SEC proposes amendments to advertising rule for investment advisers



December 18, 2019

Litigation & Private Equity Alert

Author(s): Marx P. Calderon, Daniel A. Schnapp, Edward F. Ughetta

The SEC recently proposed amendments under the U.S. Investment Advisers Act of 1940 to update and clarify the investment adviser advertising rule. This alert discusses what investment advisers need to know about the forthcoming changes to update their policies and practices and ensure compliance with the new regulations and address potential SEC scrutiny.

On November 4, 2019, the U.S. Securities and Exchange Commission (SEC) proposed amendments under the U.S. Investment Advisers Act of 1940 (the Advisers Act) to update and clarify the investment adviser advertising rule (Rule 206(4)-1), which has not been amended significantly since its adoption in 1961. The proposed rule amendments seek to address the modernization of the investment adviser world, including changes in the asset management industry and investor base, and the widespread use of social media and internet-based technologies. Investment advisers should be aware of what will be permitted in any advertisement and any new related disclosure requirements. Indeed, investment advisers should consider these proposed amendments now to prepare to update their policies and practices going forward and so comply with the new regulations and address potential SEC scrutiny.

Proposed amendments to the advertising rule

The proposed advertising rule: (1) provides an updated definition of “advertisement”; (2) expands the list of prohibited advertisement practices in light of the new definition; (3) permits certain testimonials, endorsements, and third-party ratings subject to specified disclosures; (4) clarifies regulations regarding performance advertising, particularly with respect to advertisements targeting retail investors; and (5) requires internal pre-use review and approval of advertisements prior to dissemination.

The proposed rule would update the definition of “advertisement” to include any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser. However, the proposed definition of “advertisement” excludes: (1) live oral communications that are not broadcast; (2) responses to certain unsolicited requests for specified information; (3) advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other SEC rules; and (4) information required to be contained in a statutory or regulatory notice, filing, or other communication.

The proposed rule expands upon current Rule 206(4)-1(a)(5), which prohibits “. . . any untrue statement of a material fact, or which is otherwise false or misleading.” The proposed rule lists the following prohibited advertisement practices:

  • Making an untrue statement of a material fact or omission of a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading.
  • Making a material claim or statement that is unsubstantiated.
  • Making an untrue statement or misleading implication about, or being reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the investment adviser.
  • Discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations.
  • Referring to specific investment advice provided by the adviser 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.
  • Being otherwise materially misleading.

In addition to prohibiting certain conduct, the proposed rule adds certain types of permitted advertisement content, including testimonials, endorsements, and third-party ratings. Once promulgated, the new forms of advertisement content will be subject to certain specified disclosures. For example, to use a testimonial or endorsement in an advertisement, investment advisers must disclose that the testimonial was given by a client or investor, and the endorsement was given by a non-client or non-investor, and whether cash or non-cash compensation has been provided by or on behalf of the adviser for the testimonial or endorsement. Third-party ratings must, among other things, disclose the date and period of time upon which the rating was based, whether compensation has been provided on behalf of the adviser in connection with obtaining or using the third-party rating, and the identity of the third party that created and tabulated the rating.

The proposal would restrict the use of certain performance information, with few exceptions, by prohibiting the following in any advertisement:

  • Gross performance results, unless it provides (or offers to provide promptly) a schedule of fees and expenses deducted to calculate net performance.
  • Any statement that the calculation or presentation of performance results has been approved or reviewed by the SEC.
  • 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.
  • Performance results of a subset of investments extracted from a portfolio, unless it provides or offers to provide promptly the performance results of all investments in the portfolio.
  • Hypothetical performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient, and the adviser provides certain specified information underlying the hypothetical performance.

Consistent with the SEC’s continued focus on protecting retail investors, the proposed rule would provide additional protections for an advertisement targeted to a retail audience, including (1) requiring the presentation of net performance alongside any presentation of gross performance and (2) requiring generally the presentation of the performance results of any portfolio or certain composite aggregations across one-, five-, and ten-year periods.

In addition, the proposed amendments would require advertisements to be reviewed and approved in writing by a designated employee before dissemination, except for advertisements that are: (1) communications disseminated only to a single person or household or to a single investor in a pooled investment vehicle or (2) live oral communications broadcast on radio, television, the internet, or any other similar medium.

Looking ahead

The SEC has requested public comment on the proposed amendments, and such public comment period will remain open through January 2020 (approximately 60 days after notice of publication of the proposed amendments in the Federal Register). Upon the adoption of any new or amended rules, the SEC intends to implement a one-year transition period so that investment advisers may implement necessary revisions to their policies and procedures in light of the new rules. In addition, the new rules would amend Form ADV to require additional information regarding the advertising practices of each adviser to bolster the SEC’s inspection and enforcement capabilities in this area.

In summary, the SEC remains focused on protecting investors, particularly retail investors, from misleading sales practices by investment advisers. Indeed, given recent public statements by SEC officials, it appears that the agency intends to be especially vigilant when considering investment adviser advertisements made to the retail audience. All investment advisers should become familiar with these proposed amendments, and look to make appropriate adjustments to their policies and procedures going forward to maintain compliance with the Advisers Act.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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