The SEC announced yesterday that it voted to propose amendments to update and modernize rules under the Investment Advisers Act of 1940 (“Advisers Act”) relating to advertising and payments to solicitors. Amendments are also proposed to Form ADV, the investment advisor registration form, and the books and records rule to reflect the changes proposed to the advertising and cash solicitation rules.

Proposed Amendments to Rule 206(4)-1 (the Advertising Rule)

The amendments proposed to the Advertising Rule include the following:

• Allowing testimonials and endorsements if certain specified disclosures are made, including whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the advisor.
• Allowing third-party ratings, subject to certain specified disclosures and criteria pertaining to the preparation of the rating.
• Allowing the presentation of gross performance results in non-retail advertisements (without the inclusion of net performance results) if a schedule of fees and expenses deducted to calculate net performance is provided or offered.
• Allowing the inclusion of performance results of a subset of investments extracted from a portfolio in an advertisement if the performance results of all investments in the portfolio are provided or offered.
• Prohibiting the inclusion of hypothetical performance unless the advisor has adopted and implemented policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient and the advisor provides certain specified information underlying the hypothetical performance.
• Prohibiting the inclusion of performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered or promoted in the advertisement, with limited exceptions.
• Requiring, with regard to advertisements targeted to retail audiences, the presentation of the performance results of any portfolio or certain composite aggregations across 1, 5, and 10 year periods.
• Requiring that advertisements be reviewed and approved by a designated employee before dissemination, with the exception of communications disseminated only to a single person or household (or to a single investor in a private placement) or live oral communications broadcast on radio, television, the internet, or any other similar medium.

Proposed Amendments to Rule 206(4)-3 (the Cash Solicitation Rule)

The amendments proposed to Rule 206(4)-3 by the SEC include the following:

• The application of Rule 206(4)-3 regardless of whether an advisor pays cash or non-cash compensation to a solicitor. Non-cash compensation would include directed brokerage, awards or other prizes, and free or discounted services.
• The application of the solicitation rule to the solicitation of current and prospective investors in private funds, as opposed to just the current and prospective clients of the advisor.
• The addition of two new full exemptions from Rule 206(4)-3: (1) de minimis compensation to solicitors (less than $100 in any 12 month period), and (2) advisors that participate in certain nonprofit programs.
• An expanded list of disciplinary events for which persons would be disqualified from acting as a solicitor, with a limited exception.
• The elimination of the requirement that the solicitor deliver the advisor’s Form ADV Part 2A brochure to the client or prospective client.
• The elimination of the requirement that the advisor obtain an acknowledgment from each investor regarding the receipt of the disclosures from the solicitor.

Next Steps by SEC

The SEC will be seeking comments regarding these proposed amendments. In addition, the SEC will be reviewing certain no-action letters and other guidance addressing the advertising and cash solicitation rules to determine whether these should be withdrawn in connection with any adoption of the proposed amendments.

For more information about the proposals discussed above, 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.