The SEC announced today that it is significantly updating and modernizing rules under the Investment Advisers Act of 1940 (“Advisers Act”) relating to advertising and payments to solicitors. The amendments create a single marketing rule that replaces the current advertising and cash solicitation rules. Amendments were also made to Form ADV, the investment advisor registration form, and the books and records rule to reflect the changes adopted to the advertising and cash solicitation rules.
The SEC stated that the marketing rule, amended books and records rule, and related Form ADV amendments, will be published on its website and in the Federal Register. All will be effective 60 days after publication in the Federal Register, although the SEC has adopted a compliance date that is 18 months after the effective date to give advisers a transition period to comply with the amendments.
Overall, the amendments made by the SEC will replace the current rules with more principles-based provisions. These new provisions include the following:
Definition of Advertisement
- The definition of an “advertisement” will capture both communications that were historically covered under the advertising rule as well solicitation activities covered under by the cash solicitation rule.
- First, the definition includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. Most one-on-one communications will be excluded. This definition is also subject to certain other exclusions.
- Second, the definition also includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).
Prohibition of Certain Advertising Practices
- The new rule will prohibit certain advertising practices, including the following:
- Making an untrue statement of a material fact (or omitting a material fact).
- Making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate.
- Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn.
- Discussing any potential benefits without discussing any associated material risks or limitations.
- Referencing specific investment advice provided by the firm that is not presented in a fair and balanced manner.
- Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.
- Including information that is otherwise materially misleading.
Testimonials and Endorsements
- Under the new rule, testimonials and endorsements in an advertisement are prohibited unless certain disclosure, oversight, and disqualification provisions are satisfied by the adviser.
- Advertisements will have to clearly and prominently disclose whether the person giving the testimonial or endorsement (the “promoter”) is a client and whether the promoter is compensated. Additional disclosures will be required regarding compensation and conflicts of interest. The current rule’s requirement that the adviser obtain from each investor an acknowledgement of receipt of disclosure will be eliminated.
- Advisers that use testimonials or endorsements in an advertisement will need to oversee compliance with the marketing rule. Advisers will also need to enter into a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives de minimis compensation (i.e., $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months).
Third-Party Ratings
- Third-party ratings in an advertisement will be prohibited unless the adviser provides disclosures and satisfies certain criteria pertaining to the preparation of the rating.
Performance Information
- The new rule will also include certain prohibitions regarding the use of performance information in advertisements. Importantly, there are no separate requirements for performance advertising in retail and non-retail advertisements. The prohibitions include the following:
- Gross performance, unless the advertisement also contains net performance that is equally prominent. (This requirement is applicable to all advertisements, not just advertisements directed to retail investors.)
- Any performance results, unless they are provided for specific time periods in most cases.
- The inclusion of any statement that the SEC has approved or reviewed any calculation or presentation of performance results.
- With limited exceptions, the inclusion of performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement.
- The inclusion of performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio.
- The inclusion of hypothetical performance (excluding performance generated by interactive analysis tools), unless the adviser has adopted and implemented policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the adviser provides certain information underlying the hypothetical performance.
- The use of predecessor performance unless the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser are similar. In addition, the adviser must include all relevant disclosures clearly and prominently in the advertisement.
Books and Records Rule and Form ADV
- Due to the amendments discussed above and the merger of the advertising and solicitation rules, the SEC also adopted certain related amendments to the books and records rule.
- The SEC also amended Form ADV to require investment advisers to provide certain additional information regarding their marketing practices.
Withdrawal of No-Action Letters and Other Guidance
- The Staff of the SEC will withdraw no-action letters and other guidance addressing the application of the advertising and cash solicitation rules as those positions are either incorporated into the final rule or will no longer apply.
To view the final rule adopted by the SEC, click here.
For more information about these rule changes, please contact NCA Compliance.
Hayley Nelson is the President and Principal Consultant of NCA Compliance, Inc., a compliance consulting firm providing a wide range of customized compliance solutions for investment advisors. Ms. Nelson previously worked for the Securities and Exchange Commission and a large investment manager in New York.
