OCIE Announces Most Frequent Advertising Rule Risks Identified in Examinations

September 15, 2017

OCIE Announces Most Frequent Advertising Rule Risks Identified in Examinations

WHAT HAPPENED?

On September 14, 2017, the Office of Compliance Inspections and Examinations (“OCIE”) announced the most frequent compliance issues with the Advertising Rule that were identified in their recent deficiency letters and examinations.  The Advertising Rule states that an advertisement includes the dissemination of written communication addressed to one or more persons, or any announcement in any publication or media, which offers:

• Analysis on securities or recommendation to buy or sell any security;
• Any graph, chart, formula or related device to determine whether to buy or sell any security; and
• Any other investment advisory service regarding securities.

MOST IDENTIFIED COMPLIANCE ISSUES

The following compliance issues were the most frequent deficiencies that the OCIE identified:

1. Misleading Performance Results: Examples include the use of performance without the deduction of advisory fees, inadequate disclosures about the limitations inherent in comparisons of results to benchmarks, and the use of back-tested performance without explaining how the returns were formulated.
2. Misleading One-on-One Presentations: Examples include using gross performance results without relevant disclosures and the failure to disclose that advertised performance results did not deduct advisory fees and other related expenses.
3. Misleading Claim of Compliance with Voluntary Performance Standards: For example, claiming compliance with GIPS without providing clear indication to the OCIE staff that the standards’ guidelines were sufficiently met.
4. Cherry-Picked Profitable Stock Selections: For example, advertisements that used past specific recommendations without meeting the requirements outlined in Subsection (a)(2) of the Advertising Rule.
5. Misleading Selection of Recommendations: For example, disclosing past specific investment recommendations that did not include all prior recommendations of the investment strategy, thus violating the conditions set forth in the TCW Group and Franklin no-action letters, as further described below.
   1. TCW Group No-Action Letter – The SEC Investment Management (“IM”) staff stated that advisers are permitted to disseminate advertisements that included an equal number of the best and worst performing holdings in an investment strategy, provided several representations are met[i].
   2. Franklin No-Action Letter – The SEC IM staff stated that advisers are permitted to disseminate advertisements that included past specific recommendations if they were selected by using a consistently applied, objective, non-performance based selection criteria and meet certain additional requirements[ii].
6. Inadequate Compliance Policies and Procedures Designed to Prevent Deficient Advertising Practices: Examples included policies and procedures that did not establish (i) a process for the review and approval of marketing materials prior to distribution; (ii) establish parameters for selecting which accounts for inclusion in composite performance calculations; and (iii) guaranteeing the accuracy of performance results.

TOUTING INITIATIVE OBSERVATIONS

OCIE launched its Touting Initiative in 2016, with the intent of evaluating the adequacy of disclosures provided by advisers to clients when including accolades in advertisements.  The most commonly identified compliance issues from the Touting Initiative included the following:

• Misleading Use of Third Party Rankings or Awards: Examples included the advertisement of accolades that were (i) received based on potentially false or misleading information; (ii) circulated while no longer current; or (iii) distributed without disclosing the relevant selection criteria, entity conducting the survey, or requirement of a participation fee;
• Misleading Use of Professional Designations in Form ADV Part 2B Brochure Supplements and Advertisements: For example, the failure to explain (i) the minimum qualifications required to attain the advertised employee professional designations; or (ii) that the referenced designations have lapsed; and
• Prohibited Use of Testimonials: For example, advisers publishing client endorsements on their websites, social media pages, pitch books, or in reprints of third party articles.

WHAT DOES THIS MEAN FOR ME?

Advisers are required to adopt and implement detailed, written policies and procedures reasonably designed to comply with requirements of the Advertising Rule.  Compliance programs should include a thorough review and approval process to mitigate the risks identified by OCIE staff.  This process should ensure that the compliance program is effective in removing misleading language or adding adequate disclosures to prevent the distribution of misleading advertisements.  Fairview^® supports clients in reviewing marketing materials for compliance and provides annual compliance training to assist employees with understanding the requirements of the Advertising Rule.

Please contact Fairview^® if you have any questions or concerns regarding this Risk Alert or your firm’s compliance program.

Sources: National Exam Program Risk Alert, September 2017

[i] TCW Group No Action Letter

[ii] Franklin Management No Action Letter