Playing by the Rules

The use of performance information in marketing presentations or materials also raises a number of other issues. In fact, this is the area the SEC has focused on most in the past, and is the source of a number of Enforcement actions. The most basic rule is that performance information must be presented net of fees (both advisory and brokerage fees). The only exception is for one-on-one, in-person presentations to wealthy clients and institutional clients. Even in those instances, however, there must be clear disclosure that the performance figures are gross of fees and the returns would be reduced by applicable fees.

Whenever performance information is used, it must also contain a number of SEC required disclosures, such as a notation that the figures are not indicative of future results. In addition, there are a number of restrictions and required disclosures surrounding the use of model performance results. Whenever model performance results are used, the SEC requires that they contain a number of disclosures that make it clear that the results are not actual results. If investors’ actual results differed by any significant amount from the model results, that fact must also be disclosed.

Performance advertisements also raise recordkeeping implications. Advisors must maintain records that support the performance figures they advertise. At a minimum, these records must include detailed account statements and worksheets. Recently, the SEC has also strongly encouraged keeping third-party records to support performance figures. The records kept by the advisor should allow the SEC to recreate, solely from those records, the figures that were advertised.

Another issue with performance advertisements is the ability of an advisor to market his or her services based on the investment performance the advisor achieved while employed elsewhere or associated with another entity. This is a complex area involving a great deal of SEC pronouncements. For our purposes here, it is merely worth noting that the SEC may not allow an advisor to disseminate such performance information. That is especially true if the advisor was not the sole person responsible for managing the investments whose performance is being touted or if the performance relates to portfolios with criteria or objectives that are different from those of the products or services being marketed to the potential clients. An advisor who wishes to use this kind of past performance information should consult an experienced investment management counsel to ensure that he or she can do so and that it is done properly. This is a complex area and the SEC views violations in this area very seriously.

With respect to the manner in which performance is calculated and presented, many advisors also wish to claim that their performance figures comply with the standards of AIMR, the Association of Investment Management and Research. The AIMR standards are comprehensive standards meant to promote fairness and comparability in performance presentations, and go well beyond SEC requirements. If an advisor claims AIMR compliance, however, such compliance must be ensured. If not, the SEC will determine that the representations regarding AIMR compliance are false and misleading and violate the Advisers Act’s anti-fraud provisions. What’s more, if AIMR compliance is claimed, the SEC will make it a point to check for compliance whenever they examine the advisor.

Finally, it is worth noting that in addition to the specific prohibitions of the SEC’s advertising rules, those advisors whose business activities require them to register with the NASD might also have to file advertisements with the NASD for review and approval. Like the SEC, the NASD also has its own set of rules and regulations in this area. To determine whether materials must be filed with the NASD, advisors should consider a number of factors, including whether the materials are advertisements or relate to brokerage activities.

The Use of Solicitors

Some advisors also use third-party solicitors or finders in an effort to market their services and grow their business; the SEC has a number of rules surrounding the use of such solicitors. First, an advisor cannot use a solicitor that has previously violated any of the substantive provisions of the securities laws. Second, there must be a written agreement in place between the advisor and the solicitor, and the agreement must contain a number of provisions required by the SEC. Third, whenever the solicitor solicits clients on behalf of the advisor, the solicitor must provide a separate disclosure document to the client, detailing the nature of the relationship between the solicitor and the advisor, the compensation paid to the solicitor, and indicate if the arrangement results in an increase in the fees paid by the client. Finally, the client or potential client must sign the disclosure document and the advisor must keep a copy of the signed document in his or her files.

These matters involve complicated rules whose applicability is based on fact-specific analysis. If you are unsure about any of these matters, you should contact an experienced investment management attorney.