The Securities and Exchange Commission (SEC) is proposing major changes to how investment advisers can advertise their services. The amendments to the Investment Advisers Act are intended to bring the rules into the modern age.

“The advertising and solicitation rules provide important protections when advisers seek to attract clients and investors, yet neither rule has changed significantly since its adoption several decades ago,” SEC Chairman Jay Clayton said in a press statement. “The reforms we have proposed today are designed to address market developments and to improve the quality of information available to investors, enabling them to make more informed choices.”

Advertising Restrictions Under Rule 206(4)-1

Investment advisers rely on advertisements to attract new clients and encourage existing ones to try new services. However,  Rule 206(4)-1 under the Investment Advisers Act of 1940 (Advisers Act) imposes significant restrictions on how advertising can be used, with the goal of protecting investors from potential conflicts of interest and misleading ads.

In addition to prohibiting any advertisement which contains any untrue statement of a material fact, or which is otherwise false or misleading, the current rule prohibits testimonials concerning the investment adviser or its services. It also bans direct or indirect references to specific profitable recommendations that the investment adviser has made in the past, as well as representations that any graph or other device being offered can by itself be used to determine which securities to buy and sell or when to buy and sell them. In addition, the current rule prohibits any statement to the effect that any service will be furnished free of charge, unless such service actually is or will be furnished entirely free and without any condition or obligation.

Proposed Amendments to the Advertising Rule

Since the Advisers Act rules were first enacted, technology has advanced significantly. The nature of the investment advisory industry has also evolved, along with the types of investors seeking and receiving investment advisory services. In response, the SEC’s proposed amendments to Rule 206(4)-1 seek to replace the current rule’s broadly drawn limitations with principles-based provisions.

One of the most basic changes is in the definition of the term “advertisement” itself. The SEC is proposing to define the term so that it is flexible enough to remain relevant and effective in the face of advances in technology and evolving industry practices. The definition of “advertisement” would include any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser. Proposed exclusions from the definition include:  (1) live oral communications that are not broadcast, (2) responses to certain unsolicited requests for specified information, (3) advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other Commission rules; and (4) information required to be contained in a statutory or regulatory notice, filing, or other communication.

The new rule would generally prohibit the following advertising practices: 

• Making an untrue statement of a material fact, or omission of a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading; 
• Making a material claim or statement that is unsubstantiated; 
• Making an untrue or misleading implication about, or being reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the investment adviser; 
• Discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations; 
• Referring to 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 
• Being otherwise materially misleading.

The proposed amendments clear the way for the use of testimonials, endorsements, and third-party ratings. More specifically, the proposal would permit testimonials and endorsements, subject to specified disclosures, including whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the adviser. The proposed rule would also allow third-party ratings, subject to specified disclosures and certain criteria pertaining to the preparation of the rating.

The SEC’s proposed amendments to Rule 206(4)-1 establish certain restrictions for advertisements containing performance information. The proposal would prohibit including the following in any advertisement:

• Gross performance results unless it provides (or offers to provide promptly) a schedule of fees and expenses deducted to calculate net performance; 
• Any statement that the calculation or presentation of performance results has been approved or reviewed by the Commission; 
• Performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered or promoted in the advertisement, with limited exceptions; 
• Performance results of a subset of investments extracted from a portfolio, unless it provides or offers to provide promptly the performance results of all investments in the portfolio; and 
• Hypothetical performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient and the adviser provides certain specified information underlying the hypothetical performance.

The proposed rule would provide additional protections for an advertisement targeted to a retail audience. They include requiring the presentation of net performance alongside any presentation of gross performance; and requiring generally the presentation of the performance results of any portfolio or certain composite aggregations across 1-, 5-, and 10-year periods.

Lastly, the proposed amendments would require advertisements to be reviewed and approved in writing by a designated employee before dissemination, except for advertisements that are:  (1) communications disseminated only to a single person or household or to a single investor in a pooled investment vehicle; or (2) live oral communications broadcast on radio, television, the internet, or any other similar medium.

Key Takeaway for Investment Advisers

The SEC’s proposed rules lessen several of the advertising restrictions placed on investment advisers. Once they become final, advisers should revise their policies and procedures accordingly. It is also important to recognize that while certain inclusions in advertisements are now allowed, such as testimonials, endorsements and third-party ratings, they are subject to restrictions, and advisers must still make compliance a top priority.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.