Word-of-mouth is still one of the best ways to attract business.  Investors, whether new or seasoned, consistently look to the experiences of previous customers or talk to someone they trust before they hire a financial adviser.  As a result, posting great reviews and compensating others to make recommendations continues to be a key part of many robo-advisers’ marketing campaigns.

As we noted in a prior post, you’ll want to be careful about using the statements of clients about their experience (testimonials) and other favorable comments.  As you’ll recall, Rule 206(4)-1 (the “Advertising Rule”) generally prohibits the use such statements.  That said, the SEC has, over time, softened that general prohibition through no-action letters and formal guidance, allowing firms to, under certain circumstances, publish content that includes testimonials or other good reviews (including third-party ratings).

In addition, as we also posted, Rule 206(4)-3 (the “Solicitation Rule”) prohibits an adviser from paying a third party solicitor to recommend prospects to the adviser, unless the adviser (i) enters into a written agreement with the solicitor that includes certain provisions, and (ii) the solicitor provides the prospect with the adviser’s firm brochure and a separate document disclosing the solicitation arrangement, which must be signed by the client.

As Marc mentioned last time, the recent amendments to the Advertising Rule will, among other things, eliminate the Solicitation Rule and cause testimonials and cash solicitation to be governed by a single rule. In addition, the no-action letters and formal guidance that have softened the prohibitions on testimonials will be, once the amendments are effective, superseded by the new rule.

So what are the changes you need to know about?  First, we have to learn some new definitions for a couple familiar words.  The new rule redefines “testimonial” to cover statements by a current client about their experience or recommending the adviser, and “endorsement” to mean statements by someone other than a current client about their experience or recommending the adviser.

With those new meanings in mind, here’s how the new rule works.  It allows (i) the inclusion of a testimonial or endorsement in advertising and (ii) an adviser to compensate someone for a testimonial or endorsement, provided the adviser:

• discloses, or believes the person giving the testimonial or endorsement discloses:
  • whether the person is a client,
  • whether it was a paid statement (and the terms of such payment), and
  • material conflicts of interest;
• has a written agreement with any person paid to give a testimonial or endorsement (unless there is de minimis compensation or the person is affiliated with the adviser);
• oversees compliance with the rule; and
• ensures that no “bad actors” act as promoters.

Importantly, the new rule applies whether the adviser uses cash or non-cash compensation, and it eliminates the requirement for the solicitor to deliver a copy of the adviser’s firm brochure and obtain a signed disclosure document.  Additionally, it specifically permits the use of third-party ratings in an advertisement, provided the adviser provides certain disclosures and satisfies specified criteria related to the preparation of the rating.

The recent amendments to rules governing advertising and solicitation are substantial.  While you still have ample time before compliance is required, we suggest you begin to think now about how your current practices, policies and procedures will be affected so that the transition to the new regime will be as seamless as possible.  We hope you’ll return next time, when Josh will discuss valuation and fee assessment.  Look forward to seeing you then!