Practical Lessons from the Marketing Rule Sweep

Last week, the U.S. Securities and Exchange Commission announced charges against nine registered investment advisers for holding out hypothetical performance on public websites without adopting policies and procedures specific to the use of hypothetical performance as required by the Marketing Rule. The results from this sweep encompassed performance derived from model portfolios, from back-testing, or both. The firms, ranging in size from under $50 million to over a billion in assets under management, each settled with the SEC at a combined price tag of $850,000.

It is important to remember that there are three prongs to the exception to the prohibition on using hypothetical performance:

  • Adopt and implement policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement;
  • Provide sufficient information, between content and disclosure, for the intended audience to understand the criteria used and assumptions made in calculating the hypothetical performance; and
  • Provide sufficient information, again between content and disclosure, for the audience to understand the risks and limitations (e.g., outcomes different from assumptions) of using the hypothetical performance in making investment decisions.

 

The Staff’s findings did not explicitly call out specific disclosure failures. Rather, each finding noted the failure to adopt and implement policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience.

Furthermore, in each case, the Staff cited the adopting release and the quote, “We believe that advisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation.” The inference we are forced to draw here is that if there had been effective policies and procedures in place, these particular representations would not have appeared on a public website at all because the adviser would not have any basis to assess each user’s financial situation or investment objectives.

As a broad measure, any adviser who is holding out performance will be well served to maintain inventories of both the types and the instances of the firm’s use of performance representations.  We further recommend that the types of performance be broken down into categories useful to inform how they are treated for compliance review purposes. This process will also help to identify hypothetical performance[1].

Finally, where firms are relying on hypothetical performance, whether they be models, back-tested portfolios, targets and projected performance, each type should have its own policies and procedures that cover not only the criteria, assumptions and disclosures, but also their use cases and the controls in place to ensure the use case restrictions are maintained.

SEC³ can assist with navigating you through the Marketing Rule. SEC³ works with clients to customize firm’s policies and procedures reasonably designed to not only meet the regulatory requirements but also cover the use cases and ensure proper controls are in place. SEC³ also conducts reviews of client marketing and advertising materials.

For more information, please contact us at info@sec3ccompliance.com, at (212) 706-4029 x 229, through LinkedIn or visit us on our website at www.sec3compliance.com.


[1] 206(4)-1(e)(8) Hypothetical performance means performance results that were not actually achieved by any portfolio of the adviser. Hypothetical performance includes, but is not limited to: (i) Performance derived from model portfolios; (ii) Performance that is back-tested by the application of a strategy to data from prior time periods when the strategy was not actually used during those time periods; and (iii) Targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement.

Practical Lessons from the Marketing Rule Sweep