On July 20, 2021, we released our Blog entitled “SEC Modernizes a New Marketing Rule” to provide you with a glimpse of things to come pertaining to new marketing and advertising definitions, prohibitions, amendments and SEC staff guidance set forth by the new Marketing Rule (the “Rule”). The Rule had an effective date of May 4, 2022, and must be in place by or on November 4, 2022. Worth noting is that the Rule has replaced the current advertising rules with principles-based provisions designed to accommodate the continued evolution and interplay of technology and advice. However, the Rule is a voluminous regulation consisting of over 400 pages, which is why we are taking the time to reiterate and summarize the most important aspects in order for you to quickly reach compliance by November 4, 2022.
First, please be aware that the Rule prohibits the following practices (also called the “General Prohibitions”):
- Making an untrue statement of material fact, or omitting a material fact that is necessary to make a statement not misleading;
- Making a material statement of fact that cannot be substantiated;
- Providing information that would reasonably be likely to cause an untrue or misleading implication;
- Discussing potential benefits without a fair and balanced treatment of associated risks;
- Referencing specific advice that is not presented in a fair and balanced manner;
- Including or excluding performance results or time periods, in a manner that is not fair and balanced; and
- Including information that is otherwise materially misleading.
These are principal-based prohibitions and should not be a problem with any compliance program.
DEFINITION OF ADVERTISEMENT
The definition of “advertisement” has changed. Under the Rule, “advertisement” contains two prongs:
- The first prong includes any direct or indirect communication made that:
- Offers advisory services to prospective clients (more than one); or
- Offers new advisory services to current clients (more than one).
- The second prong includes any endorsement or testimonial for which an adviser provides cash or non-cash compensation directly or indirectly.
This is a substantial change in that the first prong will exclude most one-on-one communications.
TESTIMONIALS AND ENDORSEMENTS
Testimonials and endorsements are allowed, as long as certain disclosure, oversight and disqualification provisions are in place such as:
- Disclosure. Disclosure means that any testimonial or endorsement must be clearly and prominently disclosed whether the promoter is a client and/or whether he or she is being compensated;
- Oversight and a written agreement. The adviser must oversee that the firm is in compliance with the Rule;
- Written Agreement. The adviser must seek a written agreement with the promoter, except where the promoter is an affiliate of the adviser or is receiving de minimis compensation (less than $1,000, directly or indirectly);
- Disqualification of Promoters. No “bad actors” can be promoters.
The key here is that testimonials and endorsements are now allowed under “common sense” conditions.
The Rule allows the continued use of third-party ratings as long as certain criteria are used when preparing the rating. Some of the criteria are as follows:
- Third-party ratings include ratings or rankings of the firm that unrelated people provide in the ordinary course of business.
- Advisers must have a reasonable basis to believe that any questionnaire or survey used in the preparation of third-party ratings is structured to make it equally easy for participants to provide favorable and unfavorable responses and is not designated or prepared to produce any predetermined results. This requirement ensures that any third-party ratings in ads are unbiased and therefore reliable to investors (from a credible source and presents a complete picture of an adviser’s track record);
- Disclosure to ensure third-party ratings are presented contextually in a way that helps establish the third-party’s trustworthiness. Third-party ratings must disclose as follows:
- The date the ratings were given and the period of time on which the ratings were based;
- The identity of the third parties that created and tabulated the ratings; and
- If applicable, that advisers provided compensation directly or indirectly in connection with obtaining or using the third-party ratings.
PRESENTATION OF PERFORMANCE INFORMATION
The changes to the performance results are the most substantial part of the Rule and should be carefully reviewed when using performance numbers as part of the firm’s marketing. The following changes affect how the adviser will present “performance” information in advertisements:
- Gross performance can be presented only if net performance is also shown;
- Performance results generally must also show 1, 5 and 10-year time periods;
- Performance results must include all substantially similar strategies; less than all portfolios can be shown if it doesn’t cause results to be materially higher;
- An extracted portfolio result can be used if the total performance results is also discussed; and
- Hypothetical performance can be used as long as the adviser can ensure that the performance is relevant and abides by policies and procedures that comply with the Rule.
BOOKS AND RECORDS; FORM ADV
The Rule also has amendments to the books and records rule, and the Commission amended the Form ADV to require advisers to provide additional information regarding their marketing practices to help facilitate the Commission’s inspection and enforcement capabilities.
In summary, the New Marketing Rule will impact your firm and must be implemented by November 4, 2022, one month away. This article aims to set forth the most critical changes. The Rule will require updated and new policies and procedures, likely an amended Form ADV (under Item 14, if Rule 206(4)-3, which will be replaced, is mentioned), and significant training so that advisers understand what can, and cannot, be disclosed. While the Rule may be voluminous and technical, we are always here to help you sort through the compliance jargon in order to devise a plan to ensure your compliance requirements are met so you can feel confident your firm is following the Rule properly and prepared for an eventual audit.
This article does not in any way create an attorney-client relationship. This article should not be seen as legal advice. You should consult with an attorney before you rely on this information.
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