With the date for compliance with the new Investment Adviser Marketing Rule approaching, now is the time for registered investment advisers to consider how the new rule impacts many facets of their regular practices. One area that should be carefully evaluated is the use of “hypothetical performance.” The new rule expands the definition of an “advertisement” to include many one-on-one presentations that were not covered by the former advertising rule. Now, any one-on-one presentation that contains “hypothetical performance” is subject to the general anti-fraud provisions of the new rule, as well as to several specific conditions and limitations on the use of hypothetical performance.
The definition of “hypothetical performance” is “performance results that were not actually achieved by any portfolio of the investment adviser.” That definition expressly encompasses “targeted or projected performance returns.” The illustration of “targets” or “projections” in one-on-one presentations was previously covered by the general anti-fraud rules, but the new regime imposes more onerous requirements and may indeed prevent RIAs from using the types of illustrations they are currently routinely using with new clients and prospects.
A common approach to acquiring new clients involves presenting an illustration of how a proposed portfolio will perform. This is frequently done through the use of reporting software or publishing services such as Morningstar, Riskalyze, and others, although the adviser may have the ability to customize the inputs and the contents of the final report. Sometimes specific returns are projected, while at other times the projections will show a range or band of returns coupled by a specific probability range.