Earlier this month, the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced the most frequent advertising rule compliance issues identified in its routine examinations of registered investment advisers and as part of an examination initiative focused on advisers’ use of accolades in their marketing materials (“Touting Initiative”). Rule 206(4)-1(a)(5) (“Advertising Rule”) under the Investment Advisers Act of 1940 (“Advisers Act”) prohibits an adviser, directly or indirectly, from publishing, circulating or distributing any advertisement that contains any untrue statement of material fact, or that is otherwise false or misleading. The SEC’s extensive prior guidance on the Advertising Rule provided in the agency’s opinions, court decisions and orders in settled enforcement proceedings and in no-action letters highlights the complexity of the Advertising Rule and the sometimes severe consequences of non-compliance.
The OCIE launched the Touting Initiative in 2016 to examine the adequacy of disclosures provided by advisers to their clients when touting awards, promoting ranking lists and/or identifying professional designations in their marketing materials. The initiative was apparently in response to the regularity with which staff had identified deficiencies in this type of advertising by advisers. Examples of the deficiencies identified included:
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Submitting potentially false or misleading information in the applications for these awards, rankings or designations;
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Publishing marketing materials that referenced stale ranking or evaluation information or potentially misleading advertisements that did not disclose the relevant selection criteria for the awards or rankings, or the fact that advisers paid a fee to participate in or distribute the results of the survey;
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Making misleading references to employee professional designations that had lapsed or that did not explain the minimum qualifications required to attain these designations; and
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Publishing client endorsements on firm websites, social media pages, reprints of third-party articles, or pitch books.
Other deficiencies identified by the OCIE included:
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Presenting performance results without deducting advisory fees or providing insufficient disclosures regarding the benchmarks used;
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Utilizing hypothetical and backtested performance results without explaining how these returns were derived;
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Advertising performance results gross of fees in certain one-on-one presentations without a disclosure that the advertised performance results did not reflect the deduction of advisory fees and other expenses;
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Falsely claiming compliance with the Global Investment Performance Standards (GIPs);
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Including only profitable stock selections or recommendations in presentations, client newsletters or websites, without meeting the conditions set forth in Subsection (a)(2) of the Advertising Rule;
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Not having or not implementing compliance policies and procedures reasonably designed to prevent deficient advertising practices; and
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Disclosing past specific investment recommendations that only included certain, and not all, recommendations, in order to illustrate a particular investment strategy.
In this regard, the OCIE staff highlighted the importance of compliance with certain representations contained in the TCW Group1 and Franklin2 SEC no-action letters in which the staff stated that it would not recommend enforcement action against an adviser that advertised: (i) its five (or more) best performing holdings along with an equal number of worst performers if several representations were met; or (ii) past specific recommendations that were selected using consistently applied, objective, non-performance-based selection criteria and included certain disclosures, such as that the specific recommendations did not represent all securities purchased, sold or recommended to clients during that period and the profits realized by the specific recommendations.
The OCIE’s stated goal in providing this most recent guidance was to encourage advisers to assess the full scope of their advertisements and consider whether those advertisements were consistent with the Advertising Rule, the prohibitions of Section 206 of the Advisers Act and their fiduciary duties, and review the adequacy and effectiveness of their compliance programs. In particular, the guidance emphasized the importance of having and implementing compliance policies and procedures focusing on the following issues:
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The process for reviewing and approving advertising materials prior to their publication or dissemination;
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Determining the parameters for which accounts were included or excluded from performance calculations when using composites; and
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Confirming the accuracy of performance results in compliance with the Advertising Rule.
The OCIE noted that, in response to the staff’s observations (including those identified in this guidance), advisers elected to either remove misleading advertising language or add enhanced and clarifying language; however, as noted above, over the years the SEC has also brought a number of enforcement proceedings in this regulatory area. Given the SEC’s continued focus on advertising and potentially serious implications of violating the Advertising Rule, advisers should additionally review their advertising practices and procedures to ensure that such practices and procedures are consistent with this most recent guidance.
1 The TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008).
2 Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998); see also Investment Counsel Ass’n of America, Inc., SEC Staff No-Action Letter (Mar. 1, 2004).
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