When the Securities and Exchange Commission enacted the Investment Adviser Marketing Rule at the end of 2020, it threw out decades of cobbled together opinions, no action letters, and informal guidance. In the 18 months it took to reach the compliance date, the SEC offered little in the way of additional guidance. The SEC made it very clear that it would be taking a closer look at investment advisers’ marketing practices shortly after the compliance date a year. There have been signs that the examiners have been doing just that.
Enforcement has begun. The SEC announced action against nine firms for improper use of hypothetical performance.
(8) Hypothetical performance means performance results that were not actually achieved by any portfolio of the investment adviser.
(i) Hypothetical performance includes, but is not limited to:
(A) Performance derived from model portfolios;
(B) 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…
Each of the nine firms published hypothetical performance on its website. Under 206(4)-1(d)6, an investment adviser can’t use hypothetical performance in an advertisement unless the firm:
(i) Adopts and implements 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;
(ii) Provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance; and
(iii) Provides (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; ….
In the adopting release for the Marketing Rule at page 220, the SEC points out that hypothetical performance should not be used in mass advertising:
We believe that advisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation. In that case, because the advertisement would be available to mass audiences, an adviser generally could not form any expectations about their financial situation or investment objectives.
There is no higher form of general circulation than using a public webpage to broadcast hypothetical performance. There is also the additional challenge of meeting the record-keeping requirements of the Marketing Rule for a website. To of the firms failed to have tools in place to archive their websites.
The lesson learned from these nine cases is don’t put hypothetical performance on your firm’s website.
Sources:
- Investment Adviser Marketing Rule IA-5653
- SEC Sweep into Marketing Rule Violations Results in Charges Against Nine Investment Advisers
- SEC Order – Banorte Asset Management Inc.
- SEC Order – BTS Asset Management Inc.
- SEC Order – Elm Partners Management LLC
- SEC Order – Hansen and Associates Financial Group Inc
- SEC Order – Linden Thomas Advisory Services LLC
- SEC Order – Macroclimate LLC
- SEC Order – McElhenny Sheffield Capital Management LLC
- SEC Order – MRA Advisory Group
- SEC Order – Trowbridge Capital Partners LLC