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SEC Issues Risk Alert on the Most Frequent Advertising Rule Compliance Issues and Use of Accolades in Advertisements

I.  Advertising Rule Compliance Issues

On September 14, 2017, the staff of the SEC's Office of Compliance Inspections and Examinations (OCIE) issued a National Examination Program Risk Alert on the most frequent advertising rule compliance issues identified in OCIE examinations of investment advisers. This Risk Alert reflected issues identified in deficiency letters generated in the course of over 1,000 adviser examinations conducted by OCIE staff.

The most frequent deficiencies that OCIE staff had identified in connection with Rule 206(4)-1 under the Investment Advisers Act of 1940 (the Advertising Rule) were reported in the following five primary areas:

  • Misleading Performance Results

    • Advisers that presented performance results without deducting advisory fees.

    • Advertisements that compared performance results to a benchmark but did not include disclosures about any significant differences between the adviser's strategies and the benchmark.

    • Advertisements that contained hypothetical and back-tested performance results, but did not explain how these returns were derived and did not include other material information regarding the performance results.

  • Misleading One-on-One Presentations

    • Advisers that advertised performance results gross of fees in certain one-on-one presentations, but did not include potentially relevant disclosures from the 1988 SEC Staff No-Action Letter to the Investment Co. Institute.

    • Advisers that failed to disclose that advertised gross performance results did not reflect the deduction of advisory fees and that client returns would be reduced by such fees and other expenses.

  • Misleading Claims of Compliance with Voluntary Performance Standards – Advisers that claimed that their advertised performance results complied with voluntary performance standard (such as GIPS®) that did not.

  • Past Specific Recommendations (Cherry Picking) – Advisers that included only profitable stock selections or recommendations in presentations, client newsletters or on their websites, without including the unprofitable selections, and otherwise meeting the conditions set forth in the Advertising Rule. The staff also observed advisers who appeared to have relied on SEC staff no-action letters regarding this provision of the Advertising Rule without meeting the conditions of those letters.

    • Advertisements that included an adviser's best performing holdings, but did not include an equal number of the worst performing holdings. The TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008).

    • Advertisements that included objective, nonperformance-based selection of past specific recommendations, but failed to disclose that they did not represent all securities recommended to clients during a particular period, and that discussed in advertisements the profits realized by the specific recommendations. Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998).

The Risk Alert also observed advisers that were deficient in adopting or implementing compliance policies and procedures under Rule 206(4)-7 of the Investment Advisers Act (the Compliance Rule) designed to prevent "deficient advertising practices," including procedures to:

  • Review and approve of advertising materials prior to use;

  • Determine criteria for including or excluding accounts from a composite; and

  • Confirm the accuracy of performance information.

II.  Use of Accolades in Advertisements

The Risk Alert also reported on a 2016 examination sweep of nearly 70 advisers that focused on "touting" in marketing materials. OCIE staff observed advisers that published materially misleading advertisements containing references to awards or rankings conferred by third parties that failed to disclose material facts about the awards or rankings, including:

  • Accolades that had been obtained by submitting false or misleading information in the applications for such accolades.

  • Marketing materials referenced stale ranking or evaluation information.

  • Advertisements that did not disclose:

    • The relevant selection criteria for the awards or rankings;

    • Who created and conducted the survey that the awards or rankings were drawn from; or

    • The fact that an adviser paid a fee to participate in or distribute the results of the survey.

  • Advertisements that contained references to professional designations that had lapsed or that did not explain the minimum qualifications required to attain such designations.

  • Advertisements that contained testimonials in contravention of the Advertising Rule.

III.  Conclusion

The Risk Alert did not contain any new interpretive position or policies. Advisers can expect OCIE staff to continue to focus examination resources in the area of marketing, which OCIE historically has found to contain a rich source of deficiencies and enforcement referrals. Accordingly, advisers should ensure that they understand the Advertising Rule, and have adopted and implemented robust policies and procedures to comply with the rule. Such policies and procedures should be reviewed periodically to conform with both evolving regulatory expectations and changes in the adviser's own marketing practices.

© 2020 Proskauer Rose LLP.


About this Author

Stephen T Mears, Proskauer, growth equity lawyer, buyout funds attorney

Stephen T. Mears is a partner in the Private Investment Funds Group. He concentrates on private investment funds, including venture capital, growth equity and buyout funds. He represents fund sponsors in all aspects of fund formation, operation and management, including fund structuring, portfolio investments, sales and distributions, internal governance and management, regulatory compliance and ongoing maintenance and administration. Stephen also represents institutional investors in connection with their participation in private investment funds.

Robert Plaze, Investment Manager Attorney, Regulatory and Compliance

Robert E. Plaze is a partner and a member of the Investment Management team. He advises investment advisers and investment companies on an array of matters, with a particular focus on regulatory and compliance matters arising under the federal securities laws.

Bob previously served as Deputy Director of the Division of Investment Management of the U.S. Securities and Exchange Commission. During his nearly 30 years of service with the Commission, he was responsible for policy development and management of many of the key regulatory initiatives during that period affecting investment companies and investment advisers under the Investment Company Act of 1940 and the Investment Advisers Act of 1940, including rules governing fund and adviser compliance programs, fund corporate governance, personal trading, custody and brokerage practices, prohibitions on “pay to play” practices, and protection of investor privacy. Most recently, Bob was responsible for rulemaking to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act affecting investment advisers, including rules requiring advisers to hedge funds and other private funds to register with the Commission, rules implementing new exemptions from registration and rules requiring reporting by certain exempt investment advisers.

Christopher M Wells, Proskauer Rose Law Firm, Private Investment Attorney

Christopher M. Wells is a Partner and head of the Hedge Funds Group. Chris advises hedge funds, funds of funds and other pooled investment vehicles and their managers on all aspects of fund formation, operations and compliance.

Anthony M. Drenzek, Special regulatory Counsel, Proskauer Rose, Attorney, Finance Policy Lawyer
Special Regulatory Counsel

Tony is special regulatory counsel in the Corporate Department and a member of the Private Funds Group and the Private Equity & Hedge Fund Litigation team. His practice focuses on advising U.S. and offshore private fund managers on all aspects of federal, state and SRO organizational and operational compliance, with a specific emphasis on the Investment Advisers Act of 1940.

Tony assists U.S. and offshore private fund clients in registering with the SEC as investment advisers, or reporting as exempt reporting advisers, and complying with...