The SEC staff recently issued a no-action letter modifying its position on the use of past investment recommendations in advertisements under Rule 206(4)-1(a)(2) of the Advisers Act. The no-action letter permits an adviser to distribute marketing materials to clients and prospective clients that show an equal number of holdings that contributed most positively and most negatively to the performance of a representative account’s performance, so long as the recommendations are objectively chosen and their appearance and substance meet certain criteria. See The TCW Group, Inc., SEC No-Action Letter (Nov. 7, 2008), available at  

The Restriction on Advertising Securities Recommendations and Prior SEC Staff Guidance  

Section 206(4) of the Advisers Act prohibits an adviser from engaging in any “act, practice, or course of business which is fraudulent, deceptive, or manipulative” and provides the SEC with related rule-making authority. Pursuant to this authority, the SEC adopted Rule 206(4)-1 in 1961. The rule defines the term advertisement broadly, prohibits or restricts a series of practices in advisers, advertisements, and includes a general advertising anti-fraud provision. A specific provision of the rule – Rule 206(4)-1(a)(2) – generally prohibits advertisements from including past specific recommendations that were or would have been profitable, unless the advertisement contains all recommendations for at least the past year, along with certain specified information about each recommendation. Alternatively, the rule permits an advertisement to include only an offer to provide a list of all of the adviser’s past specific recommendations for at least the past year. The primary purpose of this restriction is to prevent an adviser from “cherry picking” its profitable recommendations and fraudulently or deceptively implying that advertised recommendations are representative of the experience of the adviser’s clients.  

The SEC staff has long recognized the practical limitations of the restriction and industry concerns that the rule may be overly broad in certain contexts. As a result, the SEC staff has issued prior no-action letters that have provided limited relief. For example, the SEC staff issued a no-action letter in 1998 that permitted an adviser to discuss only a partial list of recommendations (including profitable recommendations) in quarterly reports sent to existing and potential clients, subject to a number of conditions. Those conditions included, among others, that the recommendations be selected on the basis of objective, non-performance based criteria applied consistently over time and that the advertisement not discuss, directly or indirectly, the amount of profits or losses attributable to the specific recommendations. See Franklin Management Inc., SEC No-Action Letter (Dec., 10, 1998).  

The SEC staff issued another no-action letter in 2004 that permitted an adviser to discuss only a partial list of past specific recommendations (including profitable recommendations) in attribution analyses contained in client communications. The discussion presumably could describe the amount of profits or losses attributed to specific securities, assuming that the discussion was overall balanced and not misleading. The relief, however, was also subject to a number of conditions, including generally that the communications could only be made to existing clients about their investment strategy or to potential clients or consultants who requested the information on an unsolicited basis. The SEC staff theorized that such communications were not advertisements, but were part of the adviser’s client services. See Investment Counsel Association of America, Inc., SEC No-Action Letter (Mar. 1, 2004).  

Conditions for the New Relief  

The SEC staff’s latest no-action letter provides further relief from the restriction on including past specific profitable recommendations in advertisements. In the recent no-action letter, the SEC permitted an advertisement to include a partial list of profitable recommendations even if provided to potential clients or consultants on an unsolicited basis.  

More specifically, the SEC staff addressed a request by an adviser to include in marketing materials charts that contained both the best performing and worst performing securities recommendations over a specified period together with composite performance information. The adviser intended to show the attribution analysis for an actual representative account in each investment strategy. In addition, the adviser represented that it would use a calculation methodology generally as follows: the weight (i.e., the percentage of the total account) invested in each holding would be multiplied by the rate of return for that holding during the measurement period yielding the contribution of the holding, for the period, to the account’s overall return during the period. Holdings would not be included or excluded for any other reason and thus the holdings shown in the chart would be selected in a mechanical and objective manner based on the relative impact on the account’s returns.  

The no-action letter contains a number of conditions designed to ensure that any profitable recommendations are included on the basis of an objective criteria that prevent the possibility of cherry picking. The conditions include the following:  

  1.  The calculation used to determine the inclusion of securities in the marketing materials must take into account consistently the weighting of every holding in the representative account that contributed to the account’s performance during the “measurement period” (generally the time since the prior performance period, such as a monthly or quarterly period) and the charts must reflect consistently the results of the calculation;  
  1. Each chart’s presentation of information and number of holdings must be consistent from one measurement period to the next;  
  1. The charts must show no fewer than ten holdings, including an equal number of positive and negative holdings. The SEC staff acknowledged that for some measurement periods the five most positive holdings may actually include negative performing positions, and vice versa, depending on market conditions;  
  1. The charts must disclose how a client, potential client or consultant may obtain (i) the calculation methodology and (ii) a list showing every holding’s contribution to the overall account’s performance during the measurement period;  
  1. Each chart must include all information necessary to make the chart not misleading, including presenting the best and worst performing holdings on the same page with equal prominence, and with appropriate disclose in close proximity to the performance information. Appropriate disclose would include, for example, a statement on each page containing a chart that (i) the holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients and (ii) past performance does not guarantee future results; and  
  1.  The adviser must maintain, and make available to the SEC staff upon request, records that evidence: (i) the criteria used to select the specific securities listed in each chart (i.e., the actual calculation); (ii) a list showing the contribution of each holding in the representative account to the overall account’s performance during the measurement period; and (iii) all supporting data necessary to demonstrate the calculation of the chart’s contribution analysis and to demonstrate the appropriateness of the holdings included in the chart.  

Brief Analysis  

We view the SEC staff’s recent no-action letter as further recognition of the sometimes overly restrictive nature of Rule 206(4)-1(a)(2), as well as an understanding that it should be acceptable under appropriate circumstances for an adviser to present past profitable recommendations in a balanced, objective manner. At the same time, we acknowledge that the recent no-action letter may leave open certain interpretive issues regarding its broader application, including whether the letter might apply to one-off presentations made outside a regular reporting or measurement period, whether other calculation methodologies may be acceptable and how hedging strategies need to be factored into the attribution analysis.

Finally, we caution advisers, including hedge fund managers, that may rely on the recent no-action letter to pay careful attention to the conditions for relief. In particular, the conditions require an adviser to provide clients, prospective clients, and consultants on request a list showing every holding’s contribution to the overall account’s performance during the measurement period. This condition could require the potential disclosure of all holdings in an adviser’s hedge fund, albeit on some time-delayed basis.