Under Rule 206(4)-1(a)(1) of the Investment Advisers Act of 1940, it is a fraudulent, deceptive or manipulative act for an investment advisor to “directly or indirectly” publish, circulate or distribute any advertisement that “refers, directly or indirectly, to any testimonial of any kind concerning the investment advisor or concerning any advice, analysis, report or other service rendered by such investment advisor [emphasis added].”
While this rule does not define the term “testimonial,” the Securities and Exchange Commission consistently interprets it to include a statement by a current or former client that either endorses the advisor or refers to a favorable investment experience with the advisor. An “indirect testimonial” would include an investment advisor publishing a favorable statement or endorsement attributed to its client (e.g., “our clients tell us that we are the best investment advisors in the business.”).
Based on the SEC’s broad interpretation of the word “testimonial” and the drafting of the rule itself, the ban on testimonial advertising has been extended not only to indirect testimonials, but to testimonial statements that have practically nothing to do with investment-related activities.
Why Testimonials Are Prohibited
According to the 1961 Adopting Release to Rule 206(4)-1, the rule contemplates that “advisors are professionals and should adhere to a stricter standard of conduct than that applicable to merchants; securities are ‘intricate merchandise’; and clients or prospective clients of investment advisors are frequently unskilled and unsophisticated in investment matters.”
Simply put, the SEC determined over 50 years ago that investment advisory clients are incapable of critically evaluating testimonials applied to investment advisors, even though they may be capable of evaluating testimonials proffered by merchants in practically any other industry. Apparently, the SEC has not changed this attitude since that time.
Nonetheless, testimonials are prohibited because from the SEC’s perspective they are likely to create a deceptive or mistaken impression that all of the advisor’s clients or investors typically experience the same favorable results as the person providing the testimonial, and testimonials emphasize favorable experiences and do not account for unfavorable experiences.
Testimonials Only Prohibited in Ads
Critically, the prohibition against testimonials is limited to their use in an advisor’s advertisements. Rule 206(4)-1(b) currently defines an advertisement as:
“Any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, that offers any analysis, report or publication concerning securities or that is to be used in making any determination as to when to buy or sell any security or which security to buy or sell; or any graph, chart, formula or other device to be used in making any determination as to when to buy or sell any security or which security to buy or sell; or any other investment advisory service with regard to securities.”