SEC Examinations to Focus on the New Investment Adviser Marketing Rule | Seward & Kissel LLP
On December 20, 2020, the Securities and Exchange Commission (the “SEC”) adopted reforms under the Investment Advisers Act of 1940 (the “Advisers Act”), which modernized rules that govern investment adviser advertising and payments to solicitors.1 On September 19, 2022, the SEC Division of Examinations published a Risk Alert2 to inform SEC-registered investment advisers, including advisers to private funds, about upcoming review areas during examinations focused on the new Advisers Act Rule 206(4)-1 (the “Marketing Rule”).
The compliance date for the Marketing Rule is November 4, 2022 (the “Compliance Date”). Investment advisers should consider whether they need to update or revise their written policies and procedures to ensure they are reasonably designed to prevent violations of the Marketing Rule.
II. Initial Marketing Rule Exam Initiatives and Areas of Review
The Risk Alert indicated that SEC staff will conduct a broad review through the examination process, for compliance with the Marketing Rule that will include, but will not be limited to, the following areas:
Marketing Rule Policies and Procedures: the SEC staff will review whether investment advisers have adopted and implemented policies and procedures that are reasonably designed to prevent violations of the Advisers Act by investment advisers and their supervised persons, including the Marketing Rule. In the Marketing Rule adopting release, the SEC indicated its belief that for policies and procedures to be effective, they should include objective and testable means reasonably designed to prevent violations of the Marketing Rule, which may include conducting an internal pre-review and approval of advertisements, reviewing a sample of advertisements based on risk, or pre-approving templates.
Substantiation Requirement: the SEC staff will review whether investment advisers have a reasonable basis for believing they will be able to substantiate material statements of fact in their advertisements. To demonstrate this reasonable basis, the Marketing Rule adopting release suggests that an investment adviser could make a record contemporaneous with the advertisement demonstrating the basis for their belief and might implement policies and procedures to address how to meet this requirement. However, if an investment adviser is unable to substantiate the material claims of fact in its advertisements when the SEC staff demands it, the SEC staff will presume that the investment adviser did not have a reasonable basis for its belief.
Performance Advertising Requirements: the SEC staff will review whether investment advisers are in compliance with the performance advertising requirements in the Marketing Rule, including prohibiting the following in an advertisement:
- Gross performance, unless it is accompanied by a presentation of net performance;
- Any performance results, unless they are provided for specific time periods (not applicable to the performance of private funds);
- Any statement that the SEC has approved or reviewed any calculation or presentation of performance results;
- To the extent an advertisement includes the performance of portfolios other than the portfolio being advertised, performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as the portfolio being offered in the advertisement, with limited exceptions;
- Performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio;
- Hypothetical performance, unless the investment adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the investment adviser provides certain additional information; and
- Predecessor performance, unless the personnel primarily responsible for achieving the prior performance manage accounts at the investment adviser and the accounts that were managed by those personnel at the predecessor adviser are sufficiently similar to the accounts that they manage at the investment adviser. In addition, the investment adviser must include all relevant disclosures clearly and prominently in the advertisement.
Books and Records: the SEC staff will review investment advisers for compliance with the amended books and records requirements related to the Marketing Rule. The SEC also amended Form ADV to require investment advisers to provide additional information regarding their marketing practices and reminds investment advisers of their obligation to accurately complete these questions in their next annual Form ADV amendment.
III. S&K Observations
Seward & Kissel strongly urges SEC-registered investment advisers to review their own policies and procedures and to implement any appropriate modifications.