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SEC OVERHAULS INVESTMENT ADVISER MARKETING AND SOLICITATION RULES

       

By Robert R. Boeche II, Esq. and Andrew Steiger, Law Clerk 

The Securities and Exchange Commission (SEC) recently amended the Investment Advisers Act of 1940, as amended (the “Advisers Act”) to modernize the rules governing the marketing activities of investment advisers. The previous advertising rule (Rule 206(4)-1 of the Advisers Act), and cash solicitation rule (Rule 206(4)-3 of the Advisers Act), had been updated over time by the SEC solely through a hodgepodge of narrow decisions promulgated via No Action Letters. With this amendment, the SEC codifies the collected wisdom of past decisions, and replaces the current advertising and cash solicitation rules. The result is the new Marketing Rule, which is scheduled to become effective on May 4, 2021, with a compliance deadline of November 4, 2022.

The Marketing Rule

This new framework replaces one left largely unaltered for 60 years. The Rule is intended to modernize the marketing practices of investment advisers while continuing to protect investors from misleading advertisements and solicitations.[1] The Rule redefines the term “advertisement” to encompass a broader range of marketing activity, wrapping up within the definition the traditional activities of paid solicitors as well as the concept of paid testimonials or endorsements.

Digital and Social “Advertisement”

The definition of advertisement now includes “any direct or indirect communication” which offer the adviser’s services to new or existing clients or investors.[2] This language will permit advisers to expand their marketing activities into digital and social media.[3] This change also includes a new suite of anti-cherry-picking provisions, requiring advertisements that include investment performance be presented to potential investors such that any extracted performance summaries accurately reflect overall investment performance.[4]

Testimonials, Endorsements, and other forms of Compensated Solicitation

The second prong of the new definition of “Advertisement” covers compensated testimonials and endorsements. Under the old rule, advisers attracted new clients by offering cash compensation to individuals or broker-dealer firms to introduce them to potential clients. As there is no longer a separate solicitor rule, this prong covers oral communications and one-on-one communications to capture the traditional scope of solicitation activity under the old rule.[5] The new Marketing Rule refers to those providing compensated testimonials or endorsements as “promotors,” rather than “solicitors.” The term “provider” is used to refer to a person providing unpaid testimonials or endorsements.[6]

Immediately following the effective date, advisers may for the first time use compensated testimonials and third-party endorsements in their marketing. Advertisements that include testimonials or endorsements will be subject generally to certain conditions: (i) required disclosure of the fact that the promoter is receiving compensation; (ii) disqualification of ineligible promoters; and (iii) adviser oversight and compliance, including written agreements for paid promoters.[7]

Promoter Requirements

A “promoter” means a person who for cash or other compensation either solicits a potential investor or provides a testimonial or endorsement for the marketing purposes of an investment adviser. A promoter must enter into a written agreement with the adviser describing (i) the scope of the agreed-upon marketing activities, and (ii) compensation terms for those activities.[8]

There is no presumption that a promoter must register with the SEC. However, a promoter must register if by providing an endorsement or testimonial he or she meets the definition of investment adviser or broker-dealer.[9] A promoter must therefore be careful not act as an investment adviser within the meaning of section 202(a)(11) of the Advisers Act, or as a broker-dealer under section 15(a) of the Exchange Act. For example, a person providing advice to a client as to the selection or retention of an investment manager or managers might be deemed to be “advising” others.[10] It is up to the promoter to determine under the circumstances whether it is subject to statutory or regulatory requirements under federal law, including the requirement to register.[11]

General Prohibitions

The Marketing Rule establishes a set of seven (7) broad, principles-based prohibitions that apply to any form of advertisement by an adviser, creating a unified standard for impermissible forms of advertisement. The prohibitions draw upon past anti-fraud principles and are tailored specifically to investment adviser marketing practices.[12] “Specifically, in any advertisement, an adviser may not:

(1)    Include any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading;

(2)    Include 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];

(3)    Include 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 investment adviser;

(4)    Discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits;

(5)    Include a reference to specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced;

(6)    Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced; or

(7)    Otherwise be materially misleading.”[13]

These prohibitions apply to “untrue and misleading” statements or inferences, and require “fair and balanced” presentation of risks and rewards. No intent or knowledge of wrongdoing is required, as negligence alone is sufficient here to establish a violation.[14]

Amendments to Form ADV

Form ADV Part 1A, Item 5, will now include a new Subsection L, containing eight (8) yes or no questions.[15] The adviser must indicate whether its advertisements use (i) performance results, (ii) testimonials, (iii) endorsements, (iv) third-party ratings, (v) prior investment advice, (vi) hypothetical performance, and (vii) predecessor performance.[16] If the adviser uses testimonials, endorsements, or third-party ratings, then it must also disclose whether they are paid.[17]

Marketing Rule Expressly Includes Private Funds

The new Marketing Rule expressly includes marketing communications sent to investors in “private funds,” meaning an issuer that would be an investment company but for an exemption under 3(c)(1) or 3(c)(7) of that Act.[18] The adopted rule will treat only those communications that offer new or additional advisory services as advertisements, because only they raise the same concerns as advertisements to prospective investors.[19] The new Marketing Rule does not apply to registered investment or business development companies.[20]

Conclusion

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.  The SEC will allow investment advisers a compliance period of 18-months starting from May 4, 2021, to comply with the terms of the new Marketing Rule.

We do it all and Shustak Reynolds & Partners is here to help. We focus our practice on securities and financial services law and complex business and financial disputes. We represent many broker-dealers, registered representatives, investment advisers, investors and businesses. For assistance in reviewing such rules, performing required filings and/or drafting fund documents, please write us or call us at (619) 696-9500.



 

[1] Final Rule, Securities and Exchange Commission Release No. IA-5653, at 12.

[2] Investment Advisers Act of 1940, Section 206(4)-1(e)(1) (emphasis added).

[4] Final Rule, at 78.

[5] Final Rule, at 15.

[6] Final Rule, at 8, Footnote 6.

[7] Final Rule, at 13.

[8] Final Rule, at 407.

[9] Final Rule, at 57.

[10] Final Rule, at 56, Footnote 171.

[11] Final Rule, at 57.

[12] Final Rule, at 13.

[13] Final Rule, at 65.

[14] SEC v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992).

[15] Final Rule, at 397.

[16] Final Rule, at 419.

[17] Id.

[18] Investment Advisers Act of 1940, Section 202(a)(29).

[19] Final Rule, at 35.

[20] Final Rule, at 58.

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