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Carl AyersPublisherThe SEC’s New IA Advertising Rule: A Complete Look,from Testimonials to Compliance Oversight
Michelle Jacko, CSCP,Managing Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif.Matt Lovett, CCO, BrookstoneCapital Management ( 3.5B inAUM) in Wheaton, Ill.Laura Arnott, CFA, CIPM,IACCP , Information QualityAnalyst, Barrow, Hanley,Mewhinney & Strauss ( 48Bin AUM) in DallasLes Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.The SEC’s New IA Advertising Rule: A Complete Look,from Testimonials to Compliance OversightTuesday, February 4, 2021www.regcompliancewatch.com2
Overview of our Agenda Freedom to Use New Media What Would and Wouldn’t beConsidered an Ad 7 Advertising No-No’s Rules Around Use of Testimonials Guardrails for Using Performance andHypothetical Ads Compliance Oversight Changes to the Books and Records Rule and Form ADVTuesday, February 2, 2021www.regcompliancewatch.com3
Overview of our Agenda The New Rule and Private FundsUse of Third-Party RatingsPortability of PerformanceRecordkeepingTuesday, February 2, 2021www.regcompliancewatch.com4
The SEC’s New IA Advertising RuleA Quick History – 60 Years in Coming! The New IA Advertising Rule provides modernization of an antiquated rule thatdates back to 1961 It is meant to provide consolidated and clear guidance and support thechange to a principles-based regulation It also modifies the definition of “advertisement” to be more evergreen inlight of ever-changing electronic media and mobile communications Amendments create a single rule and will replace the current advertising andcash solicitation rules The SEC will withdraw certain no-action letters and other guidanceaddressing these rules, as they will no longer provide or are incorporatedinto the final rule (to be available on the SEC website) Related amendments are made to Form ADV and the books and records ruleTuesday, February 2, 2021www.regcompliancewatch.comMichelle Jacko, CSCPManaging Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif.5
The SEC’s New IA Advertising RuleWhat Doesn’t Change – the Anti-Fraud Standards / Ads Can’t beMisleading Cannot make an untrue statement or omission of a material fact Must have a “reasonable basis” for making a material statement of fact that theadviser can substantiate upon demand by the SEC Cannot include information that would cause an untrue or misleading implicationor inference to be drawn concerning a material fact relating to the adviser Must be fair and balanced when: Discussing potential benefits; must also provide associated risks andlimitations Referencing specific investment advice provided by the adviser Including or excluding performance results or presenting performance timeperiodsMichelle Jacko, CSCPManaging Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif.Catch-all: Cannot include information that is otherwise materially misleadingTuesday, February 2, 2021www.regcompliancewatch.com6
The SEC’s New IA Advertising RuleWhat Was NOT Included in the Final Rule: One-on-one communications in the definition of an ad Two sets of rules for retail and non-retail investors Pre-approval required for review and approval of advertisements beforethey go outCompliance Timetable – Unknown! Jan. 20, 2021 – White House Chief of Staff Ron Klain instructs all agencies tonot implement any rulemaking that has not already posted to the FederalRegister. Appears Klain’s prohibition will not affect the SEC and the ad rule The New Rule’s Compliance date is 18 months after the effective date This is 60-days after publication in the Federal Register As of today, this has not yet occurredMichelle Jacko, CSCPManaging Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif.An adviser may elect to comply sooner than 18-months If it does so, the adviser will have to comply with all requirements of theRule, not just someTuesday, February 2, 2021www.regcompliancewatch.com7
The SEC’s New IA Advertising RuleThe “New” Definition of an Advertisement Any direct or indirect communication an investment adviser makes to more thanone person, or to one or more persons if the communication includeshypothetical performance, that offers the investment adviser’s investmentadvisory services with regard to securities to prospective clients or investors in aprivate fund advised by the investment adviser or offers new investment advisoryservices with regard to securities to current clients or investors in a private fundadvised by the investment adviser. Excluded from this definition are:Michelle Jacko, CSCPManaging Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif. Extemporaneous, live, oral communications (regardless of whether they arebroadcasted); Information in a statutory or regulatory notice, filing or other requiredcommunication; Communications that include hypothetical performance that is provided inresponse to an unsolicited investor request or to a private fund investor in aone-on-one communicationIt also includes any endorsement or testimonial for which an investment adviserprovides compensation, directly or indirectlyTuesday, February 2, 2021www.regcompliancewatch.com8
The SEC’s New IA Advertising RuleThe Rule’s Big Wows Use of Testimonials for the First Time – and With Any Media Includes reviews and referrals within electronic media outletsWill allow consumers to know how an adviser fares compared tocompetitorsNew Definition: Any statement by a current client or private fund investorabout their experience with the investment adviser or its supervised personsRules for Using Testimonials – Disclosures Must Include:Michelle Jacko, CSCPManaging Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif. If the testimonial was made by an advisory client or private fund investorWhether the person providing it was or is being compensatedIf the person was compensated, the forms of compensation received Includes fees based on a % of AUM, flat fees, retainers, hourly fees,reduced advisory fees, fee waivers as well as cash and non-cashrewards (including referral fees, prizes and gifts and entertainment) Any material terms related to the compensation and any conflictsAdvisers are forbidden from compensating any person for a testimonial if he/sheis an “ineligible person” subject to a disqualifying Commission action or eventTuesday, February 2, 2021www.regcompliancewatch.com9
The SEC’s New IA Advertising Rule7 Advertising No-No’s (General Prohibitions)1.2.3.4.5.Making untrue statements/ omitting material factsNot having a reasonable basis for material statements of factsUsing information to likely cause untrue or misleading inference.Discussing benefits without including risks (fair and balanced)Referencing specific investment advice that is not presented in a fair andbalanced manner6. Performance results or performance time periods not fair and balanced7. Including other materially misleading informationTuesday, February 2, 2021www.regcompliancewatch.comMatt Lovett, CCO, BrookstoneCapital Management ( 3.5B inAUM) in Wheaton, Ill.10
The SEC’s New IA Advertising RuleCompliance Oversight Pre-approval not required Drafting Policies and Procedures Clear and prominent testimonial disclosures Written endorsement agreement Material terms DisqualificationsMatt Lovett, CCO, BrookstoneCapital Management ( 3.5B inAUM) in Wheaton, Ill. Exemptions De minimus compensation Conflicts of InterestTuesday, February 2, 2021www.regcompliancewatch.com11
The SEC’s New IA Advertising Rule Best Practices and Compliance Suggestions Target audience sophistication “Substantiate” material facts Document the source Early adaptation Fully comply Handling negative reviewsTuesday, February 2, 2021www.regcompliancewatch.comMatt Lovett, CCO, BrookstoneCapital Management ( 3.5B inAUM) in Wheaton, Ill.12
The SEC’s New IA Advertising Rule Private Funds Advertisements, as defined in the first prong, include communicationsdirected to prospective private fund investors that offer new or additionaladvisory services with regard to securities. This will not include one-on-one communications to private fundinvestors or communications with existing investors – but be careful ofyour definition of one-on-one communications! The term “private fund” is defined in section 202(a)(29) of the Advisers Actand means an issuer that would be an investment company, as defined insection 3 of the Investment Company Act of 1940 (“Investment CompanyAct”), but for section 3(c)(1) or 3(c)(7) of that Act The rule excludes registered investment companies (“RICs”) and businessdevelopment companies (“BDCs”) that are subject to rule 482 or 156 underthe Securities Act because the primary goal of the proposal was alreadysatisfied by other regulatory requirements.Tuesday, February 2, 2021www.regcompliancewatch.comLaura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallas13
The SEC’s New IA Advertising Rule Private Funds Private fund advertisements would include: Pitch books Materials accompanying private placement memoranda Net v gross results must be displayed, however the 1-, 5- and 10-yearformat doesn’t apply to private funds. Private funds need not show investors the “risks and limitations” of ahypothetical ad but must “offer to promptly provide such information.” Laura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallasPrivate Fund Advertisements would not include: Private placement memoranda Account statements, transaction reports, and other similar materials Presentations to existing clients concerning funds they have investedinTuesday, February 2, 2021www.regcompliancewatch.com14
The SEC’s New IA Advertising Rule Third-Party Ratings A rating or ranking of an investment adviser provided by a personwho is not a related person and such person provides such ratingsor rankings in the ordinary course of its business Third-party ratings are differentiated from testimonials andendorsements by the requirement that a third party provides suchratings in the ordinary course of its business Third-party ratings remain subject to the general prohibitionsTuesday, February 2, 2021www.regcompliancewatch.comLaura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallas15
The SEC’s New IA Advertising Rule Third-Party Ratings An advertisement may only include third-party ratings if the adviser: Has a reasonable basis to believe that any questionnaire or surveyused in preparation of the third-party rating is structured to make itequally easy for a participant to provide favorable and unfavorableresponses, and is not designed or prepared to produce anypredetermined result; and Clearly and prominently discloses (or believes the third-party ratingclearly and prominently discloses): The date on which the rating was given and the period of timeupon which the rating was based The identity of the third-party that created and tabulated therating; and If applicable, that compensation has been provided directly orindirectly by the adviser in connection with obtaining or using thethird-party ratingTuesday, February 2, 2021www.regcompliancewatch.comLaura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallas16
The SEC’s New IA Advertising Rule Portability of Performance (aka predecessor performance) In a change from the proposed rule, the Rule excludes predecessor performancefrom the definition of hypothetical performance Predecessor performance may only be shown provided that: The person(s) who were primarily responsible for achieving prior performanceresults manage accounts at the advertising adviser The accounts managed at the predecessor adviser are sufficiently similar to theaccounts managed at the advertising adviser that the performance resultswould provide relevant information to investors All accounts that were managed in a substantially similar manner are advertisedunless exclusion of any such account would not result in materially higherperformance or alter the presentation of any prescribed time periods The advertisement clearly and prominently includes all relevant disclosures,including that the performance results were from accounts managed at anotherentityTuesday, February 2, 2021www.regcompliancewatch.comLaura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallas17
The SEC’s New IA Advertising Rule Portability of Performance General prohibitions apply to testimonials, endorsements and thirdparty ratings that contain performance from a predecessor firm Records will be required to support the performance of thepredecessor adviser that is advertisedTuesday, February 2, 2021www.regcompliancewatch.comLaura Arnott, InformationQuality Analyst, BarrowHanley ( 48B in AUM) inDallas18
The SEC’s New IA Advertising RulePerformance Advertising ProhibitionsGenerally, the new Marketing Rule prevents RIAs from advertising:Les Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla. Gross performance, unless the advertisement also presents net performance; Performance results, unless they are provided for specific time periods in most instances; Any statement that the SEC has approved or reviewed any calculation or presentation ofperformance returns; Performance results from fewer than all portfolios with substantially similar investment policies,objectives, and strategies as those being offered in the advertisement;Tuesday, February 2, 2021www.regcompliancewatch.com19
The SEC’s New IA Advertising Rule Performance results of a subset of investments extracted from a portfolio,unless the advertisement provides, or offers to provide promptly, the returnsof the total portfolio; Hypothetical performance, unless the RIA adopts and implements policies andprocedures that are reasonably designed to ensure that the performance isrelevant to the likely financial situation and investment objectives of theintended audience and the adviser provides certain information underlyingthe hypothetical performance; and Predecessor performance, unless there is appropriate similarity between thepersonnel and accounts at the predecessor RIA and the personnel andaccounts at the current firm.Tuesday, February 2, 2021www.regcompliancewatch.comLes Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.20
The SEC’s New IA Advertising RuleHypothetical performance encompasses performance results that were notactually achieved by any portfolio managed by an adviser. Hypotheticalperformance explicitly includes but is not limited to:Les Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla. Model performance Backtested performance Targeted or projected performance returnsTuesday, February 2, 2021www.regcompliancewatch.com21
The SEC’s New IA Advertising RuleHypothetical performance may only be advertised if the RIA adopts andimplements policies and procedures that are reasonably designed to ensure that: The performance is relevant to the likely financial situation and investmentobjectives of the intended audience; and Les Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.The adviser provides the criteria used, as well as the assumptions relied upon, to calculate thehypothetical performance.When the intended audience is an investor in a private fund, the adviser must offer to provide thecriteria use and assumptions relied upon to calculate the hypothetical performance.An adviser must disclose the risks and limitations of using hypothetical performance in makinginvestment decisions.Tuesday, February 2, 2021www.regcompliancewatch.com22
The SEC’s New IA Advertising RuleGross and Net-of-Fees RequirementGross performance may not be used in any advertisement unless it alsopresents net performance: With at least equal prominence to, and in a format designed to facilitatecomparison, with the gross performance results; and Les Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.Calculated over the same time period as the gross performance, using the same type of return andmethodology.The requirement to show net performance applies to all advertisements, not just retail advertisements.The gross and net-of-fees requirement formalizes guidance from no-action letters.Model advisory fees can be used to calculate net performance, provided that the results are no better thanthey would have been if the actual fees were deducted.Tuesday, February 2, 2021www.regcompliancewatch.com23
The SEC’s New IA Advertising RulePrescribed Time Periods for Presenting Performance Except for private funds, advertisements must display returns for one, five and ten-yearperiods. They must be displayed with equal prominence. If the portfolio did not existfor all of those periods, an adviser must present results for the life of the portfolio. Forexample, if the portfolio only existed for seven years, the adviser must display resultsfor a one, five, and seven-year period. An adviser may choose to show results for alonger time frame.Les Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.The prescribed time period must end on a date that is no less recent than the mostrecent calendar year-end. An adviser may be required to present performance returnsas of a more recent date than the most recent calendar year-end to comply with thenew rule’s general prohibitions. For example, it could be misleading for an adviser topresent performance returns using the calendar year-end if more timely quarter-endperformance results are available and events have occurred that would have asignificant negative impact on the adviser’s performance.Tuesday, February 2, 2021www.regcompliancewatch.com24
The SEC’s New IA Advertising RuleForm ADV & Books & Records’ changes Form ADV, Part 1a, Item 5.L will ask if you use performance ads,testimonials/endorsements, references to specific investment advice and thirdparty ratings. Expect DOE examiners to take noteChanges to Books & Records rule 204-2: Must maintain ads, disclosures,records tied to oral ads/testimonials, third-party rating questionnaires, and arecord of an ad’s “intended audience” Could be electronic: “The final rule does not prescribe or prohibit anyparticular method of maintaining records”Tuesday, February 2, 2021www.regcompliancewatch.comLes Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.25
Michelle Jacko, CSCP,Managing Partner of JackoLaw Group and CEO of CoreCompliance & Legal Servicesin San Diego, Calif.Matt Lovett, CCO, BrookstoneCapital Management ( 3.5B inAUM) in Wheaton, Ill.Laura Arnott, CFA, CIPM,IACCP , Information QualityAnalyst, Barrow, Hanley,Mewhinney & Strauss ( 48Bin AUM) in DallasLes Abromovitz, SeniorDirector of Foreside inDelray Beach, Fla.The SEC’s New IA Advertising Rule: A Complete Look,from Testimonials to Compliance OversightTuesday, February 4, 2021www.regcompliancewatch.com26
If the person was compensated, the f orms of compensation received Includes fees based on a % of AUM, flat fees, retainers, hourly fees, reduced advisory fees, fee waivers as well as cash and non -cash rewards (including referral fees, prizes and gifts and entertainment) Any material terms related to the compensation and any conflicts
