17.1 Advertising Rules

Advertising Rules for Investment Advisers

Investment advisers must follow strict rules regarding advertising to ensure communications are fair, accurate, and not misleading. The SEC's Marketing Rule fundamentally changed the advertising landscape for investment advisers.

SEC Marketing Rule (Rule 206(4)-1)

The SEC adopted a comprehensive new marketing rule in December 2020, with mandatory compliance beginning November 4, 2022. This rule consolidated previous advertising and solicitation rules into a single framework.

Definition of Advertisement

An "advertisement" includes:

- Traditional Marketing: Any communication disseminated by any means to more than one person that offers advisory services

- Compensated Testimonials/Endorsements: Any testimonial or endorsement for which an adviser provides compensation

General Prohibitions

Material Misstatements: Untrue statements of material fact

Material Omissions: Leaving out facts necessary to prevent misleading

Misleading Statements: Statements likely to deceive or mislead

Unsubstantiated Claims: Statements without reasonable basis

Cherry-Picking: Selectively presenting favorable results

Misleading Implications: Making statements that imply untrue facts

Fair/Balanced Failure: Not presenting risks alongside benefits

Testimonials and Endorsements

Key Definitions

Testimonial: A statement by a current client or private fund investor that:

- Describes their experience with the adviser

- Directly or indirectly solicits new clients

- Refers potential clients to the adviser

Endorsement: A statement by a non-client that indicates:

- Approval or support of the adviser

- Recommendation of the adviser's services

- Description of experience with the adviser

Required Disclosures

Client Status: Clearly disclose whether promoter is a current client

Compensation: Disclose if promoter is being compensated (cash or non-cash)

Conflicts of Interest: Disclose material conflicts that could affect credibility

Written Agreement: Required for compensation over $1,000 (de minimis exception)

Oversight Requirements

Advisers using testimonials/endorsements must:

- Have a reasonable basis to believe disclosures are being made

- Oversee compliance with marketing rule requirements

- Maintain policies and procedures for supervision

Performance Advertising

Presentation Requirements

Net Performance: Must always be shown; the primary requirement

Gross Performance: Only permitted if net performance is also shown

Extracted Performance: Must include total portfolio performance

Hypothetical Performance: Strict conditions apply

Hypothetical Performance

Hypothetical performance (model or backtested results) may only be shown to:

- Investors who the adviser reasonably believes can evaluate the methodology

- Must be accompanied by criteria used to generate results

- Cannot imply results represent actual trading

One-, Five-, and Ten-Year Returns

When showing performance over time periods:

- Must show 1, 5, and 10-year returns (or since inception if shorter)

- All periods must end at a consistent date (typically most recent quarter-end)

- Annualized returns required for periods over one year

Predecessor Performance

Can be used if:

- Substantially similar strategy and advisory personnel

- Records supporting performance are available

- Clear disclosure of the relationship

Third-Party Ratings

Requirements for Using Ratings

- Rating methodology must be disclosed or available

- Date of the rating must be shown

- Questionnaire or survey must have been designed fairly

- Cannot be misleading in presentation

Recordkeeping Requirements

All advertisements: 5 years from last use

Performance calculation support: 5 years

Third-party rating questionnaires: 5 years

Testimonial/endorsement disclosures: 5 years

On the Exam: The SEC Marketing Rule is frequently tested. Know that testimonials are now permitted (a major change from prior rules), but only with proper disclosures. Remember that net performance must always be shown - gross performance alone is prohibited.

Key Takeaways

- The 2022 Marketing Rule modernized adviser advertising requirements

- Testimonials and endorsements are now permitted with required disclosures

- Performance must be shown net of fees; gross only allowed with net

- Hypothetical performance has strict limitations

- All advertisements must be retained for 5 years