The compliance date for the SEC’s new investment adviser Marketing Rule is November 4, 2022, allowing just over a month for an investment adviser to finalize its implementation process to comply with the Rule, which applies to activities formerly covered by the advertising rule and the cash solicitation rule.[1]
Underlining the importance of the November 4th compliance date for the new Marketing Rule, this week, the SEC’s Division of Examinations published a risk alert (the “Risk Alert”) reminding investment advisers of their upcoming obligations under the new Rule and potential areas of focus in upcoming examinations.[2] Examination alerts preceding the compliance date for a major rule implementation have historically signaled a forthcoming examination (and sometimes enforcement) initiative. Investment advisers should consider themselves “on notice” that the SEC intends to scrutinize investment advisers’ marketing practices beginning later this year and into 2023.
This Alert briefly summarizes the Rule’s key components and provides action items an investment adviser should consider now. We have also developed a more comprehensive compliance checklist that details an investment adviser’s obligations under the Rule.
Key Elements of the Marketing Rule
The Marketing Rule changes the regulatory approach to investment adviser marketing practices in several key ways:
- Principles-based Prohibitions. The Rule includes seven principles-based prohibitions that apply to all advertisements, which track existing anti-fraud principles. Assessing whether an advertisement complies with these prohibitions largely depends on the facts and circumstances of the advertisement. Accordingly, a compliance review requires thoughtful attention to both the advertisement itself, as well as the specific audience and context in which it is used.
- Expansion to Solicitation Activity and other Third-Party Communications. To consolidate advertising and solicitation practices into one rule, the SEC adopted a broader definition of “advertisement” to include compensated endorsements made by third parties. The concept of an “endorsement” includes activity that had been covered by the cash solicitation rule, as well as other third-party statements, which effectively broadens the Rule’s scope to various types of third-party communications. The Rule also expressly imposes liability on an investment adviser for communications made by third parties that meet the definition of an advertisement.
- Private Fund Advisers. The Rule expands the definition of “advertisement” to include communications made by an investment adviser to investors in a private fund advised by the investment adviser, even though the ultimate investment decision is transactional and not advisory in nature. Thus, certain portions of PPMs and ancillary fund offering materials will be subject to the Rule’s general prohibitions and specific conditions for performance, testimonials and endorsements, and third-party ratings.
- Performance Advertising. The Rule contains specific conditions that apply to an advertisement that contains certain types of performance, including gross performance, hypothetical performance, extracted performance, related performance, and predecessor performance. These have historically been areas of focus for SEC examination and enforcement, and there are already signals of deeper engagement by the SEC staff on these topics.
- Testimonials and Endorsements. The Rule will permit an advertisement to include testimonials and endorsements, which are generally subject to the following conditions: (i) required disclosures; (ii) adviser oversight and compliance, including a written agreement for certain third parties; and (iii), in some cases, disqualification provisions.
Our Recommendations
The Risk Alert notes that the SEC staff will generally focus examinations of the Rule in the following areas: (1) policies and procedures, (2) whether an investment adviser is able to substantiate statements of material fact in an advertisement upon demand by the SEC staff, (3) performance advertising, and (4) the Rule’s amendments that address recordkeeping and Form ADV disclosures. To address these focus areas and prepare for the Rule’s implementation more generally, we recommend that investment advisers take the following actions as soon as possible in connection with the November 4, 2022, compliance date:
- Update policies and procedures so they are specifically tailored to the investment adviser’s actual practices and, at a minimum, address the Rule’s prohibitions and other key areas (e.g., performance advertising, advertising review, testimonials and endorsements, employee social media use, and third-party ratings).
- Review existing advertisements, including websites, pitch decks, email marketing, template responses to RFPs, social media posts, and other communications and draft updated disclosures. Prepare an inventory of all statements that third parties are known to be making on the investment adviser’s behalf and review the statements for consistency with the new Marketing Rule.
- Assess whether the investment adviser uses affiliated or third-party solicitors or compensates third parties (directly or indirectly) to make statements on its behalf. Investment advisers will need to take specific steps to update any existing solicitation agreements to comply with the Rule and may need new agreements with third-party endorsers captured by the new Rule.
- With respect to private fund advisers, review existing PPMs and other form documents for Marketing Rule issues. We have observed that many private fund advisers include performance information and other promotional material in PPMs and related documents that will likely implicate the Rule.
- Implement an advertisement review process that represents a practical, risk-based approach to the approval process focused on avoiding content that could potentially mislead investors.
- Ensure that the Chief Compliance Officer and other relevant legal and compliance personnel are well versed in the Rule and understand how it applies to common types of advertising that the investment adviser disseminates.
- Implement a recordkeeping process that captures contemporaneous records to substantiate any statements of material fact included in an advertisement. The SEC staff will scrutinize whether advisers are able to promptly furnish records that substantiate such facts in an examination.
Next Steps
Given the complexity of the Rule and imminent SEC staff scrutiny of marketing practices, investment advisers should now be fully engaged in finalizing their implementation of the Rule. Our team has been preparing investment advisers for the Rule’s implementation since the Rule’s proposal and adoption, and we look forward to working with our clients and friends as new market practice develops.
[1] The SEC adopted the new rule on December 22, 2020, in the form of amendments to Rule 206(4)-1 (the “Marketing Rule” or the “Rule”) under the Investment Advisers Act of 1940. The Marketing Rule overhauls previous Rule 206(4)‑1 (known as the Advertising Rule) to cover all investment adviser marketing activity, including solicitation activity. In adopting the Rule, the SEC rescinded the cash solicitation rule, Rule 206(4)-3.
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