Overview of the Division of Examination’s Risk Alert
On September 19, 2022, the U.S. Securities and Exchange (“SEC”) Division of Examinations (the “Division”) released a Risk Alert (“Risk Alert”) (titled “Examinations Focused on the New Investment Adviser Marketing Rule”) to inform SEC registered investment advisers (“RIAs”), including advisers to private funds, about upcoming review areas during examinations focused on the amended Investment Advisers Act of 1940 Rule 206(4)-1 (“Marketing Rule”).1
The Risk Alerts also reminds RIAs that the compliance date for the new Marketing Rule is November 4, 2022 (the “Compliance Date”). The Marketing Rule became effective on May 4, 2021, with an 18-month transition period until the Compliance Date. Early compliance is permitted so long as the adviser complies with the Marketing Rule in its entirety from the time of election. As of the Compliance Date, RIAs may no longer choose to comply with the previous advertising and cash solicitation rules. In addition, as of the Compliance Date, the SEC is withdrawing certain staff statements relating to the previous advertising and cash solicitation rules. IM Information Update, 2021-10 (October 2021). Any advertisements disseminated on or after the Compliance Date by advisers registered or required to be registered with the SEC are subject to the Marketing Rule.
The new Marketing Rule replaced a number of rules with what is now one Rule. The Risk Alert begins by cautioning advisers to consider “whether they need to update or revise their written policies and procedures” to make sure that they not only reflect the teachings of the new Rule but also properly implement them. The Division cautions that advisers should also review the impact of the new Rule on other books and records provisions as well as Form ADV. In sharing initial examination review areas for the Marketing Rule, the Division of Examinations encourages advisers to reflect upon their own practices, policies, and procedures and to implement any appropriate modifications to their training, supervisory, oversight, and compliance programs.
The SEC will focus its examinations on the following areas:
Marketing Rule Policies and Procedures:
The SEC staff will review whether RIAs have adopted and implemented written policies and procedures that are reasonably designed to prevent violations by the advisers and their supervised persons of the Advisers Act and the rules thereunder, including the Marketing Rule. In the Marketing Rule Adopting Release, the SEC stated its belief that “… 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.”2 Examples of objective and testable means could include, but are not limited to, conducting an internal pre-review and approval of advertisements, reviewing a sample of advertisements based on risk, or pre-approving templates.3
The SEC staff will review whether RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact in advertisements. The Marketing Rule prohibits advertisements that “[i]nclude 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 SEC.” In the Marketing Rule Adopting Release, the SEC stated “[a]dvisers would be able to demonstrate this reasonable belief in a number of ways. For example, they could make a record contemporaneous with the advertisement demonstrating the basis for their belief. An adviser might also choose to implement policies and procedures to address how this requirement is met. However, if an adviser is unable to substantiate the material claims of fact made in an advertisement when the SEC demands it, we will presume that the adviser did not have a reasonable basis for its belief.”4
Performance Advertising Requirements:
The SEC staff will review whether RIAs are in compliance with performance advertising requirements in the Marketing Rule, including the prohibitions on including the following in an advertisement:
- gross performance, unless the advertisement also presents net performance;
- any performance results, unless they are provided for specific time periods(not applicable to the performance of private funds);
- any statement that the SEC has approved or reviewed any calculation or presentation of performance results;
- to the extent an advertisement includes the performance of portfolios other than the portfolio being advertised, performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as the portfolio 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, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the adviser provides certain additional information; and
- predecessor performance, unless the personnel primarily responsible for achieving the prior performance manage accounts at the advertising adviser and the accounts that were managed by those personnel at the predecessor adviser are sufficiently similar to the accounts that they manage at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.
Books and Records:
In connection with the Marketing Rule, the SEC adopted amendments to the Books and Records Rule. The staff will review for compliance with these requirements.
The staff will review that RIAs are providing additional information regarding their marketing practices on their annual Form ADV amendment. As such, the is reminding RIAs of their obligations to accurately complete these questions in their next annual Form ADV amendment.5
RIAs should consider whether they need to update or revise their written policies and procedures, as required by Advisers Act Rule 206(4)-7, to ensure they are reasonably designed to prevent violations by the advisers and their supervised persons of the Marketing Rule. In addition, Advisers Act Rule 204-2 (Books and Records Rule), as amended, will require RIAs to make and keep certain records, such as records of all advertisements they disseminate, including certain internal working papers, performance related information, and documentation for oral advertisements, testimonials, and endorsements.
Who should you talk to if you have further questions?
If you would like further information concerning the matters discussed in this Legal Insights, please contact Robert Moreiro.
About the Author
Robert has over 20 years of considerable experience in financial services, advising Financial Institutions including Registered Investment Advisers and Broker-Dealers regarding regulatory and compliance issues. With a deep understanding of the federal securities laws, Robert provides Registered Investment Advisers and Broker-Dealers comprehensive and diverse services relating to all aspects of the federal securities laws, FINRA rules, and BSA/AML regulations. He has represented Registered Investment Advisers, Broker-Dealers, and associated persons being examined, investigated, and prosecuted by the SEC, FINRA, other self-regulatory organizations and state regulators. He has assisted several Registered Investment Advisers in establishing SEC and/or state registration including drafting and filing all of the required documentation plus creating required compliance policies and procedures. Serve as Chief Compliance Officer/AML Compliance Officer for Broker-Dealers. Served as Chief Compliance Officer for Registered Investment Adviser. Served as Expert Witness in a FINRA arbitration regarding rules and regulations applicable to Broker-Dealers and Registered Investment Advisers.
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.