Section V: Third-Party Rating Requirements
In this part of our summary, we explore the SEC’s new requirements for the use of third-party ratings. In adopting this part of the advertising rule, the SEC was particularly concerned about the use of third-party ratings as a means to mislead investors (such as only showing positive third-party ratings or otherwise purchasing good ratings for use in advertisements). Accordingly, under the amended advertising rule, an adviser will not be able to use a third-party rating unless it complies with the General Prohibitions and certain requirements, as described in more detail below.
This summary is one part of a series of updates regarding the amended marketing rule. You can read the entire article for our complete Summary of the Investment Adviser Marketing Rule or you may click on any of the links below to view a particular section.
- Summary: SEC Adopts Amendments to Investment Adviser Marketing Rule (Section I)
- Definition of an Advertisement Under the Investment Adviser Marketing Rule (Section II)
- General Prohibitions Under the Investment Adviser Marketing Rule (Section III)
- Performance Presentations Under the Investment Adviser Marketing Rule (Section IV)
- Compliance Reviews, Form ADV Amendments & Recordkeeping Requirements – Investment Adviser Advertisements (Section VI)
Defining Third-Party Ratings
1. What is a “third-party rating”?
It’s a “rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms), and such person provides such ratings or rankings in the ordinary course of its business.”
The ordinary course of business requirement would largely correspond to persons with the experience to develop and promote ratings based on relevant criteria. It is intended to distinguish third-party ratings from testimonials and endorsements that resemble third-party ratings, but that are not made by persons who are in the business of providing ratings or rankings. The requirement that the provider not be an adviser’s related person is intended to avoid the risk that certain affiliations could result in a biased rating.
2. I know of a business that provides ratings that would meet that definition – Lake Wobegon Ratings. Lake Wobegon Ratings asks investment advisory clients to rate their advisers “better than average”, “much better than average” or “clearly superior.” Can I use Lake Wobegon Ratings of my firm in my advertisements?
No. The investment adviser must have a reasonable basis to believe that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result (the “due diligence requirement”).
3. Well, how about Reese Bobby Ratings – If your adviser ain’t first, it’s last. There is that slight problem that its proprietor sometimes ingests mind-altering substances, and when that happens, let’s just say that there aren’t any records to substantiate the date on which the rating was given and the period of time upon which the rating was based. Is that going to be problematic?
Yes. The final rule will require that an investment adviser clearly and prominently disclose, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses: (i) the date on which the rating was given and the period of time upon which the rating was based; (ii) the identity of the third-party that created and tabulated the rating; and (iii) if applicable, that compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating (the “disclosure requirement”). In order to be clear and prominent, the disclosure must be at least as prominent as the third-party rating.
About the Authors
Karen A. Aspinall is a Financial Services Partner at Practus LLP. She brings a wealth of experience and a solutions-oriented approach to our legal team as an authority on regulatory compliance matters involving SEC, DOL, NFA and CFTC matters. Karen’s practical experience and pragmatic approach to problem solving are valuable for clients who are looking to navigate the complex and ever-changing regulatory landscape.
Ethan Corey has spent 22 years as an investment management lawyer specializing in distribution issues (including FINRA rules) as well as 1940 Act and Advisers Act issues. Ethan is familiar with ERISA, MSRB and CFTC rules, as well as FCA Conduct of Business Rules and MiFID II. He has been an effective advocate with regulators as a member of industry trade groups.
|Karen A. Aspinall||(949) 629-3928||Karen.Aspinall@Practus.com|
|Ethan Corey||(301) 580-6489||Ethan.Corey@Practus.com|
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.