On September 14, 2017, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published a Risk Alert, which revealed the most frequent advertising rule compliance issues identified in OCIE examinations of Registered Investment Advisers (“RIAs”). OCIE’s objective in providing this guidance was to encourage advisers to evaluate their advertisements and consider whether those advertisements are consistent with the Advertising Rule, the prohibitions of Section 206, and their fiduciary duties. The Risk Alert was also intended to motivate RIAs to review the adequacy and effectiveness of their compliance programs.
Rule 206(4)-1 under the Investment Advisers Act prohibits an RIA from using advertisements that are false or misleading in any way. The rule also prohibits advertisements containing:
- Testimonials;
- References to past specific recommendations that were or would have been profitable unless several conditions are satisfied;
- A graph, chart, formula or other device that can be used by itself to make investment decisions unless the advertisement prominently discloses the limitations on this approach; and
- Offers of a free report, analysis or other service unless it will provided entirely free and without obligation.
State advertising rules contain similar prohibitions.
Compliance issues raised by the risk alert
In the Risk Alert, OCIE staff identified the following Advertising Rule deficiencies:
Misleading performance results. OCIE staff observed that RIAs were presenting performance returns without deducting advisory fees, which is a requirement established by the Clover Capital no-action letter. Examiners also found advertisements containing hypothetical and backtested performance results without explaining how these returns were derived. The ads failed to disclose material information.
Misleading one-on-one presentations. OCIE staff reported finding misleading one-on-one presentations. There are specific disclosures required in conjunction with one-on-one presentations.
Misleading assertion of compliance with voluntary performance standards such as GIPS.
Cherry-picking of profitable stock selections. OCIE staff observed that certain RIAs’ advertisements only included their profitable securities recommendations. The RIAs did not satisfy Rule 206(4)-1(a)(2).
Misleading selection of investment recommendations. OCIE examiners found that RIAs misled investors by including only certain recommendations to illustrate a specific investment strategy. For example, the RIAs advertised their best performing holdings without listing the same number of worst performers.
Policies and procedures. OCIE staff came to realize that some advisers had not implemented policies and procedures that were reasonably designed to prevent deficient advertising practices, such as a process for reviewing and approving advertising materials prior to their publication or dissemination.
OCIE’s Touting Initiative
OCIE’s Risk Alert also discussed the its 2016 Touting Initiative, which examined the adequacy of disclosures that RIAs provided to their clients when touting awards, ranking lists, and/or accolades in their marketing materials. The Touting Initiative was prompted by examiners’ discovery that advisers advertise these accolades without disclosing material facts about them.
The Touting Initiative focused on:
- Misleading advertising of third-party rankings or awards;
- Misleading advertising of professional designations; and
- Testimonials.
OCIE staff found that advisers published potentially misleading advertisements by not disclosing the selection criteria for accolades, who created and conducted the survey, and whether firms paid a fee to participate. OCIE staff observed advertisements touting that advisers received high rankings in various publications, even though those ratings were old and were no longer applicable.
In addition, OCIE staff observed advertisements and disclosures made in advisers’ Form ADV Part 2B brochure supplements, which contained potentially false or misleading references to their professional designations.
OCIE staff also found that RIAs had published client testimonials. Testimonials from clients are prohibited whether they are published on the firm’s website, social media pages, reprints of third-party articles, or pitch books.
Conclusion
After OCIE examiners spotted these deficiencies, RIAs elected to remove misleading language or to add disclosures to correct them. Nevertheless, disclosures are not the remedy to all compliance deficiencies. For example, disclosures will not make an advertisement with testimonials compliant.
The Risk Alert can be found Here.
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