In September, the SEC published a Risk Alert highlighting the most frequent violations of the “Advertising Rules” (Rule 206-4(1) of the Advisers Act that it has identified during examinations of SEC-registered investment advisers. The Advertising Rules are generally designed to prohibit advisers from publishing, circulating or otherwise distributing advertisements that contain any untrue statement of material fact or that are otherwise false or misleading. Certain advertisements, including client testimonials and past specific investment recommendations, are expressly prohibited under the Advertising Rules; other forms of advertisements have been found to violate the Advertising Rules in court opinions and SEC enforcement actions.
Some of the most common violations of the Advertising Rules the SEC identified are described below. We have observed many of these violations in the marketplace as well.
- Misleading Performance Results – Any advertisement of an adviser’s performance results cannot be false or misleading. Consequently, historical performance results should be presented net of fees and expenses and, if compared to an index or other benchmark, include appropriate disclosures regarding the unavoidable limitations of such a comparison. If hypothetical or back-tested performance results are presented, appropriate disclosures about how those results are calculated must be provided. It is noted that, in our experience, some state securities regulators view back-tested results as inherently misleading notwithstanding any disclosures of their limitations.
- Cherry Picking – Advisers are prohibited from referencing specific investment recommendations made by the adviser unless the adviser includes allinvestment recommendations that adviser made and appropriate information and disclosures about the recommendations. The purpose of this rule is to prevent an adviser from solely highlighting its profitable recommendations, which could lead a potential client to assume all of the adviser’s recommendations are profitable.
- Third-Party Rankings and Awards – Advisers who seek to include rankings or awards in their advertisements must disclose all material information about the ranking or award being described, including the number of eligible recipients, the selection criteria, and the date on which the ranking or award was received.
- Testimonials – Advisers are prohibited from advertising any testimonials, recommendations, or accolades about the services provided by the adviser. This includes testimonials made by current or former clients of the adviser.
For most investment advisers, advertisements and other marketing materials are an unavoidable component of growing their businesses. As noted above and in the Risk Alert, these activities are subject to numerous restrictions that are easy to violate. We strongly encourage all of our clients to have all advertisements and marketing materials reviewed by your compliance staff or outside counsel prior to distribution to potential investors.