At long last, the SEC has relaxed its prohibition on testimonials in investment advisor advertisements. But before firms start enlisting clients, YouTubers, bloggers, and other social media influencers to promote their services, they need to understand the rules. Predictably, the SEC has imposed disclosures and due diligence obligations on investment advisors using endorsements and testimonials.
Before diving in, let’s review what happened. The SEC approved a new rule called under the Advisers Act, Rule 206(4)-1, referred to as the “Marketing Rule.” This rule replaced the Advertising Rule (also Rule 206(4)-1) and the Cash Solicitation Rule (Rule 206(4)-3 under the Advisers Act). The Marketing Rule became effective on May 4, 2021 and includes an 18-month transition period for advisors to comply. As noted in a recent FAQ issued by the SEC, advisors that want to take advantage of the Marketing Rule before November 4, 2022 must comply with all aspects of the rule. Practically this means that an advisor cannot start using testimonials and endorsements under the new Marketing Rule unless the firm is ready to comply with all other aspects of this rule, including those relating to presenting performance data, restrictions on hypothetical performance, and requirements for using ratings and rankings.
The chart below shows the differences between the Cash Solicitation Rule and the New Marketing Rule regarding payments to “promoters,” the new term that includes clients, private fund investors, and non-clients that endorse the investment advisory firm’s services. The biggest differences from the Cash Solicitation Rule are that the Marketing Rule allows non-cash payments, does not require Form ADV Part 2A (“brochure”) delivery by the promoter, and relaxes the conditions for promoters receiving de minimis compensation. Other differences include a new requirement for “clear and prominent” disclosure of the arrangement and conflicts of interest, and advisor oversight to ensure that any testimonial or endorsement complies with the rule. Finally, the Marketing Rule provides a definition for testimonials and endorsements as statements that “[i]ndicate approval, support, or recommendation of the advisor or its supervised persons or describes that person’s experience with the advisor or its supervised persons.” The SEC also did away with requiring disclosure of additional costs to investors or clients as a result of the paying promoters.
|Old Cash Solicitation (Advisers Act Rule 206(4)-3)
||New Marketing Rule (Advisers Act Rule Rule 206(4)-1)
|Only cash payments allowed.
||Advisors can provide cash and non-cash compensation, including gifts, fee rebates and fee waivers.
|No de minimis exemption.
||De minimis exception: no agreement required, can be “bad actors”– for compensation of less than $1,000 for one year
|Separate disclosure document signed by referred clients.
||Separate disclosure document not required and can be delivered orally (as long as recordkeeping requirements are met), but CLEAR and PROMINENT disclosure that endorsement is paid and conflict exists.
|Disclosure must include name of solicitor, advisor, relationship, and the terms of compensation arrangement.
||CLEAR AND PROMINENT DISCLOSURE includes whether the endorsement or testimonial was provided by client, non-client or private fund investors; whether compensation was provided and description of any other material conflicts. Name of promoter not required.
|Affiliates – No written agreement required, more limited disclosure, and no signed acknowledgement of receipt of disclosures required.
||No agreement required with affiliates that provide endorsements. Still subject to advisor oversight.
|Form ADV Brochure delivery required by the solicitor.
||Form ADV Brochure delivery not required by the promoter.
|Written agreement required.
||Written agreement required (unless de minimis payment or affiliates providing endorsement).
|Not applicable to private fund investments
||Applicable to private fund investments.
|Solicitation not automatically an advertisement.
||Testimonials and endorsements are advertisements, even if made orally, and even if made to only one person.
Firms that want to use testimonials or endorsements will need to make significant changes to their policies and procedures and be prepared to devote additional resources to compliance with the new rule. The SEC will undoubtedly start testing for compliance once they see advisors adopting the Marketing Rule so be prepared. Here is a checklist to help firms get started:
- Amend existing policies and procedures and develop new policies and procedures for supervision.
- Change the definition of “advertisement” in current policies and procedures to include “any endorsement or testimonial for which an investment advisor provides compensation, directly or indirectly.” And by “any,” the SEC means any communication made, whether orally or in writing, even to one person. (Advisors can exclude certain regulatory notices, filings, and other required communication, as noted in the rule). Uncompensated promotional messages are also included in the definition of “advertisement” if they are made to one or more persons and include an offer of the investment advisor’s advisory services.
- Include definitions for “testimonials” (from current clients and fund investors) and “endorsements” (from non-clients).
- Apply the Marketing Rule’s new standards to testimonials and endorsements. Testimonials and endorsements are considered advertisements and should be subject to the firm’s advertising review process. A firm cannot simply use the client’s own words. The Marketing Rule requires that the advertisement cannot be materially misleading and must provide a “fair and balanced treatment” of investment risks and limitations. Firms should also consider whether the promoter’s claims can be substantiated. For example, statements like “my portfolio has grown immensely” is likely to be viewed as misleading by the SEC. And don’t forget to include the required disclosures in each advertisement.
- Address the required disclosures, calling out those that must be provided clearly and prominently, i.e., whether the endorsement or testimonial was provided by client, non-client, or private fund investor; whether compensation was provided; and a description of any other material conflicts. Require additional disclosures (that do not have to be “clear and prominent”), including (i) the material terms of any compensation arrangement, including a description of the compensation and (ii) a description of any material conflicts of interest on the part of the promoter resulting from the relationship with the advisor and from the compensation arrangement.
- Address disclosure delivery. If the advertisement containing the endorsement or testimonial is delivered in written form, then the advisor should make sure the required disclosures are included. If the testimonial or endorsement is delivered orally, then the advisor must determine how to ensure that the disclosures are being made. This could include giving potential clients a written statement. Keep in mind that the SEC will expect to see proof of disclosure delivery. The final release allows the use of a written disclosure in connection with an oral testimonial or endorsement provided that the advisor or promoter “alert the investor to the importance of the disclosures.”
- Oversight of promoters. The rule states that if an advisor does not provide the required disclosures, it must have a reasonable belief that the promoter discloses the information. In the final release, the SEC stated that the advisor’s agreement could require the promoter to provide the disclosures to potential clients and investors as a means of having that “reasonable belief.”
- Update record keeping requirements as required under the Marketing Rule.
- Develop a process for requesting testimonials from clients. Firms should have written permission to use client names and maintain records of any payments or benefits given such as fee reductions. This permission could be included in the firm’s standard investment management agreement.
- Update the procedure for engaging with solicitors to include all promoters.
- Develop an agreement to be used with promoters that are being paid more than di minimis compensation that meets the Marketing Rule’s requirements. The agreement should include representations or attestations from the promoter, including:
- that the promoter is and will remain duly qualified, licensed, and registered, if necessary,
- the promoter is not and will not later become an “ineligible person” (the Marketing Rule bars advisors from making payments to persons subject to certain disqualifying events, and cease-and-desist orders involving violations of scienter-based fraud securities law),
- that the promoter will comply with the content and disclosure requirements of the Marketing Rule and any pre-approval requirements of the advisor.
- the scope of the promoter’s engagement and compensation.
- Institute a process to approve each promoter agreement that includes proof that due diligence has been performed on any promoter receiving more than de minimis compensation. This includes reviewing FINRA’s BrokerCheck and the SEC’s Investment Adviser Public Disclosure website.
- Include a process for tracking di minimis compensation. Once the $1,000 threshold per trailing 12-month period is exceeded for a promoter, an agreement and due diligence is required.
- Identify all conflicts of interest between the firm and the promoter so they can be disclosed in advertisements. This would include any other relationships the promoter has with the firm, which could include, for example, any family ties, services provided to the advisor by the promoter, mutual referral arrangements, etc.
- Maintain records of all arrangements.
- Address the use of an advisor’s affiliated persons for endorsements by documenting the affiliated person’s status contemporaneously with disseminating the testimonial or endorsement. Keep a memo describing the affiliation or use other pre-existing records (such as employee payroll records, IARD/CRD, or any other similar records and licensing for investment advisor representatives) as proof
NOTE: In many states, the act of recommending an investment advisor is considered providing investment advice, so a person getting paid for referrals must register as an investment advisor representative. See our blog post for more details.
- Update the Form ADV procedures to address new disclosures. The SEC is adding to Item 5 “Information about Your Advisory Business” to include a new section “L.” on marketing activities. This new section asks whether the advisor is using testimonials and endorsements, along with other activities, such as performance advertising and use of ratings.
- Expand testing of solicitation arrangements to include any new agreements with promoters. This could include periodically asking referred clients what statements the promoter made to them. If relying on promoters to provide the disclosures, ask promoters to certify periodically that they are providing the required disclosures.
- Revise existing arrangements. Advisors should review their existing solicitation agreements and determine whether they meet the requirements of the Marketing Rule. Specifically, the list of disqualifications is expanded from the Cash Solicitation Rule to include CFTC and self-regulatory organization actions and exclude actions that do not result in bars or suspension.
- Be careful of “adoption” and “entanglement.” Investment advisors can be held responsible for third-party information if they use it in their own marketing efforts (adoption), or become overly involved in creating the materials (entanglement). As discussed in the Marketing Rule’s Final Release, the SEC can hold an advisor accountable for information published by a third-party (e.g., a blogger) if the firm becomes too involved. If an advisor provides content or collaborates with a third party, the SEC could view this as crossing a line. Other factors that indicate adoption or entanglement include whether the advisor uses the content in its own marketing materials, and whether the firm selectively deletes, alters or endorses comments on third-party content. This applies to situations where a firm allows third parties to post on the firm’s website or social media page. If the advisor deletes negatives comments (or highlights positive ones), the SEC could decide that manipulated content is an advertisement and subject to the Marketing Rule.
The SEC promised to give advisors additional guidance, but aside from two initial FAQs, that hasn’t happened. In the meantime, here are a few excellent articles with additional guidance on how to comply with the Marketing Rule: