Risk Alert Examiner’s Observations on the Marketing Rule

April 22, 2024

What happened?

On April 17^th, 2024, the Division of Examinations (“EXAMS”) published a risk alert to inform investment advisers, investors, and other market participants about the examiner’s observations on the Marketing Rule. This risk alert highlights the Division’s focus on advisers’ compliance with the marketing rule and their completion of the marketing rule items contained in Form ADV as well as 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”.

Compliance Rule

While training, marketing review and approval processes, and updated compliance policies and procedures were mostly present, EXAMS observed failures in policies and procedures and implementation, including:

• Policies that were not formally adopted in writing, or that were only partially updated for the new rule.
• General policies that lacked tailoring for firms’ marketing channels, such as websites and social media, and/or specific types of ads such as testimonials, endorsements, and third-party ratings.
• Implementation failures, where policies were updated but practices were not (e.g., policies required net of fees performance to be included with any performance advertisement; but sampled advertising only included gross performance).

Books and Records Rule

Similarly, EXAMS observed that advisers had typically updated policies and procedures around marketing-related books and records requirements, but discovered deficiencies, including:

• Substantiation – Advisers did not maintain documentation to support performance claims included in advertisements.
• Third-party Ratings – Advisers completed questionnaires or surveys used to prepare a third-party rating but did not maintain a copy of such questionnaires.
• Social Media – Advisers did not maintain copies of information posted to social media.

Form ADV

EXAMS noted multiple instances of inaccurate reporting in Item 5.L of Form ADV and related disclosures in Part 2A Item 14:

• ADV said no third-party ratings, when firm websites and social media posts included third-party ratings.
• ADV said no performance advertising, when firm’s performance results were included in advertisements.
• ADV said no hypothetical performance, when hypothetical performance was included in advertisements.
• Outdated language from the prior Cash Solicitation Rule (Advisers Act Rule 206(4)-3) in Part 2A.

General Prohibitions

The staff assessed whether advisers who advertise violated any of the following General Prohibitions.  This was the longest section of the risk alert.  This is some of the most specific guidance the SEC has published on the general prohibitions to date. We have included a detailed summary of examples from each category:

Prohibitions 1 &2 – Untrue statements of material fact and unsubstantiated statements of material fact

• Saying “free of all conflicts” when actual conflicts existed.
• Stating a “network of personnel” perform advisory services when only one individual does so.
• Untrue qualifications around education, experience and professional designations claimed.
• Inaccurate service or product descriptions:
  • Referencing an ESG mandate where there was no investment mandate.
  • Claiming validation by third parties that did not take place.
  • Claiming risk tolerances were considered when in fact all clients were placed in the same investments without consideration.
  • Referencing approved securities lists or formal screening processes that did not exist.
• Claiming awards or accolades that were not received.

Prohibition 3 – Omission of material facts or misleading inference – Exams shared more example deficiencies under this general prohibition than any other.

• Stating the firm acts “in the best interest of clients” without disclosing that all investment advisers share the same fiduciary duty to act in clients’ best interests.
• Recommending investments (in print, podcasts, website) without disclosing the conflicts of interest from compensation to the firm for such recommendations.
• Stating advisers were “seen on” national media implying appearances without disclosing that the “appearances” were paid advertisements.
• Untrue or misleading Performance claims:
  • Advertising cumulative profits advisers did not believe could possibly be achieved.
  • Omitting adequate disclosure regarding share classes included in returns.
  • Using lower fees for net performance than were offered to the intended audience.
  • Omitting material information regarding fees and expenses used in calculating returns.
• Citing SEC Registration to imply a level of skill or ability and including the SEC logo to imply approval or endorsement by the SEC.
• Misleading use of third-party ratings:
  • Implying firm was sole recipient of an award when the award went to multiple recipients, or where firm was not the top recipient.
  • Indicating high ratings without disclosing the methodology for such ratings (especially where not investment related but based on AUM, client count, co-workers nominating a fellow employee, etc.)
• Using testimonials of client’s experience with a third-party product as if it was experience of the advisers’ services.
• Performance containing misleading information:
  • Benchmark index comparisons that did not define the benchmark, or failing to disclose that the benchmark did not reinvest dividends.
  • Presenting outdated performance from several years prior, presenting products no longer available to clients, and presenting lower investment costs that were unavailable.
• Misleading presentation of advisers’ performance:
  • Presenting advisers’ performance track record with securities not purchased in a similar manner in their client accounts.
  • Claiming above average performance results without clarifying the adviser did not yet have clients or documented track records.
  • Including performance information within recommendations without disclosing necessary context, such as that most investors would have experienced the same returns for the time period because of general market performance.

Prohibition 4 – Fair and balanced treatment of material risks and limitations

• Stating potential benefits connected with advisory services or methods of operation without fair and balanced treatment of material risks or material limitations of those benefits.
• Advertising on social media that highlighted performance information without also disclosing the material risks and limitations associated with the potential benefits

Prohibition 5 – Reference to specific investment advice not presented in a fair and balanced manner

• Including only the most profitable investments in the advertisement.
• Specifically excluding certain investments without providing sufficient information to evaluate the rationale (such as write-offs or lower-performing investments).
• Failing to establish policies and procedures to ensure references to specific investment advice were provided in a fair and balanced manner.

Prohibition 6 – Inclusion or exclusion or performance results or time periods in manners that were not fair and balanced

• Advertisements did not disclose the time period or whether returns were calculated for the same time period as additional performance information in the same advertisement.
• Including or excluding certain performance results, such as including only realized investment information in the total net return figure and excluding unrealized investments.

Prohibition 7 – Advertisements that were otherwise materially misleading

• Presenting disclosures in an unreadable font on websites or in videos.

What does this mean for me?

We are nearly a year and half from the initial compliance deadline of the new Marketing Rule and its principle-based approach to marketing. EXAMS staff are seeing plenty of missteps in the way firms have updated or failed to update their compliance programs, marketing review and regulatory filings to comply with this principle-based rule. This risk alert is full of specific examples the SEC sees as violations of the rule. The good news is that we finally have objective examples of how the SEC is applying the rule.

The conclusion of the risk alert states that “in sharing these staff observations, [EXAMS] encourages advisers to reflect upon their own practices, policies, and procedures and to implement any appropriate modifications to their training, supervisory, oversight, and compliance programs.” Review this list for any similar activity at your firm and make 2024 the year you update your compliance program for the new Marketing Rule to the satisfaction of SEC staff.

If you have any questions, or if you would like to speak with one of our regulatory experts, let us know.