On December 22, 2020, the Securities and Exchange Commission (the "SEC") adopted amendments to modernize and consolidate Rule 206(4)-1 ("Advertising Rule") and Rule 206(4)-3 ("Solicitation Rule") under the Investment Advisers Act of 1940 ("Advisers Act").1 The amendments are intended to modernize the existing rules governing investment adviser advertising and payments to solicitors, which have not been substantively changed since they were adopted in 1961 and 1979, respectively. The amendments combine the Advertising Rule and the Solicitation Rule into amended Rule 206(4)-1 ("Marketing Rule"), and rescind the Solicitation Rule. The Marketing Rule is discussed at a high level below.
Overview of Marketing Rule
The Marketing Rule (i) expands the definition of "advertisement"; (ii) replaces the four per se prohibitions in the Advertising Rule with a set of seven principles-based prohibitions; (iii) permits testimonials, endorsements, and third-party ratings, subject to certain restrictions and conditions; and (iv) includes specific requirements for the presentation of performance results. In a departure from the proposed amendments,2 the Marketing Rule does not define and distinguish between retail and non-retail advertisements, does not require the review and approval of advertisements prior to dissemination, and codifies existing staff no-action letters regarding the ability to advertise performance achieved at another firm.
Definition of "Advertisement"
General Definition. The definition of "advertisement" in the Marketing Rule has two prongs. First, the definition includes any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance, that offers the investment adviser's investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser, or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser.3 Excluded from this prong of the definition are (1) extemporaneous, live, oral communications4 and (2) communications that include hypothetical performance that are provided in response to an unsolicited request, or in one-on-one communications to a prospective or current investor in a private fund advised by the adviser.5 Second, the definition of "advertisement" also includes any endorsement or testimonial6 for which an investment adviser provides compensation, directly or indirectly.7 This prong of the definition is implicated by any form of compensation provided by the adviser, whether cash or noncash.8 Information required in statutory or regulatory notices, filings, or other required communications (e.g., Form ADV) is excluded from both prongs of the definition.9 The definition captures communications through emails, text messages, instant messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, and all manner of social media, as well as by paper, including in newspapers, magazines, and the mail.10
Application to Private Fund Investors. The definition of advertisement in the Marketing Rule specifically includes communications to private fund investors, which are investors in investment vehicles that would be investment companies but for Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 ("Investment Company Act"). The definition does not include communications to investors in investment vehicles that rely on other sections of the Investment Company Act to be excluded from the investment company definition (e.g., real estate funds that rely on Section 3(c)(5)(C)).
Direct or Indirect Communication. In the Adopting Release, the SEC acknowledges that investment advisers often provide intermediaries, such as consultants, other advisers (e.g., in a fund-of-funds or feeder funds structure), and promoters, with advertisements for dissemination. The SEC states that any such indirect communications would be advertisements subject to the Marketing Rule.11
Adoption and Entanglement. The Adopting Release states that third-party information may be attributable to an investment adviser, and that any such determination requires an analysis of the facts and circumstances to determine whether (i) the adviser has explicitly or implicitly endorsed or approved the information after its publication ("adoption") or (ii) the adviser has sufficiently involved itself in the preparation of the information ("entanglement").12
Guidance on Social Media. Whether content posted by third parties on an adviser's own website or social media page would be attributed to the adviser depends on the facts and circumstances surrounding the adviser's involvement, including whether the adviser was involved in the preparation of the content, selectively deleted or altered the content, or had the authority to influence the content (even if the adviser did not exercise such authority).13 In addition, depending on the facts and circumstances, social media postings on the account of an associated person of an adviser could be viewed as the adviser marketing its advisory services.14 If the adviser's policies and procedures are reasonably designed to prevent the use of an associated person's social media accounts for marketing the adviser's services, such communications would not be viewed as the adviser marketing its advisory services.15
One-on-One Communications. The Adopting Release states that the exclusion for one-one-one communications in the definition of "advertisement" applies regardless of whether the adviser makes the communication to a natural person with an account or multiple natural persons representing a single entity or account.16 Investors that share the same household would also be one person.17 However, communications that are nominally directed at or "addressed to" one person but that are in fact widely disseminated to numerous investors would not fall within the one-on-one exclusion, and would be subject to the Marketing Rule.18
Brand Content. The Adopting Release states that generally, a communication including "brand" content (e.g., displays of the adviser's name in connection with sponsoring sporting events, supporting community service, or supporting philanthropic efforts), educational materials, and market commentary would not meet the definition of advertisement, although the determination would ultimately depend on the facts and circumstances.19
Extemporaneous, Live, Oral Communications. The Adopting Release states that the exclusion from the definition of "advertisement" for extemporaneous communications does not cover prepared remarks or speeches such as those delivered from scripts, instantaneous written conversations such as in text messages or chats, or previously recorded oral communications disseminated by the adviser after it had time to review and edit the recording.20 Slides or other written materials distributed or presented to a live audience would also be considered "advertisements" if such materials otherwise meet the definition.21
Information Contained in a Statutory or Regulatory Filing or Notice. The Adopting Release states that the exclusion for information contained in a statutory or regulatory filing or notice would not extend to information that is not reasonably designed to satisfy obligations under applicable law and that offers the adviser's investment advisory services with regard to securities.22
The Marketing Rule replaces the existing prohibitions in the Advertising Rule that constitute per se violations of the Advisers Act with seven principles-based provisions.23 These provisions prohibit advertisements that (1) contain untrue statements of a material fact or omit a material fact, (2) contain material statements of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC, (3) contain information that would reasonably be likely to cause an untrue or misleading implication or inference, (4) discuss potential benefits without disclosing material risks or other limitations, (5) refer to specific investment advice where such investment advice is not presented in a fair and balanced manner, (6) contain performance where such performance is not presented in a fair and balanced manner, and (7) are otherwise materially misleading.
Testimonials and Endorsements
Definitions. Paragraph (b) of the Marketing Rule merges the Solicitation Rule into the Advertising Rule, addressing solicitation activities under the definitions of "endorsement" and "testimonial," which both include statements that directly or indirectly solicit any investor to be the adviser's client or private fund investor.24 An "endorsement" is defined in the Marketing Rule to mean any statement by a person other than a current client or investor in a private fund advised by the investment adviser that: (i) indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person's experience with the investment adviser or its supervised persons; (ii) directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.25 A "testimonial" is defined in the Marketing Rule to mean any statement by a current client or investor in a private fund advised by the investment adviser: (i) about the client or investor's experience with the investment adviser or its supervised persons; (ii) that directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) that refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.26 The Adopting Release states that a person providing an endorsement or testimonial under the Marketing Rule could be a firm (such as a broker-dealer or a bank) or its representative that solicits for an adviser, or an unaffiliated fund-of-funds or a feeder fund that solicits investors in an underlying fund or a master fund, respectively.27
Cash and Non-Cash Compensation. The Marketing Rule prohibits an adviser from directly or indirectly compensating a person for a testimonial or endorsement unless the adviser complies with the conditions in the rule discussed below. This restriction on compensation for testimonials and endorsements applies to both cash and non-cash compensation. The Adopting Release states that forms of compensation under the Marketing Rule will include fees based on a percentage of assets under management or amounts invested, flat fees, retainers, hourly fees, reduced advisory fees, fee waivers, and any other methods of cash compensation, as well as cash or non-cash rewards that advisers provide for endorsements and testimonials, including referral and solicitation activities.28 Compensation also includes directed brokerage that compensates brokers for soliciting investors, sales awards or other prizes, gifts and entertainment, such as outings, tours, or other forms of entertainment that an adviser provides as compensation for testimonials and endorsements.29
Conditions Applicable to Testimonials and Endorsements, Including Solicitations. Paragraph (b) of the Marketing Rule provides that an advertisement may not include any testimonial or endorsement, and an adviser may not provide compensation, directly or indirectly, for a testimonial or endorsement, unless the adviser complies with that paragraph's disclosure, oversight, and disqualification provisions, subject to certain exceptions.
1. Disclosure Requirements. Unless an exemption applies, the adviser must disclose, or reasonably believe that the person giving the testimonial or endorsement discloses, clearly and prominently, (i) that the testimonial or endorsement is given by a client or investor or a person other than a client or investor; (ii) that cash or non-cash compensation was provided for the testimonial or endorsement; and (iii) a brief statement of any material conflicts on the part of the person giving the testimonial or endorsement resulting from the adviser's relationship with such person.30 In addition, the adviser must disclose the material terms of any compensation arrangement31 and describe the material conflicts ("supplemental disclosure requirement").32 Material terms include whether the adviser will be paid a specific cash amount or a percentage of total advisory fees over a period of time, the readily ascertainable value of any non-cash compensation, and whether compensation is payable upon dissemination, deferred, contingent, or trailing.33 The disclosure should state that the promoter, due to the compensation received, has an incentive to recommend the adviser, resulting in a material conflict of interest, as well as any other material conflicts of interest arising from the promoter's relationship with the adviser.34 These disclosures must be provided at the time the testimonial or endorsement is disseminated.35
2. Oversight and Compliance. Unless an exemption applies, the adviser must have (i) a reasonable basis for believing that the testimonial or endorsement complies with the requirements of the rule, and (ii) a written agreement with any person giving the testimonial or endorsement that describes the scope of the agreed-upon activities and the terms of compensation.36 The Adopting Release suggests that to have a reasonable basis, the adviser might periodically make inquiries of a sample of solicited investors or require promoters to preview endorsements with the adviser.37
3. Disqualification. Unless an exemption applies, the Marketing Rule prohibits an adviser from compensating a person for a testimonial or endorsement if the adviser knows, or in the exercise of reasonable care should know, that the person giving the testimonial or endorsement is subject to certain disqualifying events enumerated in the Marketing Rule at the time the testimonial or endorsement is disseminated.38
4. Partial Exemptions.
- De Minimis Compensation. Persons giving a testimonial or endorsement that receive no compensation or total compensation of $1,000 or less (or the equivalent value in non-cash compensation) during 12 months are exempt from the written agreement requirement.39
- Advisory Affiliates. Affiliates, partners, directors, officers, and employees of the adviser are exempt from the written agreement requirement, provided that the affiliation is either readily apparent or disclosed at the time the testimonial or endorsement is disseminated, and the adviser documents such person's status at the time the testimonial or endorsement is disseminated.40
- Broker-Dealers. Registered broker-dealers are exempt from the Marketing Rule's disqualification provisions provided that they are not subject to statutory disqualification under the Securities Exchange Act of 1934. Registered broker-dealers are also exempt from the disclosure requirement when providing a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation Best Interest. Registered broker-dealers soliciting non-retail customers (as defined in Regulation Best Interest) are exempt from the supplemental disclosure requirement.41
- Rule 506(d) Covered Persons. A testimonial or endorsement by a person that is covered by rule 506(d) of the Securities Act of 1933 with respect to a rule 506 securities offering and whose involvement would not disqualify the offering under that rule is exempt from the disqualification provision.42
A "third-party rating" is defined in the Marketing Rule to mean a rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms),43 and such person provides such ratings or rankings in the ordinary course of its business.44 Paragraph (c) of the Marketing Rule subjects advertisements that include third-party ratings to certain conditions and disclosure requirements. First, investment advisers must have a reasonable basis to believe that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result.45 Second, advertisements containing third-party ratings must clearly and prominently disclose, or the investment adviser must reasonably believe that the advertisement clearly and prominently discloses, the following: (i) the date on which the rating was given and the period of time upon which the rating was based; (ii) the identity of the third party that created and tabulated the rating; and (iii) if applicable, that compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating.46 The Adopting Release states that including these disclosures in an advertisement that contains third-party ratings would not cure a rating that could otherwise be false or misleading under the Marketing Rule's general prohibitions, or under the general anti-fraud provisions of the federal securities laws.47
Paragraph (d) of the Marketing Rule sets forth seven specific requirements and prohibitions for presenting performance information relating to (1) net and gross returns, (2) prescribed time periods, (3) statements about SEC approval, (4) related performance, (5) extracted performance, (6) hypothetical performance and (7) predecessor performance.
Net and Gross Returns. The Marketing Rule prohibits any presentation of gross performance48, unless the advertisement also presents net performance49 (i) with at least equal prominence to, and in a format designed to facilitate comparison with, the gross performance, and (ii) calculated over the same time period, and using the same type of return and methodology, as the gross performance.50 Unlike the proposal, the Marketing Rule requires net performance in all advertisements (and not just in retail advertisements51), and does not include a requirement that the advertisement provide or offer to provide a schedule of fees and expenses deducted to calculate net performance. A model fee may be used to calculate net returns if the model fee is equal to the highest fee charged to the intended audience to whom the advertisement is disseminated.52 In the Adopting Release, the SEC indicates that if an investment adviser intends to charge a higher fee to the intended audience than actual fees it charged in the past, the investment adviser must use the highest potential fee that it will charge the investors or clients receiving the particular advertisement, in order to avoid violating the Marketing Rule's general prohibitions.53
Prescribed Time Periods. The Marketing Rule requires advertisements that show performance to include performance of the applicable portfolio for one-, five-, and ten-year periods (or the life of the portfolio, where applicable), each presented with equal prominence and ending on a date that is no less recent than the most recent calendar year-end.54 This requirement does not apply to private fund performance.55
Statements about SEC Approval. The Marketing Rule prohibits advertisements containing performance results from including any statement, express or implied, that the calculation or presentation of performance results in the advertisement has been approved or reviewed by the SEC.56
Related Performance. Under the Marketing Rule, advertisements showing "related performance"57 must include the performance of all "related portfolios"58 unless the exclusion of a related portfolio would not (i) result in the advertised performance results being materially higher than if all related portfolios had been included and (ii) alter the presentation of performance over the one-, five-, and ten-year periods, if applicable.59
Extracted Performance. The Marketing Rule prohibits an investment adviser from presenting extracted performance60 in an advertisement unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio from which the performance was extracted.61
Hypothetical Performance. Under the Marketing Rule, investment advisers are permitted to include hypothetical performance62 in an advertisement, provided that the adviser (1) adopts policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement, (2) provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating the hypothetical performance, and (3) provides (or, if the intended audience is an investor in a private fund, provides or offers to provide promptly) sufficient information to enable the intended audience to understand the risks and limitations of using hypothetical performance to make investment decisions.63 The SEC states in the Adopting Release that it intends for advertisements including hypothetical performance information only to be distributed to investors who have access to the resources to independently analyze such information and who have the financial expertise to understand the risks and limitations of such types of presentations.64 With respect to the presentation of hypothetical performance, investment advisers do not need to comply with the conditions on performance relating to specified time periods, related performance, and extracted performance.65
Predecessor Performance. Unlike the proposal, the Marketing Rule specifically addresses an investment adviser's ability to advertise performance achieved at another firm. The Marketing Rule prohibits the use of predecessor performance66 unless (i) the person or persons who were primarily responsible for achieving the prior performance results manage accounts at the advertising adviser; (ii) the accounts managed at the predecessor investment adviser are sufficiently similar to the accounts managed at the advertising investment adviser that the performance results would provide relevant information to clients or investors; (iii) all accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance and the exclusion of any account does not alter the presentation of any applicable time periods, if applicable; and (iv) the advertisement clearly and prominently includes all relevant disclosures, including that the performance results were from accounts managed at another entity.67 The Marketing Rule's conditions on the use of predecessor performance generally tracks the conditions set forth in existing staff no-action letters.
Amendments to Form ADV and Recordkeeping
In connection with the adoption of the amendments to the Marketing Rule, the SEC also adopted amendments to Item 5 of Part 1A of Form ADV to add a new section entitled "Marketing Activities."68 This new section requires advisers to indicate in their Form ADV (i) whether their advertisements include performance results, specific investment advice, testimonials, endorsements, or third-party ratings; (ii) whether they provide, directly or indirectly, cash or non-cash compensation in connection with the use of testimonials, endorsements, or third-party ratings; (iii) whether their advertisements include hypothetical performance; and (iv) whether their advertisements include predecessor performance.69 The SEC also adopted amendments to Rule 204-2 under the Advisers Act ("books and records rule") that require advisers to make and keep certain records regarding all advertisements they disseminate, with certain accommodations for complying with this provision in the case of oral advertisements.70 These amendments expand the current books and records rule, which requires advisers to retain only advertisements sent to 10 or more persons.71 In response to comments received, the SEC clarified that electronic mail archives are an acceptable method of maintaining records of advertisements.72
Transition Period and Compliance Date; Withdrawal of Existing No-Action Letters
The Marketing Rule will be effective 60 days after its publication in the Federal Register, and investment advisers will have eighteen months following the effective date to come into compliance with the rule.73 The SEC will publish on its website a list of no-action letters issued under the Advertising Rule and Solicitation Rule that will be withdrawn in connection with the adoption of the Marketing Rule.74