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The New Marketing Rule Part 3 – General Prohibitions

The New Marketing Rule Part 3 – General Prohibitions

What happened?

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 about 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 programs for the new regulation. This Flash Report is the third in that series.  See part one here, and part two here.

The SEC’s new advertising rule is animated by seven “general prohibitions” on advertising content. The prohibitions are intended to ensure that ads do not mislead the public. The seven general prohibitions, beginning on page 65 of the adopting release, are summarized below. They prohibit advisers from doing any of the following, in any advertisement directly or indirectly distributed:        Including any untrue statement of a material fact, or omitting to state a fact necessary in order to make the statement not misleading. The following are examples of violations:

  • Including any untrue statement of a material fact, or omitting to state a fact necessary in order to make the statement not misleading. The following are examples of violations:
    • Advertising that performance of an adviser’s strategy was positive during the last fiscal year may be misleading if the adviser omitted that a benchmark the strategy tracks experienced significantly higher returns during the same period.
    • Compensating someone who is neither a client nor a private fund investor of the adviser to endorse the adviser by claiming that they had a good experience working with them.
    • Adopting a testimonial or endorsement the adviser knows or should know to be untrue or misleading.
    • Providing a testimonial on its website where a client falsely claims to have worked with the adviser for over 20 years when the adviser has only been in business for five years.
  • Including a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate if asked to by the Commission.
    • Material facts include statements of portfolio manager certifications, the type or number of investment products offered and claims about performance.
    • The SEC clarified that opinions are not statements of material facts.
    • To demonstrate a reasonable basis, advisers could make a contemporaneous record with the advertisement or implement policies to address data retention supporting factual statements.
    • The bottom line: if an adviser is unable to substantiate a material claim when the Commission demands, it will be presumed the adviser had no reasonable basis.
  • Including information reasonably likely to cause the public to draw an untrue inference concerning a material fact about the adviser.
    • Example: listing true statements that may provide misleading context when considered together is a violation. If an adviser states that it has more than one hundred clients that have stuck with them for more than ten years, while true, that could cause an untrue inference if the adviser actually has very high client turnover.
    • Example: making claims without providing appropriate context would constitute a violation. If an adviser claims that 100 percent of their clients have seen profits, but in reality, only has two clients, the original claim would be a violation.
    • Advisers using testimonials or endorsements may comply by including a disclaimer clarifying that the testimonial is not representative. The disclosure should also link to all or a representative sample of the testimonials about an adviser.
  • Failing to provide fair and balanced treatment of material risks when discussing potential benefits to clients and investors.
    • Example: an adviser claiming that it can reduce a prospective investor’s taxes through certain strategies, without discussing risks of the strategy, would be a violation.
    • “Layered disclosures” (i.e., including hyperlinks to additional disclosures) are acceptable as long as each “layer” is fully compliant. For example, identifying a benefit of adviser’s services, accompanying the benefit with fair and balanced treatment of material risks (within the ad) and then including a hyperlink to additional content discussing additional benefits and additional risks.
  • Not presenting specific investment advice in a fair and balanced way. The new Marketing Rule prohibits references to specific investment advice if they are not presented in a fair and balanced manner.
    • Example: an adviser publishing a “thought piece” on advice given to navigate the covid pandemic would be prohibited unless it included disclosures with appropriate contextual information for an investor to evaluate the advice (such as the nature and timing of the advice and any relevant constraints, such as liquidity).
    • Facts and circumstances will determine if a presentation is fair and balanced.
    • Using objective selection criteria over consistent time periods should produce fair and balanced results.
  • Not presenting performance information in a fair and balanced way.
    • Example: an adviser “cherry-picking” exclusively positive case studies (e.g., only profitable scenarios) in a non-representative way would be a violation.
    • Example: only showing performance results for an unrepresentative time frame would also be a violation.
  • “Otherwise be materially misleading”.
    • Example: including accurate disclosures in an unreadable font would be materially misleading and a violation.

The SEC advises that enforcement decisions may hinge on the type of audience (and their background in investing) that is likely to be exposed to the ad. The SEC maintains that it is an adviser’s responsibility to understand and comply with the seven prohibitions. Advisers may be found deficient if they fail to comply due to lack of awareness—in spite of the absence of bad intentions.

What does this mean for me?Although relief from certain restrictions are offered by the new rule, 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. Future Flash Reports will outline the restrictions and requirements necessary to make use of testimonials and endorsements under the new Marketing Rule. Our next Flash Report in this series will discuss the general prohibitions under the new Marketing Rule.

Fairview Investment Services provides ongoing, full-service compliance support for investment advisers, including comprehensive marketing and advertising review. Contact Fairview Investment Services for additional information about maintaining your compliance program in an ever-changing regulatory environment.