Series 65 Changes Will Include SEC Marketing Rule

The SEC Marketing Rule

The SEC Marketing Rule, adopted by the Securities and Exchange Commission (SEC) in December 2020, represents a significant update to the regulatory framework governing investment advisers' marketing and solicitation activities. The rule consolidates and modernizes previous regulations, including the Advertising Rule (Rule 206(4)-1) and the Cash Solicitation Rule (Rule 206(4)-3) under the Investment Advisers Act of 1940. Its goal is to adapt to the changing landscape of communications and technology and address the evolving practices in investment adviser marketing and solicitation.

Definition of Advertisement

One of the critical aspects of the SEC Marketing Rule is the expanded definition of "advertisement." Accordingly, the new report includes any direct or indirect communication an investment adviser makes that:

1. Offers the adviser's investment advisory services to prospective clients or investors in a pooled investment vehicle.
2. Offers new advisory services to current clients or investors.
3. Promotes the adviser's investment advisory services.

This broader definition captures traditional marketing materials, performance presentations, and communications on social media and other digital platforms.

General Prohibitions

The SEC Marketing Rule outlines seven general prohibitions applicable to advertisements. These prohibitions prevent false or misleading statements, unsubstantiated claims, and other deceptive practices. The bans include the following:

1. Making any untrue statement of a material fact or omitting a material fact necessary to make the information not misleading.
2. Making a material claim or statement that is unsubstantiated.
3. Making an untrue or misleading implication about a material fact relating to the investment adviser.
4. Discussing potential benefits without providing a fair and balanced treatment of associated risks or limitations.
5. Including or excluding performance results or presenting performance periods in a manner that is not fair and balanced.
6. Presenting performance results without providing sufficient information for the audience to understand the context and criteria used to calculate the results.
7. Being otherwise materially misleading.

Performance Advertising

The SEC Marketing Rule introduces specific requirements and restrictions for presenting advertisement performance results. Some of the key provisions include:

1. Requiring the presentation of net performance alongside any representation of gross performance.
2. Prohibiting the use of related performance (i.e., the performance of a portfolio with substantially similar investment policies and objectives) unless specific criteria are met.
3. Requiring the presentation of performance results for specific periods, such as 1, 5, and 10 years, to prevent cherry-picking favorable periods.
4. Providing additional context for hypothetical and model performance results, including assumptions, methodology, and limitations.
5. Prohibiting the use of extracted performance, which presents the version of a subset of investments from a more extensive portfolio, unless specific criteria are met.

Testimonials, Endorsements, and Third-Party Ratings

The new rule permits using testimonials, endorsements, and third-party advertising ratings, subject to specific provisions. These include:

1. Clear and prominent disclosure of any material conflicts of interest arising from the testimonial, endorsement, or third-party rating.
2. Ensuring that the testimonial, endorsement, or third-party rating is not misleading or inconsistent with other required disclosures.
3. Overseeing the use of testimonials, endorsements, and third-party ratings to ensure compliance with the Marketing Rule.
4. Disqualifying specific individuals from providing testimonials or endorsements, such as those with a disciplinary history.

Solicitation Arrangements

The SEC Marketing Rule modernizes the regulation of solicitation arrangements by:

1. Applying the rule to cash and non-cash compensation arrangements between investment advisers and solicitors.

2. Requiring a written agreement between the adviser and the solicitor that outlines the solicitor's duties and compensation.

3. Requiring solicitors to provide clients with a disclosure document that details the nature of the relationship between the solicitor and the investment adviser and any material conflicts of interest that may arise from the compensation arrangement.

4. Mandating that investment advisers have a reasonable basis for believing that solicitors comply with the terms of their written agreement and that they are not disqualified from acting as solicitors due to disciplinary history or other disqualifying events.

Recordkeeping

The SEC Marketing Rule requires investment advisers to maintain records related to their advertising and solicitation activities. These records should include the following:

1. Copies of all advertisements, including the dissemination date and the targeted audience.
2. Document the advertisement approval process, including the identity of the designated employee who reviewed and approved the ad.
3. Records of any third-party testimonials, endorsements, and ratings, including the disclosures, the compensation arrangement, and related communications.
4. Records related to solicitation arrangements, such as the written agreement between the investment adviser and the solicitor and any disclosure documents provided to clients.

Compliance and Review

The SEC Marketing Rule emphasizes the importance of robust policies and procedures to ensure compliance with its requirements. Investment advisers must:

1. Establish, maintain, and enforce written policies and procedures reasonably designed to prevent violations of the Marketing Rule.
2. Designate an employee to review and approve all advertisements before they are disseminated. This employee should be competent and knowledgeable about the Marketing Rule and have the authority to require promotion changes before approval.
3. Monitor testimonials, endorsements, and third-party ratings to ensure compliance with the rule and to detect and address potential violations.
4. Regularly review and update their policies and procedures to reflect changes in the regulatory landscape and address any identified compliance deficiencies.

The SEC Marketing Rule significantly updates and modernizes the regulatory framework governing investment advisers' marketing and solicitation activities. By incorporating the rule into the Series 65 exam, investment advisers will be better prepared to navigate the evolving landscape of marketing and solicitation in compliance with the regulatory requirements. In addition, the rule emphasizes the importance of transparency, accuracy, and fairness in marketing communications and seeks to protect investors by preventing false or misleading advertising practices.