United States:

SEC Adopts New Marketing Rule For Investment Advisers


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On December 22, 2020, the U.S. Securities and Exchange
Commission (“SEC”) adopted amendments under the
Investment Advisers Act of 1940 modernizing the rules governing
investment adviser marketing. The amendments replace and merge into
a single rule the current advertising and cash solicitation rules.
The amended Rule 206(4)-1 (the “Marketing Rule”) will do
the following:

  • update how “advertisements” issued by SEC registered
    investment advisers are defined and analyzed;
  • replace current per se prohibitions with seven general
    principles covering all advertisements;
  • set forth specific standards for performance
    presentations;
  • apply to testimonials and endorsements (including traditional
    solicitations) for which cash or non-cash compensation is received;
    and
  • apply generally to investors in private funds advised by an
    investment adviser (“private fund investors”), not just
    its advisory clients

Noting that the current advertising and cash solicitation rules
have remained largely unchanged since their adoption more than 50
years ago, the SEC intends the Marketing Rule to incorporate
changes in technology, industry practices, and investor
expectations in seeking advisory services.

Effectiveness, Compliance Period and Effect on No-Action
Letters

The Marketing Rule will become effective on May 4, 2021, the
date 60 days after its publication in the Federal Register on March
5, 2021, and institutes an 18-month transition period before
advisers are required to comply with the rule. This transition
period will end on the rule’s November 4, 2022 compliance
date.  As the Marketing Rule is intended to integrate prior
SEC staff guidance under the current advertising and cash
solicitation rules, the SEC expects to nullify or withdraw all
related no-action letters and other staff guidance, or portions
thereof, as of this compliance date.

The Marketing Rule

The current advertising rule establishes four per se
prohibitions on practices that, at the time of enactment, appeared
likely to mislead investors. Specifically, these prohibitions cover
the use of the following: 

  1. client testimonials related to an adviser or its services;

  2. direct and indirect references to specific investment
    recommendations;

  3. representations that any chart, graph or other device can,
    alone, be used to determine which securities to buy or sell;
    and

  4. representations that services are free of charge, unless the
    services are free of charge and all other conditions and
    obligations

As investment advisory services have evolved, the SEC believes
that these prohibitions have become both over- and under-inclusive
because they do not reflect the way advisers and investors
currently communicate; do not address new ways in which current
communication channels can mislead (even inadvertently); and
underestimate the value of certain types of communication. 
Accordingly, the Marketing Rule will abandon these per se
prohibitions in favor of a robust and more adaptable
principles-based approach, which seeks to minimize the potential
for fraudulent or misleading conduct.  In addition, the
Marketing Rule will provide conditions for the use of testimonials,
endorsements, third party ratings, and certain performance
presentations, and make harmonizing updates to Form ADV and Rule
204-2 under the Investment Advisers Act (the “books and
records rule”). Specifically, the Marketing Rule will do the
following:

  1. Redefine “advertisements” in two parts as follows:

    1. The first part will capture traditional advertisements,
      including those made to private fund investors. Specifically, it
      will cover any direct or indirect communication by an investment
      adviser that offers its investment advisory services with regard to
      securities to prospective clients or private fund investors or
      offers new investment advisory services with regard to securities
      to current clients or private fund investors. Excluded will be
      (i) one-on-one communications, unless they present unsolicited
      hypothetical performance information to a non-private fund
      investor, (ii) extemporaneous, live, oral communications, and
      (iii) information contained in any statutory or regulatory notice,
      filing, or other required communication that is reasonably designed
      to satisfy the requirements of the notice, filing, or
      communication.

    2. The second part will capture, and thus subjects to the
      rule’s general provisions regarding advertisements, compensated
      “testimonials” and “endorsements” (discussed
      below), which will include activity previously covered by the cash
      solicitation rule. The exclusion in the first part of the
      definition for information contained in a statutory or regulatory
      notice, filing, or other required communication will apply to this
      second part; the exclusions for one-on-one and extemporaneous,
      live, oral communications will not.

  2. Establish the following governing principles for
    advertisements:

    1. Not making untrue statements of material facts or omissions of
      material facts that, in light of the circumstances, make the
      statements made misleading.

    2. Not making material claims or statements without having a
      reasonable basis for believing they can be substantiated.

    3. Not making implications that are reasonably likely to cause
      untrue or misleading inferences to be drawn concerning material
      facts about the adviser.

    4. Not discussing potential benefits without disclosing a fair and
      balanced treatment of the associated material risks and
      limitations.

    5. Not presenting specific prior investment advice unless done in
      a fair and balanced manner (i.e., no
      “cherry-picking” of recommendations).

    6. Not including or excluding performance results, or presenting
      performance over time periods, unless done in a fair and balanced
      manner (i.e., no “cherry-picking” of performance
      results).

    7. Not being otherwise materially misleading.

  3. Permit the use of testimonials and endorsements, subject to
    additional disclosure and oversight conditions and “bad
    actor” disqualifications, with certain exceptions.Testimonials
    and endorsements generally will cover recommendations, descriptions
    of past experiences, solicitations, and referrals made to an
    adviser’s clients and private fund investors, with testimonials
    being made by an investment adviser’s current clients and
    private fund investors and endorsements being made by others. In
    addition to complying with the Marketing Rule’s governing
    principles for advertisements if a testimonial or endorsement is
    captured by that definition, the conditions for using testimonials
    and endorsements will be as follows:

    1. The adviser must disclose, or reasonably believe that the giver
      of the testimonial or endorsement discloses, clearly and
      prominently at the time the testimonial or advertisement is
      disseminated, (i) whether or not the giver is a current client or
      private fund investor, (ii) if compensation is being provided, and
      (iii) a brief statement regarding the giver’s material
      conflicts of interest resulting from its relationship with the
      adviser.Such disclosure must also include the material terms of the
      applicable arrangement, including a description of any
      compensation, and the material conflicts of interest resulting from
      such relationship and compensation. This condition will not apply
      if the giver is an affiliate of the investment adviser (defined to
      include (1) the adviser’s partners, officers, directors, or
      employees and (2) persons that control, are controlled by, or are
      under common control with the adviser and their respective
      partners, officers, directors or employees), but only if the
      affiliation is disclosed or readily apparent to the recipient, and
      documented by the adviser, at the time the testimonial or
      endorsement is disseminated.

    2. The adviser must have a reasonable belief that the testimonial
      or endorsement complies with the Marketing Rule.

    3. Any testimonial or endorsement for which compensation (other
      than de minimis compensation of less than $1,000 over any
      12-month period) is being provided must be governed by a written
      agreement between the investment adviser and the giver that
      describes the scope of the giver’s activities and the terms of
      its compensation. The exemption for testimonials and endorsements
      given by the adviser’s affiliates described above will also
      apply to this condition.

    4. The adviser cannot provide compensation (other than de
      minimis
      compensation, as described above) for the testimonial
      or endorsement if the adviser knows, or in the exercise of
      reasonable care should know, that the giver is subject to certain
      “bad boy” disqualifications at the time the testimonial
      or endorsement is disseminated. This condition will not apply if
      the giver is subject to disqualification, but not disqualified, as
      a covered person under 506(d) of regulation D, with respect to a
      rule 506 private placement, or as a broker-dealer registered under
      section 15(b) of the Exchange Act.

  4. Permit the use of “third party ratings,” subject to
    certain due diligence and disclosure requirements.Third party
    rankings will capture all ratings or rankings of an adviser given
    by a person (other than a related person of the adviser, within the
    meaning of Form ADV) that gives such ratings or rankings in the
    ordinary course of its business. In addition to complying with the
    general conditions for advertisements, the conditions for using a
    third party rating will be as follows:

    1. The adviser must have a reasonable basis to believe that any
      questionnaire or survey used in the preparation of the rating is
      structured to make it equally easy for a participant to provide
      favorable and unfavorable responses and is not designed to produce
      any predetermined result.

    2. The adviser must disclose, or reasonably believe that the
      rating discloses, clearly and at least as prominently as the rating
      (i) the date the rating was given and time period on which it is
      based, (ii) the third party that created or tabulated the rating,
      and (iii) whether compensation was provided in connection with the
      adviser’s obtaining or using the rating.

  5. Require performance presentations to comply with the following
    conditions in addition to the Marketing Rule’s governing
    principles for advertisements:

    1. Any presentation of gross performance must include a
      presentation of net performance, calculated over the same period
      and using the same type of return and methodology, with at least
      equal prominence and in a format designed to facilitate a
      comparison between the two. The presentation of net performance
      generally must reflect all fees and expenses borne by a client or
      private fund investor, with a limited exception for fees paid for
      third-party custodial services. Net performance may be based on a
      model fee, if the model fee equals the highest fee charged to the
      advertisement’s intended audience or if deducting the model
      fee, instead of the actual fee, would not increase
      performance.

    2. Any performance presentation must include a presentation, with
      equal prominence, of performance over one-, five-, and ten-year
      periods (or, if shorter, the life of the portfolio whose
      performance is being presented), ending no earlier than the most
      recent calendar year end (the “required time
      periods”).This condition will not apply to the presentation of
      private fund performance.

    3. Performance presentations must not include any express or
      implied statement that the calculation or presentation of the
      performance has been approved or reviewed by the SEC.

    4. An adviser may present the performance of any portfolios with
      substantially similar investment policies, objectives, and
      strategies as the services being advertised (so-called
      “related performance”) only if all related
      portfolios are included. If desired, related portfolios may be
      presented on a portfolio-by-portfolio basis.Selected related
      portfolios may be excluded only if doing so does not make the
      performance presented materially higher or alter its required time
      periods.

    5. An adviser may present the performance of a subset of a
      portfolio’s investments (so-called “extracted
      performance”) only if it also presents, or offers to provide
      promptly, the performance of the entire portfolio from which the
      performance was taken.

    6. An adviser may present hypothetical performance, including
      performance derived from model portfolios, back-tested performance,
      and targets or projections, only if the presentation sufficiently
      discloses the criteria and assumptions underlying the
      performance’s calculation and the risks and limitations of
      using hypothetical performance in making investment decision, so
      the advertisement’s intended audience can understand these
      criteria, assumptions, risks, and limitations.In addition, the
      adviser must have adopted and implemented policies and procedures
      reasonably designed to ensure that any hypothetical performance
      presented is relevant to the likely financial situation and
      investment objectives of the advertisement’s intended audience.
      Presentations of hypothetical performance will not need to comply
      with the required time period, related performance, and extracted
      performance conditions described above.

    7. An adviser may present “predecessor performance,”
      defined as performance of an account or private fund that was
      advised by an adviser other than the advertising adviser (the
      “predecessor adviser”) for some portion of the period
      presented, only if all of the following conditions are satisfied:
      (i) those who made the investment decisions at the predecessor
      adviser underlying the presented performance manage accounts or
      private funds at the advertising adviser (for example, if those
      decisions were made by a committee, a substantial identity of its
      membership must manage accounts or private funds at the advertising
      adviser), (ii) the predecessor performance is of accounts or
      private funds that are sufficiently similar to those being marketed
      to be relevant, (iii) the performance of all accounts and private
      funds managed by the predecessor adviser in a manner substantially
      similar to those reflected in the predecessor performance are
      included, with an exclusion conditioned on the same criteria as
      described for “related portfolios” above, and (iv) the
      predecessor performance is accompanied by clear and prominent
      relevant disclosures, including that the performance was achieved
      by accounts or private funds managed by another adviser, with
      relevance generally being determined by reference to the Marketing
      Rule’s general principles. In analyzing whether an advertising
      adviser sufficiently continues the business of a predecessor so
      that these “predecessor performance” conditions will not
      apply, the SEC will consider, among other things, if there is a
      substantial and direct business nexus between the advisers, if the
      advertising adviser was formed in a transaction designed to
      eliminate substantial liabilities of the predecessor or spin off
      its personnel, and if the advertising adviser has, as applicable,
      assumed substantially all of the assets and liabilities of the
      predecessor.

Unlike the proposed rule, the final Marketing Rule will not
require investment advisers to review and approve advertisements
for compliance with the rule prior to dissemination. 

Changes to Form ADV

The amendments will add Item 5.L to Form ADV, which will require
advisers to report whether their advertisements include any
performance results, hypothetical performance, predecessor
performance, references to prior specific investment advice,
testimonials, endorsements, or third-party ratings and whether any
compensation was provided in connection with the use of
testimonials, endorsements, or third-party ratings. 

Changes to Books and Records Rule

Lastly, the amendments ripple through the books and records
rule.  Generally, they will require advisers to keep and
maintain records of all advertisements, even if disseminated to
fewer than 10 persons.  Accordingly, this threshold under the
current rule will be eliminated as to advertisements, although it
will be retained for non-advertisement notices, circulars,
newspaper articles, investment letters, bulletins and other
communications. As an accommodation for oral advertisements,
advisers will be required only to keep a copy of the written or
recorded materials they use in connection with oral advertisements
or, in the case of compensated oral testimonials and endorsements,
a copy of the disclosures required by the Marketing Rule.

Advisers will be required to keep and maintain all accounts,
books, internal working papers, and any other records or documents
that are necessary to form the basis for or demonstrate the
calculation of any performance or rate of return of any portfolio
(not just management accounts, as required by the current rule), as
well as all information offered or provided pursuant to the
Marketing Rule’s requirements in respect of hypothetical
performance.

In addition, the recordkeeping requirements were added for the
following:

  1. As to testimonials and endorsements, the adviser will be
    required to keep (i) any disclosures required by the Marketing Rule
    in respect of but not contained in the testimonial or endorsement,
    (ii) documentation substantiating its reasonable basis for
    believing that the testimonial or endorsement complies with the
    Marketing Rule, and (iii) a record of its affiliated persons
    (within the meaning of the exception to the disclosure requirements
    for testimonials and endorsements given by the adviser’s
    affiliates).

  2. Advisers presenting third party rankings will be required to
    keep and maintain, if obtained by the adviser, copies of any
    questionnaires and surveys used to prepare third party ratings, as
    well as documentation substantiating the rating’s compliance
    with the Marketing Rule.

  3. Advisers presenting predecessor performance will be required to
    keep and maintain any related communications.

  4. Advisers presenting hypothetical performance or net performance
    reflecting the deduction of a model fee will be required to keep
    and maintain a record of the advertisement’s intended
    audience.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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