is attributed with the content. It is important that advisers ensure that procedures and policies pertaining to the display and editing of content on social media pages and websites do not give the impression that they are slanting the content toward themselves.

5. What is deemed a “one-to-one presentation” under the Marketing Rule? In some circumstances, may an investment adviser include hypothetical performance information in one-on-one presentations or integrate them into presentations specifically designed for clients or private fund investors?

The Marketing Rule maintains the advertising rule’s exclusion of communications addressed to a single individual from the definition of “advertisement.” This is different from the proposed rule, which included communications addressed to single individuals. It has also been explained that this excludes communication with entities or accounts that represent a number of entities. Investment advisers can, however, communicate with multiple natural persons employed by or owning an entity if that entity is a prospective client or private fund investor.

In addition, specific communication types have been outlined by the SEC that do not qualify for the exemption on a one-to-one basis. Bulk emails and algorithm-driven messages sent ostensibly to a single person but actually disseminated widely are considered advertisements and do not qualify as one-to-one marketing communication. By filling in the name of a potential investor on a template presentation or mass mailing, and by including other basic investor information, you failed to meet the one-to-one requirement. In addition to actual one-to-one communications with hypothetical content, the Marketing Rule will also apply to information that is provided to unsolicited investors or to private fund investors.

6. In the final rule, does brand content or whitepaper count as advertisements?

Brand-building content that does not offer any investment advisory services, but raises the profile of the adviser in general, is usually viewed as neutral content according to the Marketing Rule. In any specific situation, determining whether brand content constitutes advertising must be based on its specifics. An adviser’s market commentary and educational materials in general are also analyzed in the Adopting Release. An advertisement would generally not consist of white papers and other general statements about investment strategies, asset classes, financial markets, or regulations that do not specifically mention a service. The Marketing Rule would apply to the part of the brochure describing aspects of the adviser’s advisory services.

7. Are communications to existing clients or existing investors in private funds considered to be advertisements? Would a prospective investor or client subsequently receive the communication from the investment adviser?

The SEC Marketing Rule recognizes advertisements directed to private fund investors or  existing clients as advertisements only if they provide them with access to new or enhanced investment advisory services. Communications that were intended to convey the results of advisory services previously contracted for but which do not describe the firm’s business plan would not be considered advertising. If offered in connection with advisory services to a potential investor, the same message could likely be considered an advertisement.

8. For purposes of the second prong of the “advertising” definition, would a website maintained by a lead-generation company or an adviser referral network be considered paid endorsements?

Almost identical to traditional non-profit solicitations under the current solicitation rule, “paid endorsements and testimonials” form the second prong of the proposed rule’s advertisement definition. Specifically, the SEC clarified that firms that generate lead generation, sell investment adviser referral programs (operators) to investors, match investment advisers with clients, or otherwise facilitate access to advice to clients when compensated by an investment adviser fall under the definition of paid promoters. Provider services for model portfolios are included in this. As operators typically connect investors with one or more investment advisers by offering to search for them on the platform, and by compensating the advisers, operators do engage in solicitation or referral activities, even though they may not actively promote or recommend specific services or products.

Alternatively, if an investor hires an adviser to assist with the implementation of a request for proposals or manager selection, and the investor agrees to only work with investment advisers who agree to compensate the consultant or advising’s expenses, as stipulated in the Adopting Release, the adviser’s compensation does not constitute an endorsement by the adviser.

Prohibitions in General

9. Investment advisers are only allowed to make material statements of fact in advertisements if they believe they can substantiate them upon request by the SEC. With regard to material statements of fact, how can investment advisers demonstrate the requirement of “reasonable basis”?

SEC members presume investment advisers with no reasonable basis for believing material statements in advertisements have no reasonable grounds for believing them. Investors may produce a contemporaneous record to prove their belief that such claims can be substantiated that elucidates the basis for this presumption. As part of meeting this requirement, advisers may also want to implement policies and procedures. It is possible to determine that, even in the event of changing circumstances or an error, this record set or policy shows that an investment adviser reasonably believed it was capable of doing so at the time of making the statement.

10. Does the Marketing Rule allow case studies?

In certain circumstances, yes. Marketers are required to present any particular investment advice they provide in their advertisements in a way that is both balanced and fair, according to the Marketing Rule. Using case studies to demonstrate an investment adviser’s most profitable investments (along with similarly unprofitable investments) is not likely to be fair and balanced. The investment adviser needs to demonstrate fairness and balance by including unprofitable case studies when applicable and/or by including for at least the relevant period covered by the list of investments the entire performance of the relevant investment strategy. The situations contemplated in prior no-action relief may be presented in many different ways in an equitable way.

11. Using balanced and fair timeframes of performance is the goal of an investment adviser, how can they achieve this?

An investment adviser’s performance may show results that are not comparable to the overall performance if performance results are presented over a short period (e.g., over a period of two months), or over an irregular period of time. These performances would be wrong and prohibited, as they are not fair and balanced. It’s also important to note that any advertising that highlights one exceptional performance period by the SEC and does not describe any unusual circumstances that led to the exceptional performance may not meet the fairness and balance requirements. To be able to present performance results fairly and accurately, there are a number of factors to be considered (as well as reporting results for the specified periods) such as including details about market conditions when the event occurred, difficult or unexpected factors, and other important influences. It is also important that advisers seeking to emphasize certain periods of performance (for example, to demonstrate under which conditions a strategy has performed) ensure in their advertisement that the reader is also given a complete picture of their growth as an adviser over time.

12. The Marketing Rule requires disclosure by investment advisers. But how can that be achieved?

Adopting such a “fair and balanced” standard for disclosures in advertisements will assist in layering information disclosures, as proposed in the Adopting Release for registered fund prospectuses and shareholder reports. As long as the additional content is not misleading or obscures critical information, hyperlinks, QR codes, and mouse-over pop-up windows are permitted. Additionally, each layer of disclosure must meet the balanced and fair standard when it comes to content that must be presented in a “balanced and fair ” manner. This requirement is likely not met, for example only disclosing its positive performance history on its homepage and providing a link to a separate page that contains a detailed disclosure of its material limitations and risks (in addition to violations of the Marketing Rule). The disclosures of specific content must also be clearly emphasized; since they are usually fixed in relation to the material they relate to. Please refer to FAQ [15].

13. Is it prohibited for an adviser to include a testimonial in an advertisement if it is likely to lead to an inference or inference that is misleading or untrue regarding a material fact regarding the investment adviser?

Considering the context and the totality of the information is a requirement of this general prohibition. According to the Adopting Release, investment advisers are not mandated to include equal numbers of negative endorsements in advertisements or to similarly balance positive and negative testimonials. If your adviser does not believe this testimony represents all views, he or she may provide a link to some examples of testimonials. Regarding layering disclosure, please refer to FAQ [12]. While generic disclaimer language such as “these results may not apply to all investors” isn’t sufficient for getting around this prohibition, it is recommended.

Endorsements and Testimonials 

14. What are the differences between current promoters and solicitors as governed by the Marketing Rule?

Specifically, the Marketing Rule applies to both current “solicitor” categories as well as to a new, broader category of “promoters”. SEC applications now include solicitation of private fund investors (instead of just advisory clients). 

Therefore, private fund consultants, capital introduction groups, placement agents, and other marketing parties involved in a fundraising campaign will typically be considered promoters. In examining their relationships with such parties, investment advisers should figure out if compensation is paid directly or indirectly (e.g., through gifts, entertainment, awards, or direct brokerage) for their services, if agreements should be amended, and what actions should be taken to act responsibly.

15. How do you define “clear and prominent” when it comes to disclosures? The Marketing Rule requires investment advisers to make prominent disclosures. Can they utilize hyperlinks to those disclosures?

For the test or endorsement to meet the “clear and prominent” standard, the SEC clarified that disclosures must be included within the endorsement or testimonial. These disclosures are necessary to be provided contemporaneously with an oral endorsement or testimonial. Those disclosures should be read in tandem with the accompanying disclosures. The Adopting Release makes it very clear a hyperlink can’t be used to hyperlink prominent and clear disclosures. Further information about layering disclosure can be found in FAQ [12].

16. Are there any terms and conditions that an investment adviser must agree to with a promoter? What changes will need to be made to current solicitation agreements?

Marketing Rule transactions between advisers and promoters require that the written agreement (i) specify the activities to be performed and (ii) specify compensation to be paid for those activities, which may include indirect compensation based on the Marketing Rule. The adviser should also draft agreements in a way that makes it easy for him/her to determine whether the endorser’s endorsement conforms to all Marketing Rules. In order for advisers to qualify for the exemptions set forth in the Marketing Rule, they should specify their roles and responsibilities to the adviser and promoter with respect to preparing, reviewing, and delivering required investor disclosures, including any conditions that would qualify the endorsements for exemption. In keeping with the marketing rule’s oversight obligations, advisers can include representations and warranties requiring the promoter to periodically submit sample endorsements, disclosures, and other information to the adviser for review and to notify the adviser of any changes in the promoter’s eligibility status or compliance.

17. What is the level of diligence that a marketing rule compliance expert must demonstrate to satisfy that an endorsement or testimonial meets the requirements for its compliance?

As indicated in the Adopting Release, the SEC said auditing the information provided by that promoter to investors would be a reasonable basis for verifying whether information provided by that promoter complies with the rules. The adviser may also enforce rules and regulations in order to assess whether testimonials and endorsements are credible; this could be done by sampling promotions or endorsements from “influencers.” In addition, an adviser could use contractual provisions such as representations, warranties, and other terms to support this reasonable belief. For example, these agreements may contain mechanisms that permit advisers to review endorsers or testimonials in advance or otherwise limit what those statements may say.

18. Investing advisers will need to perform what degree of diligence to ensure that a potential solicitor or promoter is not disqualified?

In order to satisfy the “reasonable care” standard set forth in the Marketing Rule, an adviser is not required to continually monitor the eligibility of promoters. In a Release Adopting this Rule, the SEC explained that depending on the facts and circumstances an adviser must assess eligibility, and what steps an adviser must take to make this assessment. Although advisers may regularly assess promoters’ eligibility in light of their obligations to report promptly certain disciplinary events on Form ADV, the SEC noted in the Adopting Release that advisers may likely monitor promoters in a similar way to monitor their own supervised persons.

19. Are investment advisers mandated to monitor compensated promoters’ eligibility in regard to websites posts that remain on the web for an extended period of time under the Marketing Rule?

SEC has ruled that in cases where endorsements or testimonials are published online and distributed over a long period, it may not be feasible for an adviser to provide continuous updates. If an adviser conducts a review of the eligibility of a compensated promoter more frequently than once a year, it can demonstrate that it did not know, or had reason to suspect, that the promoter had become ineligible at the time the endorsement was made available to clients or investors.

20. In a one-on-one presentation, could a compensated endorsement or testimonial from a firm’s employee be considered advertising?

Yes, possibly, based on your compensation. A marketing disclosure does not include a one-on-one presentation (unless it contains hypothetical performance), but in addition offers the possibility of compensated endorsements and testimonials, within the context of a one-on-one solicitation. For these purposes, compensation will not include regular salaries or bonuses paid to an adviser’s staff for their investment advisory activities, or for clerical, administrative, or support functions.

In spite of this, the final rule partially exempts compensation paid to advisers’ employees who make paid testimonials or endorsements. This exemption applies if the client or investor is clear or aware of the connection between the adviser and employee when the testimonial or endorsement is given, and if the adviser provides documentation of such person’s position at the time the testimonial or endorsement is given. Despite the exemption from disclosure requirements, these testimonials and endorsements must comply with a number of supervisory and disqualifying provisions. It is to be noted however, that under the adviser oversight and compliance provision, a firm’s employees are not subject to an agreement in writing.

Ratings on Third-Parties

21. In what way can an adviser determine that a third-party rating is not predetermined by the questions or survey used?

According to the SEC, an adviser can access the questionnaires or surveys used in rating preparation as part of the due diligence process. On the other hand, the SEC clarified that obtaining the questionnaire or survey used in preparing the rating may not be the sole way to satisfy this requirement, since third-party rating agencies may be reluctant to share proprietary information with advisers (such as their methodology). An adviser could also consult with the third-party rating agency about the general design, structure, and administration of the survey or questionnaire, or it might look, for example, at publicly available information disclosed on the rating agency’s website.

22. Even with the three public disclosures outlined above, would a third-party rating still be in violation of the Marketing Rule

Definitely, yes. A third-party rating is explicitly required to include specific disclosures in the Marketing Rule, however this disclosure would not be enough to correct a rating that would be considered false or misleading under the general prohibitions of the marketing rule or under the antifraud provisions of the advisers act. Ads that refer to a recently published rating and disclose the date are likely to be misleading, for instance, if the rating is based on an aspect of the company’s operations that has since changed significantly. A similar advertisement indicating that an adviser is highly rated without disclosing the fact that the rating is based solely on some criterion, such as assets under management, is misleading.

Hypothetical Performance

23. In what way should an investment advisor assess whether hypothetical performance matches the likely financial situation and investment goals of the target audience?

An investment adviser is not required by the marketing rule to inquire about an audience member’s financial situation and investment objectives in every instance, as mentioned in the Adopting Release. It would be easier to design reasonable policies and procedures that differentiate among different types of investors based on past experiences with particular types of investors. An investment adviser may consider, among other things, a client’s relationship with the adviser, the client’s net worth or investment experience (assuming the investment adviser has this information), specific regulatory requirements (i.e., qualified investors, qualified buyers, or qualified institutions), and whether professionals are the only type of investors. Investors and classes of investors may also ask investment advisers to refer to requests they have previously received to determine whether the performance presentation presented is appropriate to their respective financial situations and investment objectives.

These conditions can pose compliance challenges to private fund managers since many of them lack knowledge of the characteristics of prospective investors before offering documents are distributed. In this case, a fund manager in the private sector could create policies and procedures that would benefit from its previous fund management experience and whether investors in the previous fund valued certain types of hypothetical performance.

24. Is the Marketing Rule in line with the classification of investment analysis performance as “hypothetical performance”?

Not at all. Marketing Rule grants investors the right to advertise hypothetical performance without meeting the relevant conditions. Investment analysis tools are excluded from the definition of hypothetical performance. If you are advertising an interactive investment analysis tool, you should disclose the following information: (i) describe the methodology and criteria used, including any limitations and assumptions of the analysis tool; (ii) describe how results change across uses; (iii) include information about the investment universe considered in the analysis, describe how the tool selects investments, state if the tool favors certain investments, explain why those investments are selected, and explain that there may be similar investments to those being discussed, and (iv) clarify that the tool produces hypothetical outcomes.

25. Under the Marketing Rule, are target performances considered hypothetical results?

In short, yes. In its Adopting Release, the SEC states that the disclosure burden associated with presenting target performance would likely be lighter when compared with other types of hypothetical performance, however, target performance must still be disclosed just like model performance, back-tested results, and other types of hypothetical results, including sophistication investors. A reasonable policy and procedure must be adopted and implemented to assure that the performance target is relevant to the future financial position and investment objectives of the target market.

Net Performance

26. In general, how should net performance be calculated according to the Marketing Rule?

A portfolio’s net performance is the result of its performance (or the performance of any portions thereof, as applicable) minus any fees or expenses paid by the client or investor in relation to investment adviser regulation matters or services provided by the investment adviser. Fees and expenses that must be considered are listed in the Marketing Rule, but it is not exhaustive. Among the notable provisions of the Adopting Release is its description of “advisory fees” as including all performance-related fees that clients or investors have paid or would have compensated for investment adviser regulation matters or services they received from the investment adviser.

As part of the Adopting Release, the SEC clarified the terms of payment for administrative expenses incurred by an investment adviser in connection with the negotiation of a private fund are not included in calculating net performance (at least when marketing advisory services). Moreover, the taxes paid by investors or clients outside of the portfolio cannot be considered revenues or expenses for investment advisory services incurred by clients or investors, therefore, they cannot be deducted from net performance.

Net performance can be calculated without taking into consideration the fees charged by banks and third-party organizations for money management. Investment advisers are frequently unaware of custodian fees since advisory clients typically choose and directly pay them. As a result, those fees cannot be deducted from net performance. The investment adviser provides custodial services to the client or investor, as opposed to a third party (i.e., providing custodial services in relation to the securities or funds included in the performance), and the custodial fee must be subtracted from the profitability calculation.

27. Are model fees applicable to the Marketing Rule calculation of net performance?

There are two scenarios in which model fee deductions may be reflected in net performance. As a first step, a model fee may be applied in case the net performance figures derived from the model are lower than the results if the actual fee(s) had been subtracted. Investment advisors of private funds can, for example, display the results of the highest fee class for a fund that has multiple series or classes. To determine the net performance for the advertisement, model fees equal to the highest fee charged to the target audience may be subtracted from the total. Investors who have different investment strategies but who use the same investment adviser may present performance presented in an advertisement based on a model fee equal to the standard fee charged to the investor who has the highest fee at the time the performance is presented. 

Similarly, the success of a model track record can be calculated by a private equity fund manager according to expenses and fees charged in the fund including transactions from higher-fee funds included in the track record.

Carve-Outs and Extracted Performances

28. Does a carve-out performance have to be disclosed under the Marketing Rule?

It is permissible to present a collection of investments (i.e., a carving-out) extracted from a single portfolio under the Marketing Rule only if the advertisement includes or proposes that the whole portfolio with the performance outputs from which the performance has been extracted. The Marketing Rule makes it relatively easy to carve out performance from a single portfolio.

Advertising carve-out performance that complies with the Global Investment Performance Standards® (GIPS standards) does not violate the Marketing Rule since it does not prohibit displaying a collection of different carve-outs across various portfolios. As a composite, however, the marketing rule would consider it hypothetical, making it subject to the additional marketing requirements that apply to hypothetical advertisements. Thus, companies might have difficulty presenting online the performance of composite products that contain carvings.

Performance

29. If an investment adviser manages other funds with a similar strategy, will the related performance requirement prevent the adviser from displaying a single fund track record?

Not at all. Investment advisers selling specific funds may only show track records of those funds. An investment adviser, however, would need to comply with the related marketing rule requirements if it wishes to show prior performance of funds with similar investment strategies. Under the Marketing Rule, all related portfolios are included in any performance calculation, with one notable exception listed below.

30. To determine if an investment product is relevant to related performance, refer to what constitutes a “related portfolio”?

In the investment industry, a “related portfolio” can be defined as one that is under the management of the investment adviser and has significantly similar investment policies, objectives, and strategies as the services advertised. By way of confirmatory statement, the SEC in the Adopting Release confirmed that an investment adviser may use the same criteria for creating any composites used for purposes of the GIPS standard in order to meet the Marketing Rule’s requirement of being substantially similar. Nonetheless, each set of investment criteria may have no more than one composite aggregate allowed. Furthermore, investment advisers may omit to disclose characteristics of a related portfolio to the extent that the reported performance is not materially different from the results of the entire portfolio, only if it does not affect the results for the prescribed time periods.

Performance Timeframes 

31. Is it possible to advertise performance results outside of the one-, five-, and ten-year time periods required?

Absolutely, yes. If performance results for other periods are presented within the advertisement, these are freely added by the investment adviser, as long as the results are also presented for the prescribed timeframes. Other than that, results of the additional performance must meet the Marketing Rule’s requirements. The Investment Adviser Rule mandates that investment advisers present performance results over a ten-year period, but only if the period clearly follows those specified in the Marketing Rule.

Portability

32. Who are the people primarily responsible for the achievement of previous performance results for an investment adviser?

This “primarily responsible” criterion resembles that in the Horizon no action letter, which is based on who or how much influence an individual may have had over performance (i.e., the extent of the individual’s investment authority). In cases in which more than one person is responsible for managing the account, the person with a significant identity responsible for maintaining the prior performance must continue to be the manager.

33. Would it be appropriate to include an account presentative of a previous employer as part of the performance review?

Certainly, as long as the following requirements are met: (1) the results for the representative account need not be higher than those of all the accounts managed at the institution that precedes the adviser; (2) taking advantage of this representation will not negatively affect performance numbers (for the previously launched firm in addition to the newly launched firm) for the one, five, and ten year periods; and (3) recordkeeping is adequate to support both conclusions. As long as the advertisement shows the performance of any related portfolios included separately or as part of a composite, the advertisement can still feature a representative account performance if the first condition is not met.

Accordingly, an account from a prior firm would not be permitted to report the aggregate performance of that strategy after only eight years of performance (since the advisor would be omitting the money earned during the ten-year period).

34. Does the investment adviser have access to audit or verification statements that verify past firm performance?

Not at all. Keeping the original books and records underlying the performance of predecessors is the only way to verify the performance of predecessors. A review of audit results or verification documents, or re-creation of performance using samples of client statements and/or performance information, would not be deemed adequate to demonstrate prior firm performance and would contribute to material concerns, the SEC asserted.

35. Can third-party ratings, endorsements, and specialized investment advice be transferred from one platform to another?

As for endorsements, testimonials, investment advice, or ratings the SEC did not address these issues specifically in its final rule, but the SEC did make it clear that portability is bound up with the prohibitions in general, possibly prohibiting advisers from using outdated endorsements, ratings, or testimonials.

Form ADV amendments

36. Item 5.L requires investment advisers to update their information when it becomes necessary?

On an annual basis. Advisory responses to subsection 5.L will only need to be updated in their annual updating amendment because subsection 5.L forms part of Item 5 of the Form ADV. Plus, advisers will not have to submit responses to new Item 5.L until after the next annual amendment (or after early adopters comply with the rule) that advisers will have to submit responses to new Item 5.L. The new item 5.L will not be available until the March 2023 annual update for most advisers with December 31 fiscal year-ends.

Documentation

37. Email advertisements are often sent by investment advisers. How can email archives be used for compliance with recordkeeping regulations?

In that case, yes. It is expressly stated in the Adopting Release that an adviser could securely archive records in the cloud (or through a third-party provider) as long as they are promptly able to document the transaction in accordance with the SEC’s guidance on recordkeeping.

Letters of No Action Issued by the SEC Staff

38. When should a marketing rule-compliant investment adviser move away from the current no-action relief and adopt the current Marketing Rule?

The Marketing Rule must be complied with by the Investment Adviser by the compliance date, which is no later than the effective date of this rule. Once the Investment Adviser is prepared to meet all the requirements of the Marketing Rule, it must adhere to the Marketing Rule. Investment advisers are encouraged to evaluate their advertising practices, including any reliance on no-action relief that is not allowed under the Marketing Rule, during the 18-month period between the effective date and the compliance date. According to the Adopting Release, investment advisers may be able to use existing no-action letters as guidelines to ensure compliance with the Marketing Rule.

39. In what cases will letters of non-action be withdrawn?

In addition to publishing no-action letters to be withdrawn before the compliance date, the SEC expects to publish a list of no-action letters for the agency revocation. Due to language in the Adopting Release, it is likely that the SEC will take back, partially or completely, certain no-action relief relating to advertisements that were misleading or certain recommendations made to clients in the past, such as the ability to port over performance. The SEC Marketing Rules’ prohibitions on model performance and requirements regarding presentability and hypothetical performance will likely lead to the withdrawal of some no-action letters. A final no-action letter is likely to be withdrawn since the Marketing Rule definition of “advertisement” has superseded these letters. They will withdraw all no-action letters addressing the solicitation rule because it is being rescinded.

40. Would the SEC be willing to formally withdraw recent guidance and no-action relief related to both activities that fall within and outside of the scope of the Marketing Rule? What about the use of related performance for registered funds?

No-action relief letters or guidance may be fully or partially withdrawn by the SEC, depending on whether or not they are applicable to the topics addressed in them. In light of the Marketing Rule, no-action letters issued by the SEC staff are expected to be withdrawn regarding advisor portability. While they will not be withdrawn, related no-action letters are not being withdrawn for other activities not governed by the Marketing Rule, such as showing performance obtained from prior accounts of an adviser (for example, a private account) and using previous investment pool performance in advertising and filing by the investment companies that are registered.

Compliance Dates and Transition Period 

41. What are the disadvantages of implementing the Marketing Rule before it becomes effective?

Advisers should weigh both the advantages and pitfalls of complying with the Marketing Rule prior to its compliance date when determining whether to comply with it. Investment advisers can benefit significantly from the SEC Marketing Rule, including the opportunity to provide third-party ratings, specific investment advice, and layers of disclosure; however, there are a number of complexities and additional obligations. A number of new rules and regulations the Marketing Rule will introduce will oblige investment advisers to implement new practices and procedures, and their preparation and implementation will have a substantial impact on firms. It may also be necessary to supplement staff and/or adjust reporting lines as well as educate and train advisory personnel on the Marketing Rule. Last but not least, the SEC may release more guidance about the Marketing Rule, which should be taken into account during the transition period.

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