Signs You May Want to Reconsider Your Compliance Partner

I have a lot of respect for compliance professionals, Chief Compliance Officers, legal counsel and anyone in a regulated environment that is trying to keep their client out of trouble. At the same time, I occasionally am told stories involving compliance consultants that blow me away. So I decided to compile a list of signs that may signal you need a new compliance professional or a law firm to assist you with compliance.

  1. I drafted this report for you. It identifies every single deficiency that I uncovered. There are a lot of them and things don’t look so good for your firm. It is a roadmap for the Division of Examinations, FINRA, or a state securities regulator. I didn’t consider whether the contents of this report were privileged before sending it to you. Good luck!
  2. When you need to reach them for a compliance emergency, you can’t. They clock out at 4:30 or 5:00pm and aren’t prepared to help you or your business get it right after hours.
  3. They tell you what everyone else is doing, what you “need” to be doing; and they don’t tell you what the law actually says you must be doing.
  4. They defer to telling you “no”, because it makes their life easier.
  5. They aren’t able to provide you with a risk assessment to make informed business decisions.
  6. Hold on…that is a legal document. I can’t help you out with that. You are going to have to contact a lawyer.
  7. Hold on…that is a legal question. I can’t help you out with that. You are going to have to contact a lawyer.
  8. When asked about exploring a new, but related line of business, they tell you that they don’t have any experience with that area.
  9. They write poorly, but you need them to draft written responses to a deficiency letter.
  10. They gave you incorrect advice and it cost you time, money or energy to correct.

SEC Staff to Advisers: “You Must Fully Comply with the New Marketing Rule. You Can’t Partially Opt-In.”

On March 18, 2021, the staff of the Division of Investment Management released an FAQ regarding the new marketing rule. The new rule becomes effective May 4, 2022, but has a compliance date of November 4, 2022. The FAQ makes clear that an adviser may comply with the new rule prior to November 4, 2022, but they must be fully compliant with all aspects of the new rule when they opt in to compliance. The full text of the FAQ is set forth below:

Q: I understand that an adviser must comply with the amended adviser marketing rule with respect to its advertising and solicitation activities by the compliance date (November 4th, 2022), which is 18 months after the effective date of the rule. May an adviser choose to comply with some of the marketing rule requirements before the compliance date, but not comply with others?

A:  No. An adviser may choose to comply with the amended marketing rule in its entirety any time starting on the effective date, May 4th, 2021. Until an adviser transitions to the amended marketing rule, the adviser would continue to comply with the previous advertising and cash solicitation rules and look to the staff’s positions under those rules. The staff believes an adviser may not cease complying with the previous advertising rule and instead comply with the amended marketing rule but still rely on the previous cash solicitation rule. Advisers are reminded that they should review their compliance policies and procedures in light of regulatory developments, including the adoption of the amended marketing rule. In addition, the staff believes that when advisers transition to the amended marketing rule, they will need to implement any revisions to the written compliance policies and procedures necessary so that they are reasonably designed to prevent violations of the amended marketing rule. Advisers are also reminded that they are required to maintain a copy of all compliance policies and procedures in effect at any time within the previous five years, and that it should be clear when those policies and procedures were in effect.

SEC Issuing Legally Questionable Moratoriums on Registration for Foreign Investment Adviser Applicants

Investment advisers with their principal place of business in foreign jurisdictions have recently become subject to moratoriums on registration because the U.S. Securities and Exchange Commission (the “Commission” or the “SEC” ) and its Staff have concerns that these foreign applicants may be unable or unwilling to make their books and records available for inspection or examination due to local privacy laws. Israel is one of those countries. The United Kingdom was one of these jurisdictions until late 2020.

The SEC’s position, while well-intentioned, is not supported by the law. It also ignores the fact that (i) there are a number of registrants in these jurisdictions that have had their applications for registration deemed effective while local privacy laws were already in effect, and (ii) a number of registrants and exempt reporting advisers have clients, offices, or employees in jurisdictions subject to moratorium and the SEC and its Staff have never expressed concern over their compliance with local privacy laws.

This post walks through the law governing registration and approval as an investment adviser to show that the SEC is acting beyond its statutory authority. In doing so, it concludes that Section 203 of the Investment Advisers Act of 1940 (the “Advisers Act”) requires the SEC to approve otherwise valid applications and address the consequences of local privacy law through other means.

The Law and Issue

Section 203(a) of the Advisers Act states, “it shall be unlawful for any investment adviser, unless registered under this section, to make use of the mails or any means or instrumentality of interstate commerce in connection with his or its business as an investment adviser.”

Paragraph (c) goes on to provide the requirements for registration and the approval process. It reads:

Within forty-five days of the date of the filing of such application (or within such longer period as to which the applicant consents) the Commission shall—(A) by order grant such registration; or (B) institute proceedings to determine whether registration should be denied. Such proceedings shall include notice of the grounds for denial under consideration and opportunity for hearing and shall be concluded within one hundred twenty days of the date of the filing of the application for registration. At the conclusion of such proceedings the Commission, by order, shall grant or deny such registration. The Commission may extend the time for conclusion of such proceedings for up to ninety days if it finds good cause for such extension and publishes its reasons for so finding or for such longer period as to which the applicant consents.

The Commission shall grant such registration if the Commission finds that the requirements of [Section 203] are satisfied and that the applicant is not prohibited from registering as an investment adviser under section [203A]. The Commission shall deny such registration if it does not make such a finding or if it finds that if the applicant were so registered, its registration would be subject to suspension or revocation under subsection (e) of this section. [Emphasis added.]

The Staff is currently relying on subsection (e)(1) for denying these applications. That subsection permits denial if the applicant could be found to have “willfully made or caused to be made in any application for registration or report required to be filed with the Commission under this subchapter, or in any proceeding before the Commission with respect to registration, any statement which was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, or has omitted to state in any such application or report any material fact which is required to be stated therein.”

As grounds for the moratoriums, the SEC Staff is relying on the affirmation on the Execution Page to Form ADV, which states: “I certify that the adviser’s books and records will be preserved and available for inspection as required by law.” The Staff believes that advisers in jurisdictions subject to moratorium have arguably made false or misleading statements in an application, granting them the authority to reject these applications, because the applicant might be in breach of local law if they comply with an examination request under Section 204. However, this position is too attenuated to survive scrutiny. The reference to “law” on the Execution Page is referencing the Investment Advisers Act and not foreign privacy laws. There is no hint in any proposing or adopting release concerning Form ADV that this reference means anything other than the Investment Advisers Act. There is no precedent for the SEC denying applications because an adviser might theoretically be in violation of local tax, zoning, or employment law.

These applicants have every reason to believe they are making these affirmations in good faith and can knowingly or unknowingly violate local privacy laws without causing their affirmations on Form ADV to be false or misleading.

In any event, every investment adviser registered with the SEC that has a client, employee, or office in Israel (or any other foreign jurisdiction subject to a moratorium) would be making the same alleged false or misleading statement. For this reason, the Staff’s position is simply unfair.

Personal Note

I spent a considerable amount of time debating whether to publish this post. I sought a lot of feedback from colleagues and friends. Lawyers–including myself–in this industry do not want to offend the SEC, any Commissioner, or its Staff. That was never my intention in publishing this article. However, I think we all need to be open to constructive criticism and acknowledge when our decisions are not based in the law, are arbitrary, or unfair.

It is also important to step back and understand that new applicants want to avoid litigating with the SEC to obtain registration. It doesn’t serve as a good introduction to regulated life in the United States. So new applicants are left either (i) avoiding business in the US, (ii) bringing their activities onshore, or (iii) trying to lobby their local governments to provide some sort of privacy relief. All of these solutions are less than ideal.

I believe the SEC should discontinue the practice of moratoriums immediately and work with Congress and foreign governments to seek assurances on local privacy law.

Marketing Rule to Officially Become Effective on May 4, 2021

Its official. The Marketing Rule was published in the Federal Register this morning on March 5, 2021. This means that the rule will become effective on May 4, 2021. The new rule contemplates an eighteen-month transition period between the effective date of the rule and the compliance date. This means your firm should be prepared to comply by November 4, 2022. You should immediately begin reviewing all of your current solicitor and referral relationships and existing marketing. You should also begin developing policies and procedures designed to comply with the new rule.

For a summary of the new rule, please visit here.

For “A Running List of Practical Pointers Under the New Marketing Rule” please visit here.

Will Investment Advisers Registered with the States Be Able to Use Testimonials?

 On December 22, 2020, the U.S. Securities and Exchange Commission adopted amendments to Rule 206(4)-1 under the Investment Advisers Act of 1940 relating to advertisements. Among other things, these amendments, when effective, will permit testimonials. The rules are currently under review by the Biden Administration and won’t become effective until 60 days after they are published in the Federal Register. There is some ambiguity whether an investment adviser registered with the State of New Jersey will be able to take advantage of the amendments to Rule 206(4)-1. I suspect there is similar ambiguity under other state’s laws and regulations.

New Jersey Statute 49:3-53(a)(3) makes it unlawful to “to engage in dishonest or unethical practices as the bureau chief may by rule define in a manner consistent with and compatible with the laws and regulations of the Securities and Exchange Commission [and other organizations]. New Jersey Statute 49:3-53(f) makes it “unlawful for any person soliciting advisory clients to make any untrue statement of a material fact, or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they are made, not misleading.”

New Jersey Annotated Code 13:47A-6.3 (a)(18) and (a)(52) were promulgated by bureau chiefs to define certain dishonest and unethical practices. New Jersey Annotated Code 13:47A-6.3 (a)(18) makes the following practice “dishonest and unethical” and prohibited:

[u]sing any advertising or sales presentation by any person in such a fashion as to be deceptive or misleading. An example of the prohibited practice would be distribution of any nonfactual data, material or presentation based on conjecture, unfounded or unrealistic claims or assertions in any brochure, flyer, press release, or display by words, pictures, graphs or otherwise designed to supplement, detract from, supersede or defeat the purpose or effect of any prospectus or disclosure[.] [Emphasis added.]

New Jersey Annotated Code 13:47A-6.3 (a)(52) makes the following practice “dishonest and unethical” and prohibited:

Publishing, circulating or distributing any advertisement which does not comply with Rule 206(4)-1 [] under the Investment Advisers Act of 1940 [.]

While there is potential conflict between these two passages, I interpret New Jersey Statute 49:3-53(a)(3) as only authorizing the Bureau chief to define dishonest or unethical practices so long as they are consistent with and compatible with the laws and regulations of the Securities and Exchange Commission. I believe it would be unconstitutional for the Bureau to take the position that an investment adviser registered with the State of New Jersey would be engaged in a dishonest or unethical practice while in compliance with Rule 206(4)-1. Therefore, investment advisers registered with the State of New Jersey ought to be able to take advantage of the amendments to Rule 206(4)-1 so long as they aren’t in violation of New Jersey Statute 49:3-53(f), which is nearly identical to the general prohibition in Rule 206(4)-1(a)(1).

Advisory Fees – What Does the Law Say?

calculator and notepad placed over stack of usa dollars

There has been a lot of debate this year about the fairness of advisory fees. Who am I kidding? This is a debate that has been going on for years now. In this post, I address what the law says about advisory fees (but not performance-based fees). In my next post I plan to share some ideas that I have on the fairness and value of advisory fees.

Congress and the SEC have deferred to market forces in considering whether an advisory fee is appropriate. The SEC Staff has historically taken the position that “an investment adviser that charges a fee ‘larger than that normally charged by other advisers’ (based on factors such as size of the account, location, and nature of the business of the advisory firms being compared) has a duty under Section 206 of the Advisers Act to disclose to clients that the same or similar services may be available elsewhere at a lower fee.” The SEC Staff previously opined that this disclosure was necessary for engagements at 3%. More recently, the Staff has suggested that this disclosure would be required if an investment adviser’s fee is 2%. See, Investment Advisers: Law & Compliance § 8.03 (2020). Notably, the recent Commission Interpretation Regarding Standard of Conduct for Investment Advisers was silent on the issue of fees charged directly by investment advisers.

The SEC’s position makes sense. In the absence of specific laws, we lawyers often look to other bodies of law for precedent. One common body is the law governing agency and principal relationships–which fits quite nicely in discussing investment adviser’s relationships with their clients. The Restatement of Agency, which is a treatise summarizing the law suggests, “An agreement between a principal and an agent may also set the agent’s right to compensation at an amount or rate that is standard or customary in a particular industry.” See, Section 8.13. This follows the position of Congress and the SEC (or perhaps Congress and the SEC follow this position).

These are the reasons why we haven’t seen any real change in the industry attacking asset-based fees or the 1% fee in general. As long as a 1% fee can be considered standard or customary, it won’t be going anywhere.

Obviously, a fiduciary has an obligation to act prudently in carrying out its duties, deal fairly with clients, and make full disclosure of all material facts regarding its fees. However, this is satisfied by selecting investments that are appropriate (which may or may not be low-cost investments), accurately disclosing fees in a contract between an adviser and its client, and charging fees only according to that contract. There isn’t any obligation for an investment adviser to disclose its fees on its website so that competitors can undercut prices. There isn’t any obligation to offer the lowest rate in town or in a niche. There isn’t any legal obligation to charge an hourly rate. There isn’t even any obligation to prove your value. As it relates to the value proposition, the law simply requires that you disclose to the client: (i) your services, (ii) your fees, and (iii) that you perform the agreed upon services. The law allows clients who believe they aren’t receiving value to seek recourse or walk away from the relationship.

Investment advisers also need to comply with their obligations under Form ADV and Form CRS, but that is a slightly different topic.

* I would also note that certain state securities authorities have their own views on what fees are appropriate and what is required of investment advisers to earn fees. For example, certain states seem to prohibit subscription-based fees, because they somehow believe that advisers aren’t capable of proving they provide value in each month. If only they knew the same could be said about any other fee arrangement.

Federal Data Breach Law is Long Overdue

I recently assisted a client with a response to a data breach incident. This isn’t an uncommon occurrence. Our law firm is notified almost weekly of a data breach incident involving one of our investment adviser clients. Most commonly, an unauthorized person gains access to an employee’s email and the inbox contains non-public information.

The first thing we ask our clients is: “Do you have data breach or cybersecurity insurance?”

The second thing we try and determine is how expansive is the breach so that we can try and determine how big of a financial and time commitment it will it be for our client to comply with the law. As a general rule of thumb, breaches become more time consuming and expensive as the number of clients and the states of residency increase.

This is because there is no federal law that dictates what businesses must do in the event of a data breach. The status quo requires a business to analyze every state law where a client was potentially impacted to determine (i) what is the state’s definition of a “breach”, (ii) was the client in question subject to a “breach”, (ii) what are the business’s notification requirements, (iii) does the business have any other reporting obligations? To get a sense of how ridiculous this task is, a current list of those requirements by state is available here.

It is long past time for Congress to make this process for uniform and manageable for businesses. The array of state data breach laws is inefficient, burdensome, and might even incentivize businesses to circumvent reporting obligations in various states.

The federal law should, at a minimum, settle on a uniform definition of a “breach”. The law should also create a federal website that allows for easy reporting by businesses to the federal government. That website would then automatically notify state governments in any state where an impacted client resides. This would alleviate the burden on businesses reporting to various state Attorney Generals while still providing states with the broad police powers they are entitled to in trying to protect their citizens and resolve and prevent data breaches.

I can think of no reason why Congress shouldn’t act on this important measure, except many law firms and consulting firms profit from the current patchwork framework.

The Interconnectedness of Markets and Reserving Judgment in Light of Recent Trading Events

Acting Chair Allison Herren Lee and Commissioners Peirce, Roisman, and Crenshaw recently released a statement on the recent market volatility. Their statement highlighted the Commission’s essential mission to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.”

Recent events serve as a reminder that these functions are interconnected and there are very different and diverse investors that the Commission is tasked with protecting. The Commission should always place retail investors in a priority position when carrying out its mission of protecting investors. However, this approach becomes incredibly difficult when considering the various exposure that retail investors have to the markets.

It also begs the question which of the Commission’s essential missions should be prioritized at any one time. Should the Commission maintain fair, orderly, and efficient markets ahead of protecting investors or vice versa? In most instances, these two goals are entirely compatible.

As an example of the intricacies involved in balancing and prioritizing these missions, consider that many retail investors have an interest in a pension plan sponsored by their employer. These pension plans may have exposure to private investment funds, such as Melvin Capital, or to issuers like Tesla. They might also have exposure to companies like Robinhood Financial or the debt of Citadel LLC. They might rely on Fidelity as a custodian of the plan’s assets or as its broker-dealer. Any decision by one market participant or regulator can have a multitude of consequences on investors or the perceived fairness, order, and efficiency of the markets. It can also jeopardize or instill confidence in capital formation.

Whether the evidence ultimately shows whether any impermissible, coordinated market manipulation occurred in Gamestop stock, the interconnectedness of our financial markets makes it incredibly difficult to judge the Commission’s actions in real time and without any further inspection of its policies and actions in other facets of its mission. Before rushing to judgment on any market participant or regulator’s successes or failures in handling the recent trading issues, we should not forget the difficult balancing act that the Commission manages every day.

Managing Cryptocurency and Digital Assets in Separate Accounts. Comply With The Custody Rule!

In late 2020, MicroStrategy, led by CEO Michael Saylor, purchased $650 million worth of Bitcoin as a reserve asset. Morgan Stanley and its subsidiaries and affiliates also purchased a considerable part of MicroStrategy. In early 2021, the value of Bitcoin crossed $30,000. Then $40,000. Institutional investors started flocking to the asset. Even an old stodgy insurance company–Massachusetts Mutual Life Insurance (MassMutual), dipped its toes in the water to the tune of $100 million.

If you own or operate an investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”) or if you are a financial professional, you have probably been asked questions about Bitcoin and other digital assets. This article is intended to help address the custody issue associated with rendering investment advice on Bitcoin and other digital assets. Additional posts will address other legal and operational issues stemming from managing these digital assets.

Custody Issue

If you want to render investment advice on Bitcoin and digital assets, you need to be intimately aware of Rule 206(4)-2 under the Investment Advisers Act of 1940, as amended, or the “Custody Rule” and be prepared to comply with it.

Does Our Arrangement Currently Cause us to Have Custody or Will it in the Future?

The first issue to address is whether your firm would have “custody” over Bitcoin or any digital asset. The rule defines “custody” to include, among other things, “[a]ny arrangement (including a general power of attorney) under which [an investment adviser is] authorized or permitted to withdraw client funds or securities maintained with a custodian upon [the investment adviser’s] instruction to the custodian[.]”

If your investment adviser or any of its “related persons” have any arrangement where you are authorized or permitted to withdraw Bitcoin or other digital currencies from a client’s account (or wallet), you will likely be deemed to have custody of the client’s funds or securities under the Custody Rule.

Before you start managing Bitcoin and other digital assets for clients, you need to determine the framework. Will you rely on a custodian or will you do so directly by having access to your client’s wallet? The latter seems like a risky choice for most investment advisers and would seem to clearly implicate the Custody Rule. The former seems more practical and likely.

You should review any custodial agreements that your clients or your firm would be required to enter to determine what kind of authority you would have over their account. You should also conduct due diligence outside the walls of that agreement to understand what authority your firm will be granted. If the arrangement with the custodian only grants your firm the authority to issue instructions to effect or to settle trades, it may not implicate the Custody Rule at all. See IM Guidance Update (February 2017).

Definition of Funds or Securities

While the previous discussion assumed that Bitcoin and other digital assets are “funds or securities”, it is an unsettled matter. This very question was posed in a letter issued by the Division of Investment Management to the Investment Adviser Association in March 2019 titled Engaging on Non-DVP Custodial Practices and Digital Assets (the “IAA Letter”). I advise clients to generally treat digital assets as funds or securities, because you can almost predict with certainty that the first instance involving theft or fraud by an investment adviser or its associated persons will result in the SEC alleging that the digital asset in question is either a fund or a security.

What Does the Rule Require of Investment Advisers Deemed to Have Custody?

The Custody Rule requires investment advisers that are deemed to have “custody” over clients “funds and securities” to maintain those funds and securities with a “qualified custodian.” More specifically, the rule requires investment advisers to maintain the funds and securities with a qualified custodian (1) in a separate account for the client under the client’s name, or (2) in accounts that contain only the client’s funds and securities, under the investment adviser’s name as agent or trustee.

In addition, “[i]f you open an account with a qualified custodian on your client’s behalf, either under the client’s name or under your name as agent, you [must] notify the client in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, promptly when the account is opened and following any changes to this information. If you send account statements to a client to which you are required to provide this notice, include in the notification provided to that client and in any subsequent account statement you send that client a statement urging the client to compare the account statements from the custodian with those from the adviser.”

Third, you must “have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each of your clients for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period.”

Lastly, the funds and securities over which you have custody must generally be “verified by actual examination at least once during each calendar year…by an independent public accountant, pursuant to a written agreement between you and the accountant, at a time that is chosen by the accountant without prior notice or announcement to you and that is irregular from year to year.”

Who is a Qualified Custodian?

Under the rule, qualified custodians include banks, registered broker-dealers, and registered futures commission merchants. It is currently ambiguous whether state chartered trust companies qualify, because that answer turns on whether “a substantial portion of the[ir] business [] consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks under the authority of the Comptroller of the Currency, and [are] supervised and examined by State or Federal authority having supervision over banks or savings associations, and [] not [be] operated for the purpose of evading the provisions of the [Advisers Act].”

To date, the SEC hasn’t taken any enforcement action to challenge any state chartered trust companies or advisers using them for custodial services. In November 2020, the Division of Investment Management Staff in Consultation with FinHub Staff released a statement inviting comment on this issue. (As an aside, I recently wrote an article suggesting that the SEC should quickly issue guidance on this point after the Wyoming Division of Banking issued relief to Two Ocean Trust back in October 2020.)

Investment advisers that manage Bitcoin and digital assets seem willing to accept the risk that a trust company meets the definition of “qualified custodian” under the Custody Rule. Even Fidelity’s custody of digital assets is provided by Fidelity Digital Asset Services, LLC, a New York State-chartered, limited liability trust company (NMLS ID 1773897)–and not a bank or broker-dealer.

As my friend, Tyrone Ross, Jr., recently informed me, Anchorage received conditional approval of its national trust charter from the Office of the Comptroller of the Currency (OCC) on January 13, 2021, which makes Anchorage Digital Bank National Association, the first federally chartered bank willing and able to hold digital assets.

It appears that other entities that meet the definition of “qualified custodian” will make an entry into the market in the very near future based on the SEC’s recent statement and request for comment regarding the custody of digital asset securities by broker-dealers and the recent decision by the OCC.

Plans May Change in the Future

In 2020, it appeared that the SEC was going to amend the Custody Rule based on its regulatory agenda, but that no longer appears to be the case. It seems like the current composition of the SEC has no appetite to tackle changes to provide additional clarity on the Custody Rule as it relates to Bitcoin and digital assets at the moment, but that could change with the appointment of a new chairperson.

A Running List of Practical Pointers Under the New Marketing Rule

The new marketing rule provides an opportunity for investment advisers to compliantly test out new marketing methods. This post will provide a running list of pointers that I think investment advisers and investment professionals may find helpful or interesting. All of these practice pointers assume the rule is effective. None of these pointers should be relied upon as legal advice and I encourage you to seek out local counsel before engaging in any marketing practices under the new rule.

Also, please feel free to contact me if there are any issues that you would like me to address.

Practical Pointer #1: Centers of influence, such as lawyers and accountants, that refer clients to an investment adviser might be inadvertently providing testimonials or endorsements.

The adopting release states, “Depending on the facts and circumstances,
a lawyer or other service provider that refers an investor to an adviser, even infrequently, may also meet the rule’s definition of testimonial or endorsement.”

Under the new rule, “[a]n advertisement may not include any testimonial or endorsement, and an adviser may not provide compensation, directly or indirectly, for a testimonial or endorsement, unless the investment adviser complies” generally with three conditions. Under the new rule, a “testimonial” is defined as “any statement by a current client or investor in a private fund advised by the investment adviser:

  1. About the client or investor’s experience with the investment adviser or its supervised persons;
  2. That directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or
  3. That refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.”
Practical Pointer #2: Can an investment adviser request testimonials from its clients and then advertise them on its website?

Yes, but any advertisement would need to comply with all seven of the general prohibitions under the new marketing rule and meet the three conditions for testimonials and endorsements, absent an exemption.

The testimonial and endorsement requirements are fairly clear. Investment advisers might face trouble with the general prohibitions, and more specifically, the potential for creating untrue or misleading implications or inferences.

The adopting release provides more guidance on implications that may arise from testimonials. The adopting release states that the rule does not “require[] an adviser to present an equal number of negative testimonials alongside positive testimonials in an advertisement, or balance endorsements with negative statements in order to avoid giving rise to a misleading inference….Rather, the general prohibition requires the adviser to consider the context and totality of information presented such that it would not reasonably be likely to cause any misleading implication or inference. General disclaimer language (e.g., “these results may not be typical of all investors”) would not be sufficient to overcome this general prohibition. However, one approach that [the Staff] believe[s] would generally be consistent with the general prohibitions would be for an adviser to include a disclaimer that the testimonial provided was not representative, and then provide a link to, or other means of accessing (such as oral directions to go to the relevant parts of an adviser’s website), all or a representative sample of the testimonials about the adviser.”

As this passage makes clear, investment advisers must be thoughtful in how they solicit feedback from clients to create advertisements containing testimonials and should ensure that the ultimate presentation does not create any misleading inference or implication.

Practical Pointer #3: Can I pay a blogger or influencer to generate leads or clients for my firm?

Yes, so long as you and the blogger or influencer comply with the new marketing rule. Under the new marketing rule, a blogger or influencer that is generating leads or clients for an investment adviser will likely be providing an “endorsement” or “testimonial” under the rule.

The adopting release said as much.

Similarly, a blogger’s website review of an adviser’s advisory service would be a testimonial or an endorsement under the final marketing rule because it indicates approval, support, or a recommendation of the investment adviser, or because it describes its experience with the adviser. If the adviser directly or indirectly compensates the blogger for its review, for example by paying the blogger based on the amount of assets deposited in new accounts from client referrals or the number of accounts opened, the testimonial or endorsement will be an advertisement under the definition’s second prong.

To better understand the compliance requirements, please review the sections titled “What are the general prohibitions under the new advertising rule,” “What are testimonials and endorsements under the new rule,” and “How can an investment adviser use a testimonial or endorsement under the new rule?” available here.

Practical Pointer #4: Can I continue to use awards or rankings in my advertisements, such as those from Barron’s, CNBC, and Forbes?

Yes, but you will need to comply with new rules governing “third-party ratings”.

An advertisement may not include any third-party rating, unless the investment adviser:
(1) Has a reasonable basis for believing that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result; and
(2) Clearly and prominently discloses, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses:

(i) The date on which the rating was given and the period of time upon which the rating was based;
(ii) The identity of the third party that created and tabulated the rating; and
(iii) If applicable, that compensation has been provided directly or indirectly by the
adviser in connection with obtaining or using the third-party rating.

Practical Pointer #5: Can I use a complete or partial client list that identifies clients or private fund investors on a website or in a presentation?

Yes, but you would want to first obtain consent from any clients or investors appearing on the list. The use of the list would also need to comply with the new advertising rule’s general prohibitions, which are discussed under the heading “What are the general prohibitions under the new advertising rule” available here. For additional context on how those general prohibitions might be applied, advisors may want to review the no-action letter issued to Denver Investment Advisors, Inc. (July 30, 1993).

Practical Pointer #6: Can I record and publish a video with a client about their experience working with me? The video would discuss the services they received, their investment objectives, how we met their needs, and how we grew their investments.

Yes, but as noted above in Practical Pointer #2, any advertisement would need to comply with all seven of the general prohibitions under the new marketing rule and meet the three conditions for testimonials and endorsements, absent an exemption. As noted in Practical Pointer #2, the general prohibition against creating any misleading implication or inference will probably be most challenging.

Practical Pointer #7: Can our firm create a Google My Business page (or Angie’s List or any other third-party review service) and allow the public to review our firm’s services? What if our firm receives a defamatory or untruthful review?

Yes, the new rule permits an investment adviser to create a Google My Business page, but depending on the facts and circumstances, their page and the comments on the page might be considered advertisements under the new rule. More guidance is available below.

Under the new rule, the definition of an advertisement includes “[a]ny direct or indirect communication an investment adviser makes to more than one person…(a) that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or (b) offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser.

Does a Google My Business page (or similar review site) meet the definition of an advertisement? According to the definition, an advertisement requires that an “investment adviser make[]” a communication to more than one person. The adopting release states, “an adviser may [] ‘entangle[]’ itself in a third-party communication if the adviser involves itself in the third party’s preparation of the information”. If that occurs, the statement of the third-party would be deemed made by the investment adviser.

The adopting release states that “[w]e would not view an adviser’s edits to an existing third-party communication to result in attribution of that communication to the adviser if the adviser edits a third party’s communication based on pre-established, objective criteria (i.e., editing to remove profanity, defamatory or offensive statements, threatening language, materials that contain viruses or other harmful components, spam, unlawful content, or materials that infringe on intellectual property rights, or editing to correct a factual error) that are documented in the adviser’s policies and procedures and that are not designed to favor or disfavor the adviser. In these circumstances, we would not view the adviser as endorsing or approving the remaining content by virtue of such limited editing.”

However, whether the Google My Business page is as an advertisement made byt he investment adviser does not stop here. The investment adviser must then consider whether the Google My Business site has otherwise been “adopted” by or become “entangled” with the investment adviser.

The adopting release states:

Whether content posted by third parties on an adviser’s own website or social media page would be attributed to the investment adviser also depends on the facts and circumstances surrounding the adviser’s involvement.

For example, permitting all third parties to post public commentary to the adviser’s website or social media page would not, by itself, render such content attributable to the adviser, so long as the adviser does not selectively delete or alter the comments or their presentation and is not involved in the preparation of the content. We believe such treatment of third-party content on the adviser’s own website or social media page is appropriate even if the adviser has the ability to influence the commentary but does not exercise this authority. For example, if the social media platform allows the investment adviser to sort the third-party content in such a way that more favorable content appears more prominently, but the investment adviser does not actually do such sorting, then the ability to sort content would not, by itself, render such content attributable to the adviser. In addition, if an adviser merely permits the use of “like,” “share,” or “endorse” features on a third-party website or social media platform, we would not interpret the adviser’s permission as implicating the final rule.

Conversely, if the investment adviser takes affirmative steps to involve itself in the preparation or presentation of the comments, to endorse or approve the comments, or to edit posted comments, those comments would be attributed to the adviser. This would apply to the affirmative steps an adviser takes both on its own website or social media pages, as well as on third-party websites. For example, if an adviser substantively modifies the presentation of comments posted by others by deleting or suppressing negative comments or prioritizing the display of positive comments, then we would attribute the comments to the adviser (i.e., the communication would be an indirect statement of the adviser) because the adviser would have modified third-party comments with the goal of marketing its advisory business.

Therefore, if an investment adviser urges its clients to leave reviews on Google, then the entire Google review page could be deemed an advertisement and would become subject to the general prohibitions and the testimonial and endorsement requirements.

Practical Pointer #8: How do you differentiate between a third-party rating and an endorsement where a local publication or website ranks your services?

Many investment advisers will often participate in surveys to obtain a ranking, such as “Best Wealth Manager in New York”. Whether this rating itself and the future use of it in an advertisement is a “third-party rating” or an “endorsement” under the new rule will turn on whether the provider makes this type of ranking in the “ordinary course of its business”. In the adopting release, the Staff stated “[w]e continue to believe that the ordinary course of business requirement would largely correspond to persons with the experience to develop and promote ratings based on relevant criteria. It would also distinguish third-party ratings from testimonials and endorsements that resemble third-party ratings, but that are not made by persons who are in the business of providing ratings or rankings.”

Therefore, if an investment adviser were to pay a local newspaper that did not develop and promoting ratings in the ordinary course of its business, then the rating would likely be treated under the endorsement standard.

Practical Pointer #9: The new rule requires advertisements to generally include one-, five-, and ten-year time periods for the presentation of performance results. How does this work?

Under the new rule, an investment adviser may not include in any advertisement:

“Any performance results, of any portfolio or any composite aggregation of related portfolios, in each case other than any private fund, unless the advertisement includes performance results of the same portfolio or composite aggregation for one-, five-, and ten-year periods, each presented with equal prominence and ending on a date that is no less recent than the most recent calendar year-end; except that if the relevant portfolio did not exist for a particular prescribed period, then the life of the portfolio must be substituted for that period”

As an operational matter, this will make advertising performance really difficult. Performance will need to be calculated relatively quickly at the beginning of each calendar year so that an adviser can show performance as of the most recent calendar year-end.