EXAMS Risk Alert: Marketing Rule Observations
Main Contributor: Gretchen Sturdivan, CSCP, Compliance Manager & Creative Director
Background
It feels as though we have all been waiting eons for EXAMS to release a helpful risk alert for the new Marketing Rule. The last two they provided on June 8, 2023, and September 19, 2022, did not arm advisers with any novel insights for their compliance program. This time around in the Risk Alert released on April 17, 2024, it seems they are digging a little deeper and providing more prescriptive guidance on how to enhance advisers’ adherence to the rule.
This article will follow the format of the Risk Alert, as it is broken out into two main sections of observations that include sub-topics.
Examination Observations: Compliance Rule, B&R, and Form ADV
Policies and Procedures are Key
EXAMS noted that when policies and procedures were not tailored to the adviser’s marketing practices and did not address how they were complying with the marketing rule, this resulted in gaps to prevent violations of the Marketing Rule and/or the Books and Records Rule.
The commission stated in the Marketing Rule’s adopting release, “for these compliance policies and procedures to be effective, they should include objective and testable means reasonably designed to prevent violations of the final rule in the advertisements the adviser disseminates. Advisers can establish such… objective and testable compliance policies and procedures through a variety of tools. For example, …reviewing a sample of advertisements based on risk or pre-approving templates.” (Bold emphasis added).
This time around, EXAMS provided specific observations of items you could look to in your policies to ensure they are reasonably designed and implemented for your firm. The staff observed policies and procedures that:
Consisted only of general descriptions and expectations related to the Marketing Rule.
In the Compliance Programs Final Rule from 2003, the Commission stated that “policies and procedures should be designed to prevent violations from occurring, detect violations that have occurred, and correct promptly any violations that have occurred.” As part of this process, “[w]here appropriate, advisers’ policies and procedures should employ, among other methods of detection, compliance tests that analyze information over time in order to identify unusual patterns.”
Did not address applicable marketing channels utilized by the advisers, such as websites and social media.
Were informal rather than in writing.
Were incomplete, not updated, or partially updated for certain applicable marketing topics.
Were not tailored to address advisers’ specific advertisements.
e.g., policies and procedures to address the General Prohibitions, and advertising requirements for testimonials, endorsements, and third-party ratings utilized by advisers in advertisements.
Did not adequately address the preservation and maintenance of advertisements and related documents, such as copies of any questionnaires or surveys used in the preparation of a third-party rating (in the event the adviser has received such documents) included or appearing in any advertisement.
Were updated to reflect the Marketing Rule but were not implemented.
For example, the staff observed advisers’ policies that required net of fees performance to be included with any performance advertisement; however, the staff observed those same advisers including only gross performance in advertisements.
SCS Suggests
Though this may seem like a boring, self-explanatory section, policies are not evergreen. They should be reviewed and adjusted periodically and this risk alert is reason enough to give those marketing policies another look. Have your practices changed at all since implementing the rule during the past few years? It makes sense to tailor your policies to what you are actually producing and include the review process you have implemented. Make sure you also include how you preserve and maintain your advertisements and any related documentation, including the substantiation of material facts used in advertisements or copies of questionnaires/surveys used.
Books and Records Rule
Despite policies addressing the maintenance and preservation requirements, EXAMS still noted deficiencies in this area, including:
advisers completed questionnaires or surveys used in the preparation of a third-party rating but did not maintain a copy of such questionnaires.
advisers did not maintain copies of information posted to social media.
advisers did not maintain documentation to support performance claims included in advertisements.
SCS Suggests
Though this is limited guidance, it reiterates the point that any statement of material fact you make in advertisements, award you use, performance you show, or social media posts you make, these records all need to be maintained, per the Marketing and Books & Records Rules. It’s easy to send materials out there and keep a PDF of the PowerPoint, but these days, there is more to consider retaining in relation to the advertisement itself. Make yourself aware of the rule’s requirements, and when in doubt, be conservative with the records you maintain to cover all bases.
Form ADV Parts 1 and 2A
Even though most advisers examined had addressed the questions in Item 5.L of the Part 1 and in Item 14 of their Part 2A where applicable, the staff still observed Marketing Rule-related deficiencies on Form ADV, such as:
advisers that inaccurately reported on Form ADV, Part 1, that their advertisements did not include:
Third-party ratings, when their websites included third-party ratings or social media posts that touted the firms as being ranked in certain third-party ratings.
Performance results, when performance results were included in their marketing materials.
Hypothetical performance, when hypothetical performance was included in advertisements.
advisers using outdated language in their Form ADVs referencing provisions of the prior Cash Solicitation Rule (Advisers Act Rule 206(4)-3), inaccurately indicating that no referral arrangements existed, and omitting material terms and compensation of referral arrangements on Form ADV, Part 2A, Item 14.
SCS Suggests
Given these deficiencies and the fact that we just wrapped annual ADV filings, it might be worth a look while it’s fresh to double-check whether or not Item 5.L is truly accurate on the Part 1 and to ensure you have removed reference to the old Cash Solicitation Rule in your Part 2A. If you have referral arrangements, ensure that the material terms and compensation are disclosed in Item 14 of the Part 2A.
Examination Observations: General Prohibitions
Oh boy, this “catch-all” section of the Rule is a hot topic for deficiencies. That checks out. As a refresher, here are the general prohibitions they want adhered to:
Including an untrue statement of a material fact or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading.
Including 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.
Including 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 adviser.
Discussing any potential benefits to clients or investors connected with or resulting from the adviser’s services or methods of operation without providing fair and balanced treatment of any associated material risks or limitations.
Referencing specific investment advice provided by the adviser in a manner that is not fair and balanced.
Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.
Providing information that is otherwise materially misleading.
Deficiencies Related to the General Prohibitions
Below we list the deficiencies related to the Marketing Rule’s General Prohibitions. Please note, that while the staff references the General Prohibitions, these findings may also violate multiple prohibitions in the Marketing Rule and other provisions of the Advisers Act.
1. Untrue statements of material fact and unsubstantiated statements of material fact
The staff observed advertisements that included statements of material fact that appeared to be untrue. In this scenario, advisers generally stopped disseminating the impacted advertisements or removed the untrue statements. However, if they acknowledged that the statements of material fact were likely untrue after being unable to substantiate the statements during an examination, it constituted a violation of this general prohibition. Examples included:
Advertisements stating that the advisers were “free of all conflicts,” when in fact, conflicts existed.
Advertisements stating material facts about the advisers’ businesses that were inaccurate, including:
(1) statements that a network of personnel perform advisory services for clients when a sole individual performs such services; and
(2) statements representing erroneous adviser personnel qualifications, such as their education, experience, and professional designations.
Advertisements describing material facts about advisory services or products offered that were inaccurate, including:
(1) referencing certain investment mandates of the advisers in advertisements when there were no such mandates used by the firms (e.g., ESG mandates);
From the ESG Risk Alert in 2021, EXAM references their statement: “The Division uses the term ‘ESG’ in the broadest sense to encompass terms such as ‘socially responsible investing,’ ‘sustainable,’ ‘green,’ ‘ethical,’ ‘impact,’ or ‘good governance’ to the extent they describe environmental, social, and/or governance factors that may be considered when making an investment decision.”
(2) claiming that investment processes were validated by professional institutions when they were not;
(3) stating that the adviser considered certain risk tolerances when recommending investment strategies when all clients were placed into the same strategy without consideration of risk tolerances;
(4) referencing a list of approved securities that did not exist;
(5) referencing formalized securities screening processes that did not exist; and
(6) misrepresenting the advisers’ client base, such as describing the adviser as a “private fund adviser” when the firm did not advise any private funds.
Advertisements publicizing the receipt of certain awards or accolades that were not received.
2. Omission of material facts or misleading inference
The staff observed advertisements that appeared to omit material facts necessary to make the statements made, in light of the circumstances under which they were made, not misleading. The staff also observed advertisements that included information that could have reasonably caused untrue or misleading implications or inferences to be drawn concerning material facts relating to the advisers. Examples included:
Advertisements contained statements that advisers were different from other advisers because they acted in the “best interest of clients,” without disclosing that all investment advisers have a fiduciary duty to act in their clients’ best interests.
Advertisements recommended certain investments (e.g., on podcasts or websites) without disclosing the conflicts of interest attributed to the compensation paid to or received by the advisers for such recommendations.
Advertisements that contained untrue or misleading claims, such as:
(1) stating that the advisers were “seen on” national media, implying appearances in national news media, without disclosing that the “appearances” were in fact paid advertisements; and
(2) advertising images of celebrities in marketing materials in a manner that implied the celebrities endorsed the firms when such celebrities did not endorse the firms.
Advertisements that contained untrue or misleading performance claims, including:
(1) advertising cumulative profits that the advisers believed were not achievable or were impossible to achieve without unlimited money to invest;
(2) presenting performance information that did not provide adequate disclosure regarding the share classes included in the performance returns;
(3) using lower fees in calculations for net of fees performance returns than were offered to the intended audience; and
(4) omitting material information regarding fees and expenses used in calculating returns.
Advertisements cited SEC registration beyond factual statements as to advisers’ registration status in a way to imply that SEC registration was representative of a particular level of skill or ability, or that the SEC had either approved or passed upon the advisers’ business practices. The staff also observed advisers including the SEC logo on their websites with the purpose of implying that the websites or the advisers had been approved or endorsed by the SEC.
Advertisements contained third-party ratings:
(1) implying the advisers were the sole top recipients of certain awards when the awards went to multiple recipients or the advisers were not the top recipients; and
(2) indicating that the advisers were highly rated by various organizations without disclosing that the methodologies for such ratings were based primarily or solely on factors that were not related to the quality of investment advice, such as assets under management, the number of clients, or that adviser personnel nominated fellow employees for such awards.
The Commission stated, “an adviser’s advertisement would be misleading if it indicates that the adviser is rated highly without disclosing that the rating is based solely on a criterion, such as assets under management, that may not relate to the quality of the investment advice.”
Advertisements included testimonials that were misleading. For example, advisers included testimonials from clients of a third-party product on the advisers’ websites without any disclosures explaining the context of the testimonials, implying that the testimonials were about the advisers’ services rather than the third-party product.
Performance advertisements contained information that was misleading, such as:
Benchmark index comparisons that did not define the index or provide sufficient context to enable an understanding of the basis for such comparison or disclose that the benchmark performance did not include reinvestment of dividends.
The Commission stated, “advisers should evaluate the particular facts and circumstances that may be relevant to investors, including the assumptions, factors, and conditions that contributed to the performance, and include appropriate disclosures or other information such that the advertisement does not violate the prohibitions in paragraph (a) of the final rule or other applicable law. Depending on the facts and circumstances, disclosures may include:
(1) the material conditions, objectives, and investment strategies used to obtain the results portrayed;
(2) whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
(3) the effect of material market or economic conditions on the results portrayed;
(4) the possibility of loss; and
(5) the material facts relevant to any comparison made to the results of an index or other benchmark.”
Performance presentations that contained:
(1) outdated market data information only (e.g., market data from more than five years prior); or
(2) investment products that were no longer available to clients and included lower investment costs than were available.
Statements or presentations regarding:
(1) advisers’ performance track record with securities that were not purchased by the advisers in a similar manner in their clients’ accounts;
(2) claims that the advisers achieved above average performance results without clarifying that the advisers did not yet have clients or performance track records; and
(3) investment recommendations containing performance information that did not include disclosures to provide context to the presentations, such as advertising performance during time periods when most investors would have experienced the advertised performance returns because of general market performance.
3. Fair and balanced treatment of material risks or limitations
The staff observed advertisements that included statements about the potential benefits connected with the advisers’ services or methods of operation that did not appear to provide fair and balanced treatment of any material risks or material limitations associated with the potential benefits. For example, the staff observed advertisements on social media that highlighted performance information without also disclosing the material risks and limitations associated with the potential benefits.
4. References to specific investment advice that were not presented in a fair and balanced manner
The staff observed advertisements that included only the most profitable investments or specifically excluded certain investments without providing sufficient information and context to evaluate the rationale, such as investments that were written off as a loss or were lower performing investments. The staff also observed advisers that had not established criteria in their policies and procedures to ensure references to specific investment advice shown in advertisements were provided in a fair and balanced manner.
5. Inclusion or exclusion of performance results or time periods in manners that were not fair and balanced
The staff observed advertisements that included or excluded certain performance results or presented performance time periods in manners that were not fair and balanced. For example:
Advertisements that did not disclose the time period or did not disclose whether the returns were calculated for the same time period as additional performance information included in the same advertisement.
Advertisements that included or excluded certain performance results in manners that were not fair and balanced, such as advertisements that included the performance of only realized investment information in the total net return figure and excluded unrealized investments.
6. Advertisements that were otherwise materially misleading
The staff observed advertisements that appeared to otherwise be materially misleading, such as presenting disclosures in an unreadable font on websites or in videos.
SCS Suggests
Most of the general prohibition deficiencies seem like intentional errors that are not easily missed during an adequate review process. Ultimately, we continue to remind clients to ensure you can substantiate any material statements of fact within your advertisements. This will show the SEC that you have a reasonable basis for your belief, when including the statement in your advertisement. This Marketing Rule comes down to adequate retention of books and records and holding yourself as a fiduciary in your advertisements. Ensure you are always advertising in line with your client’s best interests.
Conclusion
Any time a risk alert is released by the SEC it’s a good indication that you should review your policies and procedures that are relevant to the risk alert. Use this as an opportunity to talk to your marketing team about what is acceptable and what is not. Take some time to review your policies and disclosure documents to ensure consistency and review a few marketing materials to determine if changes need to be made. Hopefully we continue to see more risk alerts around the marketing rule as we all work to continue to improve our understanding.