In September 2017, the OCIE issued a Risk Alert notifying advisors of the most common deficiencies related to the Advertising Rule. Interestingly, all the deficiencies identified involved misleading performance advertising. The takeaways from the Risk Alert are detailed below.
Misleading Performance Results. The Staff observed advisers that presented performance results without deducting advisory fees. The Staff also found that advisers used advertisements that compared results to a benchmark but did not include disclosures about the limitations inherent in such comparisons, including that the advertised strategy materially differed from the composition of the benchmark to which it was compared. It also found that adviser advertisements contained hypothetical and back-tested performance results, but did not explain how these returns were derived and did not include other potentially material information regarding the performance results.
Misleading One-On-One Presentations. Advisers advertised performance results (gross of fees) in certain one-on-one presentations, but did not include the following relevant disclosures:
- Performance figures did not reflect the deduction of investment advisory fees;
- Advertised performance results did not reflect the deduction of advisory fees and that client returns could be reduced by such fees and other expenses;
- Investment advisory fees are described in Part II of the adviser’s Form ADV; and
- A representative example (e.g., a cable, chart, graph, or narrative), which shows the effect an investment advisory fee, compounded over a period of years, could have on the total value of a client’s portfolio.
Misleading Claim of Compliance with Voluntary Performance Standards. The Staff found that advertisements contained misleading claims of compliance with voluntary performance standards such as the Global Investment Performance Standards (“GIPS”). For example, advisers claimed that their advertised performance results complied with a certain voluntary performance standard when it was not clear to the Staff that the performance results in fact adhered to the performance standard’s guidelines.
Cherry-Picking Recommendations. The Staff observed advisers that disclosed past specific investment recommendations that may have been misleading because they included only certain, and not all, recommendations, to illustrate a particular investment strategy, and they did not meet the conditions set forth in Subsection (a)(2) of the Advertising Rule and/or did not satisfy the representations provided in the TCW Group and Franklin no-action letters.
In TCW, the Division of Investment Management (“IM”) staff stated that it would not recommend enforcement action against an adviser that advertised the best performing holdings along with an equal number of worst performers if the following representations were met:
- Best and worst recommendations are displayed in equal prominence;
- A statement that the Holdings identified do not represent all the securities purchased, sold, or recommended for advisory clients; and
- A statement that past performance does not guarantee future results.
In Franklin, IM staff stated that it would not recommend enforcement action against an adviser for advertising past specific recommendations, provided that certain requirements were met:
- Securities were selected using objective, consistently applied non-performance based selection criteria;
- Profits and losses of any selected securities are not discussed; and
- Records of selection criteria must be maintained.
Compliance with Advertising Policies and Procedures. OCIE staff observed advisers that did not appear to have compliance policies and procedures reasonably designed to prevent deficient advertising practices. Advisors did not have, or did not implement, policies and procedures pertaining to the process for reviewing and approving advertising materials prior to their publication or dissemination and confirming the accuracy of performance results in compliance with the Advertising Rule.
Misleading Use of Third Party Rankings or Awards. The Staff observed advisers that published potentially misleading advertisements containing references to awards or rankings conferred by third parties that failed to disclose facts, which the Staff believes were material under the circumstances, about such awards or rankings. For example, advisers advertised accolades that had been obtained by submitting potentially false or misleading information in the applications for such accolades or advisers published marketing materials that referenced stale ranking or evaluation information, thus potentially misrepresenting the adviser’s current status.
Misleading Use of Professional Designations. OCIE staff observed advertisements and disclosures made in advisers’ Form ADV Part 2B Brochure Supplements that contained potentially false or misleading references to employee professional designations. For example, advisers published potentially misleading advertisements that did not disclose the relevant selection criteria for the awards or rankings, or the fact that advisers paid a fee to participate in or distribute the results of the survey.
Testimonials. OCIE staff observed advisers that had published statements of clients attesting to their services or otherwise endorsing the adviser that may be prohibited testimonials (e.g., client endorsements published in firm websites, social media pages, reprints of third party articles, or pitch books). Also of issue, but not specifically addressed by the SEC in this Risk Alert, is the use of portfolio company management testimonials by private equity fund managers.
We recently wrote about our findings having managed many SEC exams for our clients over the past year. Fortunately, our clients did not encounter any advertising type issues. However, compliant advertising requires a constant level of diligence and effective reviews by someone knowledgeable about SEC regulations and no-action letters. Contact us if we can provide assistance in this area.