SEC Issues Another Risk Alert to Investment Advisers on Marketing Rule Compliance

The Securities and Exchange Commission’s Division of Examinations (the Division) recently issued a Risk Alert (Alert) titled “Additional Observations Regarding Advisers’ Compliance with the Advisers Act Marketing Rule.” The Alert describes several common deficiencies that the Division staff observed regarding registered investment advisers’ compliance with amended Rule 206(4)-1 (the Marketing Rule) under the Investment Advisers Act of 1940 (the Advisers Act). The Division previously published a risk alert summarizing initial observations related to compliance with the Marketing Rule, which we summarized here.

This recent Alert focuses on the Division’s key observed deficiencies regarding compliance with the testimonial and endorsement provisions (Rule 206(4)-1(b)) and third-party rating provisions (Rule 206(4)-1(c)) of the Marketing Rule.

Why It Matters

The Alert is the fourth risk alert issued and latest in a series of Risk Alerts[1] and enforcement actions[2] addressing compliance with the Marketing Rule, which was overhauled by the SEC in 2022. The Alert, together with the Division’s recently published examination priorities (which we summarized here) reaffirms the Division’s continuing focus on Marketing Rule compliance and signals that investment advisers should be prepared for scrutiny of their advertisements during examinations, including with respect to the use of testimonials, endorsements and third-party rankings, each of which was highlighted by the Staff in the most recent Alert.

Summary of Key Deficiencies Cited

Key deficiencies identified in the Alert include noncompliance in the following areas:

Testimonials and Endorsements

The Marketing Rule prohibits the use of testimonials and endorsements unless the adviser satisfies certain disclosure and oversight conditions. The Alert identifies a number of recurring Marketing Rule deficiencies relating to adviser use of testimonials and endorsements, including the following:

• Clear and prominent disclosures: Advertisements that contained testimonials or endorsements that (i) did not include required disclosures, such as whether the person providing the testimonial or endorsement (referred to as the “promoter”) was a current client or investor in a private fund advised the investment adviser, was receiving compensation or was subject to material conflicts of interest, or (ii) were not provided in a manner meeting the “clear and prominent” standard, such as through the use of hyperlinked disclosures or the use of smaller font sizes.
• Disclosure of material terms of compensation arrangements: Advisers that did not disclose the material terms of compensation arrangements between the advisers and promoters, such as a description of the compensation provided directly or indirectly to the promoter.
• Disclosure of material conflicts: Advisers that did not disclose material conflicts resulting from the advisers’ relationship with promoters, such as failing to disclose material conflicts resulting from promoters’ financial interests in the advisers they promoted.
• Oversight and compliance: Advisers that did not comply with the Marketing Rule’s requirements that advisers have a reasonable basis for believing that the testimonials or endorsements complied with the Marketing Rule. For example, the Division staff observed advisers that (i) were unaware that some of their promotional arrangements met the definition of an endorsement, or (ii) did not enter into a written agreement with a paid promoter addressing the Marketing Rule’s requirements.
• Ineligible persons: Advisers that did not comply with the prohibition on compensating ineligible persons for endorsements.
• Promoter affiliated with the adviser: Advisers using promoters affiliated with the advisers and treating such promoters as exempt from certain requirements pursuant to the applicable provisions of the Marketing Rule, but not satisfying the exemption requirements to ensure that the affiliation between the promoter and the adviser was readily apparent to a client or private fund investor at the time of the endorsement.

Third-Party Ratings Provisions

The Marketing Rule prohibits the use of third-party ratings in advertisements unless the adviser has a reasonable basis for believing that questionnaires or surveys used in the preparation of the third-party ratings meet certain criteria and discloses certain information related to the ratings. The Alert identifies a number of deficiencies relating to third-party ratings, including:

• Due diligence: Advisers that did not undertake adequate diligence or obtain sufficient information to form a reasonable basis for believing that methodologies used in preparation of the third-party rating was not biased towards a favorable result. For example, some advisers had not developed policies and procedures to satisfy the Marketing Rule’s due diligence requirement.

On the other hand, the Division helpfully listed several methods that advisers used to demonstrate third-party ratings in advertisements complied with the Marketing Rule, such as (i) reviewing publicly disclosed information about third-party questionnaire or survey methodologies; (ii) obtaining the questionnaires or surveys used in the preparation of the rating; and (iii) seeking representations from third-party rating agencies regarding how the questionnaires were designed, structured and administered.

• Clear and prominent disclosures: Use of third-party ratings in advertisements without some or all of the required clear and prominent disclosures, including for example, failure (i) to identify the date of the rating or period of time to which it applied, (ii) to clearly identify the provider of the ranking; and (iii) to disclose whether any direct or indirect compensation was paid in connection with obtaining or using the rankings.

Key Takeaways

• The SEC continues to focus squarely on marketing activities by investment advisers. Reviewing compliance with the Marketing Rule continues to be an SEC priority during examinations.
• Advisers are “on notice” as to all of the issues identified in the Alert and the Division’s expectations regarding those issues. Now that the Division has published its observations and expectations on these issues, the SEC may decide to bring enforcement actions if it encounters similar deficiencies during an examination.
• Even though many advisers undertook a comprehensive review of their marketing materials in the lead-up to the implementation of the Marketing Rule, advisers should continue to take a fresh look at all marketing materials in light of the ongoing SEC guidance and Division pronouncements.
• Advisers should ensure that their Marketing Rule policies are tailored to their firm’s specific advertisements, practices and business model, and that the policies actually are implemented and followed. In the Alert, the Division identified advisers that had adopted policies with respect to testimonials and endorsements but did not implement them and disseminated advertisements that did not appear to comply with the Marketing Rule.
• The deficiencies cited in the Alert demonstrate the breadth of the prohibitions in the Marketing Rule and the various ways for the Division staff to find fault with advertisements on websites, social media accounts, pitch books, email communications and other marketing materials.

Looking Ahead

The Division’s Risk Alerts can be an indicator of where the SEC will focus its enforcement efforts for registered investment advisers. Despite the change in administration, the continued issuance of Risk Alerts related to the Marketing Rules indicates that as in prior years, the Division will continue to conduct robust examinations of Marketing Rule compliance and could make referrals to the SEC’s Division of Enforcement.