Today we continue our discussion of the SEC’s recent changes to the Advertising Rule. In our last post, Josh covered the general definitional changes and prohibitions. In this entry, we will highlight the new Advertising Rule’s impact on performance advertising.
As we have discussed, the amended rule consolidates and supersedes former rules 206(4)-1 and 206(4)-3, regarding advertising and cash solicitation, respectively. Among other things, the new rule includes specific requirements and restrictions for advertisements that include performance results. This portion of the rule generally tracks SEC guidance and reflects an effort by the agency to consolidate investment performance requirements, previously prescribed by no-action letter and other agency action, in one place.
The SEC focuses on six specific prohibitions that “warrant special attention” for their ability to cause “reasonable investors to make unwarranted assumptions” and, therefore, become prohibited misleading advertisements. These prohibitions include publishing:
- gross performance, unless the advertisement also presents net performance;
- any performance results, unless they are provided for specific time periods in most circumstances;
- any statement that the SEC has approved or reviewed any calculation or presentation of performance results;
- performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement, with limited exceptions;
- performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio;
- hypothetical performance (which does not include performance generated by interactive analysis tools), unless policies and procedures exist to ensure it is reasonably designed to be relevant to the intended audience, and includes information underlying the hypothetical performance; and predecessor performance, unless there is appropriate similarity with regard to the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.
The Amended Rule’s discussion regarding the, above, prohibitions includes instructive commentary on several topics that advisers may need to consider to asses the sufficiency of advertising policies and procedures including the definitions of gross and net performance (and appropriate deduction of fees), the elimination of “representative performance” and equating “model performance” to hypothetical performance. Advisers will need to be fully familiar with the modernization of the rule to effectively promote its products, services and market performance results. Given the time of year, including such reviews as part of annual ADV disclosure amendments could provide a handy checklist for issues that require new attention this year.
Compliance departments are well advised to review policies and procedures for conformity with the new rule, including all procedures for review and approval of advertising and other outside communications, and coordinate with investment management to ensure that historical, hypothetical and benchmark performance references satisfy new rule and its record keeping requirements. For digital advisers, this may also involve reviewing data services used to generate performance and hypothetical estimating data, and should include a review of methodologies for, and disclosure of, performance and fee calculations. Robo-advisors should be particularly aware of those platform features which automatically generate model and hypothetical changes based upon a client’s change in their risk tolerance questionnaire.
Given the time of year, including such reviews as part of annual ADV disclosure amendments could provide a handy checklist for issues that require new attention this year. Our next post will continue our deep dive into amended Advertising Rule topics: Testimonials and Endorsers.