On September 14, 2017, the SEC Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert identifying the most frequent compliance violations to the investment adviser’s advertising rule.
The Advertising Rule
The “Advertising Rule” found in Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advisers Act”) prohibits an adviser from directly or indirectly publishing, circulating or distributing any advertisement that contains any untrue statement of material fact, or that is otherwise false or misleading. “Advertising” includes any “notice, circular, letter or other written communicated addressed to one or more persons or any notice or other announcement published or made by radio or television which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.”
The Advertising Rule specifically prohibits: (i) any advertisement that directly or indirectly refers to any testimonial concerning the adviser or any report or service rendered by the adviser; (ii) an adviser from advertising past specific recommendations that were profitable to any person; (iii) any advertisements claiming that any graph, chart or formula can by itself determine whether to buy or sell a security; and (iv) advertisements that offer purportedly free reports, analysis or services.
In addition to the Advertising Rule itself, guidance on adviser advertising can be found in SEC-issued guidance updates, opinions and no-action letters, and settled or adjudicated court and administrative proceedings.
Most Frequent Advertising Rule Violations
The OCIE risk alert identified the following most frequent violations of the Advertising Rule:
- Misleading Performance Results. The OCIE often observed advertisements with misleading performance results. As an example, any advertisement of results that do not deduct the advisory fee from the presented performance, is deemed misleading. As another example, advertisements that compared results from a particular benchmark were often misleading as the parameters or strategies involved in the two comparisons were often materially different. Finally, hypothetical and back-tested performance results could be misleading where information on how returns were derived or other material information was not included.
- Misleading One-on-One Presentations. An example of a misleading one-on-one presentation would be where the adviser advertised performance results gross of fees without necessarily additional material disclosures. Again, the mere failure to disclose that advisory fees had not been deducted from an advertisement would also be misleading.
- Misleading Claim of Compliance with Voluntary Performance Standards. The OCIE staff observes cases in which an adviser claims compliance with voluntary performance standards, when in fact, they were not compliant.
- Cherry-Picked Profitable Stock Selections. An advertisement that cherry-picks profitable stock selections without a balanced presentation, including disclosure related to unprofitable selections, is misleading.
- Misleading Selection of Recommendations. The OCIE staff often finds adviser advertisements that include past specific investment recommendations in a misleading way. In the TCW Group no-action letter, the SEC specifically found that it was not misleading to include five or more best-performing holdings or stock picks, as long as an equal number of worst performers were also disclosed. Moreover, an adviser would have to also include other materially relevant information about its strategy. In the Franklin no-action letter, the SEC staff allowed advertisements including past specific performance results that used consistently applied, objective, non-performance based selection criteria, as long as the adviser included certain disclosures such as that the included results were not all results or all securities purchased or sold, and did not include profits related to specific recommendations. Many advisers fail to follow the guidance in these no-action letters.
- Compliance Policies and Procedures. Many advisers do not have adequate compliance policies and procedures to prevent deficient advertising practices. Adequate procedures would include a process for reviewing and approving advertisement materials prior to publication or dissemination; determining parameters for inclusion in performance calculations; and confirming the accuracy of performance results.
OCIE Touting Initiative
In 2016 the OCIE launched a Touting Initiative to examine adviser advertisements that touted awards, ranking lists or professional designations and accolades in their marketing materials. Where an adviser includes third-party rankings or awards in their advertisements, they must include material facts related to the award or ranking, so as not to be misleading, including the date of the award, selection criteria, who created or gave the award or ranking, and whether the adviser paid to be included. Furthermore, the OCIE found that advisers sometimes obtained a ranking or award by providing false information in their application or nomination for the award in the first place. Finally, another commonly found touting violation involved improper client testimonials.
Laura Anthony, Esq.
Anthony L.G., PLLC
A Corporate Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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