On June 8, 2023, the Division of Examinations (the “Division”) of the U.S. Securities and Exchange Commission (“SEC”) issued its second Risk Alert (the “2023 Risk Alert”) on the amended Rule 206(4)-1 (the “Marketing Rule”) under the Investment Advisers Act of 1940. The Marketing Rule became mandatory for investment advisers registered or required to be registered with the SEC (the “RIAs”) as of November 4, 2022.
Previously, on September 19, 2022, the Division published its initial Risk Alert on the Marketing Rule describing the Division’s initial four areas of review focus (the “2022 Risk Alert”). The 2023 Risk Alert reiterated the four areas of focus listed in the 2022 Risk Alert and enumerated the seven principles-based prohibitions under the Marketing Rule, which have always been a component of the Division’s examinations. More importantly, the 2023 Risk Alert highlighted three additional areas of focus during the Division’s examinations of RIAs with respect to their compliance with the Marketing Rule.
1. Three Additional Areas of Examination Emphasis
The Division announced the following three additional areas of examination review focus, so that RIAs can “reflect upon their own practices, policies, and procedures” and “implement any appropriate modifications to their training, supervisory, oversight, and compliance programs.”
(1) Testimonials and Endorsements
The Marketing Rule (and the amended Glossary of Terms to Form ADV) expanded the definition of “advertisements” to include not only traditional advertising, but also compensated testimonials and endorsements. A “testimonial” includes any statement by a current client or private fund investor regarding its experience with an RIA or its supervised persons. An “endorsement” includes any statement by a person other than a current client or private fund investor that indicates approval, support, or recommendation of (or experience with) the RIA or its supervised persons. Pursuant to the Marketing Rule, an RIA may not include any testimonial or endorsement in an advertisement, unless the RIA complies with the statutory requirements under Rule 206(4)-1(b).
The 2023 Risk Alert summarized such statutory requirements under Rule 206(4)-1(b) regarding the use of testimonials and endorsements in an advertisement, as detailed below with our corresponding practical observations.
(2) Third-Party Ratings
According to the Marketing Rule, an RIA may not include any third-party rating in an advertisement, unless the RIA complies with the specific statutory requirements under Rule 206(4)-1(c).
The 2023 Risk Alert summarized such statutory requirements under Rule 206(4)-1(c) regarding third-party ratings, as detailed below with our corresponding practical observations.
(3) Form ADV
The Marketing Rule amended Form ADV by adding an Item 5.L to Form ADV, Part 1A and revising relevant parts in the Form ADV General Instructions.
2. Four Continuing Areas of Examination Emphasis
The 2023 Risk Alert reiterated the four initial areas of focus listed in the 2022 Risk Alert, including (i) policies and procedures, (ii) substantiation requirement, (iii) performance advertising requirements, and (iv) books and records, indicating the staff’s focus on these areas continues. For details on the 2022 Risk Alert, see our article here.
3. Seven Principles-Based Prohibitions
The Marketing Rule replaced the previous four specific prohibitions with seven new principles-based prohibitions. The 2023 Risk Alert laid out all of the seven general prohibitions under Rule 206(4)-1(a), which share a common purpose of preventing fraud and misleading. The Division indicated that the staff has, and will continue to, review RIAs’ compliance in this regard in their advertisements.
Conclusion
Since the adoption of the Marketing Rule, RIAs have been conducting internal training and gap analysis, updating policies and procedures to take the new requirements into account, making conforming changes to marketing materials, and keeping proper books and records to better satisfy substantiation requirement. The 2023 Risk Alert clarified the Division’s continued focus on the previous four areas and the seven general prohibitions, and alerted the RIAs of the Division’s additional review focuses in testimonials and endorsements, third-party ratings and Form ADV amendments. RIAs need to enhance their Marketing Rule compliance in these additional areas so as to be better prepared for the Division’s possible focused examinations and broad reviews.