Breaking Down the SEC’s New Marketing Rule
With the new SEC Marketing Rule now in effect since November 4, SEC-registered investment advisors must take care to comply when advertising their services. Kimberly Versace, investment management attorney and counsel at Thompson Hine LLP, answers key questions advisors may have about the new rule.
What exactly is performance advertising? How do you see this new rule changing the way financial advisors will approach marketing their services?
There is no precise definition of the term performance advertising in the Marketing Rule, but it is generally used to mean any advertisement that shows the results achieved by an advisor’s investment portfolio(s), measured over a period of time and/or in comparison with a specific benchmark. The Marketing Rule imposes a host of requirements for particular types of performance advertising, including related performance, predecessor performance, hypothetical performance and extracted performance, each of which is defined by the rule. The rule also requires advisors who show performance to include returns for one, five and ten-year periods. There is an overarching requirement that all performance returns be shown in a manner that is fair and balanced, which means no cherry picking or highlighting potential gains without disclosing the associated risk of losses.
Many of the performance advertising requirements under the Marketing Rule are similar to, or follow from, the old Advertising Rule and related SEC guidance. However, the Marketing Rule does impose many new requirements, and it is also significantly more prescriptive in its requirements for both the content and presentation of performance. On the other hand, the Marketing Rule allows advisors more flexibility in other areas. Most notably, the rule permits the use of testimonials and specific investment recommendations, both of which were previously prohibited or restricted. The SEC also provided clarification on the use of social media. Together, these changes provide financial advisors with a significant opportunity to broaden their reach.
Does the new Marketing Rule affect how professionals should prepare for examinations?
The Marketing Rule doesn’t directly impact the examination process, but the Marketing Rule Focused Exams Risk Alert recently issued by the SEC’s EXAMS staff does remind us of a number of important considerations when preparing for an SEC exam. First, an advisor’s policies and procedures should be updated to reflect the new regulatory requirements and to capture the advisor’s own procedures for ensuring compliance. The advisor’s personnel must be prepared to demonstrate that they understand their obligations under the rule, and to explain how they follow the firm’s procedures as they perform their work. And, critically, every SEC-registered investment advisor should ensure that all of the records required by the new rule are maintained and accessible so that they can be produced upon request. None of this is new, but the EXAMS staff has given fair warning that there will not be any grace period for demonstrating full compliance with the Marketing Rule.
How do you think advisors will determine whether they need to revise their written policies and procedures, as required by Advisors Act Rule 206(4)-7?
All SEC-registered investment advisors will need to make certain updates to their written policies and procedures, at a minimum to incorporate the Marketing Rule’s new requirements and to ensure that all records are maintained. Some aspects of the rule explicitly require new written procedures, like the use of hypothetical performance. A closer review, and more substantial revision, will also be required for those who engage in marketing and advertising practices that are subject to new or more restrictive requirements. And advisors who take advantage of new flexibility, like the use of testimonials, will want to build in procedures addressing those practices. The bottom line is that the Marketing Rule reflects a significant overhaul to the prior advertising and marketing framework, and every advisory firm will want to be able to demonstrate to the SEC’s examination staff that it has appropriate procedures in place.
What is the biggest challenge you see financial advisors/exempt reporting advisors experience when developing, implementing and overseeing their compliance programs?
In my experience, there are challenges at each stage of developing, implementing and overseeing a compliance program. First, when developing the program, it is very important to ensure that policies and procedures are appropriately tailored to the particular business, investment strategies, client base and operations of a firm. Off-the-shelf procedures are a starting point but should never be the final product. Following from that, procedures must be implemented through effective processes throughout the firm, and personnel must be aware of their responsibilities. Finally, oversight should be ongoing. Formal testing and review on a periodic basis is a must, but informal monitoring and oversight should also take place from day to day through conversations, document and communications reviews and engagement with the business.
About Kimberly Versace
Kimberly is counsel in the firm’s Corporate Transactions & Securities practice group. She focuses her practice on advising investment advisers, hedge funds, private equity funds and other financial institutions on a wide range of investment management, regulatory and compliance issues. Her experience also includes counseling private fund and registered fund clients with respect to formation, offering and other securities law and trading matters.
Prior to joining Thompson Hine, Kimberly served as Chief Compliance Officer and Corporate Counsel for an SEC-registered private fund adviser. She also has several years’ experience serving as lead consultant to diverse investment adviser clients for a leading regulatory consulting firm. Kimberly spent most of her career practicing law in the securities regulation practice of a boutique law firm, with a focus on investment adviser regulation and compliance. Kimberly regularly speaks and writes on topics relating to SEC regulation of investment advisers.