Bates Research | 08-02-22
The SEC Marketing Rule - What You Need to Know
The mandatory compliance deadline for the SEC marketing rule—which replaced the former Advertising Rule and the Cash Solicitation Rule—is November 4, 2022. Advisers should be reviewing, revising, and preparing to implement procedures and policies to prevent potential violations. There’s still time, but there’s also a lot to consider, as the rule consolidates previous SEC guidance, no-action letters and exam findings on questions concerning recommendations, testimonials, and the presentation of performance metrics. Here’s what you need to know.
The marketing rule is grounded in a new definition for “advertising” and covers any direct or indirect communication by an investment adviser offering services to prospective clients or new services to current clients. Seven prohibitions apply to advertisements under this definition: (i) untrue statements or omissions of material facts; (ii) untrue or misleading implication or inference; (iii) unsubstantiated material statement of fact; (iv) description of benefits without a “fair and balanced” discussion of risk; (v) “unfair or unbalanced” reference to specific advice; (vi) “unfair and unbalanced” performance (or time periods); and (vii) otherwise misleading statements.
The core message of the new marketing rule is that advisers must lock down their documentation and reporting processes. Claims related to performance and services must be able to be substantiated, and advisers are on notice that they will need to be able to back up those claims with documentation on demand. Experts say that advisers who can’t substantiate a claim will be presumed not to have a reasonable basis for making it.
The rule is written to be broadly applied. The SEC highlighted that they are concerned with, among other things: communications of hypothetical performance; reliability of performance communications; offers to expand a financial relationship; communications related to cross sales; information on investment strategies; and, in general, any adviser/intermediary/third party distributed material conveyed to the investor. The SEC also makes clear what few items the rule does not cover. These communications include extemporaneous or unprepared remarks, routine communications such as account statements or transaction reports, even white papers—or other content that does not contain any offer—that would be contained in a required notice or filing.
Preparing for the Compliance Deadline
Advisers that are currently evaluating the processes and procedures necessary for full compliance with the marketing rule should be assessing their own advertising practices as defined under the rule. As mentioned, those communications include the way in which a firm communicates performance (i.e., related, extracted, hypothetical and predecessor performance) and the compliance requirements that apply to each, as well as the metrics the firm uses to communicate performance (e.g., gross and net numbers and/or 1-, 5-, and 10-year time intervals) to ensure consistency and not be misleading. The SEC will home in on these as they assess whether an adviser is offering “full and balanced disclosure” to investors.
Advisers should also be preparing marketing rule compliance processes and procedures if they utilize testimonials and endorsements in advertising. Testimonials are given by a current client or investor, endorsements are given by a party who is not a current client or investor (e.g., a service provider or family member). The SEC will be taking a close look at potential conflicts to paid quoters, particularly when payment involves waiving fees or other compensation. Conflicts must be prominently disclosed by explaining the terms of the compensation arrangements. (Testimonials or endorsements by broker-dealers have differing disclosure requirements depending on whether the intended audience is retail or not.) Compliance training will be required to ensure that advisers are aware of their obligation to gather testimonials or endorsements by service providers or outside parties, and to understand the rules around direct and indirect compensation to those providing them.
Disclosures and satisfying set criteria are required under the marketing rule before third-party ratings can be used in an advertisement. Use of third-party ratings raises concerns about the use of a fair and balanced methodology and on the need to substantiate claims. As a result, required disclosures should include the date of the rating, the period covered, the identity of the third party that created and tabulated the ranking, and if an advisor was paid directly or indirectly to participate.
When an adviser provides material to intermediaries for distribution, participates in its creation, uses the material in communications, and highlights, prioritizes, or deletes portions of the material, the material is considered advertising under the definition of the rule. These “affirmative actions” require significant compliance preparation, including employee training on, for example, what they’re allowed to do on social media. (Note: it is not considered advertising if modifications to the material were made by third parties, if unedited commentary was merely posted on an adviser’s website, or if procedures prohibiting employees to conduct business via social media are in place.)
The new marketing rule imposes significant oversight, recordkeeping, and disclosure requirements on investment advisers. It applies to all communication media (including e-mail blasts and social media posts). The November 4, 2022, implementation deadline is fast approaching, and the rule requires substantial changes to compliance processes and procedures that were previously designed for the former Advertising Rule and the Cash Solicitation Rule. The long lead time for compliance preparation is coming to an end. The SEC expects advisers to be ready—are you? Bates can help.
Bates supports firms navigating and implementing the SEC’s New Marketing Rule. We work with your firm to address investment adviser concerns and to support efforts to conform oversight, recordkeeping and disclosure requirements under the new rule. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems.