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Regulation and Compliance > Federal Regulation > SEC

Playing by the Rules

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Investment advisors are often encouraged to employ various marketing techniques to help expand their businesses. But be careful. Do you place the abbreviation “RIA” on your business card? Sounds innocuous enough if you are a registered investment advisor, but federal regulators beg to differ. The SEC takes the position that it is fraudulent for a registered investment advisor to use the abbreviation “R.I.A.” or “RIA,” since it suggests that the advisor has earned an educational degree or a merit-based professional designation. However, the SEC considers it perfectly acceptable for an advisor to spell out the term “Registered Investment Adviser” after his or her name, holding that the use of the full term does not have the same “misleading” implications. Advisors must keep this in mind when ordering business cards, letterhead, or marketing materials.

When advisors are planning marketing strategies, they should do so with the understanding that the Investment Advisers Act of 1940 has a number of provisions that apply in the marketing context to SEC-registered investment advisors. Many of these same provisions also apply to state-registered advisors. A general understanding of the statutory and regulatory provisions can help advisors structure their marketing initiatives to avoid unintentional violations.

Anti-Fraud Provisions

It is worth noting that advisors’ marketing initiatives, like every other aspect of their activities, are subject to the Act’s general anti-fraud provisions. That means that the SEC has broad latitude to determine which marketing activities are appropriate and which may be misleading or inappropriate. In addition, the SEC holds advisors to a standard that is significantly higher than that for other businesses when considering these issues. The kind of puffing, exaggeration, or insinuation that is the norm in other industries can cause an advisor to be the subject of an SEC Enforcement action.

In addition to restrictions on the use of RIA, the SEC has other rules in this area, some of which are not so obvious. One relates to claims that a service or product is provided free of charge. Such a claim cannot be made unless there are no conditions or obligations connected with that service or product. Any condition or obligation, even if it is not economic or monetary, precludes the use of the term “free.” Similarly, advisors are prohibited by the anti-fraud provisions from claiming that a “graph, chart, formula, or device” can by itself determine what securities an investor should buy or sell. The SEC considers such a statement to be per se fraudulent. Furthermore, even if the statement relates to the ability of such a “device” to assist a person in making investment decisions, its limitations and the difficulties of its use must be prominently disclosed.

Advertising Rules

Apart from the anti-fraud provisions, the legal provisions that apply in the marketing context are based primarily on the SEC’s advertising rules. Advisors must always consider the applicability of the SEC’s advertising rules when marketing their services. The advertising rules have a very broad reach, and apply to many communications that might not normally be considered “advertising.” The rules obviously apply to communications through radio, television, and print media, but they also apply to any writing that is addressed to more than one person. As such, letters or e-mails sent to two or more persons, as well as all materials posted on a Web site, are subject to the prohibitions and restriction of the advertising rules.

As to the specific prohibitions of the SEC’s advertising rules, the first is a prohibition on the use of testimonials. An advisor cannot generally use past or present clients to endorse the advisor or refer to the performance the advisor achieved for those clients. Nonetheless, unbiased third-party reports are allowed, as is the use of partial client lists prepared in accordance with certain criteria and containing appropriate disclosures. Likewise, advisors cannot refer to specific prior profitable recommendations in advertisements. This rule prohibits “cherry picking” past profitable recommendations (i.e., picking the profitable recommendations and omitting those that resulted in losses) without comprehensive disclosure about all recommendations made by the advisor over an extended period of time. Nonetheless, an advisor can provide, in certain instances, comprehensive lists of recommendations over an extended period of time if they contain appropriate disclosures that would put the information on those lists into the proper context.

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.

Don’T Do It!

These are the ten most common mistakes made by advisors in marketing their services:

1.Using “RIA” in business cards, stationery, or advertisements.

2.Using the testimonial of an existing or former client in advertisements.

3.Employing solicitors without complying with all of the applicable rules.

4.Posting Internet communications that don’t comply with advertising restrictions.

5.Issuing form letters or newsletters that fail to comply with advertising rules.

6.Advertising performance figures that are gross of fees.

7.Failing to file advertising materials with the SEC or NASD, as appropriate.

8.Claiming that advertised performance figures comply with AIMR standards

when some aspects of those standards have not been met.

9.Advertising model performance information (i.e., performance other than that of actual accounts) without including the proper disclosures and disclaimers.

10.Claiming that a service or product is free, when its availability is somehow conditioned or results in an obligation.

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.