My thoughts on the new Advertising Rule
Back in March 2019, Mark Schoeff from InvestmentNews reported that the U.S. Securities and Exchange Commission (“SEC”) was contemplating amending Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advertising Rule”) . Before that, Reuters made a similar report in March. Before that, the Investment Adviser Association reported in January of 2018 that the SEC was moving forward. In fact, the SEC included these on their regulatory agenda as early as Fall 2018 with a notice of proposed rule making expected in April 2019. It looks like things are moving forward, because the Commission included this on their regulatory agenda for Spring 2019 again.
It will be interesting to see what the rule proposal entails, but I am hopeful that the new rules help modernize the Advertising Rule. If I were drafting the rule release (and I am clearly not), I would make sure that it addresses these points:
- More Flexible Framework – Section 206 of the Investment Advisers Act generally makes it unlawful to engage in fraud or deceit. Over the last 80 years, the SEC has written no-action letters, drafted written guidance, and brought enforcement actions against investment advisers, which has shaped what fraud and deceit mean for investment advisers. I think it is time that the vast majority of the enlightened wisdom from those letters, guidance, and orders be wiped clean. It is time to start with a fresh deck and determine what is fraudulent and deceitful in this new world we live in. Let the words “fraud” and “deceit” stand for themselves and let us as an industry re-examine what practices we are comfortable with accepting.
- Hypothetical Back-tested Performance – I would permit the use of hypothetical back-tested performance for use in any format (electronic, retail or one-on-one presentations). However, the focus should be on (i) whether the context of the performance presentation is false and misleading, and (ii) whether the underlying data is accurate. Disclosure that accompanies a back-tested presentation should clearly be labeled: “This performance is not real. It was created using mathematical assumptions or algorithms and should not be relied upon in making your investment decision.” The SEC could also create a template disclosure document that must accompany presentations that contain back-tested materials. Instead of putting the burden on managers to use 8 point font at the back of a presentation, the SEC could product a half-page document explaining the benefits and detriments of back-testing. I think this is important because startup managers need to be able to compete with established managers. I think it is still important that performance presentations should generally be shown “net of fees”.
- Death to Anti-Testimonial Rule – Yes, testimonials run the risk of confusing investors. Yes, people are easily swayed by what their friends or paid spokespersons might tell them. However, the current framework is absolutely insane and farcical. It is time to entirely eliminate the testimonial rule. Instead, the rule should require disclosure of paid spokespersons. See FTC advertising rules already in existence. Also, any person who receives a benefit (either monetary or non-monetary) for making testimonials should have to make similar disclosures.
- Loosen Up Restrictions on Past Specific Recommendations – I believe the new proposed rules should allow investment advisers to discuss past specific recommendations in an electronic format, so long as that presentation hyperlinks to a website dedicated to all of their current recommendations and the recommendations that they have made in the past year. I am open to extending this period beyond a year. I am also open to seeing this opened up to non-electronic mediums too. If an investment adviser wants to tout performance in a Facebook ad, tweet or other electronic distribution, then they should simply show what is behind the curtains. The current rule and the relief provided by the Staff is inoperable.
Again, these views are mine alone. They don’t reflect the view of Stark & Stark, any client of Stark & Stark, or any of my colleagues. However, hopefully they become the view of the SEC soon.