In part 1 of this post, we shared that the Securities and Exchange Commission’s (SEC’s) has adopted a final rule modernizing the investment adviser marketing and solicitation rules – calling the new regulation the “marketing rule.” In part 1, we describe the regulatory process.
As of Jan. 29, 2021, the SEC has not yet published the final rule – which is about 430 pages including commentary – in the Federal Register. The rule takes effect 60 days after publication, when an 18-month transition period begins after which the SEC will require full compliance.
Balancing investor protection and adviser marketing needs
Broadly, the SEC’s reason to regulate investment adviser marketing is to prevent fraud and misrepresentation about securities investments that could mislead and financially harm investors. Some of the main provisions of the new marketing rule:
- Advertisement definition prong 1: An “advertisement” is “any direct or indirect communication an investment adviser makes that” offers their “investment advisory services” regarding securities to prospective clients or private fund investors; or offers new investment advisory services regarding securities to existing clients or private fund investors. There are several complex exceptions, but most “one-on-one communications” are excluded. The rule also excludes from the definition of an advertisement regulatory communications, communication about business development companies or registered investment companies, and “extemporaneous, live, oral communications.”
- Advertisement definition prong 2: Stemming from the current cash solicitations rule, an advertisement is also “any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly,” excluding certain regulatory communications. The communication can be oral or written and to one or more people. Compensation may be monetary or nonmonetary. (Endorsements that are uncompensated may fall under prong 1.)
- Communication modalities: Modes of communication are broadly encompassed by “any direct or indirect communication” from an investment adviser so as to include traditional plus newer modes like the Internet, mobile apps, social media, email, video and others, as well as future communication technologies as they develop.
- Adviser restrictions: An investment adviser in an advertisement may not intentionally or negligently do several specified things that could mislead investors like including untruths or unverifiable facts, presenting potential benefits without also providing “fair and balanced” treatment of material risks, treating performance results in an unfair or unbalanced way and others.
- Testimonials and endorsements: These must disclose at the time of dissemination material terms of compensation agreements and material conflicts of interest, among other requirements like whether the promoter is a client or investor. The investment adviser also has promoter oversight responsibilities. Unless the promoter is affiliated with the adviser or the compensation is worth $1,000 or less in the past year, the adviser and promoter must have a written agreement. The marketing rule has complex provisions about classes of person who are disqualified from being promoters.
- Investment performance: The rule severely restricts the use of securities performance in an advertisement unless the presentation of the performance meets precise, complicated standards.
- Third-party ratings: An investment adviser may only include third-party ratings in an advertisement with particular disclosures and if they meet specific, detailed requirements.
This is only a high-level snapshot of a complicated new SEC rule. Investment advisers and their colleagues and affiliates will need to invest time and effort during the transition period to understand the changes and implement them in practice.
