SEC Adopts New RIA Marketing Rule

On December 22, 2020, the Securities and Exchange Commission (“SEC”) finalized reforms under the Investment Advisers Act of 1940 (“Act”) to modernize rules that govern investment adviser advertisements and payments to solicitors (the “Marketing Rule”).  The SEC reflected, in its 430-page release, that the amendments are intended to create a single rule that replaces the current advertising and cash solicitation rules.

The intent of the new rule is to replace the current advertising rule’s broadly drawn limitations, with principle-based provisions designed to accommodate the continual evolution and interplay of technology and advice, and to that end, includes tailored requirements for certain types of advertisements.  For example, the Marketing Rule will require advisers to standardize certain parts of a performance presentation in order to help investors evaluate and compare investment opportunities, and will include tailored requirements for certain types of performance presentations. Additionally, advertisements that include third-party ratings will be required to include specific disclosures to prevent them from being misleading. The Marketing Rule also will permit the use of testimonials and endorsements, which include traditional referral and solicitation activity, subject to certain conditions.

With the above in mind, the following is a brief overview of the Marketing Rule.  We will follow-up this overview in the near future with a more detailed discussion of advertising, the use of testimonials, endorsements, third-party ratings, performance disclosures and the utilization of solicitors pursuant to the Marketing Rule.  It should also be noted that the Marketing Rule applies to all investment advisers registered, or required to be registered, with the SEC.  As such, it does not apply to exempt reporting advisors, who are not required to register with the SEC, or state registered investment advisers.

The Marketing Rule

The amendments to Rule 206(4)-1 set forth in the Marketing Rule will replace the broadly drawn limitations and prescriptive or duplicative elements in the current rules with more principles-based provisions, as described below.

 Definition of Advertisement

 The amended definition of “advertisement” set forth in the Marketing Rule contains two prongs: one that captures communications traditionally covered by the advertising rule, and another that governs solicitation activities previously covered by the cash solicitation rule.

  • First, the definition includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The first prong of the definition excludes most one-on-one communications and contains certain other exclusions.
  • Second, the definition generally includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).

General Prohibitions

The Marketing Rule will prohibit the following advertising practices:

  • Making an untrue statement of a material fact, or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading.
  • Making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC.
  • Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the adviser.
  • Discussing any potential benefits without providing fair and balanced treatment of any associated material risks or limitations.
  • Referencing specific investment advice provided by the adviser that is not presented in a fair and balanced manner.
  • Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.
  • Including information that is otherwise materially misleading.

Testimonials and Endorsements

The second prong of the definition of advertising address testimonials and endorsements.  In general, the marketing rule prohibits the use of testimonials and endorsements in an advertisement, unless the adviser satisfies certain disclosure, oversight, and disqualification provisions:

  • Disclosure.  Advertisements must clearly and prominently disclose whether the person giving the testimonial or endorsement (the “promoter”) is a client and whether the promoter is compensated. Additional disclosures are required regarding compensation and conflicts of interest. There are exceptions from the disclosure requirements for SEC-registered broker-dealers under certain circumstances. The rule will eliminate the current rule’s requirement that the adviser obtain from each investor acknowledgements of receipt of the disclosures.
  • Oversight and Written Agreement. An adviser that uses testimonials or endorsements in an advertisement must oversee compliance with the marketing rule. An adviser also must enter into a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives deminimus compensation (i.e., $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months).
  • Disqualification.  The rule prohibits certain “bad actors” from acting as promoters, subject to exceptions where other disqualification provisions apply.

Third-Party Ratings

 The rule prohibits the use of third-party ratings in an advertisement, unless the adviser provides disclosures and satisfies certain criteria pertaining to the preparation of the rating.

Performance Information Generally

The rule has modified and clarified performance advertising, and  prohibits any advertisement that includes the following:

  • Gross performance, unless the advertisement also presents net performance.
  • Any performance results, unless they are provided for specific time periods in most circumstances.
  • Any statement that the SEC has approved or reviewed any calculation or presentation of performance results.
  • Performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement, with limited exceptions.
  • Performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio.
  • Hypothetical performance (which does not include performance generated by interactive analysis tools), unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the adviser provides certain information underlying the hypothetical performance.
  • Predecessor performance unless there is appropriate similarity with regard to the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.

Amendments to the Books and Records Rule

In connection with the marketing rule amendments and merger of the current advertising and cash solicitation rules, the SEC also adopted amendments to the books and records rule.  These rules require investment advisers prepare and keep records of all advertisements they disseminate, including oral testimonials and oral endorsements, evidence written approval of all advertisements, and any communication or other document related to the investment adviser’s determination that a third-party rating, testimonial or endorsement complies with the Marketing Rule. Additionally, the revised rules address additional records related to performance advertising.

Amendments to Form ADV

In order to better understand advisers marketing practices and facilitate the SEC’s inspection and enforcement capabilities, the SEC is adding a new Section L (“Marketing Activities”) to the Form ADV to require advisers to provide additional information regarding adviser’s use in its advertisements of performance results, testimonials, endorsements, third-party ratings, and references to its specific investment advice. The SEC is also amending the Form ADV Glossary to incorporate the Marketing Rule’s definitions for “advertisement,” “endorsement,” “hypothetical performance,” “testimonial,” “third-party rating,” and “predecessor performance.” It should be noted that because new subsection L is included under Item 5 of Form ADV, advisers will be required to update responses to these questions in their annual updating.

 Withdrawal of Staff Guidance

The SEC will withdraw no-action letters and other previously issued guidance addressing the application of the advertising and cash solicitation rules, as those positions are either incorporated into the final rule, or will no longer apply. A list of the letters will be available on the SEC’s website.

 Effective Date

The modified marketing rule will be effective 60 days after publication in the Federal Register (which has not been published as off the date of the article); however, the SEC has adopted a compliance date that is 18 months after the effective date, to give advisers a transition period to comply with the amendments.