On November 4th, the Securities and Exchange Commission (the “SEC”) proposed
amendments (the “Proposal”) to modernize Rule 206(4)-1 (the “Advertising Rule”)
under the Investment Advisers Act of 1940 (the “Advisers Act”).
The first substantial amendment to the Advertising Rule since its adoption in 1961, the Proposal is intended to reflect “changes in the technology used for communication, the expectations of investors shopping for advisory services, and the nature of the investment advisory industry, including the types of investors seeking and receiving investment advisory
While the Proposal appears to be designed to provide investment advisers, particularly
private fund managers, with greater flexibility in the content of advertisements, such as
by withdrawing the current prohibitions on the use of testimonials and the historic
limitations on the use of investment recommendations (i.e., “cherry picking”), such
flexibility comes with tailored conditions and additional process requirements, including
new compliance policies and procedures and the designation of an employee to approve
advertisements before they are disseminated.
Below are our preliminary takeaways on select issues presented by the Proposal. We
anticipate providing a comprehensive summary of the Proposal (including the proposed
amendments to Rule 206(4)-3 under the Advisers Act, the “Cash Solicitation Rule”) in
the near future.
The SEC also proposed amendments to the Cash Solicitation Rule. Among other
changes, the proposed amendments would extend the Cash Solicitation Rule to persons
who solicit investors for private funds.
Definition of an “advertisement”. The Proposal would redefine an “advertisement” as
“any communication, disseminated by any means, by or on behalf of an investment
adviser, that offers or promotes the investment adviser’s investment advisory services
or that seeks to obtain or retain one or more investment advisory clients or investors in
any pooled investment vehicle advised by the investment adviser.”
The phrase “disseminated by any means” would clarify that the rule applies to any
form of written communications, including over social media.
Whether a communication by a third party is “by or on behalf” of an adviser would
require a facts and circumstances analysis and would be attributable to the adviser if
the adviser has taken affirmative steps with respect to the content, such as assisting
in its preparation or explicitly or implicitly endorsing or approving the information.
The Proposal explicitly incorporates communications that are intended for existing
and prospective investors in a pooled investment vehicle advised by the adviser.
The Proposal would exclude from the definition: (i) a live oral communication that is
not broadcast (but not written materials prepared in advance of any live oral
communication); (ii) responses to certain unsolicited requests for specified
information; (iii) certain communications about a registered investment company or
a business development company that are addressed by other SEC rules; and
(iv) information required to be reported in a statutory or regulatory notice, filing or
General prohibitions. The Proposal would retain the current prohibition on making an
untrue statement of a material fact or omitting a material fact necessary to make the
statement made, in light of the circumstances under which it was made, not misleading.
However, it would also add six additional prohibitions:
making a material claim or statement that is unsubstantiated (e.g., with respect to
the adviser’s skills and experience);
making an untrue or misleading implication about, or being reasonably likely to
cause an untrue or misleading inference to be drawn concerning, a material fact
relating to the investment adviser (e.g., an adviser would be prohibited from making
a series of statements that are accurate individually but whose overall effect is
discussing or implying any potential benefits without clear and prominent discussion
of associated material risks or other limitations (e.g., providing a hyperlink to review
the relevant material risks would not be consistent with the “clear and prominent”
standard, as investors may not click through to review the additional information);
referring to specific investment advice (e.g., a case study) unless it is presented in a
fair and balanced manner taking into account the facts and circumstances of the
advertisement, which may include the nature and sophistication of the audience, and
which would no longer be cured by merely furnishing the adviser’s full track record;
including or excluding performance results, or presenting performance time periods,
in a manner that is not fair and balanced; and
being otherwise materially misleading.
Testimonials, endorsements and third-party ratings. The Proposal would withdraw
the current prohibition against the use of testimonials, endorsements and third-party
ratings under the following conditions:
Any use of testimonials, endorsements and third-party ratings would be subject to
clear and prominent disclosures, including whether compensation (whether in cash
or in kind) has been provided by or on behalf of the adviser and whether the person
providing the testimonial or endorsement is a client or investor.
The Proposal would impose additional requirements for the use of third-party
ratings to provide context for evaluating the merits of the third-party rating and
would require the adviser to reasonably believe that the preparation of the rating
(e.g., the questionnaire or survey used) is not structured to produce a predetermined
result and allows for both favorable and unfavorable responses.
Performance information—retail vs. non-retail persons. The Proposal would
differentiate the information that advisers would be required to include when
distributing performance information depending on whether the recipient has access to
analytical and other resources for independent analysis of performance results. Relying
on statutory and regulatory definitions of a “qualified purchaser” and a “knowledgeable
employee” (each as defined in the Investment Company Act of 1940), the Proposal
would distinguish between a Retail Person/Advertisement and Non-Retail
Person/Advertisement and would impose the following requirements:
With respect to Non-Retail Advertisements, the Proposal would permit the
presentation of gross performance alone so long as the adviser provides, or offers to
provide, a schedule of fees and expenses deducted to calculate net performance.
With respect to Retail Advertisements, the Proposal would require advisers to
include a side-by-side presentation of net and gross performance and a presentation
of performance results for any portfolio across 1-, 5- and 10-year periods.
Performance information—track records. The Proposal would address the way in
which a firm presents its track record – that is, the performance of other funds that it
manages. In particular, the Proposal would prohibit:
the presentation of “related performance” unless it includes all related portfolios
(subject to certain limited exceptions);
the presentation of “extracted performance” unless the adviser provides, or offers to
provide promptly, the performance results of all investments in the portfolio; and
the use “hypothetical performance”7 unless the adviser adopts and implements
policies and procedures reasonably designed to ensure that the performance is
relevant to the financial situation and investment objectives of the recipient and the
adviser provides certain specified information underlying the hypothetical
Review and approval. The Proposal would prohibit any statement that the calculation
or presentation of performance results has been approved or reviewed by the SEC and
would require advertisements to be reviewed and approved by a designated employee
before dissemination, except for advertisements that are disseminated only to a single
investor or that are not live oral communications.