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.

SEC Amends Advertising and Solicitation Rules

On December 22, 2020, the U.S. Securities and Exchange Commission adopted amendments to the rules under the Investment Advisers Act of 1940 relating to advertisements. A copy of the adopting release is available here. When news first broke, I provided my initial thoughts via Twitter (which I have included below), but the purpose of this post is to provide a little cleaner overview of the amendments and the new rule.

When are the amendments effective?

The amendments will become effective 60 days after the rule is published in the federal register. It was published in the federal register on March 5, 2021, so it becomes effective on May 4, 2021.

The SEC has provided an eighteen-month transition period between the effective date of the rule and the compliance date, which means compliance is mandatory on November 4, 2021.

How does the Compliance Date and Transition Period Work?

As noted above, the SEC is providing an eighteen-month transition period between the effective date of the rule and the compliance date.

Advertisements published on or after the compliance date by investment advisers registered with the SEC will be subject to the new marketing rule.

The compliance date for the amended recordkeeping rule will also provide an eighteen month transition date from the effective date of the rule.

Advisers filing Form ADV after the eighteen-month transition period will also be required to complete the amended form, but only if they are otherwise required to amend the relevant portion of the form according to the instructions to Form ADV.

Can an investment adviser operate under the new rule during the transition period?

Although the adopting release is not clear, it appears that investment advisers may operate under the new rule immediately upon its effectiveness.

However, I wouldn’t recommend engaging in the use of testimonials without trying to clean up any other outstanding advertisements that might not be compliant.

What will be considered an “advertisement” under the new rule?

Under the new rule, the definition of an advertisement includes two distinct types of communications.

  1. First, it includes “[a]ny direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes “hypothetical performance”, (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.
  2. Second, it includes “[a]ny “endorsement” or “testimonial” for which an investment adviser provides compensation, directly or indirectly, but does not include any 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.
Are there any exceptions or exclusions to the definition of “advertisement”?

Yes. As noted in the definition above, one-on-one communications that are not “testimonials” or “endorsements” are not subject to the rule, unless they include “hypothetical performance. In addition, the following are excluded from the definition of “advertisement”:

  1. Extemporaneous, live, oral communications. According to the adopting release, this does not extend to “prepared remarks or speeches, such as those delivered from scripts.” These will be subject to the rule. Also, the adopting release states that “previously prepared live, oral communication in a non-broadcast setting, such as luncheon seminar designed to attract new investors” would be subject to the rule.
  2. Regulatory Filings. Most, but not all, information in a statutory or regulatory notice, filing, or other required communication (i.e., Form ADV Part 2 or Form CRS).
  3. Information Provided upon Unsolicited Request. Any communication that includes “hypothetical performance” that an adviser provides (1) “[i]n response to an unsolicited request for such information from a prospective
    or current client or investor in a private fund advised by the investment adviser, or (2) To a prospective or current investor in a private fund advised by the investment adviser in a one-on-one communication.
What are the general prohibitions under the new advertising rule?

Under the new rule, there are seven general prohibitions.

An advertisement may not:

  1. Include any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading.
  2. Include a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission.
  3. Include 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.
  4. Discuss 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.
  5. Include 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.
  6. Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced.
  7. Otherwise be materially misleading.
What are “testimonials” and “endorsements” under the new rule?

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.”

Similarly, an “endorsement” under the new rule is defined as “any statement by a person other than a current client or investor
in a private fund advised by the investment adviser that:

  1. Indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons;
  2. 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. 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.”
How can an investment adviser use a “testimonial” or “endorsement” under the new rule?

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 (unless it meets one of the specific exemptions, which reduces the burden on some, but not all of the conditions).

The Three Conditions

  1. Mandatory Disclosure. An investment adviser must “disclose[], or reasonably believe[] that the person giving the testimonial or endorsement discloses, the following at the time the testimonial or endorsement is disseminated:
    • Clearly and prominently:
      • That the testimonial was given by a current client or investor, and the endorsement was given by a person other than a current client or investor, as applicable;
      • That cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and
      • A brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person.
    • The material terms of any compensation arrangement, including a description of the compensation provided or to be provided, directly or indirectly, to the person for the testimonial or endorsement; and
    • A description of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person and/or any compensation arrangement.
    • These are collectively referred to as the “Disclosure Requirements”.
  2. Oversight Requirement. An investment adviser must maintain a “reasonable basis” for “believing that the testimonial or endorsement complies with the requirements of [the three conditions] (the “Oversight Requirement”). An adviser must also maintain “a written agreement with any person giving a testimonial or endorsement that describes the scope of the agreed-upon activities and the terms of compensation for those activities. (the “Written Agreement Requirement”).
  3. Disqualifying Provision. Under the new rule, an investment adviser cannot compensate a person in any manner for a testimonial or endorsement if they know or should know with the exercise of reasonable care that the person providing the testimonial or endorsement is an “ineligible person” when it is disseminated. There is a grandfathering provision in the rule that might provide some relief to “ineligible persons” assuming they were not disqualified under the prior cash solicitation rule (Rule 206(4)-3).

Exemptions from the Conditions

There are a few instances where all of the conditions referenced above are not required for compliance with the rule. Each of these situations is discussed below:

  1. Free and De Minimis Testimonials and Endorsements. In cases where an adviser disseminates an advertisement containing a testimonial or endorsement for no compensation or $1,000 or less (or the equivalent in non-cash compensation) during the preceding 12 months, the parties do not need to enter into a written agreement outlining the scope of services and the terms of compensation and the person receiving compensation could be an “ineligible person”. Put another way, the adviser must still perform the Oversight Requirement, but is excused from the Written Agreement Requirement and could pay an “ineligible person”.
  2. Payments to Employees and Related Persons. A testimonial or endorsement by an investment adviser’s “partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person” is excused from the Disclosure Requirements and the Written Agreement Requirement, “provided that the affiliation between the investment adviser and such person is readily apparent to or is disclosed to the client or investor at the time the testimonial or endorsement is disseminated and the investment adviser documents such person’s status at the time the testimonial or endorsement is disseminated.”
  3. Certain Exceptions for Broker-Dealers. For broker-dealers registered with the SEC, they are excused from the Disclosure Requirements if the testimonial or endorsement is a recommendation subject to Regulation Best Interest. In addition, there are exceptions from certain disclosure requirements if the recipient of the testimonial or endorsement is not a retail customer (as defined by Regulation Best Interest). Lastly, they are excused from the disqualification provisions so long as they aren’t subject to the statutory disqualification provisions under section 3(a)(39) of the Securities Exchange Act of 1934.
What is a “Third-Party Rating” and what are the new rules for “Third-Party Ratings”?

Under the new rule, a “third-party rating” is “a rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms), and such person provides such ratings or rankings in the ordinary course of its business.”

An investment adviser may not include any third-party rating in an advertisement unless they meet two conditions. The first condition is that the investment adviser must maintain 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.” The second condition requires that an investment adviser “clearly and prominently” disclose or that the rating itself “clearly and prominently” discloses i) the date the rating was given and time period on which the rating was based, ii) the third party that created and tabulated the rating, and iii) whether any compensation was provided directly or indirectly to obtain or use the rating.

For an example of the types of third-party ratings that, if advertised, would be subject to the rule, you may want to visit Forbes, Investment News, the Financial Times, and SmartAsset.

What are the new requirements for performance advertising?

There are quite a few new changes under the new advertising rule as it relates to performance advertising. The new rule addresses i) the presentation of gross performance, ii) mandatory prescribed time reporting requirements for portfolios and composite portfolios, iii) and rules on using “related performance”, “extracted performance”, and “hypothetical performance”.

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

  1. Gross and Net Performance. Any presentation of gross performance, unless the advertisement also contains a presentation of net performance. Net performance must be displayed with “at least equal prominence” and in a way to “facilitate comparison”. Both presentations must show the same period of time and use the same type of methodology.
  2. Prescribed Time Period Reporting. Performance for any portfolio or composite portfolio (with the exception of private fund), unless the advertisement includes performance for one-, five-, and ten-year periods. This prescribed time period reporting must not be stale. More specifically, “it must end on a date that is no less recent than the most recent calendar year-end.” In certain instances, it could require a more recent date to avoid being presented in an unfair or unbalanced manner.
  3. No Representation of SEC Approval. that contains a “statement, express or implied, that the calculation or presentation of performance results in the advertisement has been approved or reviewed by the [SEC].”
  4. Related Performance. “Related performance”, unless it includes all “related portfolios”. Under the new rule, the term “related performance” “means the performance results of one or more related portfolios, either on a portfolio-by-portfolio basis or as a composite aggregation of all portfolios falling within stated criteria.” The term “related portfolio” means “a portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered in the advertisement.” In certain instances, the new rule permits the exclusion of a related portfolio if the exclusion doesn’t result in “materially higher” performance results or alter the prescribed time periods referenced above.
  5. Extracted Performance. “Extracted performance” without providing or offering to provide promptly the total portfolio from which the performance was extracted.
  6. Hypothetical Performance. “Hypothetical performance” without complying with certain elements described below.
  7. Predecessor Performance. “Predecessor performance” without complying with certain conditions under the rule. However, this is a fairly unique issue so is beyond the coverage of this post.

What is Hypothetical Performance and what must be done to use it in an Advertisement?

Under the new rule, “hypothetical performance” is defined as “performance results that were not actually achieved by any portfolio of the investment adviser.” There are three categories of performance presentations that are specifically referenced in the new definition:

  1. Performance derived from model portfolios;
  2. Performance that is backtested by the application of a strategy to data from prior time periods when the strategy was not actually used during those time periods; and
  3. Targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement.

Under the new definition, certain interactive analysis tools are excluded from the definition of “hypothetical performance” as long as they meet the following conditions:

  1. The tool produces simulations and statistical analyses that present the likelihood of various investment outcomes if certain investments are made or certain investment strategies or styles are undertaken, thereby serving as an additional resource to investors in the evaluation of the potential risks and returns of investment choices; provided that the investment adviser:
    • Provides a description of the criteria and methodology used, including the investment analysis tool’s limitations and key assumptions;
    • Explains that the results may vary with each use and over time;
    • If applicable, describes the universe of investments considered in the analysis, explains how the tool determines which investments to select, discloses if the tool favors certain investments and, if so, explains the reason for the selectivity, and states that other investments not considered may have characteristics similar or superior to those being analyzed; and
    • Discloses that the tool generates outcomes that are hypothetical in nature.

An investment adviser will be unable to advertise hypothetical performance unless they:

  1. Adopt and implement policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement,
  2. Provide sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance, and
  3. Provide (or, if the intended audience is an investor in a private fund provides, or offers to provide promptly) sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions; Provided that the investment adviser need not comply with the i) prescribed time period condition (i.e., the 1, 5, and 10-year requirement) ii) the “related performance” requirement (i.e., the need to generally include all related performance), and iii) the “extracted performance” requirement (i.e., the need to generally provide or offer to provide the performance for the entire portfolio), each described above.
What impact do the new rules have on Form ADV?

The new rule is accompanied by amendments to Form ADV that are designed to provide the SEC with information about an investment adviser’s advertising practices. These changes can be viewed on Appendix A to the adopting release at page 420. The new Glossary of Terms to Form ADV is found on Appendix B at page 421.

What impact do the new rules have on recordkeeping obligations?

The new rule presents some interesting tweaks for recordkeeping predominantly flowing from the new definition of “advertisement”.

As the adopting release describes, “[i]nvestment advisers must make and keep records of all advertisements they disseminate, and certain alternative methods for complying with this provision are available for oral advertisements, including oral testimonials and oral endorsements. If an adviser provides an advertisement orally, the adviser may, instead of recording and retaining the advertisement, retain a copy of any written or recorded materials used by the adviser in connection with the oral advertisement. If an adviser’s advertisement includes a compensated oral testimonial or endorsement, the adviser may, instead of recording and retaining the advertisement, make and keep a record of the disclosures provided to investors. Further, if an adviser’s disclosures with respect to a testimonial or endorsement are not included in the advertisement, then the adviser must retain copies of such disclosures provided to investors.”

What if I simply want to review the new rules?

Feel free to jump to page 405-419 of the adopting release.

VOYA Financial Advisors Enforcement Action

Who should be worried? What should we be doing? What went wrong? Should we care?

The U.S. Securities and Exchange Commission (“SEC”) settled an enforcement matter with Voya Financial Advisors, Inc. on December 21, 2020. This is yet another case that does a disservice for the investment advisory legal and compliance industry by providing unclear guidance in a settled enforcement action with a party that neither admits nor denies wrongdoing.

The Illiquid Alternatives Allegation

Among the allegations raised by the SEC were that “Voya’s policy [] requir[ed] advisory clients to pay an upfront brokerage commission when purchasing illiquid alternative investment products (“Illiquid Alts”) when the same investment was available to advisory clients with the brokerage commissions waived.”

What Types of Investment Advisers Should be Worried?

For investment advisers i) that are dually registered as broker-dealers, ii) that have an affiliate that is a broker-dealer, or iii) have associated persons that are registered representatives of a broker-dealer (i.e., hybrid advisers), this case is really important. These firms should be thoughtful in the structures, policies, and disclosures in place for recommending commission-based securities products to investment advisory clients.

What Should These Firms be Doing?

Compliance departments should i) understand what securities are being recommended, ii) when they are being recommended, iii) how they are being recommended, iv) are there identical or substantially similar securities available, and if so are they less expensive, and v) are there other conflicts of interest in the recommendation process (both at the representative and firm level).

Once a compliance department understands these issues, then they should make sure that their disclosures align with any conflicted practice or that the conflicted practice is eliminated altogether. 

What Went Wrong and What Could it Have Done Differently?

In this matter, it appears that Voya had a formal policy that required advisory clients to purchase these illiquid alternative investment products (“Illiquid Alts”) on a commission basis, when they might have been able to purchase them on an advisory basis without regard to whether this was expected to be the most appropriate way for the client to acquire the security (i.e., the most affordable).

Had Voya disclosed the existence of this policy and its financial impact to clients, then I don’t believe these claims would have had merit. This much is clear from Paragraph 30 of the Order. Because the claims are also raised in the section on “best execution”, it does give me pause, but we have seen these types of claims incorrectly raised in this context in many other settled enforcement actions.  

Also, if Voya’s policy had been that representatives were required to make the most appropriate selection using their best judgment at the time of the recommendation, and the representatives actually made a justifiable recommendation, these charges would not have likely had merit.

How Much Weight Should this Case be Afforded?

I would pay serious attention to this matter and its findings, but also try and keep it in context. Voya was clearly going to take a beating on the share class selection and money market sweep issues, so they probably didn’t have much incentive to defend these claims on the Illiquid Alts as vigorously.

Department of Labor’s Final Fiduciary Rule Exemption – What’s Different Between the Proposal and the Final Exemption?

The Department of Labor announced its long-awaited final class exemption from certain prohibited transaction under the Employee Retirement Income Security Act of 1974, as
amended (the Act

Putting aside whether the Biden administration will freeze and repeal this exemption, this post is designed to address the differences between the proposal and the final exemption. The final exemption appears to be nearly identical to the proposal, with the following three major differences.

First, the final exemption includes a new disclosure requirement, which was not contemplated by the proposal. The exemption requires the following of a Financial Institution:

Prior to engaging in a rollover recommended pursuant to the exemption, the Financial Institution provides the documentation of specific reasons for the rollover recommendation, required by [the exemption], to the Retirement Investor.

Second, the policies and procedures requirement appears to have been softened.  The final exemption will require a Financial Institution relying on the exemption to maintain “policies and procedures [to] mitigate Conflicts of Interest to the extent that a reasonable person reviewing the policies and procedures and incentive practices as a whole would conclude that they do not create an incentive for a Financial Institution or Investment Professional to place their interests ahead of the interest of the Retirement Investor.” This creates a “reasonable person” standard for reviewing policies and procedures, whereas the proposed exemption would have required policies and procedures that were “prudently designed to avoid misalignment of the interests” between the Financial Institution and Investment Professional.

Lastly, the final exemption contains a self-correction process for any inadvertent non-compliance. The final exemption states:

A non-exempt prohibited transaction will not occur due to a violation of the exemption’s conditions with respect to a transaction, provided:

(1) Either the violation did not result in investment losses to the Retirement Investor or the Financial Institution made the Retirement Investor whole for any resulting losses;

(2) The Financial Institution corrects the violation and notifies the Department of Labor of the violation and the correction via email to IIAWR@dol.gov within 30 days of correction;

(3) The correction occurs no later than 90 days after the Financial Institution learned of the violation or reasonably should have learned of the violation; and

(4) The Financial Institution notifies the person(s) responsible for conducting the retrospective review during the applicable review cycle and the violation and correction is specifically set forth in the written report of the retrospective review required under subsection II(d)(2).

SEC Likely to Adopt New Advertising Rules for Investment Advisers

On Wednesday, December 16, 2020 at 10:00 am, it is looking highly like that the U.S. Securities and Exchange Commission will adopt amendments to the advertising rules under the Investment Advisers Act of 1940.

If you are interested, here is a link to the notice announcing the meeting (and the likely vote). The hearing will be available by webcast on the Commission’s website at www.sec.gov. I will be tuning in and live tweeting @advisercounsel.

My predictions:

1. We will see a new principles-based rule governing advertisements.
2. We will see the approval of testimonials and endorsements.
3. All communications, not just written communications, will be treated as advertisements. The rule will apply equally to podcasts, videos, TikTok, and more.

Assuming the rule is approved, I will be blogging about what it means for investment advisers, investment adviser representatives, registered fund managers, marketers, web developers, and public relation firms shortly thereafter. If there are any specific angles you are interested in hearing about, feel free to reach out in the meantime.

New York Investment Adviser Representatives to Become Subject to Licensing (Finally)

On December 1, 2020, New York Attorney General James announced rules that will require the licensing of investment adviser representatives (“IARs”) in New York. IARs will be required to register through the Central Registration Depository/Investment Adviser Registration Depository. If you render investment advice from a place of business in New York, now is the time to begin reviewing the rule and your licensing obligations. This new law applies even if you previously filed a NY-IAQ on behalf of a state-registered investment adviser.

Beginning on February 1, 2021, IARs of both state-registered and federally registered investment advisers will be required to meet examination requirements and register with the state. The licensing fee is $200 and will be the second most expensive in the country behind Georgia.

The rule contains an implementation period, which will allow those currently engaged in business to continue their business without an approved registration until December 2, 2021.

The rule also provides for an examination waiver for people who have been serving as IARs for at least two years prior to February 1, 2021 so long as they are not disqualified. Disqualifying events include being subject to any regulatory or civil action, proceeding or arbitration, either pending or in the preceding ten (10) years from the date of application, that would require disclosure on Form U4, or that person has been notified or has reason to believe that they currently are or remain the subject of a regulatory or law enforcement investigation related to investment-related activities.

The Office of the Attorney General provided helpful information for financial professionals and compliance departments that summarize what should be done to apply and request an examination waiver.

If you need any help (i) in determining whether you qualify for an examination waiver, (ii) how to file a Form U4, (iii) whether you must amend your firm’s notice filings, (iv) when you must file your application, or (v) in preparing and submitting your Form U4, do not hesitate reaching out.

NASAA Proposes Model Rule for Continuing Education With A Number of Shortcomings

I applaud the North American Securities Administrators Association (“NASAA”) for proposing a model rule to assist state securities regulators in implementing a mandatory continuing education program for investment adviser representatives (“IAR”) in their jurisdiction. These efforts are long overdue to convince the public that the rendering of financial advice is a legitimate profession. A copy of the press release announcing the model rule is available here. A copy of the model rule is available here.

The Shortcomings

There are a few problems with the proposal, but the biggest ones are:

  1. The model rule is only a model rule. It doesn’t require any NASAA member to implement the rule. Based on my experience, very few NASAA members adopt non-core model rules, and those that do, usually take quite a bit of time to do so. Some states have extensive rulemaking processes that need to be followed and others are at the discretion of their legislators. Reputable designations like the CFP, the CFA , IMCA, and CPAs have continuing education programs already, but other financial professionals could potentially take advantage of the resulting patchwork framework by moving their places of business to avoid continuing education.
  2. The model rule, if implemented by members, wouldn’t and couldn’t require any continuing education for the hundreds if not thousands of financial professionals who do not meet the definition of “investment adviser representative” under Rule 203A-3. These professionals might cater to only a few clients or high net worth clients and thereby avoid meeting the definition of “investment adviser representative”.
  3. If the model rule is adopted by a NASAA member, if challenged, it could be deemed unconstitutional as it relates to IARs associated with investment advisers registered with the U.S. Securities and Exchange Commission (“SEC IARs”).

The Constitutionality of the Proposal

The remainder of this post deals with the last issue. By the numbers, there are almost 4 times more SEC IARs than their state counterparts (roughly 97,000 to 27,000). So any policy change or rule seeking to further legitimize the profession and improve education must guarantee that it reaches the entire universe of SEC IARs.

Why is the model rule potentially unconstitutional? Section 203A(b) of the Investment Advisers Act of 1940 (the “Advisers Act”) states:

No law of any State or political subdivision thereof requiring the registration, licensing, or qualification as an investment adviser or supervised person of an investment adviser shall apply to any person—(A)that is registered under section 80b–3 of this title as an investment adviser, or that is a supervised person of such person, except that a State may license, register, or otherwise qualify any investment adviser representative who has a place of business located within that State;

(emphasis added).

Federal law preempts states from registering, licensing, or qualifying a “supervised person” of an investment adviser, except that it may license, register, or qualify an “investment adviser representative” who has a place of business within that state. This begs the question whether a continuing education program with ongoing requirements is a form of qualification or goes beyond the statute’s authority.

Legislative Intent

One of the principle canons of statutory constructions states: “Where the language is unambiguous, there is no occasion for the application of rules of construction.” By that, lawyers mean that where a law is clear on its face, we need not look any further. Reasonable minds might disagree on whether continuing education is a form of qualification. Merriam Webster defines “qualification” as “a condition or standard that must be complied with (as for the attainment of a privilege).” I leave it to readers to form their own opinions.

Another canon of statutory construction states that courts, “determine legislative intent by examining not only the literal words of the statute, also the reasonableness of proposed constructions, the public policy behind the statute, and its legislative history.”

Assuming that the statute is ambiguous, where would courts look for legislative intent? The National Securities Markets Improvement Act of 1996 (“NSMIA”) amended Section 203A of the Advisers Act by creating the current federal-state licensing dynamic and the qualification issue. The intent of Congress, in the words of Senator Paul Sarbanes is a bit murky:

The House and Senate compromised on the investment adviser provisions of the Senate bill…The conference report provides that investment adviser representatives of [investment advisers registered with the SEC] will continue to be licensed by the States in which they have places of business. The bill does not prohibit a State from requiring that investment adviser representatives doing business in that State designate a place of business in the State, such as an address for service of process, for purposes of maintaining State licensing authority over such individuals….

This is a moderate bill, and appropriately so, for the Federal and State laws governing our securities markets and the participants in those markets are not in need of wholesale changes. All the evidence suggests that the U.S. securities markets are functioning well. Companies continue to raise capital in the U.S. markets in record amounts. In addition to established businesses, new companies have been raising capital in record amounts. Individual investor confidence in the securities markets, measured by direct investment in securities and investment through mutual funds and pension plans, remains high. The U.S. securities markets retain their preeminent position in the world. As passed by the conference, this bill strikes a reasonable balance. It should improve efficiency in the regulation of our securities markets without unduly limiting the authority of the State regulators, thereby exposing investors to sharp practices. The bill received support from Democratic and Republican House and Senate conferees, and was passed by the House unanimously 2 days ago. I am pleased that the House and Senate, Democrats and Republicans alike, were able to reach consensus on this legislation.

NSMIA; Conference Report; Congressional Record Vol. 142, No. 139 (Senate – October 01, 1996) (emphasis added).

Senator Sarbanes’ remarks can be interpreted in a few ways. First, they suggest that the Senate is content with the status quo and there aren’t need for wholesale changes–in terms of the regulation of investment professionals. His statement makes clear that state regulators are being limited–albeit not in an unduly manner. On the other hand, his statement seems to suggest that the law grants states with continued authority to prevent investors from facing “sharp practices.”

At the time of the passage of NSMIA, the only requirement for an “investment adviser representative” to become licensed to render advice in most states was to take and pass the Series 65 examination or the Series 7 and the Series 66 examinations. The new continuing education requirement could be viewed as a substantial change of the status quo.

If the model rule is to be accepted as constitutional, judges would be wise to examine the public policy implications. Assuming education accomplishes its goal, states that adopt the model rule will likely have a more educated and ethical body of licensed financial professionals. As a practicing lawyer, I have substantial doubts about the efficacy of continuing education. I attend courses regularly where every attorney is doing other work or playing on their phones.

Putting aside the efficacy of continuing education, not all states will adopt the model rule and the timing of adoption can vary greatly. Each state can also tweak the requirements of the educational requirement (e.g, 6 ethical credits and 6 product/practice credits vs. 2 ethical credits and 10 product/practice credits). It will likely result in a patchwork of different requirements for continuing education depending on where the financial professional resides and could be susceptible to evasion or identifying the least burdensome jurisdiction.


I think NASAA’s heart and head were in the right place. However, I think there are a number of issues with the proposal, and I look forward to continue tracking the legislation as it is proposed throughout the country.

[1] NSMIA; Conference Report; Congressional Record Vol. 142, No. 139 (Senate – October 01, 1996).

Most Common Reasons For Seeking Independence – Start Your Own RIA

I work almost exclusively with independent investment advisers. My most typical client is someone who has, for one reason or another, become disillusioned with their current employer or business partner. The three most common refrains I hear from clients and prospective clients considering independence are:

  1. Restrictions. They feel like they are unnecessarily restricted or burdened by legal or compliance restrictions.
  2. Equity. They want to be more entrepreneurial and create a business with real equity, and
  3. Revenue. They don’t want to continue giving up 20-60% of their revenues to their employer or business partner.


The legal and compliance restrictions I hear about most frequently from financial professionals include:

  1. Inability to Manage Outside Assets for Compensation. Every financial professional knows that a large portion of U.S. individual’s personal wealth is tied up in their employer-sponsored retirement accounts. However, most employers won’t allow them to manage these accounts or provide advice on these accounts in exchange for compensation. If 80% of a person’s wealth is in their retirement account, why would a financial professional spend so much time and energy with that client when their revenue is tied to only a small portion of their wealth? Independence provides solutions to this problem. You can consider retainer-based fees or you can charge asset-based fees for managing these held-away accounts.
  2. Restrictions on Internet and Social Media Prospecting. Many financial professionals are prohibited from using social media, “Google My Business”, or Yelp for developing business. Obviously, employers have valid concerns relating to record retention and supervision, because they don’t want to open up the floodgates and create a headache for their compliance departments. However, smaller, nimbler investment advisers are able to engage in these activities in compliant ways.
  3. Prohibition Against Outside Business Activities. Many financial professionals want to engage in outside business activities that could be investment-related. Almost unanimously, most larger firms will prevent financial professionals from engaging in these activities for fear of liability.
  4. Inability to Serve as Trustee or Executrix. A number of financial professionals want to accept roles as trustee or executrix for longtime clients. I am not aware of any larger firms that permit these activities. These activities can be both personally rewarding and lucrative. Independence allows you to consider performing these services.


Equity is another important reason financial professionals consider independence. Based on industry-wide studies and my own experience, independent investment advisers are valued at between 1 to 4 times their annual revenue. Larger firms stand to receive upwards of double digit valuations. If you are an employee that renders investment advice at Morgan Stanley, Merrill Lynch, Goldman Sachs, UBS, Wells Fargo, or most other investment advice firms, there is an extremely high likelihood that you are not earning meaningful equity in the company. Chances are you aren’t earning any equity or you might receive some pittance of stock in an employer stock plan. Most likely, if you are deemed successful by internal standards, you will have the luxury of earning bonuses that are intended to serve as “golden handcuffs”. So many financial professionals treat their business like it is already a distinct, legal business, but in reality, they are employees of larger organizations. I find that many financial professionals want to build true equity in their business so that they can leave a legacy, build meaningful value in their business, and have endless flexibility when it comes to succession planning.


When I speak to prospective clients, another common reason for considering independence is the potential for increasing revenue. The thought of increasing revenues immediately to 100% is alluring. They all understand they will have increased expenses, but they also understand that they can control their expenses. Many people contemplating independence these days are comfortable with home offices and shared office space. Others are very comfortable with leasing their own space with equity markets at all time highs and commercial real estate at all time lows. Once you have a grasp on expenses, the math becomes quite easy. In terms of typical expenses, the following are the most meaningful recurring expenses: staff compensation, office lease or mortgage, insurance, software and technology, legal and compliance, and advertising. It is very possible for really lean businesses to keep these recurring expenses below $10,000 or $15,000. For more corporate and professional operations, it becomes more difficult to pin down the precise amount of expenses, but common percentages I often hear are between 10-20% of revenue. Every percentage can make a difference between resounding success, break-even, or a decrease in earnings, so it is essential to spend time plotting expenses.

Equity and Revenue Tools

If you are interested in charting out whether it makes sense from an equity or income perspective, Schwab Advisor Services has an interesting digital tool that allows you to compare revenues and equity in a world where you are independent versus your current model. While not perfect, this tool does provide a real sense of how income and equity can change in the independent space.


I am always happy to entertain free conversations with financial professionals considering independence. Please feel free to call or email me and we can plot out your course to independence.

Branch Office Supervision in Light of OCIE Guidance

On Monday, OCIE released a Risk Alert focused on their recent observations from focused examinations of investment advisers that operate out of multiple locations or branch offices. I provided a summary of that guidance here.

So what does this mean for investment advisers who operate multiple offices or branch offices? Advisers should review their policies and procedures and determine whether they sufficiently address business being conducted at these offices. Firms should consider the following:

Code of Ethics

  • Are “access persons” at these offices subject to the firm’s Code of Ethics?
  • Do employees prepare and submit initial holdings reports, quarterly transaction reports, and annual holdings reports?
  • Do employees at these offices report their gifts and entertainment appropriately?
  • Does the office have sufficient policies and procedures to prevent insider trading?
  • Is the business aware of and does it understand all outside business activities engaged in by employees?
  • Is the business tracking political contributions of branch office employees?

Advertising and Communications with the Public

  • Does the business treat advertisements and marketing activity consistently across branch offices?
  • Is social media use and review comparable across branch offices?
  • Are advertisements reviewed and approved in a similar manner?
  • Are performance presentations reviewed by the headquarters? Are backtested performance presentations being used without knowledge?
  • Are third-party rankings or awards being used in advertisements without approval?
  • How are client complaints handled at branch offices?
  • Are electronic communications (both internal and external) handled similarly?

Custody Related Issues

  • Does the business have policies and procedures to identify instances where a branch office activity could deem the business to have custody under Rule 206(4)-2?
    • Most commonly, I see issues in:
      • identifying “related persons” that may be deemed to have custody under the rule;
      • not identifying employees that have agreed to serve as trustee or executor for non-familial clients;
      • serving as a general partner or manager of a private investment vehicle;
      • receiving checks that are inadvertently made payable to the business or receiving stock certificates from clients;
      • obtaining check writing authority from clients;
      • obtaining login credentials to a client’s bank or brokerage account that provides the employee with ability to transfer assets; and
      • maintaining authority over a client’s managed account that provides broad disbursement authority without compliance with no-action guidance issued by the Staff.
  • If the branch office is deemed to have custody, does the business have policies and procedures to comply with Rule 206(4)-2?
    • Are client funds or securities maintained with a qualified custodian?
    • If 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, do you 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?
    • Do you 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?
    • Are the client funds and securities subject to an actual examination annually by an independent public accountant (or do you rely on the limited partnership audit exception)?

Investment Advice, Disciplinary Histories, and Litigation Risks

  • Do you have policies to identify and document instances of disciplinary or litigation events?
  • Do you have procedures to closely monitor individuals with disciplinary or litigation histories with a view towards how they render advice?
  • Have clients been notified of employee disciplinary events requiring disclosure under Form ADV Part 2B?
  • Especially when representatives serve as portfolio manager, but in all instances, have clients received appropriate disclosure of the strategy being managed by their portfolio manager?
  • Does the firm disclose all material conflicts of interest associated with rendering of investment advice at branch offices?
    • Are representatives at branch offices recommending investments where they have a material ownership interest or business relationship?
    • Are representatives receiving any type of kick-back or revenue sharing for recommending an investment?
    • Are representatives selecting or recommending non-optimal securities for a client (such as more expensive share classes)?
    • Are disclosures regarding wrap fee programs accurate? Has the business disclosed additional fees and expenses, including potential trade away fees?
  • Does the business automatically rebalance client accounts, and if so, does the business take steps to avoid paying short-term redemption fees?

Administrative and Billing Issues

  • Does the business supervise billing performed by branch offices?
  • Does the business review advisory agreements entered into by branch offices to ensure that clients are being charged the appropriate fee?
  • Are credits and reimbursements being applied consistently?

Recommendations from the Staff

  • The Staff suggested that businesses with “centralized processes mitigated instances in which supervised persons or branch offices had independent billing options or fee arrangements that deviated from client agreements or disclosures.”
  • The Staff hinted that advisers that automate and/or centralize their review and approval of personal transaction activity and educate employees on their code of ethics and personal trading policies were better positioned for compliance.
  • The Staff intimated that uniform portfolio management and centralized trading was favorable.
  • The Staff favorably highlighted compliance testing and periodic reviews of essential activities at branch offices and focused on portfolio management, monitoring trading and management activities, and supervision that did not focus exclusively on self-reporting.

This is not intended to be a verbatim recitation of the Staff’s guidance and serves to highlight some of the key points raised by the Staff. Compliance officers and legal counsel should review the Staff’s guidance and review their policies and procedures in light of this guidance.

Risk Alert Following OCIE Examinations on Branch Offices

Today, OCIE released a Risk Alert focused on their recent observations from focused examinations of investment advisers that operate out of multiple locations or branch offices.

These examinations focused on whether the examined investment advisers had adopted and implemented reasonably designed written policies and procedures and implemented investment advice in an appropriate manner. As a summary, the staff reviewed firms’ main and branch office practices for:

(1) compliance with various rules under the Investment Advisers Act of 1940, including Rule 204A-1 and Rule 206(4)-2;

(2) the adherence by branch offices to comply with disclosures and agreements with clients relating to fees and expenses;

(3) the oversight of investment recommendations, and ensuring that those recommendations are suitable and consistent with disclosures to clients;

(4) management and disclosure of conflicts of interest; and

(5) allocation of investment opportunities.