Client Alerts  - Private Equity and Venture Capital Nov 08, 2022

SEC’s New Marketing Rule for Investment Advisers Now in Effect

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SEC’s New Marketing Rule for Investment Advisers Now in Effect

On November 4, 2022, the U.S. Securities and Exchange Commission (SEC) implemented reforms to the Investment Advisers Act of 1940 that governs investment adviser advertising and solicitation of clients. The regulatory change, which consolidates these two principles into a single regulation now known as the Marketing Rule, is designed to, among other things, accommodate the continual evolution of technology while protecting investors.

The impact on regulated parties is considerable. Whereas advertising was once largely interpreted to mean brochures, market updates, magazine advertisements, websites and the like; it now applies to nearly any digital communication including email, social media, instant messaging and certain one-on-one messages. A more detailed discussion of the Marketing Rule is provided below.

Definition of Advertisement

The definition of  “advertisement” has been significantly revised and broadened, and is broken down into two prongs. Generally speaking, the first prong governs communications traditionally treated as investment adviser advertising and the second prong includes compensated testimonials and endorsements.

Advertisement – First Prong

Under the first prong, an advertisement is “any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance, that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser[.]”

The first prong, among other things (and subject to various exceptions), generally will capture the following types of communications from advisers:

  • Communications to investors in a private fund: Although investors in a private fund are not “clients” of an adviser, and the previous “advertising rule” has, historically, not been applied to these communications, advisers have always been subject to federal anti-fraud standards when communicating with private fund investors. The definition of advertisement in the Marketing Rule formalizes the application of the rule’s specific anti-fraud standards to most adviser communications with private fund investors. While information in a private placement memorandum (PPM) setting forth the material terms, risks and objectives of a private fund likely would not be considered an advertisement, PPM content that encourages an adviser’s investment advisory services would be subject to the Marketing Rule.
  • Third-party content and social media communications: An advertisement will include a communication distributed by an agent or intermediary on behalf of an adviser.

Separately, under the first prong, other categories of communications have special rules. First, the Marketing Rule excludes extemporaneous, live, oral communications from the definition of advertisement, regardless of whether they are broadcast. By contrast, written materials such as slides presented to an audience, prepared remarks and speeches, are not excluded from the definition of advertising if they otherwise meet the definition of advertisement. Second, information reasonably designed to satisfy the requirements of statutory or regulatory notices and filings will not be considered an advertisement. Finally, presentation of hypothetical performance information is excluded from the definition of advertisement only if the communication is in response to an unsolicited client request, or to a private fund investor in a one-on-one communication. However, hypothetical performance information included in all other communications that offer investment advisory services, including one-on-one communications to prospective advisory clients, will be deemed advertisements subject to the Marketing Rule.

Advertisement – Second Prong

The second prong includes compensated testimonials and endorsements that, until the implementation of the new Marketing Rule, were governed by the solicitation rule. Under the second prong, an advertisement includes “any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly, but does not include any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication[.]” Whether an adviser provides direct or indirect compensation is a factual determination and may include, for example, gifts and entertainment, awards or prizes, reduced brokerage fees and other forms of indirect benefits, provided that these benefits are designed to encourage the recipient to make a positive statement about an adviser. Notably, though, this category of testimonials and endorsements do not include an employee’s regular salary and bonus for investment advisory activities or clerical, administrative, support or similar functions.

Amendments to the Books and Records Rule and Form ADV

The Marketing Rule also includes revised recordkeeping requirements. Investment advisers must make and keep copies of all advertisements they directly or indirectly disseminate, including certain internal working papers, performance-related information, and documentation for oral advertisements, testimonials and endorsements. Certain alternative methods for complying with this requirement are available for oral advertisements, including oral testimonials and oral endorsements. The amended rule also includes specific requirements for making and keeping records related to performance information, testimonials, endorsements and third-party ratings.

Form ADV has also been amended. Now, Form ADV requires advisers to provide additional information about an adviser’s marketing activities and advertisements. According to the SEC, this additional information will help to ensure that the SEC has sufficient data to support the SEC staff’s enforcement activities.

Other Matters

The Marketing Rule also addresses numerous other matters. For instance, the Marketing Rule includes and/or governs:

  • General advertising prohibitions
  • Testimonials and endorsements, including setting disclosure requirements, prohibitions; and exemptions
  • Third-party ratings
  • Performance information
  • Portability of performance

Advisers should be aware of, and carefully consider, the new rules with respect to each of the items referenced above in connection with their communications.

SEC Risk Alert

Advisers should be aware of the SEC’s Division of Examinations Risk Alert issued on September 19, 2022. In the Risk Alert, the Division of Examinations advised, among other things, that staff will be conducting broad reviews to evaluate compliance with the Marketing Rule. These reviews will focus on:

  • Marketing Rule Policies and Procedures: SEC staff will review whether investment advisers have adopted and implemented written policies and procedures that are reasonably designed to prevent violations.
  • Substantiation Requirement: SEC staff will review whether investment advisers have a reasonable basis for believing they will be able to substantiate material statements of fact in advertisements.
  • Performance Advertising Requirements: SEC staff will review whether investment advisers are in compliance with performance advertising requirements in the Marketing Rule.
  • Books and Records: SEC staff will review investment advisers’ recordkeeping to ensure compliance with the new books and records requirements in the Marketing Rule.

Very simply, the Risk Alert puts advisers on notice that their marketing practices will be under increased scrutiny going forward. We strongly recommend that advisers review and understand the Marketing Rule and related guidance, including the Risk Alert, in their entirety.

Next Steps for Advisers

Advisers subject to the rule should take any and all necessary steps to ensure their timely compliance with the Marketing Rule. That said, high-level next steps should include, but not be limited to, the following:

  • Policies and Procedures: Advisers should update policies and procedures affected by the Marketing Rule.
  • Public Facing Materials: Advisers should review all materials which now fall under the definition of advertisements, including websites, requests for proposals, email marketing and other social media posts.
  • Third-Party Advertisements: Advisers should evaluate the use of third-party solicitors and/or third-party compensation. If so required, advisers should update solicitation agreements and/or draft new agreements with third-party endorsers to comply with the Marketing Rule.
  • PPMs: For private fund advisers, advisers should review PPMs and other material, particularly with respect to references to performance.
  • Recordkeeping: Advisers should develop and implement a recordkeeping practice that substantiates advertising statements of material fact and that otherwise complies with the requirements of the new rules.

Additional Assistance

Phillips Lytle LLP is available for assistance with respect to the Marketing Rule. This may include  conducting an internal audit of your policies, practices and procedures to verify that you are meeting your compliance obligations, and in addition to helping uncover non-compliance, assisting with any threatened or actual enforcement action by the SEC.

For further assistance, please contact Patrick T.  Fitzgerald, Benjamin M. Farber, or the Phillips Lytle attorney with whom you have a relationship.

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