The Securities and Exchange Commission (SEC) announced on Dec. 22, 2020, that it has finalized amendments to the current advertising rule (Rule 206(4)-1) and cash solicitation rule (Rule 206(4)-3) under the Investment Advisers Act of 1940. The amendments unify the current advertising and cash solicitation rules into a single rule (Marketing Rule) designed to comprehensively regulate an investment adviser’s marketing communications.
The Marketing Rule contains: (i) general prohibitions concerning advertisements; (ii) certain requirements for testimonials and endorsements; (iii) rules governing inclusion of third-party ratings in advertisements; and (iv) requirements pertaining to performance advertising.
The amended definition of “advertisement” in the Marketing Rule contains two prongs – one that addresses communications that were previously covered by the advertising rule and one that addresses solicitation activities that were previously covered by the solicitation rule.
The first prong of the definition applies to any direct or indirect communication by an investment adviser that: (i) offers the investment adviser’s investment advisory services to prospective clients or private fund investors or (ii) offers new investment advisory services to current clients or private fund investors. The first prong of the definition, however, excludes from the definition of “advertisement” (a) one-on-one communications unless they involve hypothetical performance not provided in response to an unsolicited investor request or to a private fund investor, (b) extemporaneous, live, oral communications, and (c) information contained in a statutory or regulatory notice, filing or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing or other required communication.
The second prong of the definition applies to any endorsement or testimonial for which an investment adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).
Under the Marketing Rule, investment advisers are prohibited from engaging in the following advertising practices:
The Marketing Rule defines “testimonial” to include any statement by a current client or private fund investor about the client’s or private fund investor’s experience with the investment adviser or its supervised persons. “Endorsement” is defined in the Marketing Rule to include any statement by a person other than a current client or private fund investor that indicates approval, support or recommendation of the investment adviser or its supervised persons. Testimonials and endorsements include statements related to the investment advisory capabilities of an investment adviser or its supervised persons, as well as statements related to an investment adviser’s or its supervised persons’ qualities (e.g., trustworthiness, diligence or judgment).
The use of testimonials and endorsements is prohibited under the Marketing Rule, unless certain conditions are met, including: (i) clear and prominent disclosure as to whether the person giving the testimonial or endorsement is a client and whether such person is compensated; (ii) the investment adviser must enter into a written agreement with persons providing a testimonial or endorsement unless such person is an affiliate or receives compensation from the investment adviser that is $1,000 or less in value during the preceding 12 months; and (iii) certain “bad actors” are disqualified from giving testimonials or endorsements.
The Marketing Rule defines “third-party rating” as a rating or ranking of an investment adviser provided by a person who is not a related person of the investment adviser (as defined in the Form ADV Glossary of Terms), and such person provides such ratings or rankings in the ordinary course of its business. The use of third-party ratings in an advertisement is prohibited, unless the third-party ratings comply with the Marketing Rule’s general prohibitions and certain additional conditions. The investment adviser must have a reasonable basis for believing that any questionnaire or survey used in the preparation of the third-party rating meets certain criteria and makes certain disclosures.
While the Marketing Rule’s general prohibitions set forth above apply to advertisements that include performance results, the Marketing Rule also prohibits including the following items in any performance advertisement:
The staff of the Division of Investment Management will withdraw certain no-action letters and other guidance addressing the application of the current advertising and cash solicitation rules. A list of these letters will be available on the SEC’s website.
The Marketing Rule will become effective 60 days after publication in the Federal Register. The SEC has given investment advisers 18 months after the effective date of the Marketing Rule to become compliant with its updated restrictions.
The final Marketing Rule can be found here.