SEC’s New Marketing Rule For Investment Advisers Goes Into Effect – Media, Telecoms, IT, Entertainment

The US Securities and Exchange Commission’s long-awaited
modernization of the rules governing the advertising and cash
solicitation practices of investment advisers registered or
required to be registered with the SEC was approved on December 22,
2020 and went into effect on May 4, 2021. The SEC effectively
merged changes to the advertising and the cash solicitation rules
into a single rule-referred to as the “Marketing
Rule”-which is codified in Rule 206(4)-1 under the Investment
Advisers Act of 1940, as amended (the Advisers Act). In connection
with adopting the Marketing Rule, the SEC also adopted related
amendments to its books and records rule (Rule 204-2 under the
Advisers Act) and to Form ADV. Since much of the SEC’s existing
marketing guidance has been formulated through successive no-action
letters, the SEC has indicated that it will provide future guidance
as to which no-action letters are incorporated in or superseded by
the Marketing Rule and will be withdrawn, and which no-action
letters will survive.

Investment advisers will have an 18-month transition
period-until November 4, 2022-to comply with the Marketing Rule and
the amended books and records rule and Form ADV. Early compliance
is permitted, so long as the adviser elects to comply with the new
rules in their entirety from the time of such election. Partial
compliance is not permitted.

Highlights

• The Marketing Rule seeks to address technological advances and
  evolving market practice by, among other measures, modifying the
  definition of “advertisement.” Advertisements include any
  direct or indirect communication from an adviser to more than one
  person (or to just one person if the material in question includes
  hypothetical performance) that offers the adviser’s investment
  advisory services, or that offers new services to existing clients.
  Notably, the Marketing Rule now treats indirect communications,
  such as third-party social media comments that an adviser endorses
  or promotes, and nonwritten communications, such as pre-recorded
  videos, as “advertisements,” subject to the relevant
  provisions of the new rule. Conversely, the Marketing Rule
  expressly excludes extemporaneous live communications from the
  definition of “advertisement.”




• The Marketing Rule replaces certain per se prohibitions that
  existed in the prior rules with a more flexible principles-based
  framework. For instance, the new rule permits advisers to highlight
  specific past investment recommendations in an advertisement
  without including a full year of recommendations, so long as the
  adviser presents the recommendations in a fair and balanced
  manner.




• In addition to communications with advisory clients, the
  Marketing Rule now expressly covers communications with investors
  in private funds that rely on Section 3(c)(1) or 3(c)(7) to avoid
  registration as an investment company under the Investment Company
  Act of 1940, as amended.




• The Marketing Rule does not generally consider communications
  with existing investors or clients that do not offer new or
  additional advisory services to be “advertisements.”




• The Marketing Rule does not consider any of the following to be
  “advertisements”: a description of material terms,
  objectives and risks of a fund offering included in private
  placement memoranda; account statements, transaction reports and
  other similar materials delivered to existing investors in private
  funds; and presentations to existing clients concerning the
  performance of private funds they have invested in (for example, at
  annual meetings of limited partners).




• The Marketing Rule generally does not cover any one-on-one
  communications with prospective or current investors in private
  funds. The rule considers one-on-one communications with other
  prospective or current advisory clients to be advertisements, but
  only if the communication includes hypothetical performance and the
  adviser is not providing the hypothetical performance in response
  to specific and unsolicited questions or requests from the advisory
  client.

Disclosure Obligations Generally

• The Marketing Rule prohibits
  advisers from making any untrue statement of a material fact, or
  omitting to disclose any material fact necessary to make a
  statement, in light of the circumstances in which such statement
  was made, not misleading. Advisers are also prohibited from
  including in an advertisement any material statement of fact that
  the adviser does not have a reasonable basis for believing that it
  will be able to substantiate upon SEC demand. These requirements,
  which include essentially a “10b-5” standard, are not
  technically new, but shift no-action letter guidance into the
  Marketing Rule and emphasize the importance of being able to
  document or substantiate statements used in advertising materials
  in order to show that such statements are not materially
  misleading.

• The Marketing Rule requires advisers to provide a number of
  disclosures in connection with
  testimonials (broadly, a statement by a
  client about the adviser’s services that operates to approve
  the services of an adviser or to solicit or direct business to an
  adviser) or endorsements (broadly,
  statements by persons that are not clients, which may include,
  among other communications, statements about the personal qualities
  of an adviser and statements by placement agents) that are used as
  or in advertisements. These disclosures include statements
  regarding the status of the promoter, whether compensation is paid
  to the promoter, and the existence of material conflicts of
  interests. These required disclosures must be set forth
  “clearly and prominently” within the advertisement.
  Advisers are also required to disclose material terms of applicable
  compensation arrangements and more detailed descriptions of
  material conflicts of interest in connection with testimonials and
  endorsements; however, such disclosures are not subject to the
  clear and prominent requirement and can be provided
  separately.




• Registered broker-dealers who solicit entities or individuals
  that are not investing for personal, family or household purposes
  are only required to provide the “clear and prominent”
  disclosures described above. Registered broker-dealers who solicit
  individuals who are investing for personal, family or household
  purposes, and certain investment adviser personnel, are generally
  excluded from the disclosure requirements for testimonials and
  endorsements. Note that registered broker-dealers remain subject to
  Financial Industry Regulatory Authority Inc. marketing rules which
  are unchanged by the Marketing Rule.

Treatment of Performance Data

• The Marketing Rule allows advisers to use third-party ratings
  in an advertisement, subject to certain conditions, including
  certain disclosure obligations and a requirement that the adviser
  have a reasonable basis to believe that the questionnaire or survey
  used to prepare the third-party rating is not designed to produce
  unfair results.




• The amended books and records rule generally requires an
  adviser to keep, among other things, copies of all advertisements
  disseminated by such adviser. The amended rule also requires
  advisers to keep copies of, inter alia: written communications
  relating to, and documentation supporting the calculation of,
  performance or rate-of-return calculations for both private funds
  and proprietary accounts; documentation substantiating the
  adviser’s reasonable basis for believing that a testimonial,
  endorsement or third-party rating complies with the applicable
  tailored requirements of the Marketing Rule; and a record of the
  disclosures delivered to investors in connection with testimonials,
  endorsements and third-party ratings.




• Form ADV has been amended to include a new subsection
  addressing a registered adviser’s marketing activities. Item 5
  of Part 1A of Form ADV will require information about an
  adviser’s and its relying advisers’ use in any
  advertisements of (a) performance results, (b) previous investment
  advice, (c) testimonials, (d) endorsements, and (e) third-party
  ratings.

Key Takeaways for Fund Managers

In anticipation of complying with the Marketing Rule, advisers
should:

• Prepare to be in compliance with the new Marketing Rule and the
  revised books and records rule no later than November 4, 2022.




• Update any investor communications that would be considered
  advertisements, including offering materials such as private
  placement memoranda (to the extent they include marketing
  information), pitchbooks and other marketing materials, and be
  prepared to substantiate any statements of material fact included
  in such materials.




• Adopt and/or update policies and procedures to comply with the
  new rules, including policies and procedures that govern
  communications with clients, social media use and other online
  marketing, and the use of testimonials and endorsements.




• Carefully assess the prospective use of testimonials and
  endorsements provided by others. Consider when they may be
  attributed to the adviser and become subject to the provisions of
  the Marketing Rule.




• Before providing any benefit to a person that provides or will
  be providing a testimonial or endorsement, consider whether that
  benefit may constitute compensation for the testimonial or
  endorsement, whether compensation may be provided to that person
  and whether a written agreement is required with respect to the
  benefit so provided.




• Prepare to comply with expanded recordkeeping requirements,
  including new recordkeeping requirements that apply with respect to
  performance-related communications and calculations of private
  funds and proprietary accounts.




• Use the updated Form ADV (and respond to the new questions)
  when filing your first annual amendment after the compliance
  date.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.