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Regulation and Compliance > Federal Regulation > SEC

Advisor Advertising Rules Enter 21st Century

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Registered investment advisors are ringing in the New Year with a new rule by the Securities and Exchange Commission that will allow them to market themselves in the 21st Century.

At press time in early January, advisors still were deciphering the SEC’s 400 plus-page rule — which allows advisors to use testimonials and endorsements — but largely viewed the rule as positive.

The new Investment Adviser Marketing rule creates a single rule that replaces the current Advertising and Cash Solicitation Rules. The advertising rule was adopted in 1961 and the solicitation rule in 1979.

“On balance, the new rule as adopted is a huge improvement over the current framework as well as what was proposed in 2019 — both from a compliance standpoint but also from a business marketing point of view,” said Sanjay Lamba, associate general counsel at the Investment Adviser Association, during an early January webcast. The new rule moves away “from the patchwork regulation of no-action letters” and creates a rule that is “evergreen and can adapt and change with the times.”

One immediate question among advisors: will the incoming Biden administration let the rule stand?

Valerie Mirko, a partner at Baker McKenzie in Washington, said during an early January webcast that she doesn’t expect a Biden SEC to have an impact on the ad rule. “It is unusual that this rule and others were finalized after the election — 2020 was unprecedented as well,” Mirko said. “The SEC is also an independent commission. This rule was the subject of a unanimous vote” when it passed in late December.

Former SEC Chairman Jay Clayton said in a late December statement that the “comprehensive framework for regulating advisers’ marketing communications recognizes the increasing use of electronic media and mobile communications and will serve to improve the quality of information available to investors.”

The new rule, Clayton said, “provides for an extended compliance period intended to provide advisers with a sufficient transition period, including to enable consultation with the Commission’s expert staff.”

James Lundy, partner at Faegre Drinker in Chicago, called the revamped ad rule “positive.” The old rule “was archaic and proscriptive, and no longer really appropriate for the way firms do business and communicate in the 21st century.”

Added Lundy: “We’ll all need to wait and see how [SEC] examines for compliance with and enforcement investigates potential violations of the new rule, but overall this is positive for the industry.”

In a note to IAA’s members Karen Barr, president and CEO, said that “over the years, the SEC added hundreds of pages of piecemeal guidance to the rule — making its requirements a nightmare for compliance-minded advisers to sift through, sort out, and interpret.”

The SEC has achieved a “Herculean task,” Barr said by “collecting all of that guidance, accounting for all of the information technology, social media, and marketing practice advancements over more than half a century, and fusing them into a modern, principles-based, evergreen, workable framework.”

Advisors, Barr said, “will be able to better engage on social media, share their clients’ experiences with prospects, and use specific examples to illustrate their investment process. The new, 400-plus-page rule provides advisers with plenty of new opportunities, as well as new requirements, some of which may be challenging or require more clarity.”

The SEC also is expanding the books and records rule to reflect the final marketing rule. Investment advisors “must make and keep records of all advertisements they disseminate,” IAA explained. “If an adviser’s disclosures with respect to a testimonial or endorsement are not included in the advertisement, then the adviser must retain copies of such disclosures provided to investors.”

Registered investment advisors will have 18 months after the effective date (60 days after publication in the Federal Register) to comply with the amendments. Advisors, Barr said, “have much to learn and put into practice during the rule’s 18-month implementation period.”

However, in early January, the rule had yet to show up in the federal register.

Long-Needed Modernization

As the IAA explained, the “Advertisement” definition contains “two prongs” to now include advertising and solicitation.

“The first prong captures traditional advertising with certain exclusions (most one- on-one communications and extemporaneous, live, oral communications),” IAA explained. “The second prong covers compensated testimonials and endorsements (including directed brokerage, awards or other prizes, and reduced advisory fees), and includes a similar scope of activity as traditional solicitations under the current solicitation rule.”

However, the new rule extends to non-cash as well as cash compensation. “Generally, the final marketing rule reflects a good and long-needed modernization of the very old advertising and solicitation rules,” added Sara Crovitz, partner at Stradley Ronon in Washington.

Crovitz noted that there are “no more per se prohibitions.”

For instance, “the final rule permits past specific recommendations and testimonials,” Crovitz explained. “In addition, the final rule includes sensible principles-based prohibitions. And unlike the proposal, the final rule does not generally apply to communications to one person nor does it require pre-use review of advertisements. Overall, it’s a vast improvement.”

However, some aspects of the final rules are not as welcome, Crovitz opined. “Even though advertisements generally are subject to the principles-based prohibitions, presentations of performance also are subject to some new prescriptive requirements,” she said.

For instance, most advertisements that include performance “will have to use specific time periods to show that performance,” according to Crovitz.

Also, the SEC adopted “a broad definition of hypothetical performance, including targeted performance, such as a statement that an investment adviser aims to match the performance of a particular index,” she said. “While targeted performance is not subject to the same risk of investor confusion, it is subject to the same detailed conditions and disclosures as for other hypothetical performance.”

The final rule explicitly subjects private fund advisors to the marketing rules with regard to communications to private fund investors, Crovitz explained.

“There may be some pretty significant impacts for private fund adviser compliance programs. For example, while the presentation of past specific performance is now more principles-based, which should be a welcome change to private equity advisers, the final rule also includes a flat prohibition on showing gross performance without side-by-side net performance,” according to Crovitz.

One aspect that may not stand out but is worth paying attention to as advisers plan updates to their compliance programs is the amendments to Form ADV. “The final rule requires advisers to disclose additional information about their use of certain types of advertisements and advertising practices. Advisers should be aware that the Division of Examinations will be mining this data to prepare for examinations of advisers.

Max Schatzow, a member of Stark & Stark’s Investment Management & Securities Group in Lawrenceville, NJ, said in a Twitter string that the new definition of advertisement “is much broader and includes all direct or indirect communications (a) made to more than 1 person (but includes most 1-on-1s if it contains hypothetical performance) & (b) testimonials and endorsements.”

The advertisement definition “specifically excludes: (A) Extemporaneous, live, oral communications (think unscripted speeches); (B) Info contained in a statutory/regulatory filings; or (C) certain unsolicited responses to requests for hypothetical performance,” Schatzow tweeted.

As to testmionials/endorsements, Schatzow tweeted that advisors must “disclose, or reasonably believe the person giving the testimonial/endorsement discloses that cash/non-cash compensation was provided, a statement of conflict of interest, and terms of compensation.”

Washington Bureau Chief Melanie Waddell can be reached at [email protected].


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