Advertising Risk Alert

Advertising Risk Alert

01 October 2017

An adviser’s use of marketing materials continues to be an area of high concern for the SEC, and with good reason. Marketing materials are how you showcase your firm to the world. They’re used to obtain investors, to grow the business, and find new opportunities. And you better believe the SEC is going to review them, in detail, to make sure you are not misleading your clients, prospective investors, and the market.

Most recently, in September of 2017, the Office of Compliance Inspections and Examinations (“OCIE”), issued a Risk Alert warning advisers of their most frequently found issues. They also addressed their Touting Initiative, to examine the adequacy of disclosures when advisers mention awards, rankings, or discuss their professional designations.

What to Watch Out For in Your Marketing Materials, based on OCIE’s Findings

  1. Misleading Performance Results, specifically:
    1. Performance presented without deducting advisory fees
    2. Performance compared to a benchmark that did not include disclosures about the limitations inherent in the comparison (if material)
    3. Hypothetical/back-tested results without explanation of how returns were derived and other materially important information regarding performance results

    SCS Suggests:

    • Use net performance, unless it’s for a one-on-one presentation (with the additional disclosures). If you have gross performance included, always have it on the same page for the same time period in equal prominence with the net performance.
    • Lead with the intention of full transparency. Section 206 includes general Anti-Fraud Provisions that, among other things, say you cannot mislead your clients and prospective clients, so, when putting your materials together, use your professional judgement, and ask the question “Would the absence of this fact change the interpretation?”
  2. Misleading One-on-One Presentations:
    1. Gross performance included without proper disclosures
    2. Not disclosing that advisory fees and other expenses would reduce performance results

    SCS Suggests:

    • First of all, a one-on-one presentation is when you know the recipient(s), and it’s in a setting where they can discuss fees with the adviser.
    • Include all required disclosures when presenting gross of fee performance (without net):
      • “Client returns will be reduced by advisory and other expenses incurred by the client”
      • The fee schedule or a reference to the fee schedule in the ADV Part 2A
      • A representative example of fees showing the compounding effect over a period of time on the value of a portfolio. Example: “As an example, the effect of investment management fees on the total value of a client’s portfolio assuming (a) quarterly fee assessment, (b) $1,000,000 investment, (c) portfolio return of 8% a year, (d) 1% annual investment advisory fee would be $10,416 in the first year, and cumulative effects of $59,816 over five years and $143,430 over 10 years.”
  3. Misleading Claim of Compliance with Voluntary Performance Standards
    1. Advertisements that clearly did not conform to certain voluntary performance standards while claiming compliance (e.g. GIPS)

      SCS Suggests:

      • It’s good practice to have GIPS disclosures reviewed by an expert of GIPS requirements
  4. Cherry-Picked Profitable Stock Selection
    1. Advertisements included only profitable stock selections or recommendations in newsletters/website without meeting conditions set in the Advertising Rule

    SCS Suggests:

    • If the goal is to discuss the investment process, remove the names of the securities. Otherwise, do not discuss profits on stock selections, unless you plan on including a complete list of all recommendations made within a year of the stocks discussed with all the detailed requirements of the SEC.
    • Or stick to the Franklin and/or TCW No-Action Letters (as discussed below)
  5. Misleading Selection of Recommendations
    1. Advertisements contained past-specific recommendations and only had some (and not all) recommendations for the time period in question without meeting TCW or Franklin No-Action Letter requirements

    SCS Suggests:

    • Advisers need to remember that these no-action letters provide exceptions to the Advisers Act, IF the specific facts and circumstances outlined in the no-action letter apply. Therefore, if choosing to provide information allowed by Franklin and/or TCW, make sure you are following the requirements.
  6. Compliance Policies and Procedures
    1. Basic lack of policies and procedures to prevent deficient advertising practices, for example:
      1. No review and approval process for marketing materials prior to use
      2. Lack of policies and procedures around creating and using composites including parameters for inclusion/exclusion into composite, and failure to confirm performance results

    SCS Suggests:

    • On at least an annual basis, review the adequacy of the firm’s policies and procedures.
    • If you claim compliance with GIPS, you must have written policies to conform to compliance
  7. Summary of OCIE’s Touting Initiative
      1. Misleading use of third party rankings/awards
        • Failing to disclose important facts related to awards such as:
          • Awards received based on false or misleading information on applications
          • Stale rankings still used on materials
          • Not including relevant selection criteria for awards/rankings, who created/conducted award, or that the adviser paid a fee to participate in the award/ranking
      2. Misleading use of professional designations
        • References (particularly in 2B) to designations that lapsed or did not explain minimum qualification for a designation
      3. Testimonials
        • OCIE staff observed use of client statements attesting to services (firm websites, social media pages, reprints of third party articles or pitch books)

    SCS Suggests:

      • The DALBAR no-action letter provides the best guidance on what to disclose for ratings, awards, and other accolades.
      • Often times, the source of that rating/award has the information you need on criteria, the number of advisers included, etc.

    Key Takeaways

    It’s good to read these risk alerts to understand what the SEC may be finding, but this does not address all requirements. Therefore, the CCO should familiarize themselves with the Advertising Rule and relevant no-action letters to have a good understanding of the requirements.

    Firms should regularly review their practices surrounding marketing materials, particularly the reviews conducted by compliance, and ensure written policies and actual procedures properly address the requirements.

    Training should be conducted with relevant staff (the ones preparing, reviewing, and presenting) to ensure their complete understanding of the requirements.

    At least once a year, have an independent consultant who is an expert in the requirements review your marketing materials to confirm all disclosures are included and information is presented in a manner consistent with rules and requirements.

    View the Risk Alert

     

    Contact us for a Marketing Checklist. It includes all required disclosures, organized by topic.