A Guide To Complying With The Marketing Rule

SEC Enforcement Revealed Marketing Compliance Keys For Advisors

Enforcing the Marketing Rule

A year has passed since the compliance date for amendments to the SEC’s Rule 206(4)-1, commonly known as the “Marketing Rule,” on Nov. 4, 2022. Since the SEC released less guidance on this rule than it typically does, the industry has grappled with how to comply effectively.

The SEC made its first enforcement actions on the rule in the latter half of 2023, which provide a glimpse into the SEC’s application of the rule. RIAs should consider the following key operational themes that emerged from the enforcement actions.

Examination Requests

The rule outlines records that must be maintained and available upon the SEC’s request. Recent exam requests confirm the SEC’s focus on specific policies and procedures, an RIA’s transition to compliance, materials used after compliance, and materials retired or revised from prior periods regardless of how they are presented or distributed – though the SEC typically focuses on digital distribution methods.

RIAs should be able to clearly articulate how they changed their policies and procedures to comply with the rule. For this, many RIAs maintain versions of their pre- and post-rule compliance policies and procedures, including notes on why changes were made.

Internal Review

Automation. It’s difficult to manually maintain all required records of drafts, comments, edits and final products. Software can help streamline the marketing review process and retain records. Solutions that offer case management help to track versions of content, changes, interactions between content creator and reviewer, and supporting data and documentation.

Some solutions provide tools to help reviewers transition to new content standards.  Questionnaires that capture important content elements and scrubbing tools help reviewers identify focus areas that require additional attention.

Managing disclosures. The SEC is scrutinizing the substance and consistency of marketing disclosures during examinations. An RIA should inventory all disclosures and review them for placement, structure, consistency and inclusion of all material information.

Performance Presentation

The SEC will review the presentation and calculation of performance during examinations.  Below are areas where firms should focus when reviewing performance practices.

Gross performance is the performance of a strategy before being reduced by fees. It should always be accompanied by net performance, which is performance after fees. Advisors managing private funds have found this particularly challenging because of the complexities of private fund performance reporting. A common solution is to calculate net performance based on the highest fees and expenses for the entire fund, whether calculating for an individual holding or the entire fund broadly.

Caution with performance presentation

When applicable, the performance period data must cover one, five and 10 years, as well as the period since inception.

Related performance, in which an RIA shows performance from other managed investments, should be calculated using the performance of substantially similar portfolios. An RIA should include related portfolios with unsuccessful returns.

Predecessor performance is performance from strategies managed by an RIA that are associated with a prior firm. These may only be included with current performance if the individuals primarily responsible for the results are currently managing the strategies. Any predecessor performance must include all related performance unless the omission does not result in a materially higher performance. The fact that these results occurred with a different entity must be disclosed.

Hypothetical performance is any performance data for investments that the RIA did not actually manage. This is commonly presented as models, projections or backtested data. Hypothetical performance requires disclosure of all relevant information and is discouraged for retail investors. RIAs should carefully evaluate calculations and whether they could be interpreted to be misleading.

It’s important to evaluate data sources and calculations used to determine performance or other metrics because an RIA may be asked to reproduce the calculations. The RIA must have the data sources readily available and be able to articulate how the calculation was performed.

Other Areas Of Scrutiny

Statements of fact are frequently made to describe markets, opportunity sets, track records or strategies. The rule requires statements of fact to be substantiated, but that can be difficult. An RIA should consider reframing statements as opinions and not fact.

Case studies – which are analyses showing the application of investment strategies to individual holdings – should be chosen carefully, have a logical rationale for the selection, and make full disclosure of materially important information. Any extracted performance, or performance that only focuses on parts of an entire investment, has important disclosure requirements and must be presented in a fair and balanced manner.

Testimonials are customer or business contact endorsements of an RIA’s services. Many RIAs are cautious about client testimonials. Those that use testimonials disclose compensation, conflicts of interest and important collection methods.

Third-party ratings – which are ratings of an advisory firm or strategies from an outside organization – require disclosure of important information about the third party, if any compensation or conflict of interest has occurred, and the relevant time periods used for the rating. If a rating is not from a reputable industry source or if it is calculated in a way that provides a predetermined outcome, it could be considered misleading.

Solicitors and promoters are outside parties that refer clients to an RIA by contract and for a fee. RIAs should have a written agreement with promoters or solicitors that clearly reflects defined roles for the distribution of required disclosures to end clients.

Thayne Gould is a Director at Vigilant Compliance.

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