On December 22, 2020, the U.S. Securities and Exchange Commission (SEC) passed amendments to the advertising and cash solicitation rules, along with updates to other requirements for registered investment advisers. The formerly separated rules are now combined under the new Marketing Rule, Rule 206(4)-1 of the Advisers Act, made effective May 4, 2021, with a compliance date of November 4, 2022.
With less than six months until the compliance date for the new Marketing Rule, our Flash Reports will cover areas RIAs will need to consider as they update their compliance program for the new regulation. This Flash Report is the fourth in that series. In case you missed the first three, they are linked below:
- The New Marketing Rule: Part 1 – What is an Ad?
- The New Marketing Rule Part 2 – What are Testimonials and Endorsements?
- The New Marketing Rule Part 3 – General Prohibitions
The new Marketing Rule was devised to be applicable to a variety of communication forms—including social media content. Some regulations imply novel guidelines for social media communications. This report summarizes key applications of the SEC’s new marketing rule to some common social media marketing practices.
1. Scope of Adviser Communication – The new Marketing Rule’s two-pronged definition of advertisement was designed to apply to modern communication that was not even imagined at the time the current rule was drafted. Recall that Prong One’s definition includes direct and indirect communication offering advisory services. All such offers are within the scope of the rule regardless of how they are disseminated.
- Disseminated from the Adviser or Employees: Emails, text messages, instant messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, all manner of social media, newspapers, magazines, and mail would count as direct communication (see page 17 of the adopting release of the new Marketing Rule for a discussion of this list).
- Provided to Intermediaries for Dissemination: Content provided to consultants, other advisers (such as a fund-of-funds or feeder fund structure), and any promoters would be indirect communication attributable to the firm.
Firm and employee use of social media in either of these instances should be monitored for compliance with the new Marketing Rule.
2. Scope of Third-Party Communication – Compensated testimonials and endorsements are advertisements under Prong Two of the definition of advertisements. Also, uncompensated third-party communication can be attributable to the firm as an advertisement through adoption and entanglement.
- Adoption (how a retweet becomes an ad) – Adoption occurs when the adviser or an employee explicitly or implicitly endorses or approves of third-party information after its publication.
- Retweeting, reposting, or directing traffic to third-party communication are all forms of adoption.
- Hyperlinking to a third-party webpage or quoting third-party content are other examples of adoption.
Social media can quickly expose a firm to liability for third-party information under the ad rule. Consider the general prohibitions: an adviser cannot make misleading statements itself, thus it cannot adopt third-party information that is misleading.
- Entanglement (how likes/reviews become ads) – Entanglement occurs when an adviser is involved with the preparation of third-party communication. While allowing “likes,” reviews and online comments on a firm’s social media and webpages is now permitted under the new Marketing Rule, this presents issues of entanglement.
- Any actions by the firm or an employee to “selectively delete or alter the comments or their presentation” (for example, approving comments, editing the content of comments, or organizing comments such that negative comments are obscured or minimized) would make that third-party content an ad attributable to the adviser.
- If the adviser participates in the third-party content’s preparation, such as encouraging positive reviews or likes, suggesting language to be used in online comments, or otherwise assisting in the communication, that communication would also be an ad attributable to the firm.
Employees’ social media activity may be a source of adoption and entanglement that violates the ad rule. Advisers must have adequate policies and procedures that include ongoing monitoring and supervision.
3. The Challenge for Disclosures – An added challenge to social media are the required disclosures for the use of testimonials and endorsements.
- Compensated Testimonials and Endorsements require the disclosure of compensation, whether the promoter is a client or not, a statement of any material conflicts (that may stem from the client’s relationship to the adviser or to clarify that the client’s experience is not representative of all client experiences), the material terms of any compensation arrangement. Social media sites may not afford the space or character count required to present these necessary disclosures.
- Uncompensated Testimonials and Endorsements still require disclosure of whether the promoter is a client or not and a description of material conflicts, which still runs into the same constraints of social media platforms.
- Layered disclosures One way to meet this challenge is the use of layered disclosures (i.e. including hyperlinks to additional disclosures). Layered disclosures are acceptable as long as each “layer” is fully compliant. For example, including a statement that a promoter is a current client, that cash compensation was provided, and a brief list of material conflicts of interest in the ad along with a link to a fuller description of material conflicts resulting from the promoter’s relationship with the adviser and the promoter’s compensation arrangement with the adviser would be compliant. Here, since the initial statements are presented clearly and prominently and those are the disclosures that must meet the clear and prominent standard, the first layer is compliant. Linking to the additional description, the second layer of disclosure, is also compliant as those details must not meet the clear and prominent standard but must still be disclosed.
What does this mean for me?
Given the challenges associated with monitoring social media use under the new Marketing Rule, firms may decide to continue current prohibitions on its use. Although the new rule offers relief from certain restrictions, significant compliance and operational oversight will be needed to ensure all the new requirements are fulfilled.
Fairview will continue to update you with in-depth information about the impact of these changes and how your firm may be affected. Our next Flash Report in this series will focus on requirements for the use of performance advertising.
Fairview Investment Services provides comprehensive and ongoing compliance services, including comprehensive marketing and advertising review, solicitation-related consulting, and complete examination support. Contact Us for additional information about maintaining your compliance program in an ever-changing regulatory environment.