SEC brings first Marketing Rule enforcement action: Key takeaways for advisers
The Securities and Exchange Commission (SEC) recently brought its first enforcement action charging violations of the Investment Advisers Act of 1940 (Advisers Act) amended marketing rule (the Marketing Rule) against a registered investment adviser for using hypothetical performance metrics in advertisements that were misleading, as well as certain other compliance violations (the Order).
While the adviser in the case primarily advises retail clients, the Order provides relevant insights for private fund advisers with respect to how the SEC expects advisers to comply with the Marketing Rule’s hypothetical performance requirements and indicates certain other areas of the Marketing Rule upon which the SEC staff will focus.
Scrutiny of Marketing Rule policies and procedures. The SEC found that the adviser provided hypothetical performance without adopting policies and procedures reasonably designed to ensure the presentation of hypothetical performance (eg, target returns, projections, composite returns across funds) was relevant to the likely financial situation and investment objectives of the intended audience. While the adviser in this instance had no policies and procedures, the Order demonstrates that, if the SEC views such policies and procedures as deficient, the adviser may face enforcement risk. Advisers should engage in a review of their marketing policies and procedures to ensure that they are tailored to address the types of performance included in their advertisements, including the drafting and review of related disclosures.
Evaluation of performance disclosures. The SEC found that the adviser failed to (i) present material criteria used, and assumptions made in calculating hypothetical performance and (ii) describe the associated risks in considering hypothetical performance when making an investment decision. At a minimum, advisers should review their disclosures to confirm that they include information describing the criteria, assumptions, risks, and limitations of the hypothetical performance results being presented.
- Placement and labeling of disclosures matters. The Order indicates that an advertisement that directs investors to disclosures that are accessible via an embedded hyperlink may not comport with the Marketing Rule. Specifically, the SEC found that the advertisements at issue did not include information to alert retail investors of the necessity of clicking on the embedded links to view vital information regarding the criteria, assumptions, risks, and limitations of the hypothetical performance included in the advertisements. If an adviser chooses to use embedded links or layered disclosure, the advertisement should specifically and clearly alert investors of the necessity of clicking on the embedded links containing important additional information that they should review and consider.
- Performance disclosures should include detailed information about the criteria and assumptions used in such performance calculations. The Marketing Rule does not specify a particular methodology or calculation for the different categories of hypothetical performance. Rather, an adviser must provide information about the criteria and assumptions it made in calculating the hypothetical performance so the intended audience is able to understand how the hypothetical performance was calculated. The SEC staff has indicated that it expects a general description of the methodology used so investors may understand how it was generated, including any assumptions on which the hypothetical performance rests. Advisers should also review their disclosure to confirm that they include a fulsome description of the risk and limitations of using hypothetical performance in making investment decisions.
- Explanation of assumptions used to calculate hypothetical performance should be clear and prominent. In the instant case, the adviser provided certain information about the assumptions it used to calculate its hypothetical return and certain risks, but the SEC found that this information was not presented as clearly and prominently as the highlighted hypothetical return within the advertisement. Advisers should review their hypothetical performance calculation disclosures to confirm that they comport with the Marketing Rule’s requirements and are presented in equal prominence next to the hypothetical performance data. In addition, advisers should confirm with their investor relations departments that records supporting the assumptions and calculations of hypothetical performance are maintained.
Consider and confirm the intended audience of such hypothetical performance. Here, the adviser provided hypothetical performance in its advertisements to a mass audience without information explaining how to access additional disclosures relating to such performance. Advisers should review their policies and procedures to confirm that they are reasonably designed to ensure that the hypothetical performance is relevant to the financial situation and investment objectives of the intended audience of the advertisement.
Continued regulatory scrutiny. With this Order, the SEC has put advisers on notice that the SEC will continue to examine advisers’ Marketing Rule policies and procedures and related performance disclosures included in their advertisements. While the Order is focused on policies and procedures around hypothetical performance and accompanying disclosures, the SEC Division of Examinations has issued two prior risk alerts that address compliance with the Marketing Rule, including requirements related to hypothetical performance as well as other key areas, including the general prohibitions, endorsements and testimonials, and third-party ratings. The SEC Division of Enforcement also has emphasized robust compliance as a priority.
Periodic training: Advisers should continue to conduct periodic employee training regarding the Marketing Rule that covers, among other things, the importance of detailed disclosures that describe the calculation of hypothetical performance, including the use of assumptions, and the associated risks of relying on such performance.
In addition to the Marketing Rule violations, the SEC found that a hedge clause included in the adviser’s client advisory agreements was misleading because it created the false impression that clients had waived non-waivable causes of action against the investment adviser provided by state or federal law. The SEC also charged the investment adviser with multiple compliance failures that led to misleading disclosures about custody of clients’ crypto assets, the unauthorized use of client signatures and the failure to adopt policies concerning crypto asset trading by employees that violated Advisers Act Sections 206(2), and 206(4) and Rule 206(4)-7.
Without admitting or denying the SEC’s findings, the adviser agreed to a cease-and-desist order, censure, and payment of $192,454 in disgorgement, prejudgment interest and an $850,000 civil penalty that will be distributed to affected clients.
If you have any questions about the Marketing Rule and related compliance requirements, please contact any of the authors, your DLA Piper relationship attorney, or another member of the DLA Piper Investment Funds team.
 17 C.F.R. § 206(4)-1.
 U.S. Sec. Exch. Comm’n Div. Examinations, Examinations Focused on the New Investment Adviser Marketing Rule (Sept. 19, 2022) and U.S. Sec. Exch. Comm’n Div. Examinations, Examinations Focused on Additional Areas of the Adviser Marketing Rule (June 8, 2023).
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