“Round 2” Of Marketing Rule Enforcement Actions — Focus On Hypothetical Performance – Advertising, Marketing & Branding

On April 12, 2024, the U.S. Securities and Exchange Commission
imposed fines and other sanctions on five registered investment
advisers (RIAs) for violations of the Investment Adviser Marketing
Rule (Rule 206(4)-1), which has now been in effect for nearly a
year and a half. All five firms agreed to settle the SEC’s
charges, resulting in aggregate fines of $200,000.

Hypothetical Performance. Each of the
settled cases focused on a single hypothetical performance-related
deficiency. In each case, a firm published hypothetical performance
on a publicly accessible website without, according to the orders,
having implemented policies and procedures reasonably designed to
ensure that the hypothetical performance was “relevant to the
likely financial situation and investment objectives of the
intended audience of the advertisement”— a key
requirement of the Marketing Rule.

The focus on hypothetical performance should not come as a
surprise. In the first wave of Marketing Rule enforcement actions
in 2023, the SEC’s Director of Enforcement noted continued
efforts by the SEC on this exact point, warning:

[H]ypothetical performance
advertisements may present an elevated risk for prospective
investors whose likely financial situation and investment
objectives don’t match the advertised investment strategy. . .
. It is therefore crucial that investment advisers implement
policies and procedures to ensure their compliance with the rule.
Until that is the case, we will remain vigilant and continue our
ongoing sweep[.]

Other Violations. The SEC order against
one of the five RIAs alleged a host of other violations, including
making false and misleading statements in advisory advertisements
and in a fund prospectus, advertising misleading model performance,
being unable to substantiate performance shown in its
advertisements, failing to enter into written agreements with
compensated solicitors and failing to comply with certain
recordkeeping and annual review requirements.

Penalties. The penalties for these
actions were, by today’s standards, modest, with individual
fines against four of the five firms ranging from $20,000 to
$30,000. The fact that these firms were only alleged to have
compliance shortcomings on the hypothetical performance
obligations, combined with the fact that all four undertook
corrective remedial action before being contacted by Enforcement
staffers, contributed to the relatively low penalty amounts. The
fifth firm agreed to pay a civil penalty of $100,000, reflecting
the broader scope of violations and the lack of advance
remediation.

Next Steps. Because these were publicly
available advertisements, the lessons for managers of private funds
are more thematic than directly instructive. However, for managers
utilizing broader marketing efforts, ensuring Marketing Rule
compliance while considering these enforcement actions may require
a greater investment of time and effort.

In other words, when creating flip-books and other
advertisements that contain hypothetical performance (which is
quite common), investor relations and compliance personnel should
consider how to document that the manager actually determined that
such performance was “relevant to the likely financial
situation and investment objectives” of each
advertisement’s “intended audience.” The good news is
that for advertisements circulated to accredited investors and
qualified purchasers with whom the manager has a preexisting
relationship, this should be a relatively straightforward
assignment.

The outlier order against the fifth firm communicates a broader
message for all RIAs, which could be summarized in two points:

• Ensure that all advisory advertisements are in compliance with
  the Marketing Rule’s seven principles-based general
  prohibitions.




• Ensure that the process utilized in complying with the previous
  bullet is documented.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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