Top Ten List for Complying with the SEC’s New Investment Adviser Marketing Rule | BakerHostetler

Key Takeaways
  • On November 4, 2022, amendments to Rule 206(4)-1 of the Investment Advisers Act of 1940 by the U.S. Securities and Exchange Commission (SEC) formally went into effect to implement the SEC’s new marketing rule (Marketing Rule) for registered investment advisers of all types, including those to hedge funds, private funds, and separately managed accounts.
  • Significantly, the Marketing Rule modernized the advertising and solicitation rules applicable to advisers that had somewhat developed through various no-action letters and other guidance but largely remained unchanged for decades. Those no-action letters and other guidance are now either nullified or incorporated into the new rule.
  • Among other things, the Marketing Rule broadly defines “advertisement” to generally include communications with investors and potential investors on securities advisory services, including testimonials, endorsements, and third-party ratings, but in large part excludes tailored one-on-one communications with investors.
  • The SEC’s Division of Examinations recently announced that it will actively examine compliance with this new rule through a number of specific national initiatives, noting a particular focus on whether advisers have (a) implemented appropriate written policies and procedures, (b) a reasonable basis for believing they will be able to substantiate material statements of fact in advertisements, (c) complied with the rule’s performance advertising prohibitions, and (d) maintained the requisite books and records.

The Marketing Rule seeks to address evolving changes in advertising and referral practices in the industry – particularly with respect to the use of the Internet, mobile applications, and social media – by providing an adaptable framework for the protection of investors. From this point forward, because all SEC-registered investment advisers must comply with the Marketing Rule (subject to certain limited exceptions and exemptions), they would be well advised to consider the following ten points when addressing their marketing practices.

  1. The Definition of “Advertisement” Is Significantly Broad. The Marketing Rule broadly defines “advertisement” as any direct or indirect communication made by an adviser that offers securities advisory services to prospective clients or new securities advisory services to existing clients. To remain evergreen, this sweeping definition includes communications regardless of how they are disseminated – whether (a) via emails, text messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, social media, or otherwise via digital or hard-copy means or (b) by consultants, other fund advisers, promoters, or other third parties. Subject to certain restrictions, this definition also includes compensated endorsements, testimonials, and other statements made by third parties as well as communications by advisers to investors in private funds. There are a few significant exemptions to this definition, namely (i) one-on-one communications with investors so long as they are not compensated testimonials or endorsements and do not include unsolicited hypothetical performance information (discussed more below in #2); (ii) extemporaneous, live, oral communications; and (iii) information contained in a statutory or regulatory notice, filing, or other required communication that is reasonably designed to satisfy regulatory requirements.
  2. One-on-One Communication Exclusion Explained. This exclusion applies regardless of whether the adviser makes the communication to a natural person with an account or multiple natural persons representing a single entity or account (e.g., multiple individuals sharing the same household). However, the exclusion does not apply to bulk emails or messages that are nominally directed to a person if those communications are in fact widely disseminated to numerous investors. For example, duplicated inserts into otherwise tailored one-on-one communications to individual investors constitute advertisements, while the tailored portions are subject to the exclusion.
  3. Advisers May Be Liable for Third-Party Statements. Advisers should also be aware that they may be held liable under the Marketing Rule for communications by third parties – including hyperlinks to independent webpages and public commentary on an adviser’s own website or social media page – if such communications constitute “advertisements.” While the SEC does not require advisers to oversee all activities of those third parties, it expects advisers to ensure that advertisements, including those created or disseminated by third parties, comply with the Marketing Rule through, for example, a formal authorization and review/comment process for third-party statements. Ultimately, whether an adviser endorsed, adopted, or approved a third-party statement depends on the particular facts and circumstances relating to the third party and the specific communication.
  4. Principles-Based Prohibitions Apply to All Advertisements. The Marketing Rule incorporates seven principles-based advertising prohibitions that were derived from anti-fraud concepts found in federal securities law to govern against cherry-picking and unfair or unbalanced performance disclosures, among other things. These prohibitions generally proscribe untrue statements and omissions, unsubstantiated material statements, untrue or misleading implications or inferences, omissions of material risks or limitations, and anything else that would otherwise be materially misleading. To establish a violation, the SEC need only establish negligence with respect to the conduct in relation to the advertisement’s target audience. Whether an advertisement complies with these prohibitions is based on the specific facts and circumstances relating to each advertisement.
  5. Testimonials and Endorsements Are Permitted Generally. Advisers may now include testimonials and endorsements in their advertisements, provided they adhere to certain rules regarding disclosure, oversight, and compliance. For example, testimonials and endorsements must clearly and prominently disclose at the time of dissemination (i) the speaker’s relationship to the adviser, (ii) the cash or noncash compensation provided by the adviser, and (iii) a description of any material conflicts of interest. Where compensation is above the de minimis threshold of $1,000 for a calendar year, advisers must also have a written agreement with anyone providing a testimonial or endorsement that describes the scope of the agreed-upon activities and the terms of the compensation for those activities.
  6. Third-Party Ratings Are Permitted Generally. Similarly, advisers may include third-party ratings if they have a reasonable basis to believe that the questionnaire or survey used for the rating is structured to make it equally easy for a participant to provide favorable or unfavorable responses and is not otherwise designed to produce a predetermined result. Advisers must also clearly and prominently disclose (i) the date on which the rating was given and the period of time on which the rating was based, (ii) the identity of the party making the rating, and (iii) the compensation, if any, that the adviser provided to the rater.
  7. All Advertising Material Facts Must Be Substantiated. Although advisers are not required to review and approve advertisements prior to dissemination, they must be able to demonstrate that they had a reasonable basis for believing each material fact used in the advertisements at the time such statements were made. Absent such substantiation, the SEC will assume that advisers did not have a reasonable basis. While the final rule does not prescribe or require any particular way to substantiate a material fact, the SEC noted that one way would be to create a written record of the substantiation at the same time as the advertisement is being prepared or released. 
  8. Performance Advertisements Clarified. Advisers must comply with the Marketing Rule’s prohibitions against certain performance-related advertising, including:
    • Any performance results, unless they are provided for specific time periods (not applicable to the performance of private funds);
    • Gross performance, unless net performance is also provided;
    • To the extent an advertisement includes the performance of portfolios other than the portfolio being advertised, performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as the portfolio 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, 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 additional information;
    • Predecessor performance, unless (i) the personnel primarily responsible for achieving the prior performance manage accounts at the advertising adviser and the accounts that were managed by those personnel at the predecessor adviser are sufficiently similar to the accounts that they manage at the advertising adviser and (ii) the advertising adviser includes all relevant disclosures clearly and prominently in the advertisement; and
    • Any statement that the SEC has approved or reviewed any calculation or presentation of performance results.
  1. Written Policies and Procedures Are Essential to Compliance. Like any other compliance initiative, advisers must have written policies and procedures reasonably designed to prevent violations of the Marketing Rule by themselves and their associated persons, including appropriate supervision, training, and objective testing to verify compliance. While not required per se, advisers may incorporate the use of pre-approved templates and disclosures, editing guidelines including with respect to social media activity, and internal pre-review and/or approval processes as part of their written policies and procedures to comply with this new rule. The SEC also suggested incorporating processes by which advisers spot check advertisements or conduct periodic reviews of advertisements to prevent violations.
  2. Maintain Required Books and Records. Similarly, advisers must comply with the books and records rules as amended, which now include, among other things, filing an amended Form ADV with regard to their marketing practices and keeping true, accurate, and current copies of advertisements and disclosures. Also, while a person who promotes or solicits investments for advisers still needs to provide to clients written disclosures relating to their solicitation arrangement with the adviser (except for broker-dealers who make recommendations pursuant to Regulation Best Interest), the promoter no longer needs to deliver a copy of the adviser’s brochure (Form ADV Part 2A) and advisers no longer need to obtain for their records written acknowledgments from each referred client that the client received those required disclosures from the promoter or solicitor.

Because substantial uncertainty remains around how the Marketing Rule will be interpreted in practice and the SEC’s plans to actively examine compliance with this new rule, it is crucial that advisers take measures to implement it in their compliance programs and proactively assess with the aid of regulatory compliance counsel whether any changes to their business practices may affect their disclosure, oversight, and controls with respect to their marketing practices.

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