The change here is allowing broker-dealers to provide the information to intermediary financial advisers and putting the burden on the intermediaries to prevent use directly with their retail clients. Regardless, we recommend against using hypothetical backtested performance data because of SEC concerns as well as the significant regulatory and disclosure limitations.
The SEC fined and censured a now-defunct robo-adviser for disseminating misleading marketing information that purported to show outperformance versus competitors. The SEC asserts that the respondent understated the performance of competitor robo-advisers by using only publicly available information and failing to account for actual weightings. The SEC faults the firm for publishing information without the documents or data to support its performance claims. The SEC also maintains that the firm inflated its own performance by cherry-picking certain clients and time periods. The SEC faults the firm for failing to have policies and procedures requiring the review of marketing materials in part because the Chief Compliance Officer was not aware that social media posts constituted marketing materials under the Advisers Act.
We hate (HATE!) the concept of using a competitor’s name and/or information in marketing and advertising. You are inviting your competitor to prove you wrong and thereby call you out on a regulatory violation.
The SEC censured and fined a robo-adviser for several compliance violations related to client account management and marketing. The SEC alleges that software programming errors caused the respondent’s failure to execute tax loss harvesting without violating the wash sale rules, contrary to marketing materials. The SEC also asserts that the firm retweeted client testimonials and other positive tweets made by those with an economic interest including employees, investors, and paid tweeters. Additionally, the SEC maintains that the firm failed to provide the necessary disclosure to clients about payments to bloggers to refer the clients to the respondent. The SEC charges the firm with failing to implement a reasonable compliance program in addition to violations of the antifraud rules and the recordkeeping rules.
We think robo-advisers provide innovative services to under-served retail clients. Regardless, as registered investment advisers, robos must conform to the heavily-regulated environment in which they operate. Some of these alleged violations could have been easily avoided with an industry-standard compliance program. We recommend reviewing the SEC’s previously issued regulatory compliance guidance to robo-advisers.
The SEC’s 2019 regulatory agenda includes amendments to adviser marketing rules. The SEC will consider Rule 206(4)-1, the general advertising rule that prohibits fraudulent statements and specifically limits testimonials, past specific recommendations, and “black box” claims. The SEC will also re-visit Rule 206(4)-3, which regulates the payment of cash solicitation fees to third parties. Last year, the SEC took action on 23 of the 26 rules on its regulatory agenda.
Presumably, this rulemaking review has arisen from last year’s sweep whereby OCIE reported widespread marketing violations including misleading performance claims, cherry-picking results, the use of past specific recommendations, and improper claims of GIPS compliance. The rules haven’t really changed much in several decades, so a re-boot makes some sense. We recommend that the SEC consider specific standards rather than relying on a general anti-fraud rule.
The only controversy here is whether performance information should need to comply with Rule 482. To keep performance information consistent probably makes life simpler for investors, broker-dealers, and the staff at the SEC and FINRA. Regardless, we still believe that the SEC should take a fresh look at Rule 482 given the proliferation of investment products beyond open end funds investing in publicly-traded securities.
Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues. Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.
Last year, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert warning advisers to review their marketing and advertising practices. More recently, OCIE alerted advisers to widespread noncompliance with the solicitation rule. Meanwhile, the Enforcement Division has brought several actions alleging that adviser marketing practices violated applicable law. With this increased scrutiny, advisers should re-assess the following marketing practices to avoid material exam deficiencies or enforcement actions:
10 Adviser Marketing Practices to Avoid
Hypothetical Back-Tested Performance. The SEC has consistently targeted the use of hypothetical, backtested performance, and the Enforcement Division has brought numerous cases.
The SEC censured and fined an investment adviser and its principal for allowing a radio station to air testimonials. The adviser purchased radio spots that aired over a two-year period, during which one of the radio hosts became a client. During both live and pre-recorded segments, the radio host noted his relationship with the firm, expressed his satisfaction, and praised his wealth manager by name. The SEC faults the adviser for failing to take any action to monitor the spots (including by declining to accept transcripts offered by the radio station). Separately, the SEC also accuses the adviser’s principal with failing to report personal securities accounts to the firm’s Chief Compliance Officer.
OUR TAKE: This failure to monitor media also applies to social media where firms have an obligation to squelch potential client testimonials on sites that the firm makes available (e.g. Web page, LinkedIn, Facebook).
The SEC fined a large asset manager $1.9 Million for failing to fully disclose that it used hypothetical back-tested performance data in advertisements. The SEC asserts that the respondent claimed that it could prove back to 1995 that its stock strategy combining fundamental and quantitative research outperformed either approach alone. Although the firm labeled such research as “hypothetical,” the SEC faults the firm for failing to disclose that its research was based on back-tested quantitative ratings for a time period before it generated its own quantitative models or research. Using the longer period helped boost the claimed outperformance. The outperformance data was used in marketing to institutional investors, RFP responses, and a white paper. The SEC also criticizes the compliance program because compliance personnel that reviewed the materials were not informed that the materials included back-tested data.
OUR TAKE: Do not market hypothetical, backtested performance. No amount of disclosure can ever insulate you from the SEC’s retrospective criticisms and analysis that you cherry-picked time periods or data. Also, compli-pros should note that marketing materials delivered solely to institutional investors are subject to the same rules as more widely-distributed marketing materials (with a few exceptions such as allowing presentation of gross performance together with net performance).
OUR TAKE: This case reads like a cautionary tale for large firms trying to quickly roll out a product. It appears that the portfolio management, marketing, legal, operations, and legal functions worked in silos, and, as a result, failed to properly vet or describe the products. We recommend that firms create a cross-functional product assessment team that can ask the hard questions before launching a product.