02 June 2021
Main Contributor: Katie Mogan, IACCP® Vice President, Senior Compliance Consultant
This article follows the first in our series, The Definition of an Advertisement, where we summarized the amended Marketing Rule’s definitions of an advertisement; specifically the elements covered under Prong 1 and Prong 2 of the definition. Part Two of our series will focus on the General Prohibitions outlined in the new Marketing Rule (“Rule” or “New Rule”) and what they mean in practice for our registered investment adviser audience. As we saw in the old regime, the SEC’s intent is to prevent fraudulent, deceptive, or manipulative acts and practices that are false or misleading and these outlined prohibitions set out the principles to guide advisers when creating marketing and advertising materials.
When applying the prohibitions, an adviser must consider all relevant facts and circumstances to determine proper interpretation. The SEC plainly states, “the nature of the audience to which the advertisement is directed is a key factor in determining how the general prohibitions should be applied.” The type of information and disclosures will change when advertisements are directed at retail investors versus more sophisticated institutional investors. For example, material intended for a retail investor that contains past specific recommendations may require detailed disclosures, while the same material intended for an institutional investor may require fewer disclosures or in some cases none at all.
The seven specific prohibitions that an adviser may not include or discuss in any advertisement are:
- Any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading;
- Any material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission;
- Information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser;
- Any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits;
- Referencing specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced;
- Including or excluding performance results, or present performance time periods, in a manner that is not fair and balanced, or;
- Information that otherwise would be materially misleading.
We are going to break down each prohibition and provide practical applications to help you better understand how these prohibitions apply to your firm.
Prohibition # 1: Untrue Statements and Omissions
An adviser may not Include any untrue statement of a material fact or omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading.
With this first prohibition, the SEC’s intent was to complement the Anti-Fraud Rule with a provision specific to advertisements. This first prohibition requires that all information relevant to the advertisement be provided to the client/investor. Materiality here is important and subjective, therefore we have provided some examples below to help you understand this prohibition.
Example #1: When disclosing performance, an adviser must disclose any material facts surrounding the performance. For example, if disclosing the performance was positive, it is material to disclose that the relevant benchmark performed substantially better than the ’s performance. The adviser cannot omit an important fact (the benchmark performance) because it is misleading to present the positive performance without the superior performing benchmark.
Example #2: An adviser using a client/investor testimonial in which the client/investor claims they have worked with the adviser for 20 years when the adviser has only been in business for 5 years is false and misleading and therefore prohibited.
Prohibition #2: Unsubstantiated Material Statement of Fact
An adviser may not include a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission.
This prohibition will require advisers to keep documentation of material facts discussed in their advertisements with a reasonable basis to believe the information can be verified upon demand by the SEC. Certainly, the burden of this new Rule will take some getting used to and training the marketing or content creators about this specific prohibition will be key. A few examples include:
Example #1: When detailing an employees’ credentials, for example, a CFA or series 65, verification of the credentials can be achieved via the CFA institute or FINRA’s Brokercheck.
Example #2: When providing historical market data on a particular sector and/or statements regarding that sector you must maintain the records that substantiated these claims used in the advertisement.
There are a few key components to help advisers comply with this prohibition.
- Maintain due diligence files for the information used in the firm’s advertisements. Organization of the due diligence file structure will be key to successfully implementing this prohibition and supporting your advertisements.
- Create policies and procedures around the new requirements. A very simple policy statement example might be, “If the information cannot be supported with documentation, it cannot be used.”
- Train all employees around the new requirements. Ensure individual(s) curating the content are appropriately collecting and maintaining the records and information used when preparing the advertisements. There will be a slight learning curve initially but eventually people adapt, and, in the end, this prohibition will be helpful for the individual(s) (the CCO) reviewing the materials as well.
Prohibition #3: Untrue or Misleading Implications or Inferences
An adviser may not include information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser.
In plain English, this prohibition requires you to include ALL of the relevant facts to accurately portray your firm and the point/inference you are making to clients/investors. The SEC’s intent is to prevent advisers from misleading clients/investors, purposefully or unintentionally, with information provided in marketing materials. Even true facts, when taken out of context, can be misleading. While it may be hard to know what “inferences and implications” a client/investor will glean from reading your marketing materials, the Commission included a reasonableness standard (which might help). Think of reasonableness in the way that several facts may be true individually, but when linked together they can become misleading. The examples below demonstrate this standard of reasonableness.
Example #1: You state in your marketing materials (truthfully) that all your clients have positive performance. You fail to state you only have two clients. A prospective client reading the first true fact would infer that investing with your advisory firm would give them a high likelihood of positive performance. The fact that you only have two clients is material to the fact pattern and would give the client more appropriate context to your results.
Example #2: Your materials state you have over 100 clients who have been clients for over 10 years, without also mentioning that, despite this fact, you have high client turnover. If the turnover had also been disclosed, it could have material implications on the conclusion clients/investors might make about your firm.
Pro Tip: When it comes to testimonials and endorsements and this specific prohibition, the SEC has stated that you do not need to present all testimonials/endorsements (good and bad in equal prominence), however the SEC will expect a disclaimer that the testimonial/endorsement is not representative, along with a link to the other testimonials/endorsements, in an effort to provide all the information.
Prohibition #4: Failure to Provide Fair and Balanced Treatment of Material Risks or Material Limitations
An adviser may not discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits.
The requirement is to provide the benefits and material risks in a fair and balanced manner. The SEC did not intend for advisers to provide a laundry list of risks associated with their services that overwhelm and dilute the advertisement. The most relevant risks associated with the benefits should be discussed “within the four corners of [the] advertisement,” with additional benefits and risks provided via hyperlink, QR codes, mouse-over windows or other methods offered by technology, so long as they continue to be fair and balanced. This requirement differs from Item 8 of the ADV Part 2A, which requires disclosures of material risk with respect to the securities and strategies offered by your firm. This prohibition requires risk disclosures relevant to any potential benefit advertised to clients, prospects, and investors.
Pro Tip: The SEC clarified in the release that disclosures required for testimonials and endorsements must be included within the testimonial or endorsement to meet the “clear and prominent” standard.
Example #1: If you state you can reduce a client/investor’s taxes through tax-loss harvesting strategies, you must also discuss the material risks or material limitations, including that any reduction in taxes would depend on a client/investor’s tax situation.
The SEC said, “we continue to believe that advertisements should provide an accurate portrayal of both the risks and benefits of the adviser’s services.” This is one prohibition that will take time to shake out and see exactly what the SEC thinks is appropriate when referring clients/investors to outside links and disclosures that are located outside the four corners of a marketing piece.
Prohibitions #5 and #6: Anti-Cherry-Picking Provisions: References to Specific Investment Advice and Presentation of Performance Results
An adviser may not reference specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced, and including or excluding performance results, or present performance time periods, in a manner that is not fair and balanced.
The New Rule allows references to specific investments and performance results so long as the presentation is fair and balanced. Whether the presentation of past specific recommendations or performance results is fair and balanced is dependent upon the facts and circumstances relevant to the situation presented. This principles-based concept allows more flexibility, but also more scrutiny, as the interpretation could vary among advisers and SEC staff. We did receive some examples and guidance that can be used when making your own determination of what is fair and balanced. Some key factors to consider are:
- Do not cherry pick. Do not discuss only your profitable investments without also discussing your unprofitable investments.
- Do not select times periods for presented performance that were favorable without including the unfavorable time periods.
- Do not present the performance of only one account, when other similarly managed accounts did not perform as well.
- Consider the sophistication of your audience.
Some examples to help us understand this prohibition:
Example #1: A chart or graph showing best and worst performers over a set period of time, shown in equal prominence, would be an acceptable fair and balanced approach to discuss past recommendations (TCW No Action Letter).
Example #2: A list composed of securities selected based on their weight or size in the portfolio would be an acceptable, fair and balanced approach to discuss past recommendations. You may not generate a list of securities selected based on their performance (Franklin No Action Letter).
Example #3: Presenting performance for a two-month period or over inconsistent periods of extraordinary performance with only a footnote disclosure of unusual circumstances that contributed to the results could be considered misleading. Pro Tip: Performance reporting has specific requirements and restrictions that will be covered in a future article.
Disclosures should detail market events, factors contributing to positive and negative performance as well as limitations and other material factors that contributed to the performance. Perhaps the market overall was excessively positive or one particular security contributed to the positive performance and all other holdings were down. Disclosing these details would be necessary to maintain the fair and balanced concept in your advertising. These factors, plus the additional requirements and restrictions required by the New Rule (to be discussed in a future article) will help guide your firm.
Prohibition #7: Otherwise Materially Misleading
Last, we have a catch-all prohibition. Advertising cannot be materially misleading. The SEC provides a great and practical example with regards to disclosures:
Example: If you provide the necessary and accurate disclosures on a marketing piece, but the disclosures are in an unreadable font, the advertisement would be considered materially misleading by the Commission.
These principles-based prohibitions do provide more flexibility to firms within their marketing; however, compliance staff are going to have to exercise professional judgement when taking into consideration all facts and circumstances to determine the appropriateness of the advertisements. The proposed rule suggested a requirement of pre-approval for all materials, and even though this was not implemented in the final published rule, there is no doubt that a review process is paramount, along with clear policies and procedures. At this point in time, we do not have all the answers as to what the Commission will accept, as much is up to each firm’s discretion, but we hope to have more clarification from the Commission to help guide us in the near future.