Kitces: Performance Advertising Guidelines For Investment Advisers Under the SEC’s New Marketing Rule (December 7, 2022)

Kitces has made available for download their article, “Performance Advertising Guidelines For Investment Advisers Under the SEC’s New Marketing Rule”, published on Kitces. The Executive Summary is as follows:

For investment advisers looking to attract prospective clients, advertising the performance of their investment strategies would be a logical way to market their services (at least if they had strong historical returns!). But for many years, advisers looking for guidance from the Securities and Exchange Commission (SEC) regarding what kind of performance advertising was permissible had to rely on fairly general guidelines and SEC staff statements in the form of “no-action” letters. But now, as part of its recently overhauled Marketing Rule (which also clarifies the rules surrounding investment adviser testimonials and endorsements), the SEC has codified its previous guidance regarding performance advertising into a single, fairly prescriptive rule.

To start, while the Marketing Rule contains seven general prohibitions applicable to all investment adviser advertising activities (including testimonials, endorsements, and third-party ratings, covered in a previous Nerd’s Eye View post), there are seven additional prohibitions applicable specifically to performance advertising. The first rule prohibits advisers from presenting gross performance without also presenting net performance with at least equal prominence, so that investors can assess returns that are actually received, net of fees and expenses paid in connection with the adviser’s services, and helping prospective clients better compare returns across different advisers.

The Marketing Rule also requires performance results to be presented consistently over 1-, 5-, and 10-year time periods (or the time period the portfolio has existed, if shorter than a particular prescribed period) preventing advisers from cherry-picking time periods that would make their returns appear more favorable. Furthermore, investment advisers may generally reference the performance results of related portfolios only if all related portfolios are included in the advertisement. Further, an investment adviser is prohibited from advertising performance results of a subset of investments extracted from a portfolio unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio from which the performance was extracted.

The SEC has heavily scrutinized the use of hypothetical performance in advertising for many years, and its restrictive stance is codified in the updated Marketing Rule. What actually constitutes hypothetical performance is quite broad and essentially includes any performance result that was not actually achieved by a portfolio of the investment adviser, and its distribution is limited to investors who are considered capable of independently analyzing the information and understanding the associated risks and limitations. Two final prohibitions under the Marketing Rule include restrictions on the use of predecessor performance (e.g., performance by an investment adviser before it was spun out from another adviser or by its personnel while they were employed elsewhere), as well as advertising that explicitly states or implies that that the calculation or presentation of performance results has been approved or reviewed by the SEC.

Ultimately, the key point is that the SEC’s recently overhauled Marketing Rule provides a consolidated set of guidelines for advisers to understand how RIAs are permitted to use advertising. Though, given the potential for future SEC guidance clarifying the new rule, or even possible Risk Alerts summarizing common deficiencies and best practices it observes during the course of its upcoming examinations, advisers looking to use performance advertising will want to pay close attention to how it is enforced in practice!

To read the full report, click: “Performance Advertising Guidelines For Investment Advisers Under the SEC’s New Marketing Rule”

Posted by Marin Larkin, Associate Editor, Wealth Strategies Journal.

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