SEC Brings Enforcement Actions Against Nine Investment Advisers for Violating the Marketing Rule

On Sept. 11, the Securities and Exchange Commission (SEC) announced charges against nine investment advisers^[1] for violating Rule 206(4)-1 (Marketing Rule) of the Investment Advisers Act of 1940 (Advisers Act) due to their inclusion of hypothetical performance information on their publicly available websites without adopting and/or implementing the policies and procedures required by the Advisers Act. An analysis of the violations committed by the investment advisers and the undertakings required of the investment advisers by the SEC is set forth below in further detail.

SEC concerns under the Marketing Rule

In December 2020, the SEC adopted significant amendments to the Advisers Act’s Marketing Rule, designed to regulate marketing practices in order to protect investors from fraudulent or manipulative business activities. In this regard, the Marketing Rule sets forth specific requirements that must be satisfied in order to use hypothetical performance in an advertisement.^[2] These requirements include the obligation to adopt and implement 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. 

Because it is very unusual for hypothetical performance (such as performance derived from model portfolios) to ever show a loss, the SEC tends to heavily scrutinize the use of hypothetical performance, even when it is provided to sophisticated clients. With respect to the hypothetical performance at stake in these enforcement actions, there was a heightened concern because the hypothetical performance was advertised to the general public through the use of the advisers’ websites. In this regard, Gurbir S. Grewal, director of the SEC’s Division of Enforcement, indicated that “[b]ecause of their attention-grabbing power, hypothetical performance advertisements may present an elevated risk for prospective investors whose likely financial situation and investment objectives don’t match the advertised investment strategy.” Ultimately, the SEC reasoned that investment advisers cannot form adequate expectations or judgments of a mass audience member’s financial situation or investment objectives when they publish an advertisement intended for general circulation and the general public as they would for advertisements directed to a particular intended audience.  

Advisers Act violations

Due to the accessibility of the hypothetical performance to the general public combined with the lack of the required policies and procedures, the SEC charged the nine investment advisers for willfully violating Section 206(4) of the Advisers Act and Rule 206(4)-1(d) thereunder. The charged investment advisers neither admitted nor denied the SEC’s findings but agreed to be censured, to comply with cease and desist proceedings for violating the charged provisions, to remove advertisements with hypothetical performance without having the requisite procedures and policies, and to pay civil penalties ranging from $50,000 to $75,000.

Remedial measures undertaken

Within 10 to 40 days of entry of the SEC order, certain investment advisers must remove or restrict access to all advertisements containing hypothetical performance on their websites and social media,^[3] and all investment advisers must certify that their policies and procedures are reasonably designed to ensure that hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement and must provide written certification that their undertakings comply with the SEC’s order.

The full text of the SEC press release can be found here. 

^[1] _{SEC charged the following nine investment advisers for violating the Marketing Rule: Banorte Asset Management Inc., BTS Asset Management Inc. (BTS), Elm Partners Management LLC, Hansen & Associates Financial Group Inc., Linden Thomas Advisory Services LLC, Macroclimate LLC, McElhenny Sheffield Capital Management LLC, MRA Advisory Group and Trowbridge Capital Partners LLC (Trowbridge).}

^[2] _{The announcements were advertisements because they offered each company’s investment advisory services with regard to securities to prospective clients and offered new investment advisory services with regard to securities to new clients.}

^[3] _{Only BTS and Trowbridge have undertaken to remove or restrict all advertisement containing hypothetical performance on their websites and social media.}