From the October 2007 issue of Boomer Market Advisor • Subscribe!

Client lists can be precarious marketing tools

Investment advisors often wonder if they are permitted to distribute a full or partial list of clients in their marketing materials. If they are extremely careful and watch out for potential pitfalls, they may utilize the client list. Before doing so, however, advisors should be aware of the many restrictions and legal issues that must be addressed.

Does releasing a client list violate Rule 206(4)-1 of the Investment Advisers Act?

The intent of Rule 206(4)-1 of the Investment Advisers Act of 1940 is to prevent false and misleading advertisements. In particular, Rule 206(4)-1(a)(1) prohibits the use of testimonials. Testimonials are statements of a client's experience with, or an endorsement of, an investment advisor.

Testimonials are not permitted, because they are inherently misleading. Investment advisors will use the good ones and eliminate the bad ones. Testimonials deceive customers and potential clients into believing that they are representative of each client's experience with that investment advisor.

In a no-action letter to Cambiar Investors, Inc. (available August 28, 1997), the SEC staff said that an advertisement that does no more than identify certain clients of an advisor is not a testimonial. Nevertheless, the list must not be presented in a false or misleading manner. The advertisement must not contain an untrue statement of material fact.

As the SEC indicated in this no-action letter, whether an advertisement is false or misleading depends upon all of the relevant facts and circumstances. If clients on a list are selected on the basis of how well their investments performed and that selection bias is not adequately disclosed, the advertisement may be perceived as misleading investors.

In making its decision, the SEC relied on Cambiar's representation that it would not use performance criteria in compiling its partial client list. Cambiar assured the SEC that it would disclose the criteria used to compile the list and include a disclaimer that these clients do not endorse or recommend the firm as an investment adviser.

The SEC's no-action letter to Denver Investment Advisors, Inc. (available July 30, 1993), sheds additional light on whether client lists may be distributed in marketing materials. This no-action letter responded to an investment advisor's use of a company profile that contained a list of clients.

In the response to Denver Investment Advisors, Inc., SEC staff took no position on whether client lists are testimonials. The decision for not recommending enforcement was based on three conditions being met:

  • The investment advisor must not use performance-based criteria in deciding which clients to include on the list. It must use other objective criteria, such as account size, geographic location, or client classification, to prepare the list.

  • The list must contain a disclaimer indicating that it is unknown if these clients approved of the advisor or the services provided.

  • The list must include a statement disclosing the objective criteria used to determine which clients to include on the list.

Investment advisors should think about making additional disclosures before utilizing client lists.

Other issues to consider

Advisors who distribute a list of clients are still subject to the fiduciary duties they owe under Rule 206(1) and Rule 206(2) of the Investment Advisers Act. If the investment advisor is aware that a prospective client will misinterpret the advertisement containing a client list, it must rectify the situation. The investment advisor may be required to disclose additional information or correct the misunderstanding.

Investment advisors should also obtain clients' consent before putting their names on any list. This is the right thing to do from a business and ethical standpoint. Furthermore, a number of states prohibit an investment advisor from disclosing a client's identity without consent.

In addition, investment advisors should be aware of Regulation S-P, which contains the Rules for Privacy of Consumer Financial Information. It should be examined before putting a client's name on any list, since this nonpublic personal information. Generally, Regulation S-P does not apply to institutional clients.

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