How private fund advisers are preparing for the upcoming compliance date for the SEC’s Marketing Rule – November 4, 2022
In December 2020, the Securities and Exchange Commission adopted significant reforms under the Investment Advisers Act of 1940 to modernize rules that govern investment adviser advertisements and payments to solicitors. These amendments resulted in a single rule, Rule 206(4)-1 (the Marketing Rule), which replaced the previous advertising and cash solicitation rules.
The upcoming compliance date for the amended Marketing Rule is November 4, 2022, although advisers may choose to fully comply with the Marketing Rule in advance of that date.
The Marketing Rule applies to advertisements by SEC-registered investment advisers, including registered private fund advisers, disseminated on or after the compliance date or such earlier date selected by advisers.
Below is a high-level summary of certain noteworthy changes and action items to help private fund advisers prepare for and implement the new rule.
Expanded definition of “advertisement”
The Marketing Rule applies only to communications that fall within the definition of an advertisement, which covers two types of communications. The expanded definition of advertisement now expressly includes communications to private fund investors, although market practice generally has been to subject those communications to the current advertising rule as well.
First, the definition broadly captures traditional advertisements or marketing communications to private fund investors or advisory clients. Certain types of communications are excluded from this part of the definition, including:
- Certain one-on-one communications that do not include performance information; provided that this exclusion would not apply to template inserts or other duplicated presentations or emails, even if they are directed at or addressed to one person. Additionally, hypothetical performance information would not qualify for this one-on-one exclusion unless provided in response to an unsolicited investor request or to a private fund investor in a one-on-one communication.
- Extemporaneous, live, oral communications, and information contained in a statutory or regulatory notice, filing, or other required communication (eg, Form D, Form ADV).
- Generic brand content, educational material and market commentary.
- Communications to existing private fund investors or advisory clients, absent sales content for new or additional services or products.
Second, the definition generally includes any “endorsement” or “testimonial” for which an adviser provides cash and non-cash compensation directly or indirectly (eg, directed brokerage, awards or other prizes, and waived or reduced advisory fees). Testimonials are generally statements by a current investor or client about their experience with the adviser or its personnel or that directly or indirectly solicits, or refers, a current or prospective investor or client. Endorsements are generally statements by a person other than a current investor or client that indicates approval, support or recommendation of the adviser or its personnel or that directly or indirectly solicits, or refers, a current or prospective investor or client.
In a reversal of prior SEC guidance, the Marketing Rule now captures a private fund adviser’s relationship with a placement agent. As a result, private fund advisers must comply with the Marketing Rule’s disclosure, oversight and disqualification provisions when engaging a placement agent or similar LP finder.
Compensated promoters that are covered by Rule 506(d) of Regulation D (and the related “bad actor” provisions) with respect to a Rule 506 securities offering are exempt from the disqualification provisions of the Marketing Rule provided their involvement would not disqualify the offering under Rule 506. Otherwise, a person subject to a disqualifying SEC action or any other disqualifying event (as each are described in more detail in the Marketing Rule) would be disqualified from providing compensated testimonials or endorsements, including solicitations.
Both parts of the definition of advertisement now clearly include social media and other types of electronic communications.
Advertising practices under the Marketing Rule
In an effort to streamline guidance, the Marketing Rule withdraws a number of no-action letters and other SEC guidance concerning the prior advertising and cash solicitation rules. The new principles-based approach includes seven broadly prohibited practices designed to prevent marketing practices that may be misleading, which include the following:
The Marketing Rule prohibits advisers from making a material statement of fact that the adviser does not have a reasonable basis for believing. This will require advisers to maintain documentation to support such statements. If on demand an adviser is unable to substantiate the material claims of fact made in an advertisement, the SEC will presume that the adviser did not have a reasonable basis for its belief.
Past specific recommendations
In a noteworthy departure from the prior advertising rule, the amended Marketing Rule provides flexibility for advisers to highlight past specific recommendations so long as they are presented in a fair and balanced manner.
The Marketing Rule prohibits the use of third-party ratings in an advertisement, unless the adviser provides disclosures and satisfies certain criteria pertaining to the preparation of the rating.
The Marketing Rule also includes tailored requirements for certain types of performance presentations, including the following:
- Net performance requirement: Gross performance (actual or hypothetical) may be presented only if comparable net performance is also presented with at least equal prominence.
- Hypothetical performance: Hypothetical performance (including targeted returns, projections and composite returns across funds) must include disclosures around the criteria used and assumptions made, along with risk information applicable to such hypothetical performance. In addition, advisers are required to adopt policies and procedures to ensure that the hypothetical performance used is relevant to the likely financial situation and investment objectives of the intended audience.
- Related performance: Performance results of a portfolio must also include the performance of all other portfolios that have substantially similar investment policies, objectives, and strategies (individually or in a composite); however, certain related portfolios may be excluded if (1) performance results are not materially higher than if all related portfolios had been included, and (2) the exclusion does not alter the time period presentation, if applicable.
- Extracted performance: Performance results from a subset of investments extracted from a single portfolio must provide (or offer to provide to private fund investors) the performance of the total portfolio from which the performance was extracted. Performance that is extracted from multiple portfolios would be treated as hypothetical performance and must include the required disclosures for hypothetical performance.
- Predecessor performance: Performance achieved by a group of investments consisting of an account or a private fund that was not advised by the presenting adviser during the period shown must meet certain portability standards and include required disclosures.
- Time period requirement: Advertisements with performance results must generally include 1-, 5-, and 10-year performance with an end date no less than the most recent calendar year-end. This requirement does not apply to private funds; however, it would apply to separately managed account performance results.
Amendments to the books and records rule and Form ADV
In connection with the Marketing Rule amendments, the SEC also adopted amendments to the books and records rule. In addition, the SEC amended Form ADV to require advisers to provide additional information regarding their marketing practices.
As of November 4, 2022, advisers must be fully compliant with the Marketing Rule. The SEC emphasized the required compliance date in a recently issued risk alert that informed registered investment advisers about upcoming review areas focused on the Marketing Rule during examinations. In order to comply with the Marketing Rule, advisers should, among other things:
- Update their compliance policies and procedures and conduct internal trainings to educate their employees, including teams that will be reviewing and preparing advertisements.
- Review and amend new and ongoing placement agent agreements. Private fund advisers that engage placement agents to solicit private fund investors must comply with the Marketing Rule’s disclosure, oversight and disqualification provisions. Among other things, advisers should discuss the content and method of disclosure with placement agents, including existing placement agent arrangements.
- Review marketing materials, including pitch decks and the business sections in private placement memoranda and other offering materials. The Marketing Rule will apply to all materials that are actively being shared with investors and clients, including those created and initially circulated prior to the compliance date.
If you have any questions about the Marketing Rule or how your firm can prepare for the upcoming compliance date, please contact the authors, your DLA Piper relationship attorney, or another member of the DLA Piper Investment Funds team.
 A “private fund” is defined as an issuer that would be an investment company but for the exclusions contained in Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940. Notably, this definition does not include many real estate funds, including those relying on Section 3(c)(5)(C).