SEC Risk Alert on Advisers Act Marketing Rule Compliance

Introduction  

In December 2020, the Securities and Exchange Commission (“SEC”) updated the rules under the Investment Advisers Act of 1940 (“Advisers Act”) that govern investment adviser marketing (see amended Rule 206(4)-1 (the “Marketing Rule”) and Final Rule: Investment Adviser Marketing, Rel. No. IA-5653 (Dec. 20, 2020) (the “Adopting Release”)). The Marketing Rule applies only to investment advisers (hereinafter referred to as “RIAs”) that are registered or required to be registered with the SEC under Advisers Act Section 203.

This article is intended to serve as a compliance roadmap for RIAs—one that we strongly recommend be considered by non-SEC registered firms as well—to address the advertising standards imposed by the Marketing Rule.

Risk Alerts

In September 2022, the SEC’s Division of Examinations (the “Division”) circulated a Risk Alert (Examinations Focused on New Investment Adviser Marketing Rule) to underscore its focus on RIAs’ marketing practices. In June 2023, the Division issued a Risk Alert covering the Marketing Rule’s focus on policies and procedures, the substantiation requirement, performance advertising, and books and records. See Risk Alert: Examinations Focused on Additional Areas of the Adviser Marketing Rule (June 8, 2023).

On April 17, 2024, the Division published a Risk Alert (the “April Alert”) to encourage accurate completion of the Marketing Rule items contained in Form ADV and to promote compliance with Advisers Act Rule 206(4)-7 (the “Compliance Rule”), Advisers Act Rule 204-2 (the “Books and Records Rule”), and the Marketing Rule’s “General Prohibitions.”

Note that the April Alert did not focus on deficiencies related to certain other requirements under the Marketing Rule, such as testimonials and endorsements. The Division may be expected to address these aspects of the Marketing Rule in future examinations.

Approach to Compliance Rule, Books and Records Rule, and Form ADV

The April Alert points out that RIAs need to adopt and implement written policies and procedures reasonably designed to prevent violations by the RIAs and their supervised persons of the Marketing Rule, noting that RIAs should address their marketing practices in their policies and procedures under the Compliance Rule.

Not all compliance deficiencies related to the Marketing Rule were discussed in the April Alert, but it did provide many helpful examples of “best practices.” The April Alert mentioned that RIAs’ compliance policies and procedures typically included processes to promote a firm’s compliance with the Marketing Rule.

The Division noted that RIAs typically trained relevant personnel on the Marketing Rule’s requirements and corresponding marketing policies and procedures. In general, Marketing Rule policies and procedures typically establish a process for reviewing advertisements, with many calling for the pre-approval of ads before disseminating them. The April Alert noted that the Adopting Release stated that RIAs may test ads through a variety of tools, including “reviewing a sample of advertisements based on risk or pre-approving templates.”

The April Alert pointed out that certain policies and procedures were not reasonably designed or implemented to address Marketing Rule compliance, which may allow the occurrence of violations of the Marketing Rule, Books and Records Rule, or both. Such deficient policies and procedures:

• Consisted only of general descriptions and expectations related to the Marketing Rule, which may fail to prevent violations from occurring, detect ones that have occurred, and promptly correct those that have occurred (RIAs’ policies and procedures “should employ, among other methods of detection, compliance tests that analyze information over time in order to identify unusual patterns” and “to be effective, they should include objective and testable means reasonably designed to prevent violations of the final rule in the advertisements the adviser disseminates”).

• Did not address applicable marketing channels used by RIAs, such as websites and social media.

• Were informal (not written).

• Were incomplete.

• Were not updated, or only partially updated, for certain applicable marketing topics, or updated but not implemented.

• Did not address the Marketing Rule’s "General Prohibitions" and requirements for testimonials, endorsements, and third-party ratings utilized in RIAs’ specific ads.

• Did not adequately address the preservation and maintenance of ads and related documents (e.g., questionnaires or surveys used to prepare a third-party rating (where the RIA received such documents)) included in an advertisement.

• RIAs did not maintain (1) copies of completed questionnaires or surveys used for third-party ratings (Rule 204-2(a)(11)(ii)), (2) copies of information posted to social media (Rule 204-2(a)(11)(I)), or (3) documentation to support performance claims included in ads (Rule 204-2(a)(16).

Regarding the Form ADVs, the Division found that numerous RIAs revised their forms. However, some exhibited deficiencies related to the Marketing Rule. For instance, they inaccurately reported on Form ADV, Part 1A, stating that their advertisements did not contain:

• Third-party ratings, when their websites included third-party ratings or social media posts that touted the firms as being ranked in certain third-party ratings;

• Performance results, when the latter were included in their marketing materials; and

• Hypothetical performance, when it was included in ads.

Other errors included the use of outdated language in their Form ADVs (e.g., continuing to reference provisions of the prior Cash Solicitation Rule, inaccurately indicating that no referral arrangements existed, and omitting material terms and compensation of referral arrangements on Form ADV, Part 2A, Item 14).

Compliance with "General Prohibitions":  Rule 206(4)-1(a)

The April Alert described what constitutes violations of the following "General Prohibitions":

• Including an untrue statement of a material fact or omitting a material fact necessary to make the statement made not misleading, in light of the circumstances under which it was made.

• Including a material statement of fact that the RIA does not have a reasonable basis for believing it will be able to substantiate.

• Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the RIA.

• Discussing potential benefits to clients or investors without providing fair and balanced treatment of any associated material risks or limitations.

• Referencing specific investment advice provided by the RIA in a manner that is not fair and balanced.

• Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.

• Providing information that is otherwise materially misleading (Rule 206(4)-1(a)(2) prohibits ads that “[i]nclude a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate . . . ”).

Further, the April Alert provided several "real world" examples of such General Prohibition violations, which RIAs can review as a checklist to avoid non-compliance:

• Ads stating that the advisers were “free of all conflicts,” when there were actual conflicts.

• Ads stating material facts about the RIAs’ businesses that were inaccurate, including (1) statements that a network of personnel perform advisory services for clients when a sole individual performs such services and (2) statements representing erroneous adviser personnel qualifications, such as their education, experience, and professional designations.

• Ads describing material facts about advisory services or products offered that were inaccurate, including (1) referencing certain investment mandates (e.g., ESG mandates) of the RIAs when no such mandates were applied, (2) claiming that investment processes were validated by professional institutions when they were not, (3) stating that the RIA considered certain risk tolerances when recommending investment strategies when all clients were placed into the same strategy, (4) referencing a list of approved securities that did not exist, (5) referencing formalized securities screening processes that did not exist, and (6) misrepresenting the RIAs’ client base.

• Ads publicizing the receipt of certain awards or accolades that were not received.

• Omission of material facts or misleading inference.

• Ads that omitted material facts necessary to make the statements made not misleading, in light of the circumstances under which they were made.

• Ads that included information that could have reasonably caused untrue or misleading implications or inferences to be drawn concerning material facts relating to the advisers (unless the RIA has a reasonable basis for its belief).

• Ads contained statements that advisers were different from other advisers because they acted in the “best interest of clients,” without disclosing that all investment advisers have a fiduciary duty to act in their clients’ best interests.

• Ads recommending certain investments (e.g., on podcasts or websites) without disclosing the conflicts of interest attributed to the compensation paid to or received by the RIAs for such recommendations.

• Ads that contained untrue or misleading claims, such as: (1) stating that the RIAs were “seen on” national media, implying appearances in national news media, without disclosing that the “appearances” were in fact paid advertisements and (2) advertising images of celebrities in marketing materials in a manner that implied the celebrities endorsed the firms when such celebrities did not endorse the firms.

• Ads that contained untrue or misleading performance claims, including (1) advertising cumulative profits that the advisers believed were not achievable or were impossible to achieve without unlimited money to invest, (2) presenting performance information that did not provide adequate disclosure regarding the share classes included in the performance returns, (3) using lower fees in calculations for net of fees performance returns than were offered to the intended audience, and (4) omitting material information regarding fees and expenses used in calculating returns.

• Ads citing an RIA’s SEC registration beyond factual statements as to its registration status in a way to imply that SEC registration was representative of a particular level of skill or ability or that the SEC had either approved or passed upon the RIA’s business practices (also observed were RIAs displaying the SEC logo on their websites with the purpose of implying that the websites or the advisers had been approved or endorsed by the SEC).

• Ads contained third-party ratings (1) implying the RIAs were the sole top recipients of certain awards when the awards went to multiple recipients or the RIAs were not the top recipients and (2) indicating that the RIAs were highly rated by various organizations without disclosing that the methodologies for such ratings were based primarily or solely on factors that were not related to the quality of investment advice, such as assets under management, the number of clients, or that adviser personnel nominated fellow employees for such awards.

• Ads with testimonials that were misleading (e.g., testimonials from clients of a third-party product on the RIA’s website without explaining the context of the testimonials, implying that the testimonials were about the RIA’s services rather than the third-party product).

• Performance ads with misleading information, such as: (1) benchmark index comparisons that did not define the index or provide sufficient context to enable an understanding of the basis for such comparison or disclose that the benchmark performance did not include reinvestment of dividends; (2) performance presentations that contained outdated market data or investment products that were no longer available to clients; or (3) statements or presentations regarding (a) RIA’s performance track record with securities that were not purchased by the RIA in a similar manner in its clients’ accounts, (b) claims that the RIA achieved above average performance results without clarifying that it did not yet have clients or performance track records, and (c) investment recommendations containing performance information that did not include disclosures to provide context to the presentations, such as ad performance during time periods when most investors would have experienced the advertised performance returns because of general market performance.

• Fair and balanced treatment of material risks or limitations.

• Ads with statements about the potential benefits connected with the RIA’s services or methods of operation that did not appear to provide fair and balanced treatment of any material risks or material limitations associated with the potential benefits (e.g., ads on social media that highlighted performance information without also disclosing the material risks and limitations).

• Ads that included only the most profitable investments or specifically excluded certain investments without providing sufficient information and context to evaluate the rationale, such as investments that were written off as a loss or were lower-performing investments.

• Inclusion or exclusion of performance results or time periods in manners that were not fair and balanced (e.g.:  (1) ads that did not disclose the time period or did not disclose whether the returns were calculated for the same time period as additional performance information included in the same advertisement, (2) ads that included or excluded certain performance results in manners that were not fair and balanced, such as advertisements that included the performance of only realized investment information in the total net return figure and excluded unrealized investments, and (3) ads that were otherwise materially misleading, such as by presenting disclosures in an unreadable font.

Disclosures

As a final point, the Adopting Release stated that “advisers should . . . include appropriate disclosures or other information [in their marketing materials] such that the advertisement does not violate the [general] prohibitions . . . or other applicable law.” Such disclosures may include (1) the material conditions, objectives, and investment strategies used to obtain the results portrayed, (2) whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings, (3) the effect of material market or economic conditions on the results portrayed, (4) the possibility of loss, and (5) the material facts relevant to any comparison made to the results of an index or other benchmark.

If you have any questions regarding the April Alert and any related compliance matters or wish to obtain online links to the documents discussed here, please contact Lawrence Cohen (lcohen@grsm.com) or a member of the Securities Litigation practice group.