March 20, 2025
What happened?
On March 19, 2025, the SEC updated its Marketing Rule FAQ with new guidance on extracted performance and information on how to navigate the performance versus investment characteristic question.
Extracted Performance
The SEC staff revised the question and answer on extracted performance from January 11, 2023, that had called out displays of gross performance of one investment, like case studies, or a subset of investments from a private fund. This prior answer was aimed at private fund marketing and was a point of friction. One cause of this friction was that the answer meant showing net performance at the deal-level for a single portfolio company or net performance within a subset of a private fund’s investments. These are challenging to calculate and could create misleading outcomes depending on the methodology used. While private fund investors had not been asking for deal-level net performance, private fund managers were on the hook for providing it in any presentation of performance for a single investment or subset of investments.
The new guidance removes the need for deal-level net performance, but at a cost. The total portfolio’s net performance must be shown instead. The SEC staff said in the FAQ that enforcement actions would not be brought as long as:
The SEC staff understands that time periods for extractions may not easily align with the time periods of the total portfolio’s performance and said that extracted performance calculated over a single, clearly disclosed period would not lead to a recommendation of an enforcement action. However, the SEC staff did emphasize that extracted performance presented according to the FAQ was still subject to the general prohibitions of the Marketing Rule and the anti-fraud provisions of the Advisers Act. The general prohibitions should still be on everyone’s marketing checklist when reviewing an advertisement.
Portfolio of Investment Characteristics
Performance is never defined in the Marketing Rule, which has led to a lot of questions around characteristics that are adjacent to or can be used as a proxy for performance. If a characteristic is seen as performance, then the Marketing Rule’s requirements around prominent presentation of net performance, prescribed time periods, and specific requirements for related, extracted, hypothetical, and predecessor performance would all attach.
The SEC staff stated that they recognize the uncertainty about whether certain characteristics, like yield, coupon rate, contribution to return, volatility, sector or geographic returns, attribution analyses, the Sharpe ratio, the Sortino ratio, and other similar metrics, are “performance” under the Marketing Rule. Calculating these characteristics as net performance under the Marketing Rule would be impossible or create potentially misleading results.
The view of the SEC staff is that a prominent display of gross and net performance of the total portfolio, that is not otherwise materially misleading, removes the risk of a presentation of gross characteristics misleading clients and prospective investors about the impact of fees and expenses on investment performance. The new guidance states that if an adviser chooses to present gross characteristics of a portfolio or investment in an advertisement, an enforcement action would not be recommended as long as:
Like for extracted performance, the SEC staff understands that the time periods of a characteristic may not align with the prescribed time periods for total portfolio performance. Similarly, the SEC staff cautions that presentations of characteristics, like extracted performance, and like any advertisement, are still subject to the general prohibitions of the Marketing Rule and the anti-fraud fraud provisions of the Advisers Act.
What does this mean for me?
This may be received as both good news and bad news. It is good news to have clear guidance. Many firms have already taken the risk-based approach that showing total net portfolio performance would reduce the risk of extracted gross performance being misleading. It is comforting to know that total net portfolio performance presentations further reduce the risk of using metrics that look like performance such as attribution, yield, and Sharpe Ratio. The more certainty and guidance from the SEC, the easier it is to assess a firm’s approach to marketing. Having an answer to the questions around netting out extracted performance is a welcome relief for compliance programs still wrestling with the confusing 2023 era guidance.
Guidance can also be bad news. Firms using either extractions like case studies and sector analysis or characteristics like yield and contribution to return as a way to avoid performance advertising are looking at two scary answers. These new answers strongly indicate that extracted performance and investment characteristics risk being materially misleading without prominent displays of total net portfolio performance in the advertisement. Firms that have not developed performance marketing policies and procedures and always answered “no” to performance marketing in Item 5.L of Part 1 of Form ADV, must now consider performance marketing to keep using those same extractions and investment characteristics.
The devil is also in the details. While footnote 11 in the FAQ indicates that to have equal prominence under the Marketing Rule, the total gross and net portfolio performance need not be presented on the same page as the gross characteristic presentation in the advertisement, it is the SEC staff’s view that total gross and net performance must be presented on a page prior to the gross characteristic presentation. If your firm has been hiding overall net performance in the closing pages of your deck, it is clear that the SEC staff will not view it as prominent enough to facilitate a comparison between gross performance and net performance as required by the rule.
If you have questions or could use guidance to understand what these new FAQs may mean for your firm’s compliance practices, let us know. We’d be happy to arrange a call with one of our regulatory experts
