December 23, 2020
The SEC finally adopted their long-awaited modernization to investment adviser marketing rules. The adopting release can be found here, and the language of the rule here.
The final rule has several changes from the initial proposal but holds to maintaining a single rule on the subject of advertising and eliminating the separate “cash payments for client solicitations” rule. The new rule allows testimonials and third-party endorsements provided there is proper disclosure. The new rule also features an expanded definition of “advertisement” to accommodate new technologies and routine client communications. The definition excludes communications designed to retain clients rather than attract new investors. Other important features of the new Advertising Rule include:
• Seven general prohibitions that apply to all advertisements:
- Making any untrue statements of a material fact, or omit material facts necessary to make the statement made, not misleading;
- Making material claims or statements that are unsubstantiated;
- Making untrue or misleading implications or cause untrue or misleading inferences to be drawn about material facts;
- Implying potential benefits without clearly and prominently discussing any associated material risks or other limitations associated with the implied benefits;
- Referring to specific investment advice provided by the RIA where such advice is not presented in a manner that is “fair and balanced”;
- Including or excluding performance results or time periods in a manner that is not “fair and balanced”; and
- Including information that is otherwise materially misleading.
• Conditions for the use of third-party ratings and testimonials.
• Updated rules governing performance advertising, including requirements for use of related performance, extracted performance, hypothetical performance, and predecessor performance.
• Updated presentation standards, including a 1-, 5-, and 10-year performance presentation standard comparable to the Securities Act Rule 482 applicable to mutual funds. Notably, this requirement does not apply to private funds.
Elements of these changes consolidate guidance or incorporate standards that have been in effect for decades. In some cases, the rule explicitly parallels guidance in the current framework (e.g., regarding predecessor performance), while in others the standards of the guidance are implied but not explicitly incorporated (e.g., the Clover Capital no action letter requirements). The new rule appears to have borrowed from the fair and balanced standard from FINRA. In addition, certain performance composite considerations are consistent with CFA Institute standards. Advisers seeking to understand the implications of these requirements may do well to reference guidance and enforcement actions related to advertising from these sources.
Certain changes from the proposed Rule elicited three contemporaneous comments from four of the Commissioners.
Public Statements of the Commissioners:
Commissioners Allison Herren Lee and Caroline Crenshaw
Most comments showed approval for the new rule. However, certain comments highlighted areas of particular concern, including performance advertising to retail investors, the use of hypothetical performance and concern related to the pre-approval of advertising requirement not being included.
Along with changes to the advertising rule, enhancements were adopted to disclosures on Form ADV regarding advertising practices. This includes Yes/No disclosures on the use of performance advertising (and, specifically, hypothetical and predecessor performance), past specific recommendations, testimonials, endorsements and third-party ratings, which will allow examiners to better identify high-risk practices among advisers.
The changes are a welcome update to the range of guidance and no action letters that comprise the current regime, but there is a lot to unpack in this release. Overall, the rule appears to balance the goals of protecting investors while supporting advisers’ continuing efforts to attract new business. Nevertheless, we expect that this area will remain well scrutinized. We expect to see additional interpretation and clarification as advisers implement the new Advertising Rule. Hence, we recommend cautious consideration before attempting radical departures from established practices. For help in assessing how these changes may affect your business, please reach out to us at info@seccc.com. We are here to help!
