27 November 2019
Main Contributor: Elizabeth Cope, CPA, CSCP, CIPM, CEO & Lead Consultant
Review of Part 1: The Foundation
In the first article of this series, we discussed the foundational information you need to know to ensure your marketing and advertising materials are in compliance with the SEC’s rules and regulations. We helped you clearly understand:
- the SEC’s definition of an “advertisement.” What is considered an advertisement, what is not, and why this is important;
- what the Adviser’s Act prohibits; and
- where you can find the exceptions to the rules…as there are more than 14 places to look.
If you haven’t already read Part 1: The Foundation, we suggest you start here, as it will provide you with a fundamental understanding of compliant advertising before reading on.
Review of Part 2: Testimonials
This second article focused on the use of testimonials. We started with what the Advisers Act does NOT allow you to do and followed that up with the No-Action letters and/or SEC guidance that provide you with more specific details of what you CAN do without violating the rules.
If you haven’t already read Part 2: Testimonials, we suggest you start here, as it will provide you with a fundamental understanding of compliant advertising before reading on.
Part 3: Past Specific Recommendations
This third article will focus on the DOs and DONTs of past specific recommendations. Just like we did in the Testimonial article, we will start with the Advisers Act and follow it up with the No-Action letters that provide details of what you CAN do without violating the rules. We will provide some specific examples, with the goal of you being able to better understand how to practically apply the rules within your marketing materials.
Rule 204(4)-1 of the Advisors Act prohibits an advertisement (remember the definition of an advertisement discussed in Part 1 of this series) that refers directly or indirectly to the use of your past specific recommendations.
Again, as with testimonials, the SEC has not explicitly defined “past specific recommendations,” but it is widely understood to include individual security discussions, lists of security holdings without further discussion, and recommendations made from discretionary advisory accounts. The intent of this requirement is to prevent “cherry-picking” the profitable recommendations and omitting the unprofitable ones. Also, please take note of the word “indirectly,” which can make the application of the rule tricky, because an advertisement could incidentally be considered a past specific recommendation by the very nature of the presentation.
The Advisors Act does, however, allow you to provide a list of ALL recommendations made within at least the prior one-year period. The one-year period is established by the earliest recommendation referenced in your advertisement. So, for example, if you discuss a recommendation made in 2001 and it’s the year 2019, you must include all recommendations from 2001 to present. This list of ALL recommendations MUST include the following disclosure, “It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.” The following information must also be included for every recommendation:
- Name of the security recommended;
- Date and whether the recommendation was a buy or sell;
- The market price at the time of the recommendation;
- The price at which the recommendation was to be acted upon; and
- The current market price (determined by the date you are presenting).
Please take note that the SEC, in multiple No-Actions letters, has clarified that an advisor offering more than one type of security (i.e. fixed income and equity) cannot include all recommendations for one type of security; say, equity. They must include all securities recommendations. The same can be said about “offering” to furnish a complete list upon request, while only discussing a few, select recommendations. It really is an “all or nothing” deal.
In a practical sense, the rule includes a TON of information that is not realistic to include in your advertisements. Therefore, the SEC has issued a couple of No-Action letters that allows advisers to discuss some recommendations and holdings while not violating the Rules, which we will discuss next.
Exceptions to the Rule
Objective List of Holdings
As discussed in the Franklin No-Action letter, the SEC said it would not recommend enforcement under the Advisors Act to an advisor that distributes an objective list of holdings (not based on performance), with specific disclosures.
An example of an objective list of holdings, would be your Top 10 Holdings in a particular composite or representative account. You may include such a list if the following criteria are met:
- You must maintain the records to support the list presented and the criteria used;
- Use objective, non-performance-based criteria to select the list;
- Use the same criteria each reporting period;
- Do NOT discuss, either directly or indirectly any profits or losses and/or unrealized or realized gains and losses on specific securities; and
- Add the following disclaimer “The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.”
This isn’t specified in the No-Action letter, but we also suggest you make it very clear in the advertisement whether the list was obtained from a composite or a representative account, to make sure it is not misleading.
Keep in mind the criteria identified must be met for the relief to be applied. Any deviation from these facts and circumstances should be fully thought through and substantiated, with the first question always being “Is this misleading?”
Contributors and Detractors
The TCW No-Action letter allows advisers to furnish information on the top contributors and bottom detractors on a composite or representative account in an advertisement. As with any No-Action letter, however, there are specific criteria that MUST be met in order for relief from the Advisers Act to be applied.
- The information must be provided in a chart with equal prominence (i.e. same page, same font, close proximity, etc.)
- The chart must have a minimum of 10 individual holdings displayed, selected in an objective manner by using the following calculation:
- Weight of Holding (% of the total account or composite) x Rate of Return of Holding
- The chart must equally display the contributors and detractors (i.e. top 5, bottom 5)
- The chart must include the average weight for each holding in the period presented
- The chart must also include the holding’s total contribution to the strategy or representative account’s total return
- The period used must be consistent in your advertisements (i.e. quarterly, monthly, annually)
- Records must be retained to support the selection and calculations
- Add the following disclaimer “The holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients. The calculation’s methodology along with details on all holding’s contribution to the overall account’s performance during the measurement period are available upon request. Past performance is no guarantee of future results.”
The following is an example of what the chat could look like:
As a reminder, a response to an unsolicited request is NOT an advertisement, and therefore, providing a client testimonial in response to the unsolicited request is not prohibited.
This isn’t exactly an “exception” to the rule, but I wanted to include it as a reminder, since it is kind of an exception by way of not falling under the definition of “advertisement.”
Reporting to Existing Clients
Also, take note that you are allowed to provide existing clients with details of the recommendations in their portfolios. If it is merely providing information on an existing account and not used to solicit additional business, then it is not deemed an advertisement and you are therefore not required to comply with the requirements above. However, as you may recall in Part 1: The Foundation, you are still obligated, under the anti-fraud provisions, to act as a fiduciary, which essentially means you cannot intend to mislead your client with their reporting.
The Adviser’s Act is clear that past specific recommendations are prohibited unless a full list is provided with a ton of information. There are few exceptions to this:
- Non-Objective List
- Contributors and Contractors
- Unsolicited Requests
While there are exceptions to the rule, you need to make sure that your particular circumstances meet all of the specific criteria in order for those exceptions to apply.
As usual, there is always a gray area. It’s good to have policies in place for the review and approval of all marketing materials, including your website and social media platforms.
As with all areas of compliance, sometimes advisers have unique circumstances come up around marketing and advertising. If you have a unique situation or if, after reading this, you have any questions or concerns and would like a sounding board, email us or give us a call (541) 227-2336. We are always happy to help!