How the SEC’s New Marketing Rule Is Changing the Landscape for Solicitors

The Securities and Exchange Commission recently released a new amendment to Rule 206(4)-1 (the “Marketing Rule”)[1] under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The new rule became effective May 4, 2021, and has a compliance date of November 4, 2022.[2] Part of the new Marketing Rule consolidates and incorporates Rule 206(4)-3 of the Advisers Act (previously referred to as the “Cash Solicitation Rule”) in a manner that materially updates the role third-party solicitors can play in referring prospective business to investment advisers. The new Marketing Rule offers greater flexibility to advisors in designing their marketing activities while adding additional complexity and reporting.  This article will provide a primer on changes and requirements for solicitors moving forward.

Summary of Prior Rule

Under the prior rules, the Cash Solicitation Rule established the role of the “solicitor” and provided straightforward requirements for compensating solicitors for their referral services. The reader may recall that the old rule generally required the following: (i) a written contract between the adviser and solicitor, (ii) that the solicitor delivers certain written disclosures and a copy of the adviser’s Form ADV 2A to each prospective investor that they solicit, and (iii) that the solicitor is not “disqualified” to serve as a solicitor. The Marketing Rule incorporates and expands upon these requirements.

New Definition of Advertisement; Endorsements and Testimonials

The Marketing Rule redefines the term “advertisement” to encompass a broader range of marketing activity. One effect is that the traditional role of the solicitor is entirely subsumed. “The amended definition of ‘advertisement’ contains two prongs: one that captures communications traditionally covered by the advertising rule, and [a second prong] that governs solicitation activities previous covered by the Cash Solicitation rule.” The second prong of 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).”[3]

Under the new Marketing Rule, the operative terms are now “endorsement” and “testimonial,” which are defined as follows:

• A “testimonial” is defined as “any statement by a current client or investor in a private fund advised by the investment adviser: (i) About the client or investor’s [own] experience with the investment adviser or its supervised persons; (ii) That directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) That refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.”[4]

• An “endorsement” is defined as “any statement by a person other than a current client or investor in a private fund advised by the investment adviser that: (i) Indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons; (ii) Directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) Refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.”[5]

Any person who gives a testimonial or endorsement can be referred to as a “promoter,” whether or not the promotion was given for compensation. Anybody can be a promoter under the new Marketing Rule, even a client/investor or adviser. However, please be mindful that state securities laws may attach additional registration or licensure requirements to promotional/solicitation activities.[6]

The rule’s “general prohibitions” apply content restrictions to all types of advertisements, including paid and unpaid testimonials and endorsements. Several situational restrictions also apply to the use of third-party rankings and each form of performance advertising.

The rule does not consider communications that merely promote an adviser’s services to be advertisements unless they include an actual offer of advisory services “with regard to securities.” The rule also excludes from the definition of advertisement any one-on-one communications between the advisor and a single prospective investor where hypothetical performance is not discussed.

All Compensation Covered by the New Rule

By counting both direct and indirect compensation, in either cash[7] or non-cash form,[8] the new rule recognizes all forms of value transfer. Even informal cross-disciplinary referrals from “Professional Alliances,” such as those from attorneys and CPAs, can trigger the new Marketing Rule. This vast expansion in what is considered compensation is mitigated by an increase to the de minimis threshold, now $1,000 (up from $100) per promoter within the trailing 12-month period. De minimis compensation results in a partial exemption from the prescribed conditions for testimonials and endorsements. Several other narrow exemptions exist.[9]

Conditions on Use of Testimonials and Endorsements

In order for an adviser to use any testimonial or endorsement in its marketing materials, conditions must be met with regard to (1) disclosure, (2) written agreements, (3) ineligible persons, and (4) oversight and compliance.[10]

Disclosure: An adviser either must itself disclose, or have a reasonable belief that the promoter will disclose, at the time the testimonial or endorsement is disseminated, the following:

• in a clear and prominent manner
  • that the testimonial was given by a current client/investor, or that the endorsement was given by a person other than a current client/investor,
  • that cash or non-cash compensation was provided for the testimonial or endorsement, as applicable, and
  • that the communication includes a statement of any material conflicts of interest on the part of the promoter resulting from the relationship between the adviser and promoter; and

• in a manner that need not be clear and prominent
  • the material terms of the compensation agreement, including an accurate description of the compensation, directly or indirectly, to the promoter, and
  • the details of any material conflicts of interest on the part of the promoter resulting from the relationship between the adviser and promoter.

Written Agreement: An adviser must enter into a written agreement with each promoter describing the scope of the agreed-upon activities and terms of compensation, unless the promoter is an affiliate of the adviser, or the total compensation will not exceed the de minimis threshold.  However, the adviser no longer needs to obtain a written acknowledgement from each referred client that the client has received the required disclosures from the solicitor (i.e., a disclosure statement), and the solicitor no longer needs to deliver a copy of the adviser’s Form ADV Part 2A Disclosure Brochure to the prospective client.

No Ineligible Persons: An adviser will be prohibited from compensating a promoter in an amount exceeding the de minimis threshold, directly or indirectly, if the adviser knows or should know that the promoter is ineligible due to a disqualifying SEC action or any other “disqualifying event” within the last 10 years. The concept of an “ineligible person” also extends to entities, such that a promoter firm would be ineligible if any of its employees, officers, directors, general partners, or managers were subject to a disqualifying event.

Oversight and Compliance: An adviser must itself have a reasonable basis for believing, depending on the facts and circumstances, that a testimonial or endorsement complies with all requirements of the Marketing Rule (however, as mentioned above, the rule no longer requires the promoter to deliver the adviser’s Form ADV or disclosure documents, or obtain the investor’s signed acknowledgements). In the same release, the SEC redefined Rule 204-2 to require that investment advisers retain records of all advertisements they disseminate, even those delivered on their behalf by a promoter.

Advisers Must Comply by November 2022

The SEC has allowed for a generous 18-month compliance period within which investment advisers must redesign and implement their marketing processes in accordance with the new Marketing Rule. SEC staff clarified in a subsequent release that, during the compliance period, advisers should rely either on the old Cash Solicitation rule or the new Marketing Rule, but not a combination of both. That means all updated marketing processes cannot be implemented in piecemeal fashion.[11]

The Marketing Rule’s updates are significant and will require all federally registered advisers to reassess their marketing materials, solicitation practices, policies and procedures, Form ADV disclosures, and any other methods currently employed that involve communications with current and/or prospective clients. 

If you need assistance understanding whether or how the new Marketing Rule may apply to you, do not wait to consult a securities attorney.
Shustak Reynolds and Partners regularly advises investment advisory and broker-dealer firms on the impact of applicable state and federal rules.
To discuss your situation, contact us for a confidential initial consultation.

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