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SEC Proposed Amendments to Advertising and Solicitation Rules

December 20th | 2019



Revision of Rule 206(4)-3 (the “Cash Solicitation Rule”) and Rule 206(4)-1 (the “Advertising Rule") to reflect advancements in modern technology.


On November 4, 2019, the SEC proposed amendments to Rules 206(4)-3 (“Solicitation Rule”), 206(4)-1 (“Advertising Rule”), and 204-2 (“Recordkeeping Rule”) of the Adviser’s Act, as well as Form ADV. This modernization is an overhaul of existing rules in response to changes in industry practices and technologies since the rules were initially adopted decades ago.


Proposed Amendments to the Solicitation Rule


The proposed amendment significantly expands the scope of the Solicitation Rule. While the current rule disqualifies certain persons who have engaged in misconduct from acting as solicitors, the proposed amendment expands the list of disqualifying events that render an individual ineligible to act as a solicitor, such as certain disciplinary actions brought by self-regulatory organizations and certain regulatory actions brought by the SEC. The proposed amendment also modifies the requirements for written solicitor agreements, includes certain disclosure requirements, and mandates the oversight of solicitors.


Non-Cash Compensation

The proposed rule removes the condition that a solicitor be compensated in cash for the rule to apply. Regardless of cash or non-cash compensation, such as directed brokerage, awards, prizes, or free or discounted services, the rule will now apply to such solicitor relationships.


Private Fund Solicitors

In the context of private fund advisers, the amendment clarifies that the Solicitation Rule applies to the solicitation of current and prospective investors in private funds rather than strictly to current and prospective clients of an adviser.


Written Agreement

Unless an exemption applies, the proposed amendment requires advisers that compensate a solicitor for solicitation activities to enter into a written agreement with such solicitor which includes provisions: describing the solicitation activities and compensation; requiring the solicitor to perform its solicitation activities in accordance with certain provisions of the Adviser’s Act; and requiring solicitor disclosure documents to be delivered to investors. However, the pre-existing requirement that a solicitor agree to deliver the adviser’s Form ADV brochure and perform its solicitation activities in accordance with the instructions of the adviser, are eliminated.


Exemptions

While the amended rule, as proposed, retains the current rule’s exemptions for solicitors who refer investors for impersonal investment advice, and for solicitors who are employees or are otherwise affiliated with the adviser, the amendment eliminates the written agreement requirement for such relationships. Additionally, the amendment creates two new exemptions for de minimis compensation to solicitors, and for advisers that participate in certain nonprofit programs.


Oversight of Solicitors

The amended rule, as proposed, requires advisers to have a reasonable basis for believing that the solicitor has complied with their written agreement, including complying with the solicitor disclosure requirement.


Proposed Amendments to the Advertising Rule


The proposed changes to the Advertising Rule seek to clarify current requirements, replace current prohibitions with more principles-based prohibitions, and formally codify certain requirements. In an effort to increase the Advertising Rule’s flexibility and thereby preserve its relevance in the modern context, the proposed amendment broadly expands the scope of the term “advertisement” to 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.”[1] Whereas the current rule defines restricts the scope of the term “advertisement” to written communications and radio and television broadcasts, the new definition does not. Broadcasted oral communications, non-telecasted videos, and non-radio broadcasted audio, and other modern modes of communication would now be included within the bounds of the rule.


Pre-Approval Required

While previously a best practice, the amended rule specifically requires advisers to designate an employee to be responsible for reviewing and approving advertisements. Prior to any advertisement’s first use or dissemination, it must be approved in writing by such designated employee, unless either the communication is provided to a single person or household, or to a single investor in a pooled investment vehicle; or the communication is a live oral communications broadcast on radio, television, or other similar medium.


General Prohibitions

The proposed amendment to the Advertising Rule replaces the current prohibitions with new, general, principles-based prohibitions, some drawing on language seen in other rules and regulations. Specifically, the principles-based prohibitions restrict an adviser from:

  • Making any untrue statement of material fact or omission of material fact necessary to make a statement not misleading in light of the circumstances, mirroring the language of Rule 10b-5, a frequently cited general anti-fraud rule in the context of insider trading litigation;

  • Making any unsubstantiated material claim or statement;

  • Making any untrue or misleading implication or statement likely to cause such implication regarding a material fact relating to the adviser;

  • Discussing or implying potential benefits without clearly and prominently discussing material risks and/or other limitations;

  • Presenting specific recommendations in an unfair and/or unbalanced manner;

  • Including or excluding performance results in an unbalanced or unfair manner; or

  • Disseminating an advertisement which is otherwise materially misleading.

Testimonials, Endorsements, and Third-Party Ratings


Whereas the current rule explicitly prohibits the use of testimonials, endorsements, and third-party ratings, the proposed, amended Advertising Rule eliminates the total prohibition on their use in advertisements, and instead provides specific requirements concerning their allowable use.


Testimonials and Endorsements

Specifically, the amended rule, as proposed, permits the use of testimonials and endorsements in advertisements if the adviser clearly and prominently discloses whether the testimonial or endorsement was provided by person who is a client or investor, or a person who is not a client or investor. Additionally, the use of testimonials or endorsements must be accompanied by a disclosure as to whether the testimonial or endorsement was provided in exchange for any cash or non-cash compensation.


Third-Party Ratings

The amended rule, as proposed, would allow an adviser to include third-party ratings in its advertisements if the adviser has a reasonable belief that the rating it wishes to include is designed and prepared to produce unbiased results. Furthermore, if included in an advertisement, the adviser must make clear disclosures regarding the identity of the third-party providing the rating, the timing of the rating, and whether the adviser compensated the third-party with regard to the rating.


Restrictions on the Use of Performance Information


In an effort to clarify the use of performance information, the revised rule provides more definite guidance concerning an adviser’s inclusion of performance information in its advertisements. Specifically, the amended rule, as proposed, prohibits an adviser from:

  • Including gross performance results in an advertisement unless accompanied by (or prompt offer to provide) a schedule of fees and expenses deducted to calculate net performance;

  • Making any statement or implication that the calculation of performance has been reviewed or approved by the SEC;

  • Using 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);

  • Including performance results of a subset of investments extracted from a portfolio in an advertisement, unless the adviser provides or offers to provide promptly the performance results of all investments in the portfolio; and

  • Utilizing 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 regarding the hypothetical performance.

Performance in Retail Advertisements

The amended rule, as proposed, seeks to provide additional protections for advertisements targeted to a retail audience. Specifically, the rule requires that any presentation of gross performance must be presented alongside net performance, and generally any performance of a portfolio or certain composite aggregations must include 1- year, 5- year, and 10-year periods.


Proposed Amendments to the Books and Records Rule and Form ADV


In addition to the proposed changes discussed above, the proposed amendments include changes to the Recordkeeping Rule to facilitate and encompass the new requirements relevant to the Solicitation Rule and the Advertising Rule discussed above. Additionally, Form ADV will be amended to require additional disclosures regarding an adviser’s advertising practices to bolster the SEC’s ability to conduct inspections and carry out enforcements.


To see the proposed amendments, please view the SEC’s website or the Federal Register. The public comment period will remain open for 60 days past publication on the Federal Register.

[1] https://www.sec.gov/news/press-release/2019-230

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