In a notable move, the U.S. Securities and Exchange Commission (SEC) implemented a new marketing rule on November 4, 2022, revamping regulations surrounding investment adviser advertising and the use of placement agents. This modernized rule replaces an outdated predecessor and untangles a complex web of no-action letters, streamlining the regulatory landscape and setting new standards for investment service sales. We spoke with Ira Kustin, a partner at the law firm Paul Hastings, to delve into the most significant changes ushered in by these revised rules.
The SEC regulates marketing material for investment advisors to protect investors and maintain the integrity of the financial markets. By doing so, they help prevent misleading, fraudulent, or manipulative financial advertisements that could deceive or harm potential investors.
For example, imagine an advertisement that only highlights the success stories of certain investments but conveniently ignores the ones that performed poorly. This is known as "cherry-picking" and can give potential investors a false sense of security about the advisor's overall performance. Another example is when an advisor presents "gross performance" (returns before fees and expenses) without showing the "net performance" (returns after fees and expenses), creating an illusion of higher returns than what the investor would actually receive.
The SEC’s new rule is intended to require investment advisors to present more accurate, transparent, and balanced information so as to help potential investors make better-informed financial decisions. The revamped rule, “Modernized Marketing Rule for Investment Advisers” attempts to do so by prohibiting bad behavior such as making false or misleading statements, discussing benefits without mentioning related risks, selectively presenting investment advice, and providing deceptive information.
A primary focus of the new rule involves the presentation of performance information in advertisements. Kustin emphasizes that advisors need to pay close attention to the rule's nuances concerning related performance, extracted performance, hypothetical performance, and predecessor performance rules. Although each type of performance adheres to particular guidelines, the primary objective is to maintain transparency, enabling potential investors to comprehend the advisor's track record and methodologies. Additionally, advisors must present the gross performance of their funds alongside net performance figures, highlighting the SEC's commitment to transparency by requiring advisors to clarify the effects of costs and fees on returns.
Significantly, the new rule consolidates the previous advertising rule and the formerly distinct cash solicitation rule. Consequently, the updated rule affects how firms engage placement agents or other parties compensated for investor solicitation. Companies must disclose the agents' status as clients or investors, implement written agreements, and guarantee agent adherence to the marketing rule. Additionally, disqualification rules are in place, preventing specific individuals from being compensated for endorsements or testimonials.