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Written by: Samuel Guy and Thomas Yates
On April 17, 2024 the Division of Exams (“EXAMS” or “the staff”) released a Risk Alert: Initial Observations Regarding Advisers Act Marketing Rule Compliance. This Risk Alert highlights areas of focus for Advisors to stay in compliance with the Rule 206(4)-1 (the “Marketing Rule”) as discovered through the staff’s preliminary assessments and findings concerning the updated rule.
Observations Regarding the Compliance Rule, Books and Records Rule, and Form ADV
The staff's review of whether Advisors adopted and implemented written policies and procedures reasonably designed to prevent violations produced the following findings, including deficiencies:
Policies and Procedures
The staff generally observed that compliance policies and procedures were updated to comply with the Marketing Rule. It was also observed that further steps were often taken; Advisors typically held training on the Marketing Rule’s requirements, Advisors implemented policies and procedures for reviewing marketing materials, and Advisors required pre-approval of marketing materials before dissemination. However, the staff also observed some common deficiencies concerning policies and procedures and the Marketing Rule, which are as follows:
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Policies and Procedures were general, informal, or not fully updated to cover all applicable marketing topics, or not properly implemented in the Advisor’s marketing materials.
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Policies and Procedures cover the General Prohibitions of the Marketing Rule, but do not cover the specific types of marketing materials utilized by the Advisor, such as testimonials or third-party ratings.
Books and Records
The staff observed that Advisors updated their practices to reflect the Marketing Rule’s books and records maintenance and preservation requirements, however, some common deficiencies were also observed:
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Questionnaires or surveys used in preparation for a third-party rating were not archived.
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Social Media posts were not archived.
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Documentation to support performance claims were not maintained.
Form ADV
The staff observed that Advisors updated their ADV documents in response to the Marketing Rule. However, the Staff did observe misreporting in ADV1 Item 5.L, where the Advisor utilized a certain type of marketing (i.e. Performance results, Third-party rating) that was not disclosed. Further, some Advisors had inaccuracies in ADV2 Item 14 as they were not properly disclosing their referral arrangements.
Observations Regarding Compliance with the Marketing Rule’s General Prohibitions
The staff’s review of the Marketing Rule assessed whether the Advisor’s marketing materials violated any of the General Prohibitions. Common deficiencies of these are organized by the prohibition, and are as follows:
Untrue statements of material fact and unsubstantiated statements of material fact.
The following are some instances of untrue statements in advertising materials observed by the staff during their preliminary assessment:
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Advertisements stated the Advisor was free of all conflicts of interest when conflicts did exist.
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Advertisements that misrepresent the Advisors’ business, such as misreporting the individuals performing advisory services, the qualifications of individuals employed by the Advisor, or awards granted to the Advisor.
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Advertisements that misrepresent facts about the Advisors’ investment processes, such as claiming these processes were validated by professional institutions or followed certain mandates, such as ESG, when this could not be substantiated by the Advisor.
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Advertisements in which Advisors could not substantiate investment practices, such as stating the client’s risk tolerance were considered, referencing security screening processes that did not exist, or referencing a list of approved securities that did not exist.
Omission of material facts or misleading inference.
The following are the primary instances of omission of material facts or misleading inference in advertising materials observed by the staff:
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Advisors attempted to differentiate themselves by stating they “acted in the best interest of clients” without disclosing that all Advisors have a fiduciary duty to act in the client's best interest.
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Advisors recommended certain investments in advertising materials without disclosing the compensation received by the Advisor for the recommendation.
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Advisors misrepresented the requirements of being SEC-registered. For example, Advisors implied that SEC registration represented a particular level of skill, or that the SEC had approved the firm's business practices, sometimes by including the SEC logo on their website or marketing materials.
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Advertisements containing third-party rankings did not disclose that other Advisors received the award and implied they were the sole recipient, or did not include the necessary disclosures explaining the methodology behind the ranking.
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Advertisements containing testimonials did not include context around what the testimonial was endorsing. In one instance, the Advisor included testimonials for a third-party product but represented the testimonial as being about the Advisors’ services.
Omission of material facts or misleading inference related to performance.
The following are the primary instances of omission of material facts or misleading inference related to performance advertisements observed by the staff:
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Facts included in performance marketing materials included outdated market data information or investment products and fees that are no longer available to clients.
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Marketing materials that omitted necessary context around performance results. For instance, omitting context around fees and expenses when calculating returns, or omitting context around general market performance.
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Misrepresenting performance track record, such as stating securities were bought in client accounts when they were not, or not disclosing that the Advisor did not have clients in the model of the performance report.
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The Advisor used a benchmark index but did not properly define the index or include enough context.
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Advertisements did not disclose the time period or whether the returns were calculated from the time period defined in the material.
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Some performance results were included or excluded in an unfair or unbalanced manner. For example, an Advisor only included the performance of realized investment information in total net return and excluded unrealized investments.
Other Deficiencies
The staff observed several deficiencies related to the fair and balanced presentation of marketing materials by advisors. Notably, many advertisements failed to disclose the material risks and limitations associated with the services offered. Additionally, references to specific investment advice often lacked balance, particularly with omissions in disclosures concerning the exclusion of certain investments. The staff also noted that advisors lacked adequate policies and procedures to ensure that such information was presented fairly. Furthermore, some advertisements contained materially misleading disclosures, including some that were unreadable, compromising the clarity and integrity of the information presented to clients.
In light of these deficiencies, advisors are urged to review and enhance their compliance practices. This should include updating and strictly implementing policies and procedures, ensuring comprehensive and accurate maintenance of books and records, maintaining accurate and reflective policies to the advisor’s marketing practices and reviewing marketing materials to eliminate misleading information. By taking these steps, advisors can seek to ensure transparency, accuracy, and adherence to Marketing Rule.
AdvisorAssist has published multiple resources for Advisors as they strive to enhance their policies and procedures surrounding the Marketing Rule. Targeted Mock Examinations through AdvisorAssist are available to those who wish to test the effectiveness of their current process. We urge you to review any of the following resources, or reach out to your Compliance Consultant for further assistance:
SEC Marketing Rule Examination Sweep
SEC 2023 Priorities and the Marketing Rule – How Important is a Retrospective Review?
SEC Sample Marketing Exam Request
Related: Insights for Registered Investment Advisors on Navigating the New Independent Contractor Rule