On Monday, November 4, 2019, the U.S. Securities and Exchange Commission (SEC) voted to propose amendments to the rules governing advertising by investment advisers under the Investment Adviser Act of 1940. The purpose of the amendments is to modernize the current Rule 206(4)-1 – reflecting changes in technology, changing investor expectations and the evolution of industry practices – and to replace the broadly-drawn limitations in the current rules with “principles-based” provisions.
In its press release announcing the proposed rule, the SEC provided a detailed fact sheet of the proposed amendments. Although it will take some time to analyze the 500-plus page proposing release, our sense is that most investment advisers and their clients will see the changes as a significant step in the right direction.
Some important highlights of the amendments noted by the SEC in its fact sheet are as follows:
- Broader Definition of Advertisement. The definition of an “advertisement” would be broadened to include “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.” The following specific exclusions from this definition are provided:
- Live oral communications that are not broadcast;
- Responses to certain unsolicited requests for specified information;
- Advertisements, other sales material or sales literature relating to a registered investment company or business development company and that fall within the scope of other SEC rules; and
- Information required in statutory or regulatory filings, notices or other communications.
- Testimonials, Endorsements and Third-Party Ratings. The proposed amendments would permit an adviser to publish testimonials and endorsements, subject to specified disclosures, such as whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the adviser. Advisers would be permitted to publish third-party ratings, subject to specific disclosure requirements and certain criteria pertaining to the preparation of the rating.
- Internal Pre-Use Review and Approval. The proposed amendments would require advertisements to be reviewed and approved in writing by a designated employee prior to dissemination, except for advertisements that are: (1) communications disseminated only to a single person or household or to a single investor in a pooled investment vehicle; or (2) live oral communications broadcast on radio, television, the internet or any other similar medium. The latter exception will provide much needed relief to advisers who to date have been advised by compliance consultants and attorneys to script almost any broadcast presentation and to avoid straying from the pre-approved script if at all possible.
- General Prohibitions. While the proposed amendments will be more permissive in some respects, they would prohibit the following advertising practices:
- Making an untrue statement of a material fact, or omission of a material fact necessary to make the statement, in light of the circumstances under which it was made, not misleading;
- Making a material claim or statement that is unsubstantiated;
- Making an untrue or misleading implication about, or being reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the investment adviser;
- Discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations;
- Referring to specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
- Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and
- Being otherwise materially misleading.
These prohibitions replace the current de facto list of prohibited activities with principles-based anti-fraud standards similar to those applicable to disclosures in securities offerings and public reporting under the Securities Act of 1933, the Securities Exchange Act of 1934 and Rule 10b-5. While these new prohibitions may allow for increased flexibility over the current de facto list of prohibited activities, such principle-based standards (as reflected in the term “fair and balanced”) may cause concern over the lack of specificity. This is especially true when considering what standards the SEC’s Office of Compliance Inspections and Examinations will apply when conducting adviser examinations.
- Performance Information. The proposal would amend the restrictions on performance information in a number of respects. In particular, the proposal would prohibit including gross performance results in any advertisement unless the adviser provides (or offers to promptly provide) a schedule of fees and expenses deducted to calculate net performance. The proposal would also prohibit including in any advertisement:
- Performance results from fewer than all portfolios with substantially similar investment policies, objectives and strategies as those being offered or promoted in an advertisement (with limited exceptions);
- Performance results of a subset of investments extracted from a portfolio, unless the adviser provides (or offers to promptly provide) the performance results of all investments in the portfolio;
- Hypothetical performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the financial situation and investment objectives of the recipient and provides certain specified information underlying the hypothetical performance; and
- Any statement that the calculation or presentation of performance results has been approved or reviewed by the SEC.
- Retail Advertisement. For advertisements targeting retail advisory clients, the proposed rule would require the presentation of net performance alongside any presentation of gross performance, and performance results of any portfolio or certain composite aggregations across 1, 5 and 10 year periods.
The SEC proposal also includes amendments to the rules governing solicitors working on behalf of investment advisers. The most notable changes are the expansion of the scope of the rule to apply to (1) any solicitor compensation arrangement, whether cash or non-cash, and (2) any solicitation of current and prospective investors in private funds (as opposed to just solicitation of current and prospective clients of the adviser (i.e. for separately managed accounts)).
The advertising and solicitation rules have not been significantly amended since their adoption by the SEC in 1961 and 1979, respectively. The SEC staff has sought to update the advertising rule since at least April of 2000. The change in these amendments, if adopted as proposed or with minimal changes after the comment period, will have a substantial effect on the investment advisory industry as whole. Over the next few weeks, as we review and analyze these proposed amendments, we expect to publish additional alerts and articles providing analysis with respect to effects on (1) retail investment advisers, (2) advisers to separately managed accounts, (3) private fund advisers and (4) institutional investors (providing insight on what they can expect to see in promotional materials if adopted).
If you have questions about the SEC’s release, the proposed amendments or their effect, please contact a member of Hirschler’s Investment Management Practice Group.
 See “SEC Proposes to Modernize the Advertising and Cash Solicitation Rules for Investment Advisers,” available at https://www.sec.gov/news/press-release/2019-230.
 See Rule 206(4)-3.
 See Paul F. Roye, Director, Division of Investment Management, “2000 and Beyond – SEC Priorities for the Investment Adviser Profession,” The Investment Counsel Association of America (April 6, 2000); available at https://www.sec.gov/news/speech/spch361.htm.
Kristen M. Chatterton