On September 14, 2017, the National Exam Program of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published a Risk Alert outlining registered investment adviser compliance issues relating to Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advisers Act”). According to OCIE, these issues were most frequently identified in SEC deficiency letters sent to registered investment advisers as part of the SEC’s examination initiative focusing on advisers’ use of accolades in their marketing materials (the “Touting Initiative”). The Risk Alert is intended to assist advisers in adopting and implementing an effective compliance program.
Misleading Performance Results
OCIE staff observed advertisements that the staff believed contained misleading performance results.
The staff observed examples of advisers that presented performance results without deducting advisory fees, and advertisements that compared results to a benchmark, but did not include disclosures about the limitations inherent in such comparisons, such as material differences between the benchmark and the strategy. The staff also observed advertisements that contained hypothetical and back-tested performance results, but did not explain the derivation of the returns, nor did they include other potentially material information regarding the performance results.
Misleading One-on-One Presentations
OCIE observed advertisements that the staff believed contained misleading one-on-one presentations.
The staff observed examples of advisers that advertised performance results (gross of fees) in certain one-on-one presentations, but did not include potentially relevant disclosures, such as the fact that results do not reflect advisory fees charged and that client returns would be reduced by advisory fees and other expenses.
Misleading Claim of Compliance with Voluntary Performance Standards
OCIE observed advertisements that the staff believed contained misleading claims of compliance with voluntary performance standards.
The staff observed examples of advisers that claimed adherence to certain voluntary performance standards in advertised performance results. However, according to the staff, it was not clear that they were actually adhering.
Cherry-Picked Stock Selections and Misleading Selection Recommendations
OCIE observed advertisements that the staff believed contained cherry-picked stock selections and misleading selections of investment recommendations.
The staff observed examples of advisers that included only profitable stock selections or recommendations in advertisements, and advisers that disclosed past specific investment recommendations, but did not meet the conditions of Rule 206(4)-1(a)(2).
Generally, advertisements that refer to an adviser’s past specific recommendations, that were or would have been profitable to any person, are considered “fraudulent or deceptive” unless an advertisement, and the list if it is furnished separately:
- States the name of each security recommended, the date and nature of each recommendation, the market price at that time, the price at which the recommendation was to be acted upon, and the market price of each security as of the most recent practicable date; and
- Contains a cautionary legend.
Compliance Policies and Procedures
OCIE observed that the staff believed that certain advisers did not appear to have (or did not appear to adequately implement) compliance policies and procedures reasonably designed to prevent deficient advertising practices, containing processes for:
- Reviewing and approving advertising materials prior to their publication or dissemination;
- Determining the parameters for which accounts are included or excluded from performance calculations when composites are used; and
- Confirming the accuracy of performance results in compliance with Rule 206(4)-1.
OCIE’s Observations from the Touting Initiative
In 2016, OCIE launched the Touting Initiative to examine the adequacy of disclosures that advisers provided to their clients when advisers included rakings, awards or other accolades in marketing materials.
Misleading Use of Third-Party Rankings or Awards
OCIE observed advertisements that the staff believed contained potentially misleading use of third-party rankings or awards, including:
- Advertising accolades obtained through the submission of potentially false or misleading information as part of the application process;
- Publishing marketing materials that referred to outdated and inapplicable rankings or evaluation information; and
- Publishing advertisements that failed to disclose the relevant selection criteria for awards or rankings, or advisers who created and conducted the survey and paid a fee to participate in or distribute the results.
Misleading Use of Professional Designations
OCIE observed advertisements (and disclosures contained in Form ADV) that the staff believed contained potentially false or misleading references to professional designations.
OCIE observed advisers that published potentially prohibited statements from clients attesting to or endorsing the adviser’s services.
Generally, advertisements that refer, “directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser” are considered “fraudulent or deceptive” under Rule 206(4)-1(a)(1).
OCIE’s Risk Alert highlights the staff’s attention toward adviser advertising. OCIE noted that, in response to the staff’s observations, advisers elected to remove misleading advertising language or add enhanced and clarifying language. Advisers should review their advertisements to ensure compliance, as well as ensuring that their compliance policies and procedures are robust and up-to-date.