On Sept. 19, 2022, the Division of Examinations of the Securities and Exchange Commission (EXAMS) published a Risk Alert (the Risk Alert) that identified the upcoming areas of review with respect to examinations of SEC-registered investment advisers (RIAs) focusing on compliance with amended Rule 206(4)-1 of the Investment Advisers Act of 1940 (the Marketing Rule). The Marketing Rule was adopted by the SEC on Dec. 22, 2020 (the New Marketing Rule Release), creating a single rule in lieu of the previous separate advertising and cash solicitation rules. The EXAMS staff issued the Risk Alert in anticipation of the approaching compliance date for the Marketing Rule, which is Nov. 4, 2022 (Compliance Date).
The Risk Alert encourages RIAs to consider their compliance with the Marketing Rule by reviewing their practices, policies and procedures and by modifying their training, supervisory, oversight and compliance programs, as necessary. The Risk Alert identifies four areas of review that the EXAMS staff will focus on in their upcoming examinations, each of which is discussed below.
The Areas of Review
Marketing Rules Policies and Procedures
The EXAMS staff will assess whether the written policies and procedures of RIAs are reasonably designed to prevent violations of the Investment Advisers Act of 1940 (the Advisers Act), including violations of the Marketing Rule. The SEC reiterated its position from the New Marketing Rule Release that effective policies and procedures should include objective and testable means aimed at preventing violations of the Marketing Rule. According to the Risk Alert, such means may include pre-approving advertisements or advertisement templates or reviewing a sample of advertisements based on risk.
The EXAMS staff will also review whether RIAs have a reasonable basis to believe that they will be able to substantiate material statements of fact in their advertisements. As initially set forth in the New Marketing Rule Release, some ways in which RIAs can demonstrate a reasonable belief are (i) by making a record contemporaneous with the advertisement that demonstrates a reasonable basis for the RIA’s belief, or (ii) by implementing policies and procedures to address how the RIA meets the reasonable belief requirement. According to the Risk Alert, if an RIA is unable to substantiate the claims made in an advertisement when demanded by the SEC, the SEC will presume that the RIA did not have a reasonable basis for believing it can substantiate those claims.
Performance Advertising Requirements
The EXAMS staff will also review whether RIAs are compliant with the Marketing Rule’s performance advertising requirements, including the prohibitions on including the following in advertisements:
- Gross performance unless accompanied by net performance.
- Any performance results that are not for specific time periods (this is not applicable to the performance of private funds).
- Any statement that the SEC has approved or reviewed any calculation or presentation of performance results.
- If an advertisement includes the performance of portfolios other than the specific portfolio being advertised, performance results from fewer than all portfolios having substantially similar investment policies, objectives and strategies as the portfolio offered in the advertisement, unless the advertised performance results are not materially higher than if all related portfolios had been included and the exclusion does not alter the presentation of any applicable prescribed time period.
- Performance results from a subset of investments extracted from a portfolio, unless the performance results for the total portfolio are also provided or offered to be promptly provided.
- Hypothetical performance (which does not include performance generated by interactive analysis tools), unless the RIA implements policies and procedures reasonably designed to ensure that such performance is relevant to the likely financial situation and investment objectives of the intended audience and the RIA provides additional information about the hypothetical performance that is tailored to the audience receiving the advertisement, such that the intended audience has sufficient information to understand the criteria, assumptions, risks and limitations.
- Predecessor performance, unless the personnel primarily responsible for achieving such performance manage accounts at the RIA and the predecessor accounts are sufficiently similar to the accounts that they manage at the RIA. All relevant disclosures must be clearly and prominently included in the advertisement.
Books and Records
Finally, the EXAMS staff will examine compliance with the amendments to the recordkeeping requirements under the Advisers Act that were adopted in connection with the Marketing Rule. These amendments require, among other things, that RIAs keep records of advertisements disseminated by them and maintain all written communications relating to the performance or rate of return of any portfolios. RIAs will need to maintain accounts, books, internal working papers and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any portfolios, including, with respect to hypothetical performance and predecessor performance, all information provided or offered to investors.
In addition to these four focus areas, the Risk Alert also reminds RIAs that Item 5 of Form ADV Part 1A is being amended to require additional disclosures regarding marketing practices. RIAs filing Form ADV (or filing an annual update) after the Compliance Date will need to respond to the amended version of Item 5. With these points in mind, RIAs should consider their current compliance programs, practices, policies and procedures to make sure that they are prepared for any upcoming examinations.
The Risk Alert can be found here.