When selling investment products, you cannot merely disclose the good facts. In this case, the respondent may not (or may) have known the investments were Ponzi schemes, but he did have enough facts to suspect and should have warned potential investors.
The SEC charged an investment adviser with using his radio show and other advertisements to mislead investors. The adviser advertised that he had been selected to host the radio show, when, according to the SEC, he actually paid to host and broadcast the show. He also claimed to hold a fictitious “Qualified Retirement Advisor” designation. The SEC also accuses the adviser of intentionally concealing his significant disciplinary history by failing to deliver Form ADV and using internet search suppression consultants to hide his background. As alleged, the adviser also failed to disclose compensation arrangements and conflicts of interests. The principal, who also served as the firm’s Chief Compliance Officer, is also charged with operating a compliance program with insufficiently tailored policies that the firm failed to implement.
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.
Earlier this week, the SEC proposed a new investment adviser advertising rule that would dramatically alter current adviser marketing practices. Proposed Rule 206(4)-1 changes the definition of “advertising,” applies different standards to retail-directed advertisements, allows testimonials, and requires a responsible employee to review and approve all materials. The Release is over 500 pages, so we offer a summary of the most significant changes in the proposed rule. Please note, however, that this proposal still has to go through a lengthy comment process before the law actually changes.
The 10 Most Significant Changes in the Proposed Adviser Advertising Rule
Expanded Definition of “Advertisement”. The proposed rule applies to “any communication, disseminated by any means.” This definition includes all digital and social media communications.
Includes Private Funds. The definition of “advertisement” includes communications intended to obtain investors for a pooled investment vehicle (other than a registered fund) advised by the investment adviser.
Gross Performance Allowed. The proposed rule allows the use of gross performance for non-retail accounts if the adviser includes the fees and expenses that would be deducted to determine net performance.
Performance Periods. Retail advertisements (see below) must include one, five, and ten-year (or life if shorter) performance numbers.
Extracted Performance Restricted. A presentation of a subset of portfolio performance must include (or offer to provide) the results of all portfolio investments.
Higher Standards for Retail Advertisements. A retail advertisement is a communication directed to anybody other than a qualified purchaser (Investment Company Act Section 2(a)(51)) and a knowledgeable employee (Investment Company Act Rule 3c-5). For example, an adviser can only show gross performance if it also shows net performance.
Practically Outlaws Hypothetical Performance. The disclosure requirements for the use of hypothetical performance are so stringent that the rule essentially outlaws the use of such information.
Testimonials Permitted. For the first time, advisers could use client testimonials so long as significant disclosure is included. This will facilitate social media comments and likes.
Designated Reviewer. A designated employee (presumably the Chief Compliance Officer) must review and approve all advertisements.
Compliance and Recordkeeping. The new rule requires advisers to enhance policies and procedures to ensure the accuracy of any marketing claims, comply with the new Rule’s requirements, and maintain supporting documentation.
The SEC has proposed a new investment adviser advertising rule that broadens the definition of “advertising,” more specifically regulates performance information, and allows certain testimonials and endorsements. Revised Rule 206(4)-1 would broadly include any communication distributed by any means that promotes advisory services or a pooled fund and prohibits any misleading or unsubstantiated statements. The new rule would also require all retail-directed advertisements to include one, five and ten-year periods when presenting performance information. Advisers would also be able to use testimonials so long as the adviser fully discloses whether the person is a client and whether compensation has been provided. The new rule would also require approval in writing by a designated employee before dissemination. The SEC said it may rescind current no-action letters. The SEC also proposed a new solicitation rule that would require additional disclosure about the solicitor but eliminate the current rule’s requirement to collect client acknowledgements. Both rules require at least a 60-day comment period.
We like that the SEC has modernized certain areas (e.g. testimonials) and has clarified how to present performance information. We believe that clearer rules help compliance professionals and reduce the likelihood of enforcement cases resulting from subjective standards.
Don’t make promises based on a promise. It appears that the respondent genuinely believed the money was coming, but, unfortunately, the third party never legally committed. As the old saying goes, “If wishes were fishes, we’d all have a fry.”
Just because you do not register with the SEC does not mean that you are exempt from its antifraud rules. Section 206 applies to any statement made by an investment adviser, whether registered or unregistered, that could defraud any client or prospective client.
Didn’t know that name-dropping could result in securities fraud? Any misstatement arguably relied upon by investors could give rise to Section 17(a)(2) charges of offering securities by means of an untrue statement of a material fact.
This case should be read by any potential client/investor enticed by a too-good-to-be-true investment pitch. It is unfortunate when legitimate investment managers have to compete for business against wrongdoers who outright lie about their performance.
SEC fined a large commercial bank for failing to disclose that it only
recommended hedge funds that paid a portion of the management fee back to the
bank. The bank marketed a robust due
diligence process conducted by a purportedly independent, in-house research
group performing a multi-step due diligence process to select hedge funds from
an “extremely large universe.” In fact,
the bank only recommended hedge funds that paid back management fees that it
called “retrocessions.” Although the
bank disclosed that it might receive revenue sharing and the amount actually received
from each hedge fund, the actual due diligence process did not comport with
marketing promises. The bank, which is
not a registered adviser or broker-dealer, was charged with violating the Securities
Act’s anti-fraud provisions (17(a)(2)).
Check the marketing team’s enthusiasm at the door. The SEC doesn’t allow firms an exception from the securities laws for product hype, regardless of how clients/investors may perceive the statements. Rather than caveat emptor (buyer beware), caveat venditor (seller beware) governs sales of securities products.