The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has issued a new alert, highlighting the most common compliance issues relating to Rule 206(4)-1 (the “Advertising Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”). OCIE identified these compliance issues as part of its “Touting Initiative,” an examination initiative launched in 2016 to examine the adequacy of disclosures that advisers provided to their clients when touting awards, promoting ranking lists, and/or identifying professional designations (collectively, “accolades”) in their marketing materials. The OCIE based its findings on deficiency letters resulting from over 1,000 adviser examinations. The risk alert provides guidance to advisers who are reviewing the adequacy and effectiveness of their compliance programs in light of the Advertising Rule. Although most experienced people in the industry will not be shocked by anything in the alert, the alert is a helpful reminder about the SEC’s continuing focus on these issues.
In addition to certain specific prohibitions, the Advertising Rule generally prohibits an adviser, directly or indirectly, from publishing, circulating, or distributing any advertisement that contains any untrue statement of material fact, or that is otherwise false or misleading. The Advertising Rule (and the interpretations offered in SEC no-action letters and other SEC updates) defines “advertisements” very broadly, and includes any written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television (or other electronic media, including social media), which offers (1) any analysis, report, or publication concerning securities, or which is to be used in determining whether to buy or sell any security, or (2) any graph, chart, formula, or other device to be used in determining whether to buy or sell any security, or (3) any other investment advisory service regarding securities.
Advertising Rule Compliance Issues
The following compliance issues were identified in the risk alert:
- Misleading Performance Results. Examples included advertisements presenting performance results without deducting advisory fees, advertisements that compared results to a benchmark but did not include disclosures about the limitations inherent in such comparisons (such as not disclosing that the advertised strategy materially differed from the composition of the benchmark to which it was compared), and advertisements that contained hypothetical and back-tested performance results but did not explain how these returns were derived and did not include other potentially material information regarding the performance results.
- Misleading One-on-One Presentations. Examples included advertisements that contained gross performance results but did not disclose that the advertised performance results did not reflect the deduction of advisory fees and that client returns would be reduced by such fees and other expenses.
- Misleading Claim of Compliance with Voluntary Performance Standards. Examples included advertisements where advisers claimed that their advertised performance results complied with a certain voluntary performance standard but it was not clear that the performance results in fact adhered to such standard.
- Cherry-Picked Profitable Stock Selections. Examples included advisers who included only profitable stock selections or recommendations in their presentations, client newsletters, or on their websites, without meeting the conditions set forth in Subsection (a)(2) of the Advertising Rule.
- Misleading Selection of Recommendations. Examples included advisers who disclosed past specific investment recommendations that included only certain, and not all, recommendations in order to illustrate a particular investment strategy, but which recommendations did not meet the conditions set forth in Subsection (a)(2) of the Advertising Rule and did not satisfy the conditions upon which the SEC Investment Management (“IM”) staff provided certain relief in the TCW Group and Franklin no-action letters.
- TCW Group No-Action Letter – IM staff stated that advisers are permitted to disseminate advertisements that included an equal number of the best- and worst-performing holdings in the relevant investment strategy, provided several representations are met.
- Franklin No-Action Letter – IM staff stated that advisers are permitted to disseminate advertisements that included past specific recommendations if they were selected by using a consistently applied, objective, non-performance-based selection criteria, provided that certain additional requirements were met.
- Compliance Policies and Procedures. Examples included advisers who did not implement policies and procedures pertaining to (i) the process for reviewing and approving advertising materials prior to their dissemination, (ii) determining the parameters by which accounts were included or excluded from performance calculations when using composite performance calculation, and (iii) confirming the accuracy of performance results in compliance with the Advertising Rule.
Touting Initiative Observations
OCIE launched the Touting Initiative in 2016 to examine the adequacy of disclosures that advisers provided to their clients when including accolades in their marketing materials. The following compliance issues from the Touting Initiative were identified in the risk alert:
- Misleading Use of Third-Party Rankings or Awards. Examples included advisers who advertised accolades that had been obtained based on potentially false or misleading information; advisers who published marketing materials referencing stale ranking or evaluation information; and advisers who did not disclose who created and conducted the survey, the relevant selection criteria for the awards or rankings, or the fact that advisers paid a fee to participate in the survey.
- Misleading Use of Professional Designations. Examples included potentially false or misleading disclosures in advisers’ Form ADV Part 2B Brochure Supplements, such as references to professional designations that have lapsed or that did not explain the minimum qualifications required to attain such designations.
- Testimonials. Examples included client endorsements published in firm websites, social media pages, reprints of third-party articles, or pitch books.
In response to OCIE examinations where the above-discussed deficiencies were identified, investment advisers elected either to remove the misleading language from their advertisements or to add appropriate disclosures that were designed to prevent the advertisements from being misleading.
We recommend that advisers consider the above examples while examining their advertising materials and, if necessary, make appropriate adjustments to increase the adequacy and effectiveness of their policies and procedures designed to monitor compliance with the Advertising Rule.