The Advertising Rule Settlements
On July 10, 2018, the Securities and Exchange Commission (the “SEC”) announced five settlements (the “Advertising Rule Settlements”) in connection with violations of Section 206(4) of the Investment Advisers Act of 1940 (the “Advisers Act”) and Rule 206(4)-1(a)(1) thereunder.1 Each of the Advertising Rule Settlements involves the improper use of testimonials on social media.
Section 206(4) generally prohibits investment advisers from engaging in fraudulent, deceptive or manipulative conduct, and Rule 206(4)-1 (the “Advertising Rule”) prohibits registered investment advisers from using false or misleading advertisements. Testimonials in advertisements are deemed per se misleading and the Advertising Rule prohibits registered investment advisers from including them in advertisements.2 The term “testimonial” is not defined in the Advertising Rule, but the staff has consistently interpreted that term to include a “statement of a client’s experience with, or endorsement of, an investment adviser.”3
In March 2014, the Division of Investment Management published a guidance update (the “Guidance Update”) on the application of the Advertising Rule to the use of social media by investment advisers and investment adviser representatives (“IARs”).4 Among other things, the Guidance Update clarified that it is not permissible for an investment adviser or an IAR to invite clients to post public commentary directly on their internet site, blog or social media site that serves as an advertisement. In addition, in a September 2017 risk alert, the Office of Compliance Inspections and Examinations (“OCIE”) noted that it had observed advisers that had published statements of clients attesting to their services or otherwise endorsing the adviser that may be prohibited testimonials (e.g., client-endorsements published on firm websites and social media pages, and in pitch books and reprints of third party articles).5
Four of the Advertising Rule Settlements6 involve a registered investment adviser or an IAR hiring marketing consultant Create Your Fate, LLC (“Create Your Fate”) to contact their advisory clients and solicit testimonials for publication on their websites, Google, and social media sites, including Yelp, Facebook, and YouTube. In addition to hiring Create Your Fate to solicit client testimonials, one of the settled parties, HBA Advisors, LLC, orally solicited clients and other individuals to post testimonials on Yelp. The testimonials posted by HBA’s clients on Yelp included statements that HBA had enabled clients to purchase unique investments, protected clients’ investments from risk, helped clients generate significant investment returns, made clients feel more secure about retirement, and provided a high level of service. The HBA settlement order states that several professionals also published testimonials on HBA’s Yelp page, stating that they were comfortable referring clients to HBA because, among other things, HBA was trustworthy and had helped them increase the value of their investments.7 Certain of the testimonials in respect of the IARs were captioned as “Five Star Reviews,” and other testimonials indicated that the IARs were knowledgeable, trustworthy, provided a high level of service, and helped clients generate investment returns. The SEC separately settled with the owner of Create Your Fate for causing the violations of the Advertising Rule described above.8
In the fifth Advertising Rule Settlement, the SEC found that dually-registered investment adviser and broker-dealer Romano Brothers & Company (“Romano Brothers”) violated the Advertising Rule by publishing videos on its website and on YouTube that contained statements by its advisory clients about their experiences with the firm. The videos included statements that clients had profited from Romano Brothers’ services and that Romano Brothers’ services had provided them with income, security and peace of mind. The settlement order indicates that in determining to accept the Romano Brothers’ offer of settlement, the SEC considered remedial acts promptly undertaken by the Romano Brothers, including hiring a new Chief Compliance Officer and updating its compliance manual and training program.
Registered investment advisers should ensure that their policies and procedures are reasonably designed to comply with the Advertising Rule, and that all adviser personnel are aware of the restrictions on their use of social media under the Advertising Rule.
The Pay-to-Play Settlements
On July 10, 2018, the SEC also announced settlements (the “Pay-to-Play Settlements”) with two registered investment advisers and one exempt reporting adviser relying on the venture capital adviser exemption for violations of Advisers Act Rule 206(4)-5 (the “Pay-to-Play Rule”).9 The Pay-to-Play Rule prohibits investment advisers (including exempt reporting advisers) from receiving compensation for providing investment advisory services to a government entity10 for two years after the adviser, or certain of its executives or employees, makes a campaign contribution to certain elected officials or candidates who can influence the selection of that government entity’s investment advisers. The Pay-to-Play Settlements are the second wave of SEC settlements based on violations of the Pay-to-Play Rule. In January 2017, the SEC settled with ten investment advisers (five of which were exempt reporting advisers) for Pay-to-Play Rule violations.11 These settlements demonstrate the SEC’s continued focus on pay-to-play enforcement cases and serve as a reminder that exempt reporting advisers are not exempt from SEC enforcement. Advisers should ensure that their compliance policies and procedures include monitoring and testing functions reasonably designed to detect and prevent violations of the Pay-to-Play Rule.