SEC Amends Investment Adviser Advertising & Solicitation Rules

DEC 12, 2019 | PRACTUS LLP

SEC Amends Investment Adviser Advertising & Solicitation Rules

On November 4, 2019, the Securities and Exchange Commission (SEC) proposed to amend its rules under the Investment Advisers Act of 1940 (Advisers Act) governing investment adviser advertisements and payments to solicitors, as well as related record-keeping requirements.1   The SEC also proposed to amend Form ADV in order to obtain additional information regarding advisers’ advertising practices.  The proposed amendments to Rule 206(4)-1 under the Advisers Act (the Advertising Rule) would be the first substantive amendments to the Advertising Rule since its adoption in 1961.  The proposed amendments to Rule 206(4)-3 under the Advisers Act (the Solicitation Rule) would be the first substantive amendments to the Solicitation Rule since its adoption in 1979.  The amendments would replace a plethora of SEC staff no-action letters that have been issued as investment advisers’ advertising and solicitation practices have increasingly diverged from the advertising and solicitation landscapes that faced the SEC at the time that it adopted the Advertising and Solicitation Rules.

Advertising Rule Amendments

The current Advertising Rule does not take into account several important developments in advertising practices, audiences and media.  In 1961, investment advisers marketed primarily to a retail clientele.  Personal computers, the internet, satellite radio, smartphones, tablets, social media, smart speakers, podcasts and streaming services were the stuff of fiction in 1961.  The Advertising Rule’s per se prohibitions on testimonials and past specific recommendations and its failure to address performance presentations represent issues not contemplated in 1961.

Structure of the Rule.  The proposed amended Advertising Rule is organized as follows, as a means reasonably designed to prohibit fraudulent, deceptive or manipulative acts:

  1. Thou Shalt Not.  Certain advertising practices will always be forbidden, regardless of the form of advertisement; 
  2. My Way or the Highway.  If an advertisement includes testimonials, endorsements or third-party ratings, certain tailored restrictions or conditions will apply;
  3. Performance Commands.  If an advertisement includes performance results, how it can be presented will depend in part on the advertisement’s intended audience; and 
  4. Review First.  A designated employee must review and approve in writing most advertisements before they are used. 

The proposed rule would apply to all investment advisers registered, or required to be registered, with the SEC.  It would not apply to exempt reporting advisers or to advisers subject to state registration.

Definition of “Advertisement” – What’s In and What’s Out?  

What’s In?

  1. any communication
  2. disseminated by any means
  3. by or on behalf of an investment adviser: “On behalf of an investment adviser” can occur if a third party posts information about an investment adviser where the adviser has involved itself in preparing the information (entanglement) or has explicitly or implicitly endorsed or improved the information (adoption).
  4. that 
    • offers or promotes the investment adviser’s investment advisory services; or 
    • seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser.”

What’s Out?  A communication that otherwise would be deemed an advertisement would be excluded from the definition of an advertisement if it is:

  1. A live oral communication that is not broadcast on radio, television, the internet, or any other similar medium; 
  2. A communication by an investment adviser that does no more than respond to an unsolicited request for specified information about the investment adviser or its services, other than: 
    • any communication to a client or prospective investor that is not a qualified purchaser2 or knowledgeable employee3 (Retail Person) that includes performance results; or 
    • any communication that includes hypothetical performance; 
  3. An advertisement, other sales material, or sales literature that is about an investment company registered under the Investment Company Act of 1940 (1940 Act) or about a business development company (BDC) and that is within the scope of rule 482 or rule 156 under the Securities Act of 1933 (Securities Act); or
  4. Any information required to be contained in a statutory or regulatory notice, filing, or other communication.
    • The proposing release states that “[t]his exclusion would apply to information that an adviser is required to provide to an investor under any statute or regulation under Federal or state law.”  However, not all information required to be included in a regulatory filing is required to be provided to investors.  

General Prohibitions.  No-nos include:

  1. any advertisement that includes any untrue statements of material fact or that omits a material fact necessary in order to make the statement made, in the light of the circumstances in which it was made, not misleading.  
  2. Any advertisement that includes any material claim or statement that is unsubstantiated.
  3. any advertisement that includes an untrue or misleading implication about, or is reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to an investment adviser.
  4. any advertisement that discusses or implies any potential benefits connected with or resulting from the investment adviser’s services or methods of operation without clearly and prominently discussing associated material risks or other limitations associated with the potential benefits.
  5. any reference to specific investment advice not presented in a fair and balanced manner.
  6. any inclusion or exclusion of performance results or time periods presented for performance not presented in a fair and balanced manner.
  7. any advertisement that is otherwise materially misleading.

Testimonials, Endorsements, and Third-Party Ratings

The rule would apply only if a testimonial, endorsement or third-party rating was an advertisement – in other words, if it’s a communication by or on behalf of4 the investment adviser.  There are no bright line rules – it’s a facts and circumstances test.


  1. Testimonial – any statement of a client’s or investor’s experience with the investment adviser or its advisory affiliates.
  2. Endorsement – any statement by a person other than a client or investor indicating approval, support, or recommendation of the investment adviser or its advisory affiliates.  
  3. Third-Party Rating – any rating or ranking of an investment adviser provided by a person who is not a related person, and such person provides such ratings or rankings in the ordinary course of its business.

Advisory affiliate and related person are defined in the Form ADV Glossary of Terms.


  1. Clear and Prominent Disclosure.
    • Testimonial: that it was given by a client or investor. 
    • Endorsement: that it was given by a non-client or non-investor.
  2. Was it Paid For?  If the testimonial, endorsement or third-party rating was paid for (whether cash or non-cash compensation) by or on behalf of the adviser, then the adviser must disclose this.  
  3. Third-Party Rating
    • must prominently disclose the date on which the rating was given and the period of time upon which the rating was based; 
    • must prominently disclose the identity of the third party that created and tabulated the rating;
    • if a rating is based to a significant degree upon client/investor questionnaires or surveys, the questionnaire or survey must make it equally easy for a respondent to provide a negative or positive rating.

Performance Advertising

Application of the General Prohibitions to Performance Advertising.  Depending upon the performance presentation, advisers may need to supplement a performance presentation with disclosure of:

  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.

Requirements for Gross and Net Performance. 

  1. Advertisements to Retail Persons5 (Retail Advertisements): 
    • Must include net performance – performance after giving effect to the deduction of those fees and expenses that an investor “has paid or would have paid” in connection with the services provided:
      1. an adviser can instead deduct a model fee equal to the highest fee charged to the portfolio generating the performance presented;
      2. an adviser can instead deduct a model fee equal to the highest fee charged to the intended audience of the advertisement; and 
      3. an adviser need not deduct custody fees paid to third parties; 
    • present performance using 1, 5 and 10-year periods (or life of vehicle/strategy if shorter); and
    • gross and net performance must be calculated over same time periods and using same types of returns and methodologies.
  2. Advertisements solely to Non-Retail Persons (Non-Retail Advertisements).  May include gross performance only.  However, if advisers do not provide net performance or a schedule of fees or expenses, they must offer to provide promptly a schedule of fees and expenses.
  3. All Advertisements:  
    • No advertisement can represent that the SEC has approved or reviewed the performance results presented.
    • Related Performance.  If advisers present performance of one or more portfolios, either on a portfolio-by-portfolio basis or as one or more composite aggregations of all portfolios, managed by the investment adviser, with substantially similar investment policies, objectives, and strategies as those of the services being offered or promoted in the advertisement (so-called “related portfolios”), it must include all related portfolios or exclude only those related portfolios that have higher performance relative to the remaining portfolios.  Unlike FINRA, the SEC would permit the use of related performance in Retail Advertisements.
    • Extracted Performance.  
      1. Definition – the performance results of a subset of investments extracted from a portfolio.
      2. An adviser may include extracted performance in an advertisement only if the advertisement provides or offers to provide promptly the performance results of all investments in the portfolio from which the performance was extracted
    • Hypothetical Performance
      1. Definition – performance results that were not actually achieved by any portfolio of any client of the investment adviser.  Examples include:
        • backtested performance; 
        • representative performance (performance derived from representative ‘‘model’’ portfolios managed contemporaneously alongside portfolios managed by the adviser for actual clients, and which do not reflect decisions made by the investment adviser in managing actual accounts); and
        • targeted or projected performance returns
      2. Conditions on Presentation
        • The adviser must implement policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the financial situation and investment objectives of the person to whom the advertisement is disseminated; 
        • The adviser must provide sufficient information to enable the recipient to understand the criteria used and assumptions made in calculating the hypothetical performance; and
        • The adviser must provide (or, if the recipient is a Non-Retail Person, offer to provide promptly) sufficient information to enable the recipient to understand the risks and limitations of using hypothetical performance in making investment decisions. 
      3. Review and Approval of Advertisements.  An adviser would be required to appoint at least one designated employee to review advertisements for consistency with the Proposed Rule, and to approve each advertisement, except for advertisements that are:  (i) communications that are disseminated only to a single person or household or to a single investor in a pooled investment vehicle; or (ii) live oral communications that are broadcast on radio, television, the internet, or any other similar medium.
      4. Proposed Amendments to Form ADV.  The SEC proposes to amend Form ADV, Part 1A, Item 5.  It would add a new subsection on advertising practices, that would elicit the following information from an adviser:
        • do any of its advertisements contain performance results, and if so, were all of the performance results verified or reviewed by a person who is not a related person;
        • do any of its advertisements include testimonials or endorsements, or include a third-party rating, and if so, does the adviser pay or otherwise provide compensation or anything of value, directly or indirectly, in connection with their use; and
        • do any of its advertisements include a reference to specific investment advice provided by the adviser.

Proposed Amendments to the Solicitation Rule

The SEC would expand the rule to cover solicitation arrangements involving all forms of compensation, rather than only cash compensation. It would expand the rule to apply to the solicitation of current and prospective investors in any private fund, rather than only to “clients” (including prospective clients) of the investment adviser.  Consequently, the SEC is proposing to change the name of the Solicitation Rule from “Cash Payments for Client Solicitations” to “Compensation for Solicitation”.  As a practical matter, most of the substantive proposed changes relate to third-party solicitors employed by an investment adviser.

  1. Scope of the Rule: Who is a Solicitor.  The proposed definition would significantly expand upon the current definition, which covers “any person who, directly or indirectly, solicits any client for, or refers any client to, an investment adviser”, to include persons who solicit investors in private funds.
  2. Expanding the Rule to Address All Forms of Compensation.  The proposed rule would expand upon the current scope of coverage – cash payments – to encompass non-cash compensation provided to solicitors.  An adviser would be prohibited from paying a solicitor any form of compensation, directly or indirectly, for any solicitation activities unless the adviser complies with the terms of the Solicitation Rule.  Examples of non-cash compensation include:
    • directed brokerage;
    • sales awards or other prizes; 
    • training or education meetings;
    • outings, tours, or other forms of entertainment;
    • free or discounted advisory services; and
    • the adviser providing investment advice that directly or indirectly benefits the solicitor – e.g., recommending investment products sold by the solicitor.
  3. Compensation for the Solicitation of Existing and Prospective Investors.  The current Solicitation Rule does not cover solicitation of existing or prospective investors in private funds.  The amendments would expand the Solicitation Rule to address these types of solicitations, but would not reach solicitations of existing and prospective investors in registered investment companies and BDCs as the SEC believes that solicitations of investments in those vehicles are addressed under existing regulatory requirements.
  4. Solicitor Disclosure.  
    • The proposed disclosure would expand upon the current required disclosures to include disclosure of any potential material conflicts of interest on the part of the solicitor resulting from the investment adviser’s relationship with the solicitor and/or the compensation arrangement. 
    • The Proposed Rule would permit either the investment adviser or the solicitor to deliver the required disclosure, whereas currently, the obligation falls only on the solicitor.  
    • The proposal would also replace the current requirement that the solicitor state whether the client will pay a specific fee to the adviser in addition to the advisory fee, and whether the client will pay higher advisory fees than other clients (and the difference in such fees) because the client was referred by the solicitor with a requirement that the solicitor disclose to the investor the amount of any additional cost to the investor as a result of solicitation.  
    • In instances in which a solicitor disseminates a mass solicitation, the Proposed Rule would permit the solicitor disclosure to be delivered at the time of solicitation or as soon as reasonably practicable thereafter, because it may not be practicable to deliver the solicitor disclosure at the time of initial mass solicitation.  “Reasonably practicable” means promptly after the investor expresses an initial interest in the adviser’s services.
  5. Exempt Arrangements.  The Proposed Rule would substantially retain the current rule’s partial exemptions for (1) solicitors that refer investors for impersonal investment advice, and (2) solicitors that are employees or otherwise affiliated with the adviser.  These arrangements would no longer be subject to the current rule’s written agreement requirement.  The proposal would also add two new full exemptions for: (1) de minimis compensation to solicitors, and (2) advisers that participate in certain nonprofit programs.
  6. Written Agreement.  The Proposed Rule would eliminate or replace some of the current written agreement requirements:
    • the requirement that the solicitor deliver the adviser’s brochure would be eliminated;
    • the requirement that the solicitor undertake to perform its duties consistent with the instructions of the adviser would be eliminated; and 
    • the current requirement that the written agreement contain an undertaking by the solicitor to perform his duties under the agreement in a manner consistent with the provisions of the Advisers Act and the rules thereunder would be replaced with the requirement that the solicitor agree to perform its solicitation activities in accordance with sections 206(1), (2), and (4) of the Advisers Act.
  7. Oversight of Solicitors.  The Proposed Rule would largely mirror the Current Rule’s requirement that the adviser have a reasonable basis for believing that the solicitor has complied with its obligations under the written agreement, including complying with the solicitor disclosure requirement.
  8. Disqualification for Persons Who Have Engaged in Misconduct.  The Proposed Rule replaces the absolute bar on compensating ineligible solicitors with a bar on compensating individuals that it knows, or that it, in the exercise of reasonable care, should have known, is an ineligible solicitor.  In addition, the prohibition would attach if the solicitor is subject to a disqualifying Commission action or is subject to any disqualifying event at the time of the solicitation, instead of at the time the adviser compensates, or engages, the solicitor for solicitation.


Professor Grant Gilmore wrote that “[t]he most difficult period in the life of a statute . . . is middle age.  Admittedly the statute is no longer what it once was but there is life in the old dog yet.  An occasional subsection still has its teeth . . . . “  This is equally true of the Advertising Rule and the Solicitation Rule.  The proposed amendments to the Advertising Rule and the Solicitation Rule overall represent a welcome effort by the SEC to bring clarity and currency to two Advisers Act rules that are afflicted by Gilmore’s metaphor of statutory “middle age.”  Many of the changes proposed to the two rules reflect nothing more than an attempt to codify IM no-action and interpretative positions taken since the rules were adopted.  

However, the SEC has also sought to make some substantive changes from the current regime, and not solely with respect to testimonials, past specific recommendations, non-cash compensation for solicitations or solicitations for pooled investment vehicles managed by the adviser.  Advisers would need to produce more information for Form ADV.  Advisers that seek to use hypothetical performance would need to develop policies and procedures addressing the use of hypothetical performance.  The lack of a bright line test indicating when an adviser has adopted a third party’s advertisement or has become entangled in its preparation may cause advisers to forego interactions with third parties that would ordinarily appear to be benign and are unlikely to cause the preparation and dissemination of unfair or misleading communications about the adviser.  Moreover, there remains enough ambiguity and potential conflicting outcomes that we believe that a thoughtful notice and comment process will serve only to further improve the two proposed rule amendments.  The comment period on the Proposed Rules ends on February 20, 2020.  If you are interested in commenting on the Proposed Rules, we encourage you to contact a Practus attorney, who can assist you in drafting a comment letter to the SEC.

1Investment Adviser Advertisements; Compensation for Solicitations, Investment Advisers Act Rel. No. 5407 (Nov. 4, 2019), 84 FR 67518 (Dec. 10, 2019) (Adopting Release). 
2A qualified purchaser is generally an entity with at least $25 million in investments or a natural person with at least $5 million in investments.
3A knowledgeable employee is generally an employee actively participating in the investment activities of a company excluded from the definition of investment company under Section 3(c)(7) of the 1940 Act (one that generally can be sold only to qualified purchasers), or that company’s affiliates.
4A testimonial, endorsement or third-party rating is on behalf of an investment adviser if the adviser has involved itself in preparing the testimonial, endorsement or third-party rating or has explicitly or implicitly endorsed or improved the testimonial, endorsement or third-party rating.
5“Retail Persons” do not encompass qualified clients and knowledgeable employees.

Practus, LLP provides this information as a service to clients and others for educational purposes only. It should not be construed or relied on as legal advice or to create an attorney-client relationship. Readers should not act upon this information without seeking advice from professional advisers.

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