The Marketing Rule: Key Takeaways from the SEC Enforcement Actions

In 2019, the Securities and Exchange Commission (“SEC”) published the Investment Adviser Marketing Rule (“Rule”) updating the advertising regulations for investment advisers, which took effect on November 4, 2022. The Rule applies to entities registered as investment advisers (“Investment Advisers”) that provide services to a pooled investment vehicle, such as 3(c)(1) or 3(c)(7) funds (collectively “Private Funds”).

The Rule covers communications that can be considered an advertisement, which is any direct or indirect communication an Investment Adviser makes that (a) offers advisory services with regard to securities to prospective clients or investors in a Private Fund; or (b) offers new investment advisory services with regard to securities to current clients or private fund investors.

What is Not Considered an Advertisement?

The following items are not considered an advertisement within the amended Marketing Rule:

• extemporaneous, live, oral communications
• information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication
• a communication that includes hypothetical performance that is provided in response to an unsolicited investor request or a private fund investor in a one-on-one communication

One-on-one communication is an advertisement if it includes compensated testimonials and endorsements, and certain communications with hypothetical performance information.

What are the General Marketing Prohibitions for Any Investment Adviser to a Pooled Investment Vehicle?

• Making any untrue statement of a material fact or omitting a material fact necessary to avoid making a misleading statement to any investor
• Including a material statement of fact that the Investment Adviser does not have a reasonable basis for
• Including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the Investment Adviser
• Discussing any potential benefits to clients or investors connected with or resulting from the Investment Adviser's services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits
• Including a reference to specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced
• Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced
• Otherwise, be materially misleading

Other Prohibitions

An advertisement may not include any testimonial or endorsement , and an adviser may not provide compensation, directly or indirectly, for a testimonial or endorsement, unless further compliance sections of the Rule are met.

Advertisements should also not include any third-party rating unless further compliance sections of the Rule are met.

One-on-one communication is an advertisement if it includes compensated testimonials and endorsements, and certain communications with hypothetical performance information.

SEC Enforcement Actions

On August 21, 2023 , the SEC announced its first enforcement action arising out of the Rule, penalizing fintech adviser Titan Global Capital Management USA LLC (“Titan”) with $850,000 in civil penalties (plus prejudgment interest and disgorgement). The SEC stated that Titan violated the Rule by (1) advertising hypothetical performance without implementing 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, (2) failing to provide information and assumptions underlying the hypothetical performance advertised, and (3) making misleading statements about hypothetical performance metrics in its advertisements. The SEC also noted that Titan advertised its crypto strategy on its website with a 2,700% annualized return without clearly disclosing that such a return had been extrapolated from a three-week period and that it was based on a hypothetical account with no actual trading.

Although Titan included some embedded links labeled as “Disclosures” or “Track Record” in the fine print, the SEC considered these were insufficient to notify about the investment risks to potential investors. The SEC also found that Titan committed Rule violations related to the crypto strategy because they (1) made conflicting disclosures about how client “crypto” assets were custodied, and (2) failed to adopt policies and procedures concerning employee personal trading in “crypto” assets despite disclosure to the contrary.

On September 11, 2023, the SEC announced a settlement with nine Registered Funds over alleged violations of the Rule and the corresponding provisions of the books and records requirements in Rule 204-2(a)(11) under the Investment Advisers Act of 1940 (the “Advisers Act”) as a result of their use of a hypothetical model or back-tested performance returns on their public websites in the absence of required policies and procedures.

As of November 2023, these have been all the enforcement actions related to the Rule violations since its compliance date. Below is a list of items advisers should consider and adopt in relation to the recent SEC discussions and settlements.

What Should Advisers Do to Ensure Compliance with the Rule?

1. Adopt and implement policies and procedures to ensure compliance with the Advisers Act and the Rule, including policies and procedures to confirm that dissemination of hypothetical performance is relevant to the financial situation and investment objectives of the intended audience.
2. Review publicly accessible websites for the use of hypothetical performance.
3. Verify performance disclosures include detailed information about the criteria and assumptions used in such performance calculations, including a general description of the methodology used, so investors may understand how it was generated. If an Investment Adviser uses hypothetical performance, it should include a description of the risks and limitations of using such performance in making investment decisions.
4. Maintain copies of all advertisements disseminated, including all advertisements that are posted electronically and subsequently revised, such as prior versions of website pages, and email archives.
5. Confirm with their investor relations departments that records supporting the assumptions and calculations of hypothetical performance are also maintained.
6. Alert investors of the necessity of clicking on the embedded links to view the information regarding the criteria, assumptions, risks, and limitations of the hypothetical performance included in the advertisements.

Websites that Include Information for Both Private Funds and Their Investment Advisers

The SEC limited the application of the advertisement definition to Investment Advisers, and not to communications made by Private Funds. However, when both the Private Fund and the Investment Adviser use the same website, a homogenous marketing plan for these entities may be best for them since the website might have overlapping information. As a general recommendation, companies that use the same website for press releases, investor communications, or other marketing strategies for both the Private Fund and the Investment Adviser should have separate sections for each entity and verify the Investment Adviser's information complies with the Rule.

For 2024, the SEC has already announced that one of its exam priorities is the examination of Investment Advisers to Private Funds, specifically their possible conflicts of interests, controls, and disclosures regarding Private Funds managed side-by-side with Investment Advisers and the use of affiliated service providers. This means the Investment Adviser's examination can lead to the examination of certain agreements, compensation, communications with clients and investors, and other information the Investment Adviser and the Private Fund share in the regular course of business.

The SEC is increasingly showing interest in the Investment Advisers' activities, mainly the review of their policies and procedures, and their disclosures and investor communications. The 2023 enforcement actions provide new elements to interpret the Rule and include certain activities as good practice within each fund, but the advisers must constantly review and update their information to adapt to the rapidly evolving scenario of the investment management industry.

If you have any questions about the application of the Rule to your fund, don't hesitate to contact the FinTech Law team.