RecommendationsYou want to attract clients. You need to advertise to attract clients. You might think that a great way to attract new clients is to advertise how past recommendations or security selections have worked for current clients. You may want to explain on your website or app how your model works by giving examples of sample investments. This all seems too easy. Well, it’s not. As Craig began to explain in our last post, the rules governing investment adviser advertising are layered and can be confusing. In this post, we’ll tackle the dos and don’ts of past specific recommendations.

As a quick recap, Rule 206(4)-1 (the “Advertising Rule”) under the Investment Advisers Act of 1940 (the “Act”) is the principal rule that governs adviser advertising. While neither the Act nor the Advertising Rule define the phrase “past specific recommendation”, the SEC staff has interpreted its meaning very broadly to include individual stock discussions as well as lists of portfolio holdings without further discussion.

The Advertising Rule prohibits advertisements that refer directly or indirectly to the adviser’s past specific profitable recommendations unless the advertisement includes or offers to provide a list of all recommendations made by the adviser within at least the prior one-year period and includes the following:

  • The name of each security recommended;
  • The date and nature (buy or sell) of each recommendation;
  • The market price at that time;
  • The price at which the recommendation was to be acted upon (i.e., the time of the recommendation); and
  • The market price of each security as of the most recent practicable date.

Moreover, on the first page of any recommendation, the following cautionary legend, in typeface at least as large as the largest print used in the text, must also be included: “It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in the list”.

If you just read that requirement and thought, wow that’s burdensome, you’re not alone. Fortunately, there are situations in which past specific recommendations can be presented without the full disclosure requirements.

Additionally, advisers can use advertising that includes a limited number of past specific recommendations, so long as the advisers:

  • Use objective, non-performance based criteria (e.g. based on size of position) to select the specific securities listed;
  • Consistently use the same criteria to select the specific securities discussed;
  • Avoid discussing the amount of the profits or losses, realized or unrealized, of any of the specific securities; and
  • Maintain records regarding all recommendations and the selection criteria used to select the securities in the advertising.

Finally, advisers can use advertising that includes “Best Performers/Worst Performers” charts for a representative portfolio for a particular investment product. In order to include one of these charts, the SEC requires that:

  • The calculation and the weighing of positions be applied consistently during the appropriate measurement period;
  • The presentation of the information and number of holdings in the charts be consistent from measurement period to measurement period;
  • The charts show no fewer than 10 holdings (i.e., 5 best and 5 worst performers), with an equal number of positive and negative holdings;
  • The charts disclose how to obtain the formula and methodology for computing which positions are included in the charts;
  • The charts disclose how to obtain a list showing the contribution of each holding in the portfolio to the portfolio’s performance;
  • The charts be presented to reduce the chance a reader will be misled, such as by (i) presenting the best and the worst holdings on the same page with equal prominence and near required disclosure and portfolio performance information, (ii) including disclosure that the chart does not include all securities bought, sold or recommended to clients and (iii) including disclosure that past performance does not guarantee future results; and
  • The adviser maintains appropriate records consisting of (i) the calculation used to select securities included in the chart, (ii) a list showing the contribution of each holding to the portfolio’s overall performance during the relevant measurement period and (iii) all supporting data.

Even with these basics in mind, determining when a past specific recommendation can be included in an advertisement is a fact specific determination that can be tricky and is certainly an area where a legal or compliance professional can add value. To further complicate matters, on November 4, 2019, the SEC proposed a series of amendments to several rules governing investment advisers including the Advertising Rule. We will detail these proposed amendments, and their potential impact, including changes to how past specific recommendations can be presented in a future post. In our next post, we’ll continue to review advertising as Craig discusses the use of testimonials.

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