The Marketing Rule, Advisers Act Rule 206(4)-1, Section (e)(1) defines hypothetical performance as “performance results that were not actually achieved by any portfolio of the investment adviser and includes, but is not limited to:
- Targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement.
- Performance derived from model portfolios;
- 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
- Targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement.”
It’s okay to use hypothetical performance in your marketing materials, IF (that’s a big if) the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement. (See section (d)(6)(i) of the Marketing Rule)
In the release, the SEC states
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. (See page 220)
Earlier this spring the SEC brought enforcement actions against five firms for publishing hypothetical performance on their websites. The SEC just found another firm who published returns from model portfolios on its website. See IA Release 6646.
It’s become very clear that model portfolio returns do not belong on a firm’s website.
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