January 14, 2021Client Alert

SEC Modernizes Marketing Rules for Investment Advisors

On December 22, 2020, the Securities and Exchange Commission announced reforms to its rules issued under the Investment Advisers Act regarding investment advisor advertisements and payments to solicitors. The current rules – Rule 206(4)-1 and Rule 206(4)-3 – were adopted to target misleading advertising practices and help clients understand the conflicts of interest of paid solicitors. The new single marketing rule (the “Marketing Rule”) replaces and updates both rules, which have not been substantively updated since their adoption over forty years ago. The SEC has made related amendments to Form ADV (the investment advisor registration form) and Rule 204-2 (the books and records rule). The SEC will also withdraw its guidance addressing the existing advertising and solicitation rules.

Definition of Advertisement

The Marketing Rule expands the definition of “advertisement” to include two prongs: (i) offers of an investment advisor’s investment advisory services to prospective clients or private fund investors, or offers of new services to existing clients or private funds, and (ii) compensated testimonials and endorsements.

Prong 1: Communications Other than Compensated Testimonials and Endorsements

The first prong includes any direct or indirect communication that offers the investment advisor’s services to prospective clients or investors in a private fund advised by the investment advisor, or that offers new services to current clients or private fund investors.

This prong includes communications made by third parties if:

  • the investment advisor has authorized the communication or participated in creating/disseminating it;
  • the advertisement is attributable to the investment advisor and the advisor has endorsed the information or been involved in preparing it; or
  • the advertisement offers the investment advisor’s services.

Generally, information included in private placement memoranda, generic brand content, educational material, and market commentary will not be advertisements. In addition, the definition does not extend to advertisements of registered investment companies or business development companies.

The Marketing Rule excludes the following from the prong’s definition:

  • one-on-one communications, unless the communication includes hypothetical performance information that is not provided in response to an unsolicited investor request or to a private fund investor;
  • extemporaneous, live, oral communications; or
  • information contained in a statutory or regulatory notice, filing, or other required communication.

The Marketing Rule also lists seven prohibitions that generally preclude investment advisors from making materially untrue or misleading statements, or from discussing their services or performance results in an unfair or unbalanced way.

Prong 2: Compensated Testimonials and Endorsements, Including Solicitations

A second prong applies to “any endorsement or testimonial for which an investment advisor provides compensation, directly or indirectly.” Like the first prong, information contained in a statutory or regulatory notice, filing, or other required communication are excluded. Unlike the first prong, there are no exclusions for extemporaneous, live, oral communications or one-on-one communications.

Advertisements that include any testimonials or endorsements (whether compensated or not) must clearly and prominently disclose: that a testimonial/endorsement was given by a current client or private fund investor or by another third party; material conflicts of interest; and the material terms of any compensation arrangement. In addition, the investment advisor must have a reasonable basis for believing that the testimonial/endorsement complies with the Marketing Rule and must have a written agreement with a promoter that describes the scope and terms of compensation of the promoter’s activities.

Limited exclusions from these various conditions are available to:

  • an investment advisor’s affiliated person if the affiliation is readily apparent or disclosed to the client/investor;
  • registered broker-dealers for recommendations subject to Regulation Best Interest and involving non-retail customers; and
  • persons covered by the “bad actor” provisions of Regulation D with respect to Rule 506 offering and whose involvement would not disqualify the offering under Rule 506.

Unlike the Marketing Rule, investment advisors would not need to review and approve promoters’ advertisements prior to dissemination. However, investment advisors should have a compliance program that includes objective and testable means reasonably designed to prevent violations of the Marketing Rule, such as internal pre-reviews of advertisements.

Third-Party Ratings

Third-party ratings in an advertisement must comply with the Marketing Rule’s general prohibitions. In addition, the investment advisor must have a reasonable basis to believe that any survey used in the rating allows for unfavorable responses and is not designed to produce a predetermined result. The investment advisor must clearly and prominently disclose (or reasonably believe that the third-party rating discloses) the date and time period of the rating, the third party that created it, and whether the advisor provided compensation for it.

Performance Advertising

Advertisements that include performance information must not state that the performance results have been approved or reviewed by the SEC, or provide information relating to gross performance unless net performance is also provided. Further, advertisements must not provide information regarding:

  • performance of related portfolios, unless it includes all related portfolios;
  • performance of a subset of investments extracted from a portfolio, unless the investment advisor provides or offers to provide the performance results of the total portfolio;
  • hypothetical performance, unless the investment advisor adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement and provides certain specified information underlying the hypothetical performance; or
  • performance of a predecessor, unless the personnel and accounts of the predecessor and current investment advisor are sufficiently similar, all similarly managed prior accounts are factored into the calculation, and the advertisement includes all relevant disclosures.

Transition period and compliance date

The compliance date will be eighteen months following the effective date of the Marketing Rule, which will be 60 days after its publication in the Federal Register. The Form ADV amendments will be effective after a similar eighteen-month transition period.

The Securities & Capital Markets team at Michael Best has experts who can assist investment advisors in complying with the Marketing Rule. Please do not hesitate to contact a member of our team for additional information.

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