SEC Announces Focus Areas for Next Stage of Marketing Rule Exams

On June 8, 2023, the Division of Examinations (EXAMS) of the Securities and Exchange Commission (the SEC) published a Risk Alert regarding its priorities for the next stage of examinations with respect to Rule 206(4)-1 (the Marketing Rule).¹  EXAMS’ additional stated priorities are: (i) “testimonials” and “endorsements”; (ii) third-party ratings; and (iii) accurate completion of the new “Marketing Activities” sub-item on Form ADV.

To prepare for this next round of Marketing Rule examinations, SEC-registered investment advisers should be reviewing their current and future engagements and relationships with ”promoters” (including placement agents, solicitors, finders, investor referral networks or programs, affiliate referral programs, lead-generation firms, and platforms or networks that make advisers or private funds accessible to investors) to ensure compliance with the disclosure, oversight, written agreement, and disqualification requirements of the Marketing Rule’s “testimonial” and “endorsement” framework.²  SEC-registered investment advisers should also be reviewing their advertisements for compliance with the disclosure and due diligence requirements with respect to third-party ratings, rankings, and awards and for accurate responses to the new Marketing Rule-related Form ADV questions.

While the new Risk Alert indicates new focus areas for the Marketing Rule in exams, EXAMS did not provide any observations from the examinations it has conducted since the end of the compliance period on November 4, 2022. In addition, neither EXAMS nor the Division of Investment Management has provided any additional material written public guidance on the wide range of interpretative questions with respect to the Marketing Rule since November 4, 2022, with the sole exception of the FAQ on January 11, 2023, with respect to application of the net performance requirement to the performance of individual investments.³

Focus Areas in First Risk Alert

This is the second Risk Alert regarding the Marketing Rule,⁴  and the first issued by EXAMS since the beginning of enforcement of the Marketing Rule on November 4, 2022.

In the prior Risk Alert, EXAMS stated that its focus areas would be: (i) policies and procedures reasonably designed to prevent violations of the Marketing Rule; (ii) adherence to a “substantiation requirement” that advisers have a reasonable basis for believing that they are able to substantiate material statements of fact in advertisements; (iii) compliance with performance advertising requirements; and (iv) maintenance of adequate books and records.

In the second Risk Alert, EXAMS states that it will continue to focus on these areas, emphasizing the importance of written policies and procedures. It also emphasize that it will continue to focus on whether any advertisements have violated the “general prohibitions.”

Testimonials and Endorsements

With respect to testimonials and endorsements, EXAMS states that it will focus on:

• Required Disclosures — containing, in particular, the inclusion of clear and prominent disclosures regarding whether the person giving a testimonial or endorsement (a Promoter) is a client or investor, the compensation of the Promoter, and/or a statement of conflict of interest of the Promoter
• Oversight of Promoters — sufficient compliance oversight by advisers to ensure that they have a reasonable basis for believing that the testimonials or endorsements comply with the Marketing Rule
• Written Agreements — required written agreements under the Marketing Rule are entered into between investment advisers and Promoters (excluding communications by affiliates whose affiliation is readily apparent and Promoters receiving de minimis compensation)
• “Bad Actor” Disqualification — whether the adviser knew, or reasonably should have known, that the promoter was an “ineligible person” (commonly known as “bad actors” and defined in the Marketing Rule)

“Promoter” is an expansive concept that can pick up a range of relationships, including, but not limited to, U.S. or non-U.S. placement agents (soliciting either U.S. or non-U.S. investors for U.S. and non-U.S. funds), solicitors, finders, investor referral networks or programs, affiliate referral programs, lead-generation firms, and platforms or networks that make advisers or private funds accessible to investors. SEC-registered investment advisers should review for whether they have any such relationships and any contracts or other agreements with any such active relationships and for future relationships. Please see our Practical Guide to the Application of the Marketing Rule to Private Fund Placement Agents for additional information on the requirements with respect to private fund placement agents.

Third-Party Rankings

Regarding third-party rankings, EXAMS states that it will focus on:

• Required Disclosures — provision of certain clear and prominent disclosures regarding (i) the date; (ii) the time period covered; (iii) the identity of the third party; and (iv) any compensation paid by the adviser in using or obtaining a third-party rating
• Required Due Diligence — whether questionnaires or surveys used in third-party ratings meet certain specific requirements, including that they make it equally easy for a participant to provide favorable and unfavorable responses, and are not designed to produce any predetermined results

Investment advisers should review and flag any use of any rating, rankings, or awards used in any “advertisement” to make sure that the above-noted required disclosures have been included and that the required due diligence has been performed.

Form ADV

EXAMS also notes that it will review whether investment advisers have accurately completed the Marketing Rule-related questions on their annual amendments to their Form ADVs.

Investment advisers should review their responses to Item 5.L. of Form ADV Part 1A to make sure that they have submitted accurate responses with respect to (i) performance results (including “hypothetical performance” and “predecessor performance”); (ii) references to specific investment advice (e.g., case studies); (iii) “testimonials” and “endorsements”; and (iv) third-party ratings, rankings, and awards. Some of these terms (in particular, “testimonials”, “endorsements,” and “hypothetical performance”) have technical definitions that are more expansive than their commonly understood meaning, but there is also uncertainty as to how expansively the SEC staff will interpret their meaning under the Marketing Rule.

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As noted, the Risk Alert does not provide any observations from the examinations that have been conducted to date, nor does it provide any additional guidance on the interpretive questions relating to the Marketing Rule. We will continue to monitor these examinations as well as other official and unofficial guidance with respect to the Marketing Rule.

 

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^[1] See SEC Division of Examinations, Risk Alert: Examinations Focused on Additional Areas of the Adviser Marketing Rule (Jun. 8, 2023).
^[2] Please also see our Practical Guide to the Application of the Marketing Rule to Private Fund Placement Agents (Sep. 27, 2022), available at https://www.goodwinlaw.com/en/insights/publications/2022/09/09_28-practical-guide-to-the-application, for additional guidance with respect to placement agents for private funds.
^[3] Please see our Client Alert: SEC Staff Issues Important New Guidance on Presentation of Investment-Level Performance Under the Marketing Rule (Jan. 12, 2023), available at https://www.goodwinlaw.com/en/insights/publications/2023/01/01_12-sec-staff-issues-important-new-guidance, for additional information on this FAQ.
^[4] See SEC Division of Examinations, Risk Alert: Examinations Focused on the New Investment Adviser Marketing Rule, (Sep. 19, 2022).