4 Key Issues of the SEC Marketing Rule

By Thomas D. Giachetti, Esq. and Joseph C. Antonakakis, Esq.

The amended Marketing Rule, part of the Investment Advisers Act, has now been in effect for nearly three years. Unfortunately, too much confusion and bad advice has resulted. We continue to do our best to simplify SEC rules and its related guidance to make it more understandable for the industry. We focus in this article on the four key issues addressed in the rule, although for many, much of it is not materially applicable. Where it is applicable, those firms must have thorough understanding of the rule specifics to achieve compliance.

Introduction

Relative to all marketing and advertising, an investment adviser has a duty to never misrepresent or omit material facts. They must remain prepared to corroborate statements made during a regulatory exam or inquiry, and when applicable include clear and conspicuous conflict of interest disclosures. The question advisers should ask themselves is not can you do it, but rather, should you do it? We know many advisers continue to engage in various marketing-related practices and efforts without having suffered any adverse regulatory consequences. However, as we have written and have lectured at conferences for years, “the other kids are doing it” will provide no defense in the event of a regulatory inquiry. 

Caveat: This article is an overview. Compliance (and potential exceptions) will depend upon the specific situation presented.

Issue 1: Performance Presentations

If your firm does not advertise performance (i.e., actual composites, representative accounts, back-tested hypotheticals, etc.), this portion of the rule has little applicability. But if it does, you must be aware that the SEC continues to view all non-GIPS verified presentations in an aggressive manner. Therefore, if you are using any type of non-GIPS verified performance presentation, be prepared to defend it during a regulatory exam. All performance presentations must be accompanied by clear and conspicuous disclosures to mitigate regulatory scrutiny; such disclosures will depend upon the specific type of presentation—one size does not fit all.

The SEC loathes hypotheticals, and we strongly recommend their use with retail clients (given their ability to appreciate material limitations pertaining to such presentations) should be limited to when it is compelling to provide them. Even then, to mitigate (not eliminate) regulatory scrutiny, we also strongly recommend their use be limited to presentation only upon express retail prospect or client request, and (whenever possible) the adviser should obtain a corresponding written acknowledgement by the client/prospect confirming their request, their understanding of the material limitations, and that they have had an opportunity to ask questions. Remember, unlike an actual composite, the use of a hypothetical presentation in a one-on-one setting is an advertisement under the rule that requires disclosure at Item 5.L. of Part 1 of Form ADV.

Issue 2: Use of Testimonials

Under the Marketing Rule, testimonials are statements from current clients or investors in a private fund that discuss or describe the client’s or investor’s experience with the investment adviser and directly or indirectly are used to encourage others to become adviser clients or private fund investors.

After advisers have determined they will request testimonials from current clients, they must take certain steps to ensure compliance with the rule, which generally prohibits “cherry-picking” and requires that all advertisements are fair and balanced, including testimonials. When asking current clients for testimonials, advisers should ask all clients (or with potential limitations, a specific subset of similar clients, such as all ERISA plan clients), not just those who might provide a positive review. Similarly, advisers must follow a fair and balanced approach when including testimonials in advertising material. Ensuring a fair and balanced advertisement means the adviser should include (and make conspicuously available) both positive and negative testimonials in advertising materials and should not materially edit the testimonials. The adviser must document and maintain records indicating that all clients have been invited to provide a review, regardless of whether the client has had a positive or negative experience with the adviser. While not expressly required, advisers should consider obtaining written consent from clients providing testimonials noting the client acknowledges the adviser may include the testimonial in publicly available advertisements.

Further, the rule requires disclosures to appear alongside testimonials. Disclosures should be made on the same page and be as prominent as the testimonials themselves. This clearly presents a challenge when the advertisement is hard copy vs electronic (website, etc.). Three distinct statements should be disclosed alongside the testimonials: (1) whether the testimonial was given by a current client; (2) whether cash or non-cash compensation (e.g., a fee reduction, extravagant or frequent firm-paid entertainment, etc.) was provided in exchange for the testimonial and the terms of the compensation agreement; and (3) a statement of any material conflict of interest (e.g., is the person or entity providing the testimonial a compensated promoter; if yes, the promoter has an incentive to recommend the adviser, resulting in a material conflict of interest).

The clear and prominent disclosures may be part of a “layered disclosure” approach. A succinct, tailored disclosure is included with the advertisement, and a more detailed disclosure on content such as compensation arrangements and material conflicts of interest could be provided through hyperlinks, supplementary documents, or the back of a slide deck.

Issue 3: Third-Party Ratings, Rankings, and Awards

The rule permits adviser advertisements of third-party ratings, rankings, and awards (e.g., Forbes, Barron’s, etc.) as long as certain disclosures are prominently and conspicuously displayed. The disclosure must clearly and prominently disclose (1) the date on which the rating was given and the period of time upon which the rating was based; (2) the identity of the third party that created the rating and the criteria/methodology for the ranking; and (3) whether any direct (e.g., payment to submit an application or to be considered) or indirect (e.g., donation, payment to advertise) compensation was provided in connection with obtaining or using the third-party rating/ranking. As with testimonials, the SEC has indicated that rating disclosures should be made on the same page and be as prominent as the testimonials themselves. Again, this clearly presents a challenge when the advertisement is hard copy vs electronic (website, etc.). In addition, be aware of advertising of stale rankings from several years ago without conspicuous disclosure that the adviser has not been again ranked since such dates. Rankings more than a few years old that have not been repeated will engender SEC scrutiny; firms should consider deleting them, or at the very least providing corresponding conspicuous disclosure regarding their limitations.

Issue 4: Use of Promoters/Payment of Referral Fees

Advisers must have a reasonable belief that the promoter (formerly referred to as a solicitor) made required disclosure regarding the referral arrangement. They must have a written agreement with the promoter (excluding those whose total annual referral compensation for all introductions is reasonably anticipated to be less than $1,000, in the aggregate) that requires the promoter to provide required disclosures to prospective clients, including the compensation arrangement with the adviser. Please Note: Given that the onus is on advisers to prove promoters discharged their obligations, we strongly recommend they generally require all promoters (excluding the adviser’s employees and management, and those whose total annual referral compensation for all introductions is reasonably anticipated to be less than $1,000, in the aggregate) provide a separate written disclosure statement to be executed by all introduced prospects and returned to advisers for their records.

Summary

It’s a brave new world when it comes to adviser marketing. While not all firms have taken the leap, those that have would be well-advised to become familiar with the requirements for providing non-GIPS verified performance presentations; using testimonials; advertising third-party ratings, rankings, and awards; and using promoters/paying referral fees—or face the potential adverse consequences of not adhering to the SEC’s amended Marketing Rule.

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Thomas D. Giachetti is a Senior Shareholder and Joseph C. Antonakakis is an Associate of the Investment Management & Securities Practice Group of Stark & Stark, a 100+ attorney law firm representing investment advisers serving clients throughout the United States and abroad.

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