In 2020, the SEC formalized Rule 206(4)-1 (the Marketing Rule) under the Investment Advisers Act of 1940 (the Advisers Act) with the goal of codifying the multiple sources of guidance and case law that had accumulated over the years regarding the promotion of services under the previous regime. Since its implementation, investment advisers have faced challenges due to the regulation’s ambiguity. Despite the Staff’s initial release of a two-item FAQ to clarify the adoption time frame and reporting period for the Marketing Rule, many substantive questions remained well after the November 2022 compliance date.
Who Is Impacted?
Registered Investment Advisers (RIAs) are directly impacted by the Marketing Rule. The Advisers Act defines investment advisers as any person or firm that is engaged in the business of providing advice to others or issuing reports or analyses regarding securities for compensation. The Marketing Rule sets standards for how RIAs market their services, including presenting performance data, substantiating claims and ensuring advertisements are “fair and balanced.”
Key questions that arose in the industry following the adoption of the Marketing Rule included:
- Can firms present gross performance for a single investment if net performance for the entire portfolio is also shown?
- What practical criteria does the SEC expect to meet the “fair and balanced” standard in advertisements?
- What types of evidence are needed to substantiate both express and implied claims?
Questions in the industry surrounding the presentation of gross and net performance led the Staff to update the FAQ again in 2023 and 2024. These updates clarified that net performance advertising must be presented in all circumstances, including for single asset investments. They also specified that gross and net performance must be calculated using the same time frame and methodology and highlighted the importance of accurately calculating an internal rate of return (IRR) when subscription lines of credit are used. See, SEC Marketing Compliance Frequently Asked Questions (Feb. 6, 2024).
Where We Are Today
For the first time, when completing the 2023 Form ADV, RIAs were asked questions about their marketing practices: Did the firm’s marketing materials include performance? Did they offer specific investment advice or include testimonials, endorsements, or third-party ratings? If so, was cash or non-cash compensation provided in connection with these? Did any marketing materials contain hypothetical or predecessor performance?
To answer these questions accurately, firms first needed to review their marketing materials collectively to understand their overall marketing landscape. Subsequently these questions helped the SEC assess the firm’s risks and exam candidacy. A year later, the Investment Advisers Association (IAA) released a report compiling data from these public disclosures, highlighting key findings.
- 6% of RIAs presented performance information in marketing
- 5% of RIAs include hypothetical performance
- 2% included endorsements (from non-investors), while only 8% included testimonials (from investors).
See, IAA, “Investment Adviser Industry Snapshot 2024.”
While the firms brought to enforcement are likely reeling from the penalties associated with these violations, these actions provided a wake-up call for others in the industry whose own practices may not fully meet Marketing Rule requirements. Investor relations, along with legal and compliance teams, must collaborate on the production of all advertising materials to ensure regulatory compliance.
Lack of Hypothetical Performance Controls
In April 2024, the SEC charged five RIAs and ordered collective six figure fines when it determined that the firms advertised hypothetical performance to the general public on their websites without implementing policies and procedures to ensure the hypothetical performance was relevant to the likely financial situation and investment objectives of each advertisement’s intended audience, as required by the Marketing Rule. Further, in August 2024, a sixth RIA was charged and fined six figures for similar misuse of hypothetical performance that was disseminated to a mass audience on its website rather than presenting hypothetical performance relevant to the likely financial situation and investment objectives of the intended audience. See, SEC, Administrative Proceeding File No. 3-21987, In the matter of The Pacific Financial Group, Inc. (Aug. 9, 2024).
In the April 2024 Risk Alert, the SEC reviewed if investment advisers had implemented written policies to prevent violations of the Investment Advisers Act and Marketing Rule. The agency observed instances where advisers’ policies and procedures were not adequately designed or implemented to ensure compliance with the Marketing Rule. For example, the SEC found that advisers’ policies were often too general, failed to address specific marketing channels like websites and social media, were informal or unwritten, and were incomplete or not fully updated. See, “Initial Observations Regarding Advisers Act Marketing Rule Compliance” (April 17, 2024).
For effective compliance, firms should ensure their policies include clear, objective, testable methods and controls. This could involve conducting internal pre-reviews and approvals of advertisements, regularly reviewing a sample of advertisements based on identified risks and pre-approving advertisement templates to ensure consistency and adherence to the rules. These steps help create a robust framework to prevent violations and demonstrate a proactive approach to compliance with the Marketing Rule.
While the Marketing Rule provides flexibility as to how advisers conduct this oversight, we believe that maintaining clear policies regarding controls would be a key component of maintaining compliance.
Substantiation Requirement
Recent SEC examinations show increased scrutiny of marketing materials, including statements of fact and performance. Initial requests typically ask for advertisements and marketing materials distributed during the review period, followed by supplemental requests for documents to substantiate specific claims made or in support of performance numbers presented. Claims made or performance included in advertising that cannot be substantiated may raise the risk of a firm being brought to enforcement.
In September 2024, the SEC brought charges against nine RIAs for violating the Marketing Rule, in part for disseminating advertisements they could not substantiate. See, “Press Release: SEC Charges Nine Investment Advisers in Ongoing Sweep into Marketing Rule Violations” (Sept. 9, 2024). These ads included false claims about third-party ratings, unsubstantiated claims of conflict-free advisory services, and misleading testimonials and endorsements. Some firms also used outdated third-party ratings without proper disclosure. The firms were fined a collective $1.24 million in civil penalties.
It is important that firms maintain a log of all marketing material that meets the SEC’s definition of “advertising” and ensure claims can be adequately substantiated with factual, documented support. For example, if an investor presentation claims a fund’s default rates consistently outperform a specific index, the adviser must maintain clear documentation of the default rate numbers and details about the comparison group, including how the default rates are tracked.
Similarly, if an advertisement claims that robust due diligence and monitoring has resulted in lower defaults compared to the market, the adviser must be able to evidence this with documentation.
Lastly, if an advertisement claims a fund’s strategy is expected to generate significantly higher returns than similar market strategies or benchmarks, the adviser must provide the calculations and data supporting these claims, as well as explain how the statement fairly represents any associated risks or limitations.
These examples illustrate the importance of thorough documentation and clear, detailed explanations to support marketing statements and comply with regulatory requirements during an examination.
Kroll’s Marketing Review Team Observations
Kroll evaluates several hundred marketing documents per quarter and has observed several trends, specifically related to the Marketing Rule’s seven general prohibitions (see, 17 CFR 275.206(4)-1 — Investment adviser marketing), some of which are highlighted below:
- Lack of Disclosures, or Missing Details: Although the Marketing Rule requires disclosures when marketing testimonials or endorsements, third-party rating, predecessor performance and hypothetical performance, we know from the SEC’s Final Rule that lack of disclosures generally can make information appear false or misleading. Disclosures in marketing decks often fail to adequately describe the adviser’s calculation methodologies related to performance, or other pertinent details that would aid a reasonable investor in understanding the information being presented. Additionally, an adviser may experience a performance anomaly due to an unusual circumstance but fail to provide a disclosure explaining the context of such performance, leading to information that can be deemed misleading. Alternatively, some firms include disclosures or provide details about information not pertinent to the page, which may lead regulators to the view that other information in the advertisement may not have been adequately reviewed or updated.
- Unsupported Statements of Fact: Firms often make statements about their investment advisory business or funds that seem factual but are actually They also frequently use superlatives that are difficult to substantiate. It’s important to hedge such language to clarify these are opinions (e.g., “we believe,” “we expect,” “in our opinion”).
- Performance:
- Hypothetical: The Marketing Rule requires advertisements to show net performance alongside gross performance with equal prominence, using the same time period and This remains challenging for RIAs as they may need to create hypothetical net performance metrics and include detailed disclosures to assure investors of the calculation methods and inputs used.
- IRRs: The same metric must be applied to IRRs. For example, if an adviser excludes the impact of fund-level borrowing in gross IRR, they cannot include it in net IRR. Presenting inconsistent methodologies or time periods for gross and net IRR would violate the Marketing Rule.
- Predecessor performance: Predecessor performance can be included only if the personnel primarily responsible for achieving the prior performance manages similar accounts at the advertising adviser, all relevant disclosures are clearly and prominently provided, and supporting documentation is maintained.
- Fee Calculations: The adviser may not use lower fees in calculations for net of fees performance returns than were offered to the intended Nor may the adviser omit material information, including calculation methodologies, regarding fees and expenses used in calculating returns.
- Extracted Performance: Firms will often cherry-pick their best performing assets or the best performing funds in their marketing materials. The SEC’s Marketing Rule Risk Alert also highlights this is a common finding. (See, “Initial Observations Regarding Advisers Act Marketing Rule Compliance” (April 17, 2024).) Advertisements must include performance results from all portfolios with similar investment policies, objectives, and strategies, and must provide or offer to provide the performance results of the total portfolio if only a subset of investments is shown. The Marketing Rule requires that performance be presented in a fair and balanced manner.
- Unreadable Disclosures/Footnotes: When including disclosures and footnotes, advisers often use a font size or color that is unreadable, or place a disclosure in a way that makes it difficult to connect what is being disclosed with the information presented. Information — especially material that is important for an investor to understand — that is not easily readable may be deemed misleading, a violation of the Marketing Rule’s general prohibitions. Kroll recommends that font color not be lighter than the color presented on the slide, and the size be kept to an eight-point font minimum. (SEC’s Rule 2a-7 under the Investment Company Act of 1940 includes requirements for disclosures in mutual fund One of these requirements is that disclosures must be in a minimum font size of 8 points.) Additionally, disclosures should be added directly to the page with the accompanying footnote or a reference to where they can be found on a separate page.
- Outdated information: While the Marketing Rule does not specify that firms use the most recent information available to them, information in adviser’s materials may become stale overtime. Such stale information, consequently, can be deemed misleading, as it does not provide investors with accurate information.
- Benchmarks: Comparing fund performance to certain benchmarks has been a staple in RIA marketing for years, and nothing in the Marketing Rule prohibits the use of benchmarks; the SEC in its Final Rule agreed that that the use of index-based data can be informative to investors as a benchmarking tool. However, RIAs that benchmark performance in a way that leads to misleading comparisons (e.g., comparing a private equity fund’s performance to the S&P 500) may ultimately bring greater scrutiny from the SEC. Benchmark index comparisons that lack a clear definition of the index or sufficient context for understanding the basis of the comparison were cited in the SEC’s April 2024 Risk Alert.
- Failing to Maintain Required Records: Rule 204-2 under the Investment Advisers Act, also known as the “Books and Records Rule,” mandates that RIAs maintain copies of each advertisement and all documents necessary to substantiate the calculation of any performance or rate of return. While RIAs typically have standard marketing materials (g., pitchbooks, quarterly letters) readily available, they often lack easily accessible support for performance figures and may not retain online sources cited in marketing materials, such as website articles or other data. Firm’s that only maintain the URL citation may face challenges if the URL changes or is no longer available. This can lead to difficulties during exams as advisers scramble to find information that may no longer be available. Additionally, RIAs using predecessor firm performance in their marketing materials face the added hurdle of obtaining permission from former employers to access supporting documentation for prior performance.
Key Takeaways
Navigating the SEC’s Marketing Rule is fraught with complexities and potential pitfalls. However, mastering its major elements is crucial for protecting a firm from exam deficiencies or, worse, referrals to the SEC’s Division of Enforcement. Here are some key takeaways for legal and compliance professionals assisting RIAs in their marketing activities.
- Review Policies and Procedures: We recommend that advisers thoroughly review their practices, policies, and procedures in light of the initial examination review areas for the Marketing Rule. Advisers should implement necessary modifications to their training, supervisory oversight, and compliance programs to ensure full compliance and enhance their operational effectiveness.
- Include Robust Disclosures: While the Marketing Rule is prescriptive in the required disclosures necessary for the use of testimonials and endorsements, detailed disclosures are often needed to meet the “fair and balanced” condition of the Marketing Rule, as well as the requirement not to be “misleading.”
- Substantiate Statements of Fact: A common practice in RIA advertisements is to make certain claims about the adviser’s business: How it’s a “unique,” “leading” or “top” firm; that the RIA has an “unrivaled” proprietary approach with “unmatched performance”; or perhaps the investment team has “superior expertise.” While there may be merit to these statements, the Marketing Rule’s requirement that advisers “substantiate material statements of fact” makes it difficult for RIAs to substantiate these claims as factual to the SEC — whose “material” threshold is broad. It is unlikely that the SEC would find exaggerated or unsubstantiated language in marketing materials acceptable; therefore, when reviewing marketing materials, we often advise clients to hedge these claims, as they may be difficult to substantiate as factual. Alternatively, we recommend clearly stating that these statements represent the adviser’s opinion.
- Maintain Supporting Documentation: Advisers must be able to provide documented support for factual statements or performance data in marketing While they have discretion over the format and scope, the documentation must objectively support the claims. When in doubt, consider: Can I cite my source? Where is the supporting documentation located? If third-party created, is it reasonable?
- Ensure Benchmarks Are an Apples-to-Apples Comparison: Advisers should ensure that fund performance comparisons with benchmarks or industry averages are fair and Misaligned comparisons may be considered misleading under the Marketing Rule.
- Involve Compliance: The key takeaway from recent enforcement actions and the SEC’s April 2024 Risk Alert is that compliance must be involved. Due to the Marketing Rule’s nuances and gray areas, compliance can help ensure that requirements are met before approving any marketing materials. This often requires compliance review, final approval of any changes and oversight of marketing channels, such as social media and websites. Proper governance and oversight of marketing are crucial.
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Colleen Corwell is the Managing Director and head of U.S. Compliance Consulting at Kroll, based in New York. With over 20 years of experience, she has served as Chief Compliance Officer for more than 20 firms, including registered investment advisors, investment companies and broker-dealers. Colleen has held senior positions at ACA, Foreside Financial, Alaric Compliance, Ameriprise, Capital One, and ING. She holds a B.A. from The College of William and Mary, an MBA from Touro University, and has completed the Corporate Governance Program at The Wharton School. Colleen is also a Certified Anti-Money Laundering Specialist (CAMS) and holds multiple FINRA registrations. Outside of her professional career, she was the Head Coach of the Division I Women’s Soccer Team at American University and is currently a yoga teacher in New York City.
Shannon Nolan is a Vice President in the Financial Services Compliance and Regulation practice at Kroll, based in New York. With nearly three years of experience, she supports SEC-registered investment advisers, including private equity and hedge fund managers, in navigating complex regulatory environments. Shannon holds a Juris Doctorate from the University of Connecticut School of Law and a Bachelor of Arts in Communications from Drexel University. She is admitted to practice law in Connecticut and serves on the board of incorporators for Kurn Hattin Homes, a charitable residential home and school for children in need.
Nikolas Simonlacaj is an Analyst in the Financial Services Compliance and Regulation practice at Kroll, based in New York. Nikolas assists SEC-registered investment advisers navigate an intricate regulatory landscape by conducting thorough analyses of federal securities regulatory requirements and providing advisers with tailored advice and testing to enhance and strengthen their compliance programs. Nikolas graduated Cum Laude with a Juris Doctorate from the Elisabeth Haub School of Law at Pace University. He received a Bachelor of Arts in Communications from Boston University.
This article appeared in Business Crimes Bulletin, an ALM/Law Journal Newsletters publication that features the news and analysis you need to stay on top of the fast-changing, multi-faceted world of financial and white-collar crime.