01 March 2021
The SEC proposed and adopted the new Marketing Rule, (the “Rule”) which will eventually replace the current Advertising Rule (Rule 206(4)-1, originally adopted in 1961) and the Solicitation Rule (Rule 206(4)-3, originally adopted in 1979). The Rule is a complete rewrite of the existing Advertising and Solicitation Rules, implementing a “principles based” approach to accommodate the ever-changing landscape of how firms market their services.
Advisors rely not only on the current Advertising and Solicitation Rules, but also on several no-action letters. The intent with this re-write is to remove several no-action letters and instead incorporate those requirements into the new Rule. Key changes include: a new definition of “advertisement”; principles-based prohibitions; specific disclosure requirements and restrictions for performance, testimonials and endorsements, third-party ratings; clarification on the applicability for private fund managers; new ADV disclosure requirements around advertising; and new books and records requirements. The current Solicitation Rule will be obsolete and incorporated within this Rule, with solicitors now referred to as “promoters.”
Pro Tip: Do not be fooled. This is an exciting and much needed re-write of a rule that reflects the common age, however, at the end of the day, this rule was not written to accommodate advisors. This Rule was re-written to achieve the SEC’s main goal – protecting investors. With the new principals-based prohibitions, the onus is on the advisor to substantiate whether statements can be supported with fact or are misleading. More due diligence will be required from compliance teams and there will be some tough lessons as we discover how the SEC “intended” the rule to be addressed.
Many questions remain while we wait for Frequently Asked Questions (“FAQs”) to clarify and provide advice on the new Rule which will take effect 18 months after the Rule hits the Federal Register (which as of the date of this article has not yet occurred).
Our goal over this article series is to break down the Rule into quantifiable sections to help facilitate your understanding and application. We will also continue to provide you with new information and interpretations as they are brought forth.
In the meantime, let’s tackle the updated definition of an advertisement.
What Is an Advertisement?
Under the new Rule, the definition of an advertisement includes two prongs, each capturing different types of communication.
The first prong includes any direct or indirect communication an investment advisor makes that:
- offers the investment advisor’s investment advisory services with regard to securities to prospective clients or investors in a private fund (managed by the advisor) or;
- offers new investment advisory services with regard to securities to current clients or private fund investors.
Before delving into the nuances of the first prong, it is important to clarify what is specifically excluded from the definition of an advertisement in the first prong:
- One-on-one communications UNLESS it includes hypothetical performance that is not provided 1) in response to an unsolicited request or 2) to a private fund investor,
- Extemporaneous, oral, and live communications,
- Information contained in statutory or regulatory notices, filings, or other required communications (provided they are reasonably designed to satisfy the requirements of such notice, filing), for example your ADV Part 2A and Form CRS, and;
- Communications designed to retain existing investors.
If your one-on-one communication is merely the same material provided to each person individually (such as a mass mailing) or a pitch deck that includes inserts used in multiple materials, then those communications and/or inserts would be subject to the definition of an advertisement under this first Prong. The SEC did, however, clarify that responses to an RFP, even if made public due to the Freedom of Information Act, are NOT considered advertisements under this first Prong.
Under the new Rule, all offers of an advisor’s services with regard to securities, regardless of how the information is communicated, falls under the definition of an advertisement. This includes, but is not limited to, communications made by text message, instant message, electronic presentation, video, film, podcast, digital audio or video file, blog, billboard, and all manner of social media, as well as by paper, including newspaper, magazine, and the mail. This first prong, “captures traditional advertising” and now incorporates private funds, which the current Advertising Rule does not explicitly address.
General brand content, educational material, and market commentary would not be deemed advertising if they do not offer services with regard to securities. For example, indication at a sports event that it has been sponsored by your advisory firm is not deemed advertising. Additionally, a market commentary and/or educational piece that provides information about the market or even certain types of securities is not deemed advertising, unless the piece further denotes how the advisory firm’s services can assist the potential investor.
An indirect communication would apply to materials provided to third parties such as consultants, other advisors (e.g., in a fund-of-fund or feeder fund structure), and promoters for delivery to current and prospective clients or investors.
Indirect Communications that Include Information Provided by Third Parties
The definition covers certain indirect communications (which we will explain further below) distributed by the advisor that incorporate statements or information prepared by third parties. Although the new Rule does not require the advisor to oversee all activities of the third party, the advisor is responsible for ensuring all advertisements comply with the new Rule, regardless of who creates or disseminates them. A facts and circumstances test will be applied to determine responsibility of the material prepared by third parties (see Adoption and Entanglement below). If an advisor is working with a third party to create advertisements and the advisor makes suggestions not incorporated by the third party, the SEC stated in those situations an advisor would not be held accountable. Another example: If an advisor provides data or materials which are then modified by the third party without knowledge or consent of the advisor, then the advisor would not be held accountable for changes made to the advertisement. It will be important to establish policies and procedures, retain documentation of your production process, and maintain copies of any edits when working with third parties in order to keep organized records to substantiate your comments and review.
Adoption and Entanglement
As mentioned above, whether or not the third-party information is the responsibility of the advisor will be a facts and circumstances test to determine 1) whether the advisor has “Adopted” the information: explicitly or implicitly endorsed or approved the information or 2) whether the advisor is “Entangled:” the extent to which the advisor has involved itself in the preparation of the material. If an advisor uses third-party performance data in their advertising materials, the advisor has “adopted” the third-party content and the performance is now attributable to the advisor. If the performance is now attributable to the advisor, the performance must meet certain performance requirements under the new Rule, which we will go over later in this series. Under the entanglement theory, if an advisor involves itself in the preparation, the advisor is also responsible for that material. However, the SEC has allowed a provision, dependent upon written policies and procedures, to make pre-established, objective edits to remove statements of profanity, defamatory or offensive statements, threatening language, materials that contain viruses or other harmful components, spam, unlawful content, or materials that infringes on intellectual property rights, and editing to correct a factual error.
Social media is now directly addressed in the Marketing Rule, albeit in a more facts and circumstances way as opposed to listing permitted and prohibited use. Advisors may freely post on social media and comments and likes are permitted so long as the advisor treats all comments and likes equally. Others may post, like, and comment freely on the advisor’s social media page and this indirect content will not be considered advertising, unless the advisor influences, prepares, endorses, approves, edits, favorably sorts, deletes, or in any way modifies such comments, posts, and likes. If the ability to modify, edit, delete, and/or prioritize comments exists on a platform but the advisor does not utilize such features, then the advisor’s use would be deemed appropriate and not attributable to the advisor. The new Rule also makes it clear that an advisor cannot simply exclude employee social media from this definition of an advertisement because investors may not be able to differentiate between the advisor and its employees. This would also require a facts and circumstances analysis. If the advisor, for example, adopts policies to prevent the use of employee social media accounts for marketing the advisor’s services and has proper supervision in place, then they could in fact exclude employee social media from application of the rule. Supervision could include conducting periodic training, obtaining attestations, and periodically reviewing content that is publicly available on employee social media accounts. Though not much has changed here in the way of supervision, the rule has made clear the dos and don’ts of social media.
Prong 2 replaces the old Cash Solicitation Rule and includes any endorsement or testimonial for which an advisor provides cash or non-cash compensation, directly or indirectly. Unlike prong 1, this type of advertisement includes oral communications and one-on-one communications, due to the additional conflict presented (financial incentive for the promoter) for recommending and endorsing an advisor. This change will address compensated testimonials, endorsements, and activities of solicitors under one rule and a set of conditions.
Uncompensated testimonials and endorsements included in advisors’ advertisements (defined above) would fall under Prong 1.
Testimonials and Endorsements
A testimonial is any statement by a current client or private fund investor about the client’s or private fund investor’s experience with the investment advisor or its supervised persons.
An endorsement includes any statement by a person other than a current client or private fund investor that indicates approval, support, or recommendation of the investment advisor or its supervised persons or describes that person’s experience with the investment advisor or its supervised persons.
Testimonials and endorsements include statements about an advisor or its supervised persons’ qualities and expertise as it relates to the services provided. This second prong is trigged by any form of cash or non-cash compensation. Examples of cash compensation include fees based on a percentage of assets under management or amounts invested; flat fees; retainer fees; hourly fees; reduced advisory fees and fee waivers; and any other method of compensation. Non-cash compensation includes directed brokerage; sales awards or other prizes; gifts and entertainment such as golf or sporting events and other types of entertainment provided in exchange for testimonials or endorsements. Once again, the types of cash and non-cash compensation that trigger the rule can depend on facts and circumstances.
Both prongs explicitly include communications provided to prospective fund investors. However, the first prong, as mentioned above, does not include one-on-one communications provided to private fund investors. Additionally, communications provided to existing investors are excluded. This includes hypothetical performance, private placement memoranda (PPM), transaction reports, account statements and presentations of fund performance for funds investors that are currently invested in the funds managed by the advisor. If a pitchbook or other materials accompany the PPM or other excluded materials, then facts and circumstances prevail in determining whether the material would be considered an advertisement under the first Prong.
The new definition of an advertisement is complex and now multifaceted compared to the old definition. Social media, private funds, endorsements and testimonials, as well as other marketing-related activities now have a clear place in the Rule. Adherence to the Rule must include adoption of all aspects of the Rule, , not certain aspects over others. Before you start implementing new policies and procedures, remember the new Rule is not in effect yet and has not been posted to the federal register (at the time of publishing this article). Once posted to the federal register, the Rule does not take effect for 18 months, so there is time to further acquaint ourselves with the Rule. Stay tuned for our future articles in this series where we will cover the general prohibitions covered by this new Rule; the conditions applicable to testimonials and endorsements, including solicitors; use of third-party rankings; and requirements when advertising performance (including portability of performance, updated books and records requirements, and amendments to the Form ADV).