Morningstar Presentations Present Issues for Investment Advisers

As an attorney in the investment management space, I have seen the use of Morningstar presentations create issues for investment advisers at an increasing rate during examinations conducted by the Securities and Exchange Commissions (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”).

The issues that I have seen typically revolve around the use of hypothetical back-tested performance. Most typically, a financial professional will create a presentation that compares the client or prospective client’s current portfolio to a portfolio being recommended by the financial professional. It will show a distinct improvement in one or more of the following variables: performance, expenses, or risk metrics. These presentations are not reviewed by compliance (or anyone for that matter) prior to their delivery to the client or prospect. OCIE has continually taken issue that these presentations violate Section 206 of the Investment Advisers Act because they are misleading. They also allege that these presentations are “advertisements” under Rule 206(4)-1 and that they violate the rule. The presentations are not typically labeled as hypothetical back-tested performance presentations. Further, the template or stock disclosures provided by Morningstar do not consistently or automatically comply with the no-action letter guidance issued by the SEC.

In any event, if your firm currently permits its financial professionals to use Morningstar presentations (or any similar product or software, such as HiddenLevers), now is a good time to review your policies and procedures. Some things to focus on:

1. How does your firm train and supervise your financial professionals on the use of Morningstar (and performance presentations in general)?
2. Does legal or compliance review each presentation before it is provided to a client? If not, how does it ensure compliance with the SEC’s no-action guidance on backtesting?
3. Have you reviewed the Morningstar presentations and the disclosure and are you confident that your firm’s use of the presentations meets the SEC no-action guidance relating to backtesting?

I believe that Morningstar should try and make some slight re-designs to the presentation formatting and disclosures to maximize the likelihood of compliance for investment advisers. They may also want to provide their users with some type of whitepaper, education, or training to reduce the examination and enforcement risk for users.

* This post was updated on September 22, 2020 at 9:15am to remove any reference to issues involving LPL Financial.