The Marketing Rule has been in effect since November 4, 2022, and it continues to raise difficult and nuanced interpretive issues for RIAs concerning their advertising materials and client solicitation arrangements. On June 8, 2023, the SEC EXAMS Staff issued its first Risk Alert following the Marketing Rule's effective date. The Risk Alert supplements previous guidance and, along with several recent SEC orders charging RIAs with Marketing Rule violations, serves as a reminder that the SEC is squarely focused on Marketing Rule compliance.
Risk Alert
Testimonials and Endorsements
The SEC's Division of Examinations ("EXAMS") Staff Risk Alert focuses on certain high-level issues regarding testimonials1 and endorsements,2 serving as a clear reminder that the SEC remains focused on this nuanced area of the Marketing Rule even as it continues to cause substantial industry confusion. Testimonials and endorsements are considered advertisements subject to all of the rules generally applicable to marketing materials (net performance, case studies, etc.), and they are also subject to certain additional requirements.
In the Risk Alert, the Staff underscores the importance of providing clear and prominent disclosures about whether a promotor is a compensated client or investor and whether any material conflicts of interest are present. The Risk Alert also reiterates the importance of maintaining appropriate oversight of testimonials and endorsements (including having "a reasonable basis" for believing that the testimonials or endorsements used are compliant with the Marketing Rule), entering into written agreements with promotors (unless for de minimis compensation), and paying close attention to avoid compensating ineligible persons for testimonials or endorsements.
Determining what constitutes a testimonial or endorsement requires careful analysis. In light of the Risk Alert, it is critical that registered investment advisers carefully consider whether distribution counterparties such as placement agents, consultants, cap intro, databases, and various platform arrangements are providing testimonials or endorsements.
Substantiation Requirements and Performance Advertising Requirements
While the Staff will continue its review of RIAs' policies and procedures and books and records, the Staff will also review RIAs' marketing materials, focusing on whether RIAs are in compliance with the Marketing Rule's (i) substantiation requirement, which requires RIAs to have a reasonable basis for believing they will be able to substantiate material statements of fact in advertisements upon demand by the SEC and (ii) performance advertising requirements, which set forth specific requirements and restrictions for advertising performance results (among other things, the Marketing Rule contains performance advertising requirements and restrictions related to net performance, related performance, extracted performance, predecessor performance, and hypothetical performance).
Notably, the Risk Alert underscores that, in addition to traditional marketing materials, the Staff will look at RIAs' websites to ensure compliance with the requirements listed above. In this regard, RIAs should consider conducting a comprehensive review of their websites to ensure that the content complies with the Marketing Rule. Further, those firms advising both registered funds (not covered by the rule) and private funds that have taken a "bifurcated" approach to compliance in their marketing materials and websites should make sure that pitch-books and websites advertising out-of-scope products are clearly distinguished from those advertising private fund products or the services of the adviser more generally.
SEC Orders Alleging Violations of the Marketing Rule
The August Order
On August 21, 2023, the SEC agreed to a cease-and-desist order (the "August Order") with a registered investment adviser operating a technology investment platform primarily for retail investors (the "FinTech Adviser"). The August Order alleged several violations under the Advisers Act, including: (i) using hypothetical performance in an advertisement without adopting and implementing the policies and procedures required by the Marketing Rule; (ii) making misleading statements in website advertisements about the hypothetical performance of certain investment strategies; and (iii) failing to include information about the risks and limitations of using hypothetical performance when making decisions about investments.
The August Order also sheds some light on the SEC's expectations regarding the use of hyperlinked disclosures in website advertisements. While the FinTech Adviser provided two generic hyperlinks that allowed investors to access "some" information about the assumptions used to calculate the hypothetical performance and the related risks associated with its use, the advertisement failed to alert retail investors that they needed to click the links "to view vital information about the criteria, assumptions, risks, and limitations of the hypothetical performance results."
The September Orders
On September 11, 2023, the SEC announced charges against nine RIAs for advertising hypothetical performance to the general public on their websites without adopting or implementing policies and procedures required by the Marketing Rule (the "September Orders").
The alleged violations generally involved the advertisement of hypothetical performance derived from model portfolios ("model performance") and performance that was generated by applying a strategy to data from earlier periods when the strategy was not in use ("backtested performance") while simultaneously failing to adopt and implement the policies and procedures required by the Marketing Rule. As a result, the nine RIAs were charged for disseminating hypothetical performance in advertisements to a mass audience in violation of the Marketing Rule. Certain firms were also charged for failing to maintain required copies of their advertisements.
Conclusion
The June 2023 Risk Alert, the August Order, and the September Orders serve as important reminders that SEC Staff is carefully monitoring for compliance with the Marketing Rule, especially with regard to testimonials, endorsements, and the use of hypothetical performance in advertisements. RIAs should ensure that their policies and procedures, marketing materials, and websites have been reviewed and updated for compliance with the requirements of the Marketing Rule and should remain alert for further regulatory guidance from the SEC. For additional Linklaters insight into the Marketing Rule, please see our March 2023 Regulatory Update, our September 2022 Regulatory Update, and our 2021 Comprehensive Alert on the Marketing Rule.
Footnotes
1. The definition of "testimonial" includes any statement by a current client or private fund investor: (i) about the client's 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.
2. The definition of "endorsement" includes any statement by a person other than a current client or private fund investor 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.
We are also grateful to Bhavishya Barbhaya, Haanbee Choi, Michal Folczyk, Matthew Gallot-Baker, and Daniel Kim for their contributions to this regulatory update.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
