December 3, 2019
The Securities and Exchange Commission (the “SEC”) announced proposed reforms to the SEC Rule 206(4)-1 (the “Advertising Rule”) and 206(4)-3 (the “Solicitation Rule”) governing the use of marketing and advertisement by SEC-registered investment advisers on November 4, 2019. The proposed rule amendments (the “Marketing Amendment”) will be the first major amendments to these regulations since the adoption of the rules in 1961 and 1979, respectively. This alert summarizes the proposed changes and highlights key planning considerations for advisers.
Proposed Changes to the Advertising Rule
The proposed reforms to the Advertising Rule aim to update the regulation to reflect changes in the industry since the rule’s adoption in 1961. Other than a minor amendment in 1997, the SEC has failed to update the rule to reflect almost 60 years of changes in technology, modes of advertising, and communication expectations between advisers and their target market that have drastically transformed the industry. If accepted, the proposed changes will replace the original per se prohibitions outlined in the Advertising Rule with a more flexible principles-based approach. The following is a list of proposed revisions to the Advertising Rule:
- Makes an untrue statement of a material fact or omits to state a material fact necessary to make the statement made not misleading in light of the circumstances;
- Makes an unsubstantiated material claim or statement;
- Makes an untrue or misleading implication (or a statement reasonably likely to cause such implication) about a material fact relating to or concerning the investment adviser;
- Implies or discusses potential client benefits without clear and prominent disclosure of associated material risks or other limitations;
- Refers to specific investment advice from the adviser without presenting such advice in a fair and balanced manner;
- Includes or excludes certain performance results or metrics without presenting such results or metrics in a fair and balanced manner; or
- Is otherwise materially misleading.
This broader framework is a clear departure from the current rule’s prohibitions on specific types or modes of advertisements that may be misleading.
- Third-Party Ratings. Third-party ratings are permitted only if the adviser reasonably believes that such rating is designed and prepared to produce unbiased results and is accompanied by certain clear disclosures relating to the timing of the rating, identity of the third party, and any compensation paid in connection with the rating.
- Testimonials and Endorsements. As the use of testimonials in advertising materials is prohibited under the current Advertising Rule, the express allowance of testimonials and endorsements in advertising is a notable change in the Marketing Amendment. With the proposed modifications, investment advisers would be able to promote their services using testimonials and endorsements only if advisers clearly and prominently disclose (a) whether such testimonial or endorsement was given by a client/investor or non-client/non-investor and (b) whether any cash or non-cash compensation was provided in connection with such endorsement or testimonial.
- Gross performance results, unless accompanied by (or promptly followed by) a schedule of fees and expenses deducted to calculate net performance;
- Any statement or implication that the performance information has been reviewed or approved by the SEC;
- Performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered or promoted in the advertisement (with few exceptions);
- Performance results for only a portion of investments within a certain portfolio, unless such advertisement provides or offers to provide such results for the full portfolio; and
- Hypothetical performance, unless the adviser (a) adopts and implements policies and procedures reasonably designed to ensure that performance is relevant to the financial situation and investment goals of the target audience of such advertisement and (b) discloses sufficient information relating to the assumptions used to calculate such performance and the attendant risks and limitations of such data.
Proposed Changes to the Solicitation Rule
Since its adoption in 1979, the Solicitation Rule has applied to only situations in which advisers pay cash compensation to solicitors for services rendered. The proposed Marketing Amendment expands this rule to also apply to situations in which advisers pay any direct or indirect compensation to solicitors, including directed brokerage or fee-reduction arrangements. In addition, the proposed modifications would apply the Solicitation Rule to cover solicitation of existing and prospective investors in private funds.
Though the Marketing Amendment retains most of the current Solicitation Rule’s partial exemptions (such as for solicitors that refer investors for impersonal advisory services like robo-advice), the proposal includes the two new exemptions for de minimis compensation to solicitors (less than $100 in any 12-month period) and firms that utilize certain nonprofit programs. Other changes to the Solicitation Rule include the following:
Proposed Changes to the Books and Records Rule; Form ADV Disclosures
In order to track compliance with the aforementioned changes to the Advertising Rule and the Solicitation Rule, the SEC proposed new record-keeping requirements for advisers under Rule 204-2 of the Advisers Act (the “Books and Records Rule”). Under these proposed modifications, each adviser must make and retain records of each of the following:
In addition, the Marketing Amendment would require advisers to disclose on Form ADV whether any advertisement:
Practical Ramifications for Investment Advisers
These proposed updates to the Advertising Rule and Solicitation Rule aim to provide a framework that will be more “evergreen” in light of continuing changes in technology within the investment advisory industry, expectations of investors when shopping for advisory services, and the types and sophistication of investors seeking services. Such framework is expected to be much more reliant on compliance and policies and procedures approach than in the past.
If adopted, the Marketing Amendment would drastically change the advertising landscape for advisers today and would require increased record-keeping practices and administrative oversight in order to remain in compliance. These proposed versions are subject to public review and comment for the next 60 days.
These materials have been prepared for informational purposes only and are not legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Internet subscribers and online readers should not act upon this information without seeking professional counsel.