SEC Adopts Revised Marketing Rule for Investment Advisers

On December 22, 2020, the Securities and Exchange Commission ("SEC") announced it had finalized revisions under the Investment Advisers Act of 1940 (the "Advisers Act") that govern investment adviser advertisements and payments to solicitors. The revisions create a single rule designed to comprehensively regulate investment advisers' marketing communications.

The SEC's adopted revisions attempt to replace the existing regulatory structure with a “principles-based” rule. The SEC's intention is that the rule will continue to be relevant as technology continues to advance industry practices and investor expectations. The primary updates to the revised rule are, as summarized in the SEC's press release, below.

Definition of Advertisement

Definition of Advertisement. The amended definition of “advertisement” contains two prongs: one that captures communications traditionally covered by the advertising rule and another that governs solicitation activities previously covered by the cash solicitation rule.
 

• First, the definition includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The first prong of the definition excludes most one-on-one communications and contains certain other exclusions.
• Second, the definition generally includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).

General Prohibitions

The marketing rule will prohibit the following advertising practices:
 

• making an untrue statement of a material fact, or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading;
• making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC;
• 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 adviser;
• discussing any potential benefits without providing fair and balanced treatment of any associated material risks or limitations;
• referencing specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
• including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and
• including information that is otherwise materially misleading.

Testimonials and Endorsements

The marketing rule prohibits the use of testimonials and endorsements in an advertisement, unless the adviser satisfies certain disclosure, oversight, and disqualification provisions:
 

• Disclosure. Advertisements must clearly and prominently disclose whether the person giving the testimonial or endorsement (the “promoter”) is a client and whether the promoter is compensated. Additional disclosures are required regarding compensation and conflicts of interest. There are exceptions from the disclosure requirements for SEC-registered broker-dealers under certain circumstances. The rule will eliminate the current rule’s requirement that the adviser obtain from each investor acknowledgements of receipt of the disclosures.
• Oversight and Written Agreement. An adviser that uses testimonials or endorsements in an advertisement must oversee compliance with the marketing rule. An adviser also must enter into a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives de minimis compensation (i.e., $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months).
• Disqualification. The rule prohibits certain “bad actors” from acting as promoters, subject to exceptions where other disqualification provisions apply.

Third-Party Ratings

The rule prohibits the use of third-party ratings in an advertisement, unless the adviser provides disclosures and satisfies certain criteria pertaining to the preparation of the rating.

Performance Information Generally

The rule prohibits including in any advertisement:
 

• gross performance, unless the advertisement also presents net performance;
• any performance results, unless they are provided for specific time periods in most circumstances;
• any statement that the SEC has approved or reviewed any calculation or presentation of performance results;
• performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those 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 (which does not include performance generated by interactive analysis tools), 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 information underlying the hypothetical performance; and
• predecessor performance, unless there is appropriate similarity with regard to the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.

The revised rule, and related revised rules, will become effective 60 days after publication in the Federal Register. The SEC has granted an 18-month grace period from the date of the revisions becoming effective to allow for a transition to comply with the new requirements.

This publication is intended for general informational purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.