Most Common Advertising Rule Compliance Issues Raised in OCIE Deficiency Letters
Investment Management Update
Date: October 26, 2017
The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently issued a risk alert identifying the issues raised most often in deficiency letters to investment advisers citing compliance issues related to Rule 206(4)-1 (“Advertising Rule”) of the Investment Advisers Act of 1940 (“Advisers Act”), which prohibits advisers from directly or indirectly publishing or distributing advertisements that contain false or misleading statements of material fact.
Advisers must provide investors truthful and accurate performance results. OCIE has issued deficiency letters to advisers for failing to deduct advisory fees from performance results, measuring results against a benchmark without describing the inherent limitations of such comparisons, and including hypothetical or back-tested performance returns without explaining how those results were derived. Advisers should diligently provide all relevant and necessary details to put their performance results in the proper context.
The Advertising Rule applies to written materials that accompany oral presentations, including graphs, charts, formulas or reports. OCIE noted that advisers commonly provide written materials containing performance results gross of fees or failing to disclose advisory fees or reductions for other expenses. Advisers cannot rely on providing those disclosures orally during the presentation. Because OCIE reviews written materials separately to determine whether they are misleading, advisers should confirm that all necessary disclosures are printed on their written materials.
Voluntary Performance Standards
OCIE has cited advisers for certifying compliance with voluntary performance standards (e.g., Global Investment Performance Standards (GIPS)) without any evidence to support those assertions. Advisers should review all certificates or statements of compliance to ensure they are updated and accurate.
Cherry-Picked Stock Selections
The Advertising Rule prohibits advisers from misleading potential investors by presenting, publishing or displaying only stock selections that would have been profitable. Subsection (a)(2) of the Advertising Rule permits advisers to list all recommendations made during the preceding year, provided they meet specific disclosure requirements.
OCIE examines advertisements that promote only certain specific investment recommendations to illustrate a particular investment strategy. The SEC has issued no-action letters to advisers whose advertisements included an equal number of their best- and worst-performing holdings or disclosed recommendations that were selected using consistently applied, objective, non-performance-based selection criteria. Advisers should avoid advertisements containing misleading selections of investment recommendations, including those that include only certain, and not all, recommendations.
Insufficient Policies and Procedures
The Advisers Act requires all advisers to have compliance policies and procedures that are reasonably designed to prevent violations of the Advertising Rule. OCIE has noted deficiencies when an adviser’s policies and procedures do not sufficiently address the process for reviewing and approving advertisements prior to distribution, determining which accounts to include or exclude from composite performance calculations, and confirming the accuracy of performance results. Advisers must routinely review their compliance policies and procedures to ensure they are adequate and effective.
OCIE’s 2016 Touting Initiative, which examined advertisements that tout awards received, promote rankings on lists or identify professional accolades, found that such advertisements present opportunities for advisers to run afoul of the Advertising Rule. OCIE remarked that several advisers published accolades they obtained after submitting potentially false or misleading applications. Some advisers published materials with stale rankings or evaluations that were no longer relevant, while others touted awards without revealing that the nominee pool was limited or receipt of the award required payment. OCIE also reviewed Form ADV Part 2B brochure supplements and found advisers using professional designations that had lapsed or were not widely recognized, as well as inappropriate client testimonials used as adviser endorsements. Advisers should carefully review all written materials, whether disseminated in print or electronically, for any potentially misleading statement or puffery.
OCIE reminds advisers to consider whether their advertisements and compliance programs are consistent with the Advertising Rule, the Advisers Act and their fiduciary duties. Advisers should routinely assess their promotional materials and procedures to ensure full compliance and take immediate corrective measures when necessary. Failure to comply with the Advertising Rule’s requirements may lead not only to a deficiency letter, but to further action from the Division of Enforcement.
FOR MORE INFORMATION
For more information, please contact:
Andrew J. Davalla
Donald S. Mendelsohn
Philip B. Sineneng
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