The SEC charged
an unregistered day trader for lying about his trading success and misappropriating
client funds. The defendant convinced clients to hire him by asserting that
that he had done very well as a day trader over several years and then promised
over 50% annualized returns. Once retained,
the trader did very poorly and siphoned client assets for personal
expenses. According to the SEC, he then
concealed his misconduct by delivering false account statements and implementing
a microcap wash sale scheme. The
defendant also faces criminal charges brought by the U.S. Attorney’s Office for
the Eastern District of New York.
Lying about your investment track record constitutes securities fraud, subjecting you to civil and criminal penalties. Do not make performance claims unless you can affirmatively support your claims with hard data.
SEC’s Investment Management Division Director, Dalia Blass, anticipates that
the Division will soon recommend changes to the adviser marketing and solicitation
rules. In her annual speech to the Investment
Company Institute membership, Ms. Blass also announced initiatives for a
summary shareholder report, updates to the valuation guidance, modernization of
the offering rules for business development companies and closed-end funds, and
changes to the rules for funds’ use of derivatives. Additionally, Ms. Blass wants the Division to
finalize the proposed ETF and fund-of-funds rules. She has also asked the staff to begin an
outreach to small and mid-sized fund sponsors about regulatory barriers. She announced that the Division is
considering the formation of an asset management advisory committee to solicit diverse
viewpoints on critical issues.
We applaud the reinvigorated Investment Management Division for tackling some of the thornier problems that have faced the industry for many years. For instance, the marketing rules haven’t changed for decades despite revolutionary change in the financial services industry.
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.