Published on September 7, 2021 by Mary Fernandez
SEC has recently published Marketing Rule 206(4) that applies to investment advisors. Through this article, we bring to light the reforms and modernization of existing guidelines taking into consideration the impacts and changes that technology has on traditional rules.
Here we list out potential effects of this rule and some resulting thoughts around it.
Background of the rule:
The Investment Advisers Act 1940 is a body that regulates companies involved in investing, reinvesting and trading in securities. After a decade of long standing rules the organization has decided to reform and amend the existing rules on December 2020. The Act came into effect on May 4, 2021 by merging the rules that govern investment adviser advertisements and payments to solicitors into one single rule known as the “Marketing rule” to regulate investment advisers marketing communications.
Time period to comply:
The Act was published in the U.S Federal Register on 4th March, 2021 and will be given an 18 month transition period for compliance which lapses on 4th November, 2022.
Changes that led to reformation:
1. Advancements in technology and mode of communications
2. Changes in the expectations of investors seeking advisory services
3. Diversification of profiles in the investment advisory industry
There are broadly three categories that these can be broken down into:
Category 1: Advertisements
Additions to existing rules:
Due to rapidly growing technological advancements and increasing dependence on electronic communications there is an inclusion to regulate both direct and indirect forms of communications with existing and new investors along with clients for new products and services
For example: Third-party social media comments that an adviser endorses or promotes, and non-written communications, such as pre-recorded videos
The rule replaces prohibitions with principle based framework. It relaxes certain prohibitions based on specifications made on past investment recommendations. The act specifies that a company can present specific past investment recommendations in an advertisement excluding a full year of recommendations provided it is portrayed in a fair and balanced manner
The Rule exempts communications with investors in private funds that rely on Section 3(c) (1) or 3(c) (7) from registering as an investment company under the Investment Company Act of 1940
The rule considers direct communications with prospective or current advisory clients to be advertisements only if there is an inclusion of hypothetical performance and the adviser is not providing the hypothetical performance in response to specific and unsolicited questions or requests from the advisory client
The statements made in an advertisement should be true and not misleading and should not omit any details that are material and required to be provided
When questioned or demanded to provide justification for the said statements the advisor should have material evidence and facts to support mentioned statements
The advisor should communicate the exact details mentioned in the statements and not make verbal additions to it
Performances mentioned in the statements should be fair and not misleading. There should not be any over or under statements of it
Spontaneous communications between investors and clients on topics not related to investment products
Communications with existing clients and investors that do not offer new or additional advisory services to be advertisements
Category 2: Testimonies and Endorsements
An advisor that uses testimonials and endorsements in advertisements should abide and comply with the marketing rule
The advisor should mention the identity of the person making a testimonial or an endorsement and whether compensation is provided for it
Additional disclosures for compensation and conflicts of interest can either be a part of the advertisements or provided separately
Advisers generally must enter into written agreements with third parties who will be compensated for testimonials and endorsements
Registered broker-dealers who solicit individuals that are investing for personal, family or household purposes, and certain investment adviser personnel, are generally excluded from the disclosure requirements for testimonials and endorsements
The Rule prohibits advisers from paying any person for a testimonial or endorsement if that person has been subject to certain disqualifying events (fraud, convicted, etc.) under the Advisers Act and violates securities laws or laws laid down by SEC
A person can be excluded from entering into a written agreement where the promoter is an affiliate of the adviser or the promoter is paid minimum value compensation (i.e., $1,000 or less or the equivalent value in non-cash compensation, during the preceding twelve months)
Category 3: Third Party Disclosures
The marketing rule instructs advisors that use third party ratings in advertisements provide appropriate disclosure that the methods of obtaining the foresaid ratings like questionnaires and surveys are fair and not bias
The amended books and records rule requires an advisor to keep copies of all the advertisements. It also requires advisors to document and keep copies of written communications, calculations of performance results, and material evidence that testimonies, endorsements and third party ratings comply with the marketing rule. The record of such copies should also be disclosed to clients and investors
Term 5 of Part 1A of Form ADV will require information about an adviser’s and its relying advisers’ use in any advertisements of (a) performance results, (b) previous investment advice, (c) testimonials, (d) endorsements, and (e) third-party ratings
The rule prohibits the use of third-party ratings in an advertisement, unless the adviser provides disclosures and satisfies certain criteria pertaining to the preparation of the rating.
Firms such as Acuity Knowledge Partners can partners with you to handle and review all the marketing related contents keeping all the changing and latest regulation in mind.
Acuity Knowledge Partners is an influential player in the global market, offering compliance expertise and a wide array of other services. We enable our compliance clients to manage increasing demands on their teams by providing customized managed services solutions, based on specialized skills and technology, and by delivering operational efficiency, resilience, and significant cost savings. We believe our offering is even more relevant in the post-COVID-19 economic and operating environment, where compliance teams have seen a significant increase in workload in tasks such as trade surveillance, communications surveillance, distribution compliance and virtual client on-boarding and transaction monitoring. Please refer to Acuity’s compliance offerings in details here.
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About the Author
Mary Ann Fernandez is an associate and has been associated with Acuity Knowledge Partners for about 3 years now. At Acuity Knowledge Partners she is part of the corporate and forensic compliance team where she monitors and surveils electronic communication for a client. She is a graduate who specialized in Finance and Accounting and holds a Bachelor’s degree from Christ University, Bangalore.
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