SEC Adopts New Marketing Rule For Investment Advisers – Media, Telecoms, IT, Entertainment
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On December 22, 2020, the U.S. Securities and Exchange
Commission (“SEC”) adopted amendments under the
Investment Advisers Act of 1940 modernizing the rules governing
investment adviser marketing. The amendments replace and merge into
a single rule the current advertising and cash solicitation rules.
The amended Rule 206(4)-1 (the “Marketing Rule”) will do
the following:
- update how “advertisements” issued by SEC registered
investment advisers are defined and analyzed;
- replace current per se prohibitions with seven general
principles covering all advertisements;
- set forth specific standards for performance
presentations;
- apply to testimonials and endorsements (including traditional
solicitations) for which cash or non-cash compensation is received;
and
- apply generally to investors in private funds advised by an
investment adviser (“private fund investors”), not just
its advisory clients
Noting that the current advertising and cash solicitation rules
have remained largely unchanged since their adoption more than 50
years ago, the SEC intends the Marketing Rule to incorporate
changes in technology, industry practices, and investor
expectations in seeking advisory services.
Effectiveness, Compliance Period and Effect on No-Action
Letters
The Marketing Rule will become effective on May 4, 2021, the
date 60 days after its publication in the Federal Register on March
5, 2021, and institutes an 18-month transition period before
advisers are required to comply with the rule. This transition
period will end on the rule’s November 4, 2022 compliance
date. As the Marketing Rule is intended to integrate prior
SEC staff guidance under the current advertising and cash
solicitation rules, the SEC expects to nullify or withdraw all
related no-action letters and other staff guidance, or portions
thereof, as of this compliance date.
The Marketing Rule
The current advertising rule establishes four per se
prohibitions on practices that, at the time of enactment, appeared
likely to mislead investors. Specifically, these prohibitions cover
the use of the following:
- client testimonials related to an adviser or its services;
- direct and indirect references to specific investment
recommendations; - representations that any chart, graph or other device can,
alone, be used to determine which securities to buy or sell;
and - representations that services are free of charge, unless the
services are free of charge and all other conditions and
obligations
As investment advisory services have evolved, the SEC believes
that these prohibitions have become both over- and under-inclusive
because they do not reflect the way advisers and investors
currently communicate; do not address new ways in which current
communication channels can mislead (even inadvertently); and
underestimate the value of certain types of communication.
Accordingly, the Marketing Rule will abandon these per se
prohibitions in favor of a robust and more adaptable
principles-based approach, which seeks to minimize the potential
for fraudulent or misleading conduct. In addition, the
Marketing Rule will provide conditions for the use of testimonials,
endorsements, third party ratings, and certain performance
presentations, and make harmonizing updates to Form ADV and Rule
204-2 under the Investment Advisers Act (the “books and
records rule”). Specifically, the Marketing Rule will do the
following:
- Redefine “advertisements” in two parts as follows:
- The first part will capture traditional advertisements,
including those made to private fund investors. Specifically, it
will cover any direct or indirect communication by an investment
adviser that offers its investment advisory services with regard to
securities to prospective clients or private fund investors or
offers new investment advisory services with regard to securities
to current clients or private fund investors. Excluded will be
(i) one-on-one communications, unless they present unsolicited
hypothetical performance information to a non-private fund
investor, (ii) extemporaneous, live, oral communications, and
(iii) information contained in any statutory or regulatory notice,
filing, or other required communication that is reasonably designed
to satisfy the requirements of the notice, filing, or
communication. - The second part will capture, and thus subjects to the
rule’s general provisions regarding advertisements, compensated
“testimonials” and “endorsements” (discussed
below), which will include activity previously covered by the cash
solicitation rule. The exclusion in the first part of the
definition for information contained in a statutory or regulatory
notice, filing, or other required communication will apply to this
second part; the exclusions for one-on-one and extemporaneous,
live, oral communications will not.
- The first part will capture traditional advertisements,
- Establish the following governing principles for
advertisements:
- Not making untrue statements of material facts or omissions of
material facts that, in light of the circumstances, make the
statements made misleading. - Not making material claims or statements without having a
reasonable basis for believing they can be substantiated. - Not making implications that are reasonably likely to cause
untrue or misleading inferences to be drawn concerning material
facts about the adviser. - Not discussing potential benefits without disclosing a fair and
balanced treatment of the associated material risks and
limitations. - Not presenting specific prior investment advice unless done in
a fair and balanced manner (i.e., no
“cherry-picking” of recommendations). - Not including or excluding performance results, or presenting
performance over time periods, unless done in a fair and balanced
manner (i.e., no “cherry-picking” of performance
results). - Not being otherwise materially misleading.
- Not making untrue statements of material facts or omissions of
- Permit the use of testimonials and endorsements, subject to
additional disclosure and oversight conditions and “bad
actor” disqualifications, with certain exceptions.Testimonials
and endorsements generally will cover recommendations, descriptions
of past experiences, solicitations, and referrals made to an
adviser’s clients and private fund investors, with testimonials
being made by an investment adviser’s current clients and
private fund investors and endorsements being made by others. In
addition to complying with the Marketing Rule’s governing
principles for advertisements if a testimonial or endorsement is
captured by that definition, the conditions for using testimonials
and endorsements will be as follows:
- The adviser must disclose, or reasonably believe that the giver
of the testimonial or endorsement discloses, clearly and
prominently at the time the testimonial or advertisement is
disseminated, (i) whether or not the giver is a current client or
private fund investor, (ii) if compensation is being provided, and
(iii) a brief statement regarding the giver’s material
conflicts of interest resulting from its relationship with the
adviser.Such disclosure must also include the material terms of the
applicable arrangement, including a description of any
compensation, and the material conflicts of interest resulting from
such relationship and compensation. This condition will not apply
if the giver is an affiliate of the investment adviser (defined to
include (1) the adviser’s partners, officers, directors, or
employees and (2) persons that control, are controlled by, or are
under common control with the adviser and their respective
partners, officers, directors or employees), but only if the
affiliation is disclosed or readily apparent to the recipient, and
documented by the adviser, at the time the testimonial or
endorsement is disseminated. - The adviser must have a reasonable belief that the testimonial
or endorsement complies with the Marketing Rule. - Any testimonial or endorsement for which compensation (other
than de minimis compensation of less than $1,000 over any
12-month period) is being provided must be governed by a written
agreement between the investment adviser and the giver that
describes the scope of the giver’s activities and the terms of
its compensation. The exemption for testimonials and endorsements
given by the adviser’s affiliates described above will also
apply to this condition. - The adviser cannot provide compensation (other than de
minimis compensation, as described above) for the testimonial
or endorsement if the adviser knows, or in the exercise of
reasonable care should know, that the giver is subject to certain
“bad boy” disqualifications at the time the testimonial
or endorsement is disseminated. This condition will not apply if
the giver is subject to disqualification, but not disqualified, as
a covered person under 506(d) of regulation D, with respect to a
rule 506 private placement, or as a broker-dealer registered under
section 15(b) of the Exchange Act.
- The adviser must disclose, or reasonably believe that the giver
- Permit the use of “third party ratings,” subject to
certain due diligence and disclosure requirements.Third party
rankings will capture all ratings or rankings of an adviser given
by a person (other than a related person of the adviser, within the
meaning of Form ADV) that gives such ratings or rankings in the
ordinary course of its business. In addition to complying with the
general conditions for advertisements, the conditions for using a
third party rating will be as follows:
- The adviser must have a reasonable basis to believe that any
questionnaire or survey used in the preparation of the rating is
structured to make it equally easy for a participant to provide
favorable and unfavorable responses and is not designed to produce
any predetermined result. - The adviser must disclose, or reasonably believe that the
rating discloses, clearly and at least as prominently as the rating
(i) the date the rating was given and time period on which it is
based, (ii) the third party that created or tabulated the rating,
and (iii) whether compensation was provided in connection with the
adviser’s obtaining or using the rating.
- The adviser must have a reasonable basis to believe that any
- Require performance presentations to comply with the following
conditions in addition to the Marketing Rule’s governing
principles for advertisements:
- Any presentation of gross performance must include a
presentation of net performance, calculated over the same period
and using the same type of return and methodology, with at least
equal prominence and in a format designed to facilitate a
comparison between the two. The presentation of net performance
generally must reflect all fees and expenses borne by a client or
private fund investor, with a limited exception for fees paid for
third-party custodial services. Net performance may be based on a
model fee, if the model fee equals the highest fee charged to the
advertisement’s intended audience or if deducting the model
fee, instead of the actual fee, would not increase
performance. - Any performance presentation must include a presentation, with
equal prominence, of performance over one-, five-, and ten-year
periods (or, if shorter, the life of the portfolio whose
performance is being presented), ending no earlier than the most
recent calendar year end (the “required time
periods”).This condition will not apply to the presentation of
private fund performance. - Performance presentations must not include any express or
implied statement that the calculation or presentation of the
performance has been approved or reviewed by the SEC. - An adviser may present the performance of any portfolios with
substantially similar investment policies, objectives, and
strategies as the services being advertised (so-called
“related performance”) only if all related
portfolios are included. If desired, related portfolios may be
presented on a portfolio-by-portfolio basis.Selected related
portfolios may be excluded only if doing so does not make the
performance presented materially higher or alter its required time
periods. - An adviser may present the performance of a subset of a
portfolio’s investments (so-called “extracted
performance”) only if it also presents, or offers to provide
promptly, the performance of the entire portfolio from which the
performance was taken. - An adviser may present hypothetical performance, including
performance derived from model portfolios, back-tested performance,
and targets or projections, only if the presentation sufficiently
discloses the criteria and assumptions underlying the
performance’s calculation and the risks and limitations of
using hypothetical performance in making investment decision, so
the advertisement’s intended audience can understand these
criteria, assumptions, risks, and limitations.In addition, the
adviser must have adopted and implemented policies and procedures
reasonably designed to ensure that any hypothetical performance
presented is relevant to the likely financial situation and
investment objectives of the advertisement’s intended audience.
Presentations of hypothetical performance will not need to comply
with the required time period, related performance, and extracted
performance conditions described above. - An adviser may present “predecessor performance,”
defined as performance of an account or private fund that was
advised by an adviser other than the advertising adviser (the
“predecessor adviser”) for some portion of the period
presented, only if all of the following conditions are satisfied:
(i) those who made the investment decisions at the predecessor
adviser underlying the presented performance manage accounts or
private funds at the advertising adviser (for example, if those
decisions were made by a committee, a substantial identity of its
membership must manage accounts or private funds at the advertising
adviser), (ii) the predecessor performance is of accounts or
private funds that are sufficiently similar to those being marketed
to be relevant, (iii) the performance of all accounts and private
funds managed by the predecessor adviser in a manner substantially
similar to those reflected in the predecessor performance are
included, with an exclusion conditioned on the same criteria as
described for “related portfolios” above, and (iv) the
predecessor performance is accompanied by clear and prominent
relevant disclosures, including that the performance was achieved
by accounts or private funds managed by another adviser, with
relevance generally being determined by reference to the Marketing
Rule’s general principles. In analyzing whether an advertising
adviser sufficiently continues the business of a predecessor so
that these “predecessor performance” conditions will not
apply, the SEC will consider, among other things, if there is a
substantial and direct business nexus between the advisers, if the
advertising adviser was formed in a transaction designed to
eliminate substantial liabilities of the predecessor or spin off
its personnel, and if the advertising adviser has, as applicable,
assumed substantially all of the assets and liabilities of the
predecessor.
- Any presentation of gross performance must include a
Unlike the proposed rule, the final Marketing Rule will not
require investment advisers to review and approve advertisements
for compliance with the rule prior to dissemination.
Changes to Form ADV
The amendments will add Item 5.L to Form ADV, which will require
advisers to report whether their advertisements include any
performance results, hypothetical performance, predecessor
performance, references to prior specific investment advice,
testimonials, endorsements, or third-party ratings and whether any
compensation was provided in connection with the use of
testimonials, endorsements, or third-party ratings.
Changes to Books and Records Rule
Lastly, the amendments ripple through the books and records
rule. Generally, they will require advisers to keep and
maintain records of all advertisements, even if disseminated to
fewer than 10 persons. Accordingly, this threshold under the
current rule will be eliminated as to advertisements, although it
will be retained for non-advertisement notices, circulars,
newspaper articles, investment letters, bulletins and other
communications. As an accommodation for oral advertisements,
advisers will be required only to keep a copy of the written or
recorded materials they use in connection with oral advertisements
or, in the case of compensated oral testimonials and endorsements,
a copy of the disclosures required by the Marketing Rule.
Advisers will be required to keep and maintain all accounts,
books, internal working papers, and any other records or documents
that are necessary to form the basis for or demonstrate the
calculation of any performance or rate of return of any portfolio
(not just management accounts, as required by the current rule), as
well as all information offered or provided pursuant to the
Marketing Rule’s requirements in respect of hypothetical
performance.
In addition, the recordkeeping requirements were added for the
following:
- As to testimonials and endorsements, the adviser will be
required to keep (i) any disclosures required by the Marketing Rule
in respect of but not contained in the testimonial or endorsement,
(ii) documentation substantiating its reasonable basis for
believing that the testimonial or endorsement complies with the
Marketing Rule, and (iii) a record of its affiliated persons
(within the meaning of the exception to the disclosure requirements
for testimonials and endorsements given by the adviser’s
affiliates). - Advisers presenting third party rankings will be required to
keep and maintain, if obtained by the adviser, copies of any
questionnaires and surveys used to prepare third party ratings, as
well as documentation substantiating the rating’s compliance
with the Marketing Rule. - Advisers presenting predecessor performance will be required to
keep and maintain any related communications. - Advisers presenting hypothetical performance or net performance
reflecting the deduction of a model fee will be required to keep
and maintain a record of the advertisement’s intended
audience.
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.
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