The Securities and Exchange Commission has released updated guidance on its marketing rule, answering questions on the net performance requirement as it relates to abstracted performance as well as determining whether certain portfolio or investment characteristics are performance.
Natasha Greiner, director of the agency's Division of Investment Management, said at the Investment Adviser Association's annual compliance conference on March 7 that after three years, "the industry is still grappling" with the rule.
After taking over the IM director's role a year ago, Greiner said it was a priority for her to look at the "pain points" related to the rule — and "what isn't working."
Gail Bernstein, IAA general counsel and head of policy, said at the event that the forthcoming FAQs "would remove impediments to advisors sharing important information with investors and reduce the risk of investor confusion." The updated guidance "would permit advisors to advertise the performance of individual investments as well as portfolio and investment characteristics on a gross basis if the net and gross performance of the entire portfolio is also included prominently in the advertisement," Bernstein said.
Extracted Performance
The concerns "over how to display extracted performance and other portfolio metrics for private funds has been a topic of discussion in the industry since the new rule was passed," Amy Lynch, founder and president of FrontLine Compliance, told ThinkAdvisor Thursday.
Extracted performance "means the performance results of a subset of investments extracted from a fund or other portfolio," Lynch explained.
"For example, a fund could extract out three portfolio companies and show the returns for those three investments only as opposed to the entire fund."
Over the past two and a half years, FrontLine "has seen SEC examiners interpret extracted performance in conflicting ways during exams," Lynch relayed. "We even experienced one examiner that told the registrant not to even show the team its extracted performance because it did not want to comment on it. When a rule is controversial even for the regulator, it’s time for a change."
Julia Reyes, partner at ACA Group, added that "the ability to present extracted performance on a gross basis — if full portfolio gross and net performance are also disclosed — is a positive development. Private fund managers were applying an arbitrary fee to individual investments making those returns meaningless and public market managers were making the same arbitrary calculations to sector and geographic returns."
These net returns "were only calculated in service of the rule and did not help investors understand the metrics shown. Still, firms must be diligent in ensuring disclosures remain balanced and not misleading," Reyes said.
The new FAQ "provides exactly the guidance needed and is in line with how FrontLine has been advising its clients since 2022," Lynch continued.
Lynch pointed to the FAQ's footnotes, which she said "are the most meaningful" in that they provide the details on the necessary disclosure language required to make the presentation not misleading.
"It’s good that the overall fund performance does not need to be on the same page as the extracted performance since page space can become an issue in marketing materials," Lynch said. "This will also make it easier to display the data with 'at least equal prominence.'”
The SEC also addressed in the FAQ the potential for the extracted performance data "to have a different time period than the overall fund data," Lynch pointed out.
"This can now be easily addressed via clear disclosures regarding the difference. Again, this is how the industry has already been handling this issue, so the guidance is in line."
Portfolio Characteristics
The FAQ's answer on portfolio characteristics like Sharpe ratios, yields and contributions to return "is also welcomed," Lynch said.
"Again, the staff is stating that if the gross and net performance of the total fund portfolio is shown in equal prominence then that will make the presentation of other characteristics not misleading when shown," Lynch said.
The two FAQs "align in their approach so now the private fund industry has a clearer understanding of how to handle these two situations and better yet, they match," Lynch said.
Photo: Diego M. Radzinschi/ALM
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