SEC Modernizes and Combines Investment Adviser Advertising and Cash Solicitation Rules

On December 22, 2020, the SEC adopted amendments to the advertising and cash solicitation rules (available here) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), along with corresponding amendments to the books and records rules and Form ADV.

The amendments create a merged rule (the “Marketing Rule”) that replaces both the investment adviser advertising rule in Rule 206(4)-1 (the “Old Advertising Rule”) and the cash solicitation rule in Rule 206(4)-3 (the “Old Solicitation Rule”) under the Advisers Act, neither of which had been substantively revised since their initial adoption in the 1960s. The Marketing Rule is intended to modernize the regulatory regime to reflect changes in the investment advisory market and means of communication by creating rules that are evergreen and can evolve with changing technologies.

The Marketing Rule moves to a more principles-based approach focused on advertisements not being “fair and balanced” and not materially misleading based on facts and circumstances. Many of the new requirements of the Marketing Rule and practices discussed in the adopting release are already best practices in the private funds industry; so while some changes will be necessary and some additional flexibility has been granted, the Marketing Rule is not expected to mark a sea change in the industry.

The following are certain highlights of the Marketing Rule and its application to private fund advisers. A more detailed summary of the Marketing Rule, including a comparison against the Old Advertising Rule and the Old Solicitation Rule, is attached as Annex A and Annex B, respectively.

Definition of “Advertisement”

The Marketing Rule defines advertisement as:

(1)                any direct or indirect communication an investment adviser makes to more than one person (or to just one person if the communication involves hypothetical performance), that (x) offers the adviser’s investment advisory services with regard to securities to prospective clients or prospective private fund investors, or (y) offers new investment advisory services with regard to securities to current clients or current private fund investors; in each case, excluding:

(a)                extemporaneous, live, oral communications (but not any scripts or prepared materials for such a communication);

(b)                information contained in a statutory or regulatory notice, filing or other required communication that is reasonably designed to satisfy the requirements thereof; and

(c)                communications that include hypothetical performance provided either (x) in response to an unsolicited request for such information from a prospective or current client or private fund investor; or (y) to a prospective or current private fund investor in a one-on-one communication; and

(2)                any endorsement or testimonial (to one or more persons) for which an adviser provides cash or non-cash compensation, directly or indirectly, excluding information contained in a statutory or regulatory notice, filing or other required communication that is reasonably designed to satisfy the requirements thereof.

The first prong of the definition relates to traditional advertisement activities previously captured by the Old Advertisement Rule. The second prong is intended to pick up traditional testimonial and endorsement activities previously addressed under the Old Advertisement Rule as well as solicitation activities previously addressed under the Old Solicitation Rule by defining “endorsement” to include solicitation or referrals of current or prospective clients or private fund investors.

General Prohibitions

The Marketing Rule prohibits the following in any advertisement:

• any untrue statement of a material fact, or omission of a material fact necessary to make the statement, in light of the circumstances in which it was made, not misleading (i.e., a “10b-5” standard);
• a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC;
• information that is reasonably likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser;
• discussion of potential benefits to clients or investors in connection with the investment adviser’s services or methods without a fair and balanced discussion of any material risks or limitations associated with the potential benefits;
• reference to specific investment advice provided by the investment adviser where such advice is not presented in a fair and balanced manner;
• performance results that include or exclude certain results or time periods in a manner that is not fair and balanced; and
• otherwise being materially misleading.

These prohibitions apply to all advertisements; advertisements subject to additional specific requirements discussed below will still need to be held to these overarching standards.

Performance

The Marketing Rule incorporates many of the principles that applied to performance advertising in the line of no-action letter guidance under the Old Advertising Rule, but gives investment advisers incrementally more flexibility by taking a more principles-based approach and not limiting advisers to the specific requirements of the no-action letter guidance.

Under the Marketing Rule:

• gross performance must be accompanied by net performance presented with equal prominence in a format designed to facilitate comparison with gross performance;
• performance results, other than performance results of a private fund, must be presented over one-, five-, and ten-year time periods with equal prominence;
• any express or implied statement that the calculation or presentation of performance results has been approved or reviewed by the SEC is prohibited;
• if performance results from any related portfolio (i.e., a portfolio with substantially similar investment policies, objectives, and strategies as that being offered in the advertisement) is included, the performance of all related portfolios must be included, subject to certain exceptions;
• extracted performance (i.e., performance of a subset of a single portfolio) is permitted so long as the advertisement provides, or offers to provide promptly, performance results of the total portfolio;
• hypothetical performance (i.e., performance results that were not actually achieved by any portfolio of the adviser[1]) may be presented only if the adviser (x) adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement, and (y) provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating the hypothetical performance; and
• predecessor performance (i.e., performance of a portfolio that was not advised at all times during the relevant period by the advertising adviser) is permitted only if (x) there is sufficient similarity with regard to the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser that the prior performance would provide relevant information to clients or investors; (y) all relevant prior accounts are included, subject to certain exceptions, and (z) certain required disclosures are included clearly and prominently.

Testimonials, Endorsements and Third-Party Ratings

The Marketing Rule gives additional flexibility in using testimonials (from clients) and endorsements (from non-clients) and provides additional structure around the use of third-party ratings, in each case, subject to certain requirements intended to ensure that their use is not misleading.

Withdrawal of Prior No-Action Letters

Certain previously issued no-action letters regarding the Old Advertising Rule and the Old Solicitation Rule will be withdrawn as the guidance provided in those letters either is incorporated into the Marketing Rule or will no longer apply. A list of withdrawn no-action letters will be (but has not yet been) published on the SEC’s website.

The SEC does note in the adopting release that the guidance in certain prior no-action letters may continue to be useful as examples of practices that the Staff would consider “fair and balanced” or “not misleading”, but emphasizes that those no action letters are no longer considered prescriptive.

Books and Records Rule; Form ADV; Policies and Procedures

Rule 204-2 under the Advisers Act is being amended to reflect new requirements under the Marketing Rule, including expanding record keeping requirements to all advertisements. Form ADV is also being amended to include questions regarding an adviser’s advertising practices.

Investment advisers will need to update their compliance policies and procedures to reflect the Marketing Rule in general as well as its particular requirements. Importantly, the adopting release indicates that for related compliance policies and procedures to be effective, they should include “objective and testable means reasonably designed” to prevent violation of the Marketing Rule.

Effective Date

The Marketing Rule will be effective 60 days after publication in the Federal Register. Advisers will have an 18-month transition period after the effective date to bring their marketing materials into compliance with the Marketing Rule.  

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[1]     Hypothetical performance includes, without limitation, performance of model portfolios, backtested performance, and targeted or projected performance, but does not include interactive analysis tools that produce simulations and statistical analyses or predecessor performance (which is subject to its own requirements).

[2]     Hypothetical performance includes, without limitation, performance of model portfolios, backtested performance and targeted or projected performance, but does not include interactive analysis tools that produce simulations and statistical analyses or predecessor performance (which is subject to its own requirements).