On September 19, 2022, the SEC’s Division of Examinations published a Risk Alert dealing with the Commission’s initial areas of review of Registered Investment Advisers’ (RIAs) compliance with the Marketing Rule. In its latest Risk Alert published on June 8, 2023, SEC staff added to the list of areas that will be under the microscope during examinations.
The Division of Examinations’ previous Marketing Rule Risk Alert stated that examinations would focus on the following requirements:
- Implementing policies and procedures that are reasonably designed to prevent Marketing Rule violations by RIAs and their supervised persons;
- Substantiation of material statements of fact in advertisements, which means advisers must have a reasonable basis for believing they will be able to prove them if called upon to do so;
- Performance advertising compliance obligations; and
- Books and records related to advertisements RIAs disseminate, including internal working papers, performance-related data, and documentation pertaining to oral advertisements, testimonials, and endorsements.
The June 8, 2023 Risk Alert made it clear that RIAs can expect examiners to look closely at the above areas, as well as other important provisions of the Marketing Rule.
Seven general prohibitions in the Marketing Rule
RIAs and Chief Compliance Officers should take note of the Marketing Rule’s general prohibitions whenever they advertise. The Marketing Rule prohibits the following advertising practices:
- Making an untrue statement of a material fact, or omitting a material fact that is necessary to avoid making a statement misleading under the circumstances;
- Making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate if requested to do so by the SEC;
- Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact about the adviser;
- Discussing any potential benefits without providing a fair and balanced treatment of any related material risks or limitations;
- Referencing specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
- Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and
- Including information that is otherwise materially misleading.
The Marketing Rule’s general prohibitions apply to performance advertising. The rule also established specific restrictions on advertisements containing performance results.
Testimonials and endorsements
Examiners will ascertain whether RIAs are in compliance with the Marketing Rule’s requirements that apply to advertisements containing testimonials and endorsements. RIAs must clearly and prominently disclose whether the person giving the testimonial or endorsement, referred to as the promoter, is a client or investor. If applicable, RIAs must disclose if the promoter is compensated. In addition, firms must disclose all material conflicts of interest.
Oversight conditions must be satisfied. For example, advisers must have a reasonable basis for believing that the testimonials or endorsements disseminated comply with all requirements of the Marketing Rule.
Subject to certain exceptions, RIAs must enter into written agreements with promoters. As an example, a written agreement is not needed where the promoters are applicable affiliates of the adviser, and this affiliation is readily apparent or disclosed or the promoters receive de minimis compensation. De minimis compensation is defined as the receipt of $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months.
Examiners will investigate whether ineligible persons have been compensated for testimonials or endorsements. They will be on the lookout for situations where the adviser knew, or reasonably should have known the person was ineligible. The Risk Alert warned that certain “bad actors” are prohibited from acting as promoters unless they qualify for an exemption.
Third-party ratings
According to the Risk Alert, examiners will be scrutinizing RIAs using third-party ratings in advertisements. When advertising these ratings, an RIA must provide, or reasonably believe that the third-party rating provides, clear and prominent disclosure of:
- the date when the rating was given and the time frame upon which the rating was based;
- the identity of the third party that created and tabulated the rating; and
- any compensation that has been provided, directly or indirectly, by the adviser to obtain or use the third-party rating.
Questionnaires or surveys used to prepare a third-party rating must satisfy certain conditions. The adviser must have a reasonable basis for believing that the questionnaire or survey is structured to make it equally easy for a participant to provide favorable and unfavorable responses. The questionnaires and surveys should not be designed to achieve any predetermined result.
Takeaways
The Risk Alert also warned RIAs that their Form ADVs must provide additional information regarding their marketing practices. RIAs should disclose whether they are using advertisements containing performance, testimonials, endorsements, and third-party ratings. Examiners will determine whether RIAs accurately answered the questions in their annual Form ADV amendments.
RIAs should take note of Risk Alerts like this one in order to evaluate their supervisory and compliance policies and procedures. They should use the information in this Risk Alert to strengthen their policies and procedures.
The Division of Examinations’ Risk Alert is available here or at https://www.sec.gov/files/risk-alert-marketing-rule-announcement-phase-3-060823.pdf.
About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.
RIA Compliance Group, LLC – 701 SE 6th Ave, Suite 201, Delray Beach, FL 33483 – Tel: 561-600-0564 – sales@ria-compliance.com
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