This year, the Securities and Exchange Commission (SEC) sent a clear message to the investment advisory industry with its latest enforcement actions related to the SEC Marketing Rule. Five firms were charged and fined over $200,000 for a range of violations, underscoring the agency's commitment to ensuring advisers adhere to the rule's strict compliance requirements.

At the heart of these cases were issues surrounding the use of hypothetical performance data in firm advertising and marketing materials. Some quick background: The SEC Marketing Rule, officially known as Rule 206(4)-1 under the Investment Advisers Act of 1940, underwent significant amendments that were adopted during the pandemic. The definition of “advertisement” was expanded to include performance information in ads. Testimonials and endorsements are permitted, subject to certain conditions. The SEC wanted to emphasize the importance of transparency and accuracy in marketing communications by investment advisors.

These enforcement actions also send a clear message that the SEC is actively policing the investment advice industry when it comes to marketing and advertising activities. Firms should thoroughly review and update their marketing policies and procedures to align with the new rule’s requirements. They should start with the most crucial question when reviewing any advertisement: ‘Who is the audience?’ This query is a cornerstone of an effective compliance strategy. It’s not just about following rules; it’s about understanding your audience and tailoring your approach. SEC cases highlight the importance of an audience-first mindset.

Firms Charged with Violations

The SEC found that the five advisory firms – GeaSphere LLC, Bradesco Global Advisors Inc., Credicorp Capital Advisors LLC, InSight Securities Inc., and Monex Asset Management Inc. – had advertised hypothetical performance on their public websites without putting the proper policies and procedures in place. Specifically, the SEC determined that these firms failed to adopt and implement measures designed to ensure the hypothetical performance information was relevant to their intended audience's likely financial situation and investment objectives. Rather, the performance data was presented to the public, which the SEC says is generally not permissible under the rule.

Hypothetical performance, as opposed to actual trading results, is derived from models of simulations using historical data to project potential future performance. These projections are used to illustrate how a particular strategy might have performed under hypothetical market conditions. Hypothetical performance data can be misleading, if not properly contextualized, or if the assumptions behind the models are not fully disclosed, according to the SEC.

Beyond the hypothetical performance issues, the SEC also cited these firms for various other Marketing Rule violations, including:

• Failing to maintain copies of advertisements that appeared on their websites
• Lacking documentation to substantiate the performance claims made in advertisements
• Not conducting the required annual reviews of their compliance policies and procedures

GeaSphere LLC was hit with a $100,000 fine, the most significant penalty of the group. The Commission found the firm violated the rule in multiple ways, showcasing a widespread compliance breakdown. This included making false and misleading claims about its investment performance, failing to present net performance figures alongside reported gross performance as required, and being unable to properly substantiate the advertised performance data. Four of the firms received reduced penalties due to the corrective steps they had taken before being contacted by SEC staff.

This "self-report credit" highlights the importance of proactively addressing compliance deficiencies rather than waiting for regulatory action.

Review Compliance Policies Regularly

Beyond the performance issues, the SEC also determined that GeaSphere had advertised hypothetical performance on its website without the necessary policies and procedures in place to ensure relevance to the intended audience. The compliance breakdowns at the firm extended to its basic record-keeping obligations as well – the firm failed to maintain copies of the advertisements that appeared on its website. It also lacked the proper books and records to demonstrate how it calculated the performance figures in those ads. Perhaps most troublingly, the firm was cited for neglecting to conduct the annual review of its compliance policies and procedures required under SEC rules.

Firms should also maintain clear, organized, and easily accessible records of all advertisements disseminated. Digitized records and a central hub for storing and tracking information are ideal. External support that includes efficient tools to help comply with the Marketing Rule, like reporting and archiving software, can go a long way to ensuring compliance. Years ago, I developed a checklist for hypothetical/model performance advertising to help multiple stakeholders avoid mistakes. This resource streamlined the process for everyone involved, including compliance, marketing, and methodology calculations.

Advisers must have a comprehensive understanding of the Marketing Rule's requirements and be diligent in maintaining robust compliance programs. Failing to get Marketing Rule compliance right can result in significant regulatory penalties and lasting reputational damage. Investment advisers would be wise to heed the lessons from these enforcement actions and make adherence a top priority.