On December 16th, the SEC released a Risk Alert containing observations of investment advisers’ compliance with Rule 206(4)-1 (the “Marketing Rule”). The Commission provides risk alerts such as this to inform and remind investment advisers and stakeholders of advisers’ compliance requirements. Regarding testimonials and endorsements, the Commission observed common deficiencies in the following requirements: (1) clear and prominent disclosures, (2) disclosure of material terms of compensation arrangements, (3) disclosure of material conflicts, (4) oversight and compliance, (5) ineligible persons, and (6) promoter affiliated with the adviser.
In the Risk Alert, the SEC staff observed adviser advertisements containing testimonials or endorsements that failed to provide one or more of the required clear and prominent disclosures. This includes whether the promoter, the person providing the testimonial or endorsement, was a current client, was a current investor in a private fund advised by the investment adviser, was paid cash or non-cash compensation, or had a material conflict of interest. The Commission found cases where the disclosures were made but not in a clear and prominent manner, as the disclosures were made via hyperlink or made in smaller or lighter font than the associated testimonials and endorsements. Commission staff also noted cases where advisers incorporated client testimonials or endorsements on third-party websites onto their own websites without adding sufficient disclosure. Finally, SEC staff observed advisers that compensated clients to write reviews on third-party websites without having basis to reasonably believe that the promoters complied with the disclosure requirements for paid testimonials.
The SEC staff continued to find advisers that had not disclosed material conflicts of interest resulting from the advisers’ relationships with the promotors and/or their compensation arrangements. The Risk Alert gave the example of advisers who failed to disclose material conflicts resulting from promoters’ financial interests in the advisers. This includes promoters who were investors in the advisers and promoters who were principals or officers of other advisory firms with sub-advisory or other arrangements with the advisers.
Further, Commission staff observed advisers who failed to meet the “reasonable basis for belief requirement” (oversight and compliance provision requiring advisers to have a reasonable basis for believing that testimonials and/or endorsements comply with the Marketing Rule). The Risk Alert gave examples of advisers that were (1) unaware that their arrangements were testimonials or endorsements; (2) had no documentation, written policies, or documented agreements to satisfy the reasonable basis for belief requirement; (3) did not create or maintain agreements that sufficiently described the scope of promotion activities or compensation terms with paid promoters; or (4) exceeded the $1,000 de minimis exemption threshold by making multiple payments under $1,000 that totaled $1,000 within twelve months.
SEC staff also found advisers that knew, or reasonably should have known, that promoters were disqualified from giving endorsements by the Marketing Rule and used them anyway. Examples included advisers compensating promoters who were disqualified because of their disciplinary histories with state securities regulators.
Finally, Commission staff found advisers insufficiently disclosing their use of promoters affiliated with their firms. In such cases, advisers did not adequately disclose, and did not warrant exemption from adequately disclosing their affiliation with the promoters as required by the Marketing Rule. Examples included failure to disclose the affiliation until prospective clients or investors met the advisers, rather than at the time the testimonials or endorsements were provided.
The various observations and examples given in the Risk Alert highlight the difficulty and importance of full compliance with the SEC Marketing Rule. As always, it is necessary for investment advisers to consult with experienced legal and compliance professionals to avoid regulatory pitfalls.
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