SEC’s Observations on Advisers’ Compliance with Marketing Rule

The Securities and Exchange Commission’s Division of Examinations (the “Division”) issued a Risk Alert titled “Additional Observations Regarding Advisers’ Compliance with the Advisers Act Marketing Rule.”

The Marketing Rule requires advertisements to be clear, balanced, and substantiated, and establishes standards for presenting performance results and using client testimonials and third-party endorsements.

The Risk Alert focuses on the Division’s observed deficiencies regarding compliance with the testimonial and endorsement provisions and third-party rating provisions of the Marketing Rule. Furthermore, the Risk Alert underscores the importance of ensuring full compliance with the Marketing Rule, as the SEC continues to review marketing materials and firm websites during examinations.

Stark & Stark’s team of attorneys can assist with the review of marketing and advertising materials, including firm websites, to ensure compliance with the Marketing Rule.

Testimonials and Endorsements

The Marketing Rule prohibits the use of testimonials and endorsements, unless an Adviser satisfies certain disclosure and oversight conditions. The Alert identifies several deficiencies related to testimonials and endorsements, including:

• Clear and prominent disclosures: Advertisements that contained testimonials and endorsements did not provide the required disclosures, such as whether the person providing the testimonial or endorsement was a current client or investor in a private fund advised by the Adviser, received compensation or had a material conflict of interest. Disclosures presented though hyperlinks or in smaller font sizes were noncompliant. Further, the Staff noted that Advisers incorporated testimonials from third-party websites onto their own websites without disclosing that those testimonials and endorsements were provided by current or former clients.
• Disclosure of material terms of compensation arrangements: Advisers did not disclose the material terms of compensation arrangements, including a description of the compensation provided directly or indirectly to the promoters, and generic disclosures that omitted material details did not meet compliance requirements.
• Disclosure of the material conflicts: Advisers failed to disclose material conflicts arising from their relationships with promoters or compensation arrangements, such as promoters’ financial interests in the Advisers.
• Oversight and compliance: Advisers failed to comply with the requirement to have a reasonable basis for believing that testimonials or endorsements comply with the Marketing Rule. The Staff indicated instances where Advisers (i) did not recognize certain arrangements involved statements that met the definition of an endorsement or (ii) lacked written agreements with paid promoters that described the scope of the activities and terms of compensation for those promotion activities.
• Ineligible persons: Advisers appeared to violate the prohibition on compensating ineligible persons for endorsements when they knew, or should have known through reasonable care, that the promoters were ineligible at the time the endorsements were disseminated.
• Promoter affiliated with the adviser: Advisers used affiliated promoters that did not meet the disclosure and agreement requirements under the Marketing Rule. For example, the Advisers did not meet the exemption requirements that ensure the affiliation was clearly disclosed to clients or private fund investors at the time of the endorsement.

Third-Party Ratings, Rankings, and Awards

The Marketing Rule prohibits the use of third-party ratings in advertisements unless the adviser has a reasonable basis to believe that the underlying questionnaires or surveys meet specified criteria and provide required disclosures. Our team has seen extensive and aggressive review and fines relating to improper use of third-party ratings, rankings, and awards. The Alert identifies several deficiencies related to third-party ratings, including:

• Due diligence: Advisers did not conduct sufficient due diligence to form a reasonable basis that the third-party rating methodologies were not designed to provide predetermined outcomes. Staff observed that Advisers had not implemented adequate policies and procedures to meet the due diligence requirement, including reviewing or obtaining the underlying questionnaires or surveys for third-party ratings. The Staff provided examples of due diligence steps Advisers could take to demonstrate compliance with the Marketing Rule, including: (i) reviewing publicly available methodology, (ii) obtaining copies of the questionnaires or surveys, and (iii) seeking representations from the rating provider regarding design, structure and administration.
• Clear and prominent disclosures: Advisers used third-party ratings without providing all required disclosures, including the rating date and period, the identity of the rating provider, and any direct or indirect compensation related to obtaining or using the rating (e.g., paid logo use, reprints, or priority placement). Additionally, using hyperlinks and smaller texts for disclosures, and placing the disclosures at the bottom of the website page away from the actual rating did not meet compliance requirements.

Takeaways

It is abundantly clear that the Division continues to focus on Advisers’ marketing activities, making Marketing Rule compliance a priority during examinations. Advisers should ensure their Marketing Rule policies are tailored to their respective firm and fully implemented into practice. The Alert noted Advisers who had adopted policies on testimonials and endorsements but failed to implement them into practice. The deficiencies cited in the Alert illustrate the broad scope of the rule and the various ways Staff may identify compliance issues across websites, social media, presentations, and other marketing materials.

Stark & Stark attorneys are available to assist with matters related to the Marketing Rule, including the review of marketing materials and Advisers’ websites.