SEC’s New Marketing Rule for Investment Advisers Goes into Effect
The US Securities and Exchange Commission’s long-awaited modernization of the rules governing the advertising and cash solicitation practices of investment advisers registered or required to be registered with the SEC was approved on December 22, 2020 and went into effect on May 4, 2021. The SEC effectively merged changes to the advertising and the cash solicitation rules into a single rule—referred to as the “Marketing Rule”—which is codified in Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended (the Advisers Act). In connection with adopting the Marketing Rule, the SEC also adopted related amendments to its books and records rule (Rule 204-2 under the Advisers Act) and to Form ADV. Since much of the SEC’s existing marketing guidance has been formulated through successive no-action letters, the SEC has indicated that it will provide future guidance as to which no-action letters are incorporated in or superseded by the Marketing Rule and will be withdrawn, and which no-action letters will survive.
Investment advisers will have an 18-month transition period—until November 4, 2022—to comply with the Marketing Rule and the amended books and records rule and Form ADV. Early compliance is permitted, so long as the adviser elects to comply with the new rules in their entirety from the time of such election. Partial compliance is not permitted.
- The Marketing Rule seeks to address technological advances and evolving market practice by, among other measures, modifying the definition of “advertisement.” Advertisements include any direct or indirect communication from an adviser to more than one person (or to just one person if the material in question includes hypothetical performance) that offers the adviser’s investment advisory services, or that offers new services to existing clients. Notably, the Marketing Rule now treats indirect communications, such as third-party social media comments that an adviser endorses or promotes, and nonwritten communications, such as pre-recorded videos, as “advertisements,” subject to the relevant provisions of the new rule. Conversely, the Marketing Rule expressly excludes extemporaneous live communications from the definition of “advertisement.”
- The Marketing Rule replaces certain per se prohibitions that existed in the prior rules with a more flexible principles-based framework. For instance, the new rule permits advisers to highlight specific past investment recommendations in an advertisement without including a full year of recommendations, so long as the adviser presents the recommendations in a fair and balanced manner.
- In addition to communications with advisory clients, the Marketing Rule now expressly covers communications with investors in private funds that rely on Section 3(c)(1) or 3(c)(7) to avoid registration as an investment company under the Investment Company Act of 1940, as amended.
- The Marketing Rule does not generally consider communications with existing investors or clients that do not offer new or additional advisory services to be “advertisements.”
- The Marketing Rule does not consider any of the following to be “advertisements”: a description of material terms, objectives and risks of a fund offering included in private placement memoranda; account statements, transaction reports and other similar materials delivered to existing investors in private funds; and presentations to existing clients concerning the performance of private funds they have invested in (for example, at annual meetings of limited partners).
- The Marketing Rule generally does not cover any one-on-one communications with prospective or current investors in private funds. The rule considers one-on-one communications with other prospective or current advisory clients to be advertisements, but only if the communication includes hypothetical performance and the adviser is not providing the hypothetical performance in response to specific and unsolicited questions or requests from the advisory client.
Disclosure Obligations Generally
» Fair and Balanced and Not Materially Misleading
- The Marketing Rule prohibits advisers from making any untrue statement of a material fact, or omitting to disclose any material fact necessary to make a statement, in light of the circumstances in which such statement was made, not misleading. Advisers are also prohibited from including in an advertisement any material statement of fact that the adviser does not have a reasonable basis for believing that it will be able to substantiate upon SEC demand. These requirements, which include essentially a “10b-5” standard, are not technically new, but shift no-action letter guidance into the Marketing Rule and emphasize the importance of being able to document or substantiate statements used in advertising materials in order to show that such statements are not materially misleading.
» Requirements Applicable to Testimonials and Endorsements
- The Marketing Rule requires advisers to provide a number of disclosures in connection with testimonials (broadly, a statement by a client about the adviser’s services that operates to approve the services of an adviser or to solicit or direct business to an adviser) or endorsements (broadly, statements by persons that are not clients, which may include, among other communications, statements about the personal qualities of an adviser and statements by placement agents) that are used as or in advertisements. These disclosures include statements regarding the status of the promoter, whether compensation is paid to the promoter, and the existence of material conflicts of interests. These required disclosures must be set forth “clearly and prominently” within the advertisement. Advisers are also required to disclose material terms of applicable compensation arrangements and more detailed descriptions of material conflicts of interest in connection with testimonials and endorsements; however, such disclosures are not subject to the clear and prominent requirement and can be provided separately.
- Registered broker-dealers who solicit entities or individuals that are not investing for personal, family or household purposes are only required to provide the “clear and prominent” disclosures described above. Registered broker-dealers who solicit individuals who are investing for personal, family or household purposes, and certain investment adviser personnel, are generally excluded from the disclosure requirements for testimonials and endorsements. Note that registered broker-dealers remain subject to Financial Industry Regulatory Authority Inc. marketing rules which are unchanged by the Marketing Rule.
Compensated Testimonials and Endorsements
» The Marketing Rule considers any testimonial or endorsement for which an adviser directly or indirectly provides compensation to be a per se “advertisement.”
» Advisers generally must enter into written agreements with third parties who will be compensated for testimonials and endorsements.
» The Marketing Rule generally prohibits advisers from paying any person for a testimonial or endorsement if that person has been subject to certain disqualifying events, including convictions for certain bad acts under the Advisers Act and orders from the SEC in connection with violations of certain securities laws.
Treatment of Performance Data
» The Marketing Rule requires advisers who include performance results in advertisements to present the results in a fair and balanced manner, and to include net performance information whenever gross performance is presented.
» Advertisements that include actual performance information must present performance results of the relevant portfolio over one-, five- and 10-year periods to the extent applicable. This requirement, however, does not apply to private funds.
» The Marketing Rule permits advisers to use hypothetical performance results (including modeled, backtested, targeted or projected performance) in advertisements, subject to certain conditions, including a requirement that the information be relevant to the likely financial situation and investment objectives of the intended audience; limitations also apply to the use of related performance and extracted performance.
» The Marketing Rule also addresses portability of performance and related disclosures; “ported” performance requires disclosures generally consistent with previous SEC guidance on such information.
- The Marketing Rule allows advisers to use third-party ratings in an advertisement, subject to certain conditions, including certain disclosure obligations and a requirement that the adviser have a reasonable basis to believe that the questionnaire or survey used to prepare the third-party rating is not designed to produce unfair results.
- The amended books and records rule generally requires an adviser to keep, among other things, copies of all advertisements disseminated by such adviser. The amended rule also requires advisers to keep copies of, inter alia: written communications relating to, and documentation supporting the calculation of, performance or rate-of-return calculations for both private funds and proprietary accounts; documentation substantiating the adviser’s reasonable basis for believing that a testimonial, endorsement or third-party rating complies with the applicable tailored requirements of the Marketing Rule; and a record of the disclosures delivered to investors in connection with testimonials, endorsements and third-party ratings.
- Form ADV has been amended to include a new subsection addressing a registered adviser’s marketing activities. Item 5 of Part 1A of Form ADV will require information about an adviser’s and its relying advisers’ use in any advertisements of (a) performance results, (b) previous investment advice, (c) testimonials, (d) endorsements, and (e) third-party ratings.
Key Takeaways for Fund Managers
In anticipation of complying with the Marketing Rule, advisers should:
- Prepare to be in compliance with the new Marketing Rule and the revised books and records rule no later than November 4, 2022.
- Update any investor communications that would be considered advertisements, including offering materials such as private placement memoranda (to the extent they include marketing information), pitchbooks and other marketing materials, and be prepared to substantiate any statements of material fact included in such materials.
- Adopt and/or update policies and procedures to comply with the new rules, including policies and procedures that govern communications with clients, social media use and other online marketing, and the use of testimonials and endorsements.
- Carefully assess the prospective use of testimonials and endorsements provided by others. Consider when they may be attributed to the adviser and become subject to the provisions of the Marketing Rule.
- Before providing any benefit to a person that provides or will be providing a testimonial or endorsement, consider whether that benefit may constitute compensation for the testimonial or endorsement, whether compensation may be provided to that person and whether a written agreement is required with respect to the benefit so provided.
- Prepare to comply with expanded recordkeeping requirements, including new recordkeeping requirements that apply with respect to performance-related communications and calculations of private funds and proprietary accounts.
- Use the updated Form ADV (and respond to the new questions) when filing your first annual amendment after the compliance date.
This Advisory provides summary highlights of the Marketing Rule that may be of particular interest to investment advisers. Arnold & Porter will issue further alerts exploring specific aspects of, and potential issues presented by, the new Marketing Rule.