The SEC's Office of Compliance Inspections and Examinations (OCIE) issued a risk alert summarizing the compliance issues most frequently identified in SEC-registered investment advisers' deficiency letters with respect to Rule 206(4)-1 (the Advertising Rule) under the Investment Advisers Act of 1940. These issues include OCIE's examination initiative focusing on advisers' use of touting awards, promoting ranking lists, and/or identifying professional designations in marketing materials.
The Advertising Rule prohibits an adviser from publishing or distributing any advertisement that contains any untrue statement of material fact, or that is otherwise false or misleading. The Advertising Rule also includes four specific restrictions:
(i) Prohibition of certain testimonials,
(ii) advertising past specific recommendations of the adviser that were or would have been profitable to any person,
(iii) prohibition of a chart or formula can by itself determine whether to buy or sell a security, and
(iv) restrictions on offering purportedly free reports, analyses, or services.
The Advertising Rule also encompasses SEC enforcement opinions and staff no-action letters and guidance updates.
The OCIE staff has identified the following categories of deficiencies:
1. Misleading Performance Results. These include:
(i) Presenting performance results without deducting advisory fees,
(ii) comparing results to a benchmark but failing to disclose that the advertised strategy materially differed from the composition of the benchmark, and
(iii) advertisements that contained hypothetical and back-tested performance results without explaining how these returns were derived.
2. Misleading One-on-One Presentations. One-on-one presentations with clients or potential clients present different concerns, such as failing to disclose that the advertised performance results did not reflect the deduction of advisory fees and that client returns would be reduced by the fees and other expenses.
3. Misleading Claim of Compliance with Voluntary Performance Standards. These include claims that advertised performance results complied with a certain voluntary performance standard (such as Global Investment Performance Standards), when it was not clear that the performance results adhered to the standard's guidelines.
4. Cherry-Picked Profitable Stock Selections. This includes advertising only profitable stock selections or recommendations without adequate disclosures, including the conditions in Rule 206(4)-1(a)(2).
5. Misleading Selection of Recommendations. This includes advertising past specific investment recommendations that may have been misleading because they included only certain, and not all, recommendations, to illustrate a particular investment strategy and failing to comply with Rule 206(4)-1(a)(2) disclosures. OCIE noted certain no-action letters with exceptions to this restriction, including:
(i) Advertising the adviser's five (or more) best performing holdings along with an equal number of worst performers provided several representations were included, and
(ii) advertising past specific recommendations that were selected using consistently applied, objective, non-performance based selection criteria, subject to certain required disclosures.
6. Compliance Policies and Procedures. Even if an adviser has otherwise complied with the Advertising Rule, the failure to adequately implement compliance policies and procedures with respect to the Advertising Rule is itself a violation. Such compliance procedures need to include:
(i) A process for reviewing and approving advertising materials prior to their publication or dissemination,
(ii) when using composites, determining the parameters for which accounts were included or excluded from performance calculations, and
(iii) confirming the accuracy of performance results in compliance with the Advertising Rule.
7. Misleading Use of Third Party Rankings or Awards. OCIE staff observed potentially misleading advertisements containing references to awards or rankings conferred by third parties that:
(i) Failed to disclose the accolades had been obtained by submitting potentially false or misleading information in the applications,
(ii) included stale ranking or evaluation information potentially misrepresenting the adviser's current status, and
(iii) published potentially misleading advertisements that did not disclose the relevant selection criteria for the awards or rankings, or who created and conducted the survey and that advisers paid a fee to participate in or distribute the results of the survey.
8. Misleading Use of Professional Designations. OCIE staff observed advisers' Form ADV Part 2B Brochure Supplements that contained potentially false or misleading references to employee professional designations, such as references to professional designations that have lapsed or that did not explain the minimum qualifications required to attain the designations.
9. Testimonials. These include published statements of clients attesting to the adviser's services or otherwise endorsing the adviser that may be prohibited testimonials. An adviser should assess its marketing and advertising policies within its compliance policies and procedures, and consider whether its advertisements are complaint with the Advertising Rule.