Tag: Rule 206(4)-1

Initial Observations Regarding Advisers Act Marketing Rule Compliance

With the issuance of the Marketing Rule for Investment Advisers (Rule 206(4)-1) decades of interpretations and guidance were wiped out. We’ve been waiting to see what falls under those seven general prohibitions in the Marketing Rule. We’ve been thirsting for more guidance.

We’ve gotten some additional clarification on the performance aspects of marketing. We know we can’t put hypothetical performance on a website. We know the net and gross returns have to be calculated in the same manner. (see FAQ 4).

The Division of Examinations released a Risk Alert with the Initial Observations Regarding Advisers Act Marketing Rule Compliance that provides some of that additional guidance of what not to do. It’s mostly a hit list of what not do.

  1. Don’t claim that your investment processes were validated by professional institutions when they were not.
  2. Don’t state that you considered certain risk tolerances when recommending investment strategies when all clients were placed into the same strategy without consideration of risk tolerances.
  3. Don’t reference a formalized securities screening processes that did not actually exist.
  4. Don’t describe yourself as a “private fund adviser” when you don’t actually advise any private funds.
  5. Don’t say that you received awards that you didn’t actually receive.
  6. Don’t say you are different from other advisers because you act in the “best interest of clients”. (Without disclosing that all investment advisers have a fiduciary duty to act in their clients’ best interests.)
  7. Don’t say that were “seen on” national media, without disclosing that the “appearances” were in fact paid advertisements.
  8. Don’t include the Securities and Exchange Commission logo on your website.
  9. Don’t claim that you achieved above average performance results without disclosing that you did not yet have clients or performance track records.
  10. Don’t print disclosures in an unreadable font on websites or in videos.
  11. Don’t use outdated market data information.
  12. Don’t market performance of only realized investment information in the total net return figure and exclude unrealized investments.

These dozen are just some of the anecdotes mentioned in the Risk Alert. Most of these are very obvious failures.

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New Marketing Rule FAQ

The Division of Examinations has been taking a close look at investment adviser marketing since the Marketing Rule rule compliance deadline last fall. We’re getting dribbles of updates as a result of those exams, with the SEC just starting to point out things it hasn’t liked in exams.

The first was extracted performance from a private fund in January 2023.

“[A]n adviser may not show gross performance of one investment or a group of investments without also showing the net performance of that single investment or group of investments, respectively.”

The latest FAQ focuses on the calculation of net and gross performance.

Q: Must gross and net performance shown in an advertisement always be calculated using the same methodology and over the same time period?

Yes, is the answer. The extra point made in the answer is taking into account the use of a subscription credit facility when calculating returns. If you exclude the use of the facility in one calculation you have to exclude it in the other calculation. And vice versa.

The FAQ goes on to make another point about calculating new IRR when a fund uses a credit facility.

“[A]n adviser would violate the general prohibitions (e.g., Rule 206(4)-1(a)(1) and Rule 206(4)-1(a)(6)) if it showed only Net IRR that includes the impact of fund-level subscription facilities without including either (i) comparable performance (e.g., Net IRR without the impact of fund-level subscription facilities) or (ii) appropriate disclosures describing the impact of such subscription facilities on the net performance shown.”

The new Private Fund Quarterly Reporting Rule also requires calculation of returns with and without the use of the credit facility. (Assuming the rule is not vacated by the courts after the recent hearing.) Add in this FAQ and I see the SEC having a very negative view on private fund’s use of credit facilities.

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Abusing Hypothetical Performance Under the New Marketing Rule

“These charges mark the first violation of the SEC’s amended marketing rule” according to the SEC press release.

Really, when use marketing collateral that your strategy has a 2700% return, you are going to catch the attention of the regulators. Titan Global Capital Management USA LLC, a New York-based FinTech investment adviser, used this hypothetical performance in its advertisements. Plus this was for a crypto strategy, so it’s even more suspect. I assume this lead the Securities and Exchange Commission to take a closer look at Titan Global and find a host of other problems.

The SEC Order provides great insight into what the SEC thinks about compliance with the Marketing Rule as a registered investment adviser. There has been a great deal of mumbling in the compliance world about the lack of guidance from the SEC on how to comply with the general provisions. The SEC annulled decades of guidance on how to be complaint with advertising. The one substantive FAQ about net performance for a single investment in a fund didn’t come out until four months after the compliance deadline.

So how did Titan Global achieve this 2700% return? They took their strategy and ran it for three weeks against price changes, with no actual money invested. During those three weeks, the strategy yielded a 21% return. Titan Global extrapolated that being able to achieve that return for a whole year and came up with a 2700% annualized return.

Titan Global is registered with the SEC as an investment adviser and put a marketing policy in place in June 2021 to comply with the Marketing Rule. There is no question about jurisdiction or applicability of the rule.

A list of the errors cited by the SEC:

  1. Titan Global failed to adopt and implement any policies or procedures reasonably designed to ensure that the hypothetical performance metrics included in its advertisements complied with the Marketing Rule.
  2. The hypothetical performance results were materially misleading. (Advisers Act section 2026(2)
  3. Titan Global failed to present material criteria used and assumptions made in calculating its hypothetical performance projection, including sufficient information to appreciate the significant risks and limitations associated with this hypothetical performance projection.
  4. Titan Global’s target audience was retail investors which requires heightened disclosure.
  5. Titan Global did not disclose in the advertisements that the 2,700 percent annualized return was based on a purely hypothetical account in which no actual trading had occurred.
  6. Titan Global failed to disclose that the annualized return had been extrapolated from a period of only three weeks.
  7. Titan Global failed to disclose Titan’s views as to the likelihood that this three week performance could continue for an entire year.
  8. Titan Global did not disclose whether the hypothetical projection was net of fees and expenses.
  9. Titan Global did provided information about the assumptions it used to calculate the hypothetical annualized return, and risks, as clearly and prominently as the highlighted 2,700 percent annualized return.
  10. The disclosures failed to disclose the significant risks associated with the strategy.

The SEC sums this all up by saying Titan Global’s “advertisement did not present the hypothetical projected performance in a fair and balanced way, or in a way that was not materially misleading.”

I don’t think there is much argument with that summary. This is not a marginal case. I think this advertising would have been found to be misleading under the old Advertising Rule. This part of the SEC Order just uses some of the new language in the Marketing Rule to frame the violation.

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Hypothetical Backtested Performance

Yesterday’s post on faking returns made me think about the use of theoretical models and the ability of an investment adviser or fund manager to use hypothetical performance instead of actual performance. The real use of performance figures is in advertising, so the SEC’s rules on advertising are the key focus. (I don’t see how hypothetical performance works on reports to investors, unless you’re Bernie Madoff.)

Backtesting involves the use of theoretical performance developed by applying a particular investment strategy to historical financial data. You’re more likely to see it for a quantitative or formula-based strategy than anything else. The backtested results show investment decisions that theoretically would have been made had the given strategy been employed during the particular past period of time. However, backtesting does not involve actual market risk or client money.

The SEC rules do not explicitly address model performance. You would have to look at IA Rule 206(4)-1 (a)(5) which prohibits any advertisement that “contains any untrue statement of a material fact, or which is otherwise false or misleading.” Backtesting is going to start from a position as being highly suspect since it’s not based on actual events.

The adviser will need to disclose that there are inherent limitations on the data derived from the retroactive application of a model developed with the benefit of hindsight. The adviser needs to disclose the reasons why actual results may differ. See In re Market Timing Systems, Inc. et al., SEC Release No. IA-2047

One of the problems with backtesting is whether the securities and trades that would be used going forward were available in past. This is a particular problem when using synthetic products or derivatives. Of course, the advertised performance must reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid.

The most obvious need in using a theoretical model is that adviser needs to disclose that the performance was derived from the retroactive application of a model developed with the benefit of hindsight and not with real money at stake. See In re Schield Management Company et al., SEC Release No. IA-1872

The SEC has indicated that labeling backtested returns as “hypothetical”, “pro-forma”, or that “actual results were available upon request” in and of itself, is insufficient to satisfy the disclosure requirement. (see In re Schield Management Company et al., SEC Release No. IA-1872  and In re LBS Capital Management, Inc., SEC Release No. IA-1644) It  fails “to convey fully the inherent limitations of the data derived from the retroactive application of a model developed with the benefit of hindsight.” The disclosures need to be robust enough to dispel the misleading suggestion that the advertised performance represented actual trading.

There are no set rules, so you need to look toward enforcement actions to see what actions the SEC found to be egregious.

In re Patricia Owen-Michel, SEC Release No. IA-1584 (Sept. 27, 1996)

In the enforcement case against Patricia Owen-Michael, the SEC sanctioned the president of an investment adviser for allegedly circulating misleading advertisements that used a computer-based statistical model to select stocks and mutual funds and to generate trading signals. The adviser’s advertisements included charts and graphs depicting hypothetical performance of an investment model applied retroactively. The SEC alleged that the various charts and graphs depicting hypothetical performance of the model failed to disclose:

  • That the adviser only began offering the given service after the performance period depicted by the advertisement;
  • That the advertised performance results do not represent the results of actual trading but were achieved by means of the retroactive application of a model designed with the benefit of hindsight;
  • All material economic and market factors that might have had an impact on the adviser’s decision making when using the model to manage actual client accounts;

In re Schield Management Company et al., SEC Release No. IA-1872 (May 31, 2000)

In the 2000 case against Schield Management, the SEC alleged that the firm distributed materially false and misleading advertisements because it combined the pre-implementation data with performance data from periods following Schield’s implementation of the relevant trading strategies. One chart showed that the Schield’s model consistently outperformed the S&P 500 index without disclosing that Schield’s actual implementation of the strategy actually underperformed the S&P 500 index. The advertisements also failed to disclose that it applied materially different trading rules in calculating the performance of the strategy before and after the actual implementation of the strategy.

According to the SEC, Schield published advertisements that materially overstated their performance because they failed to deduct the full management fee and other fees earned by the firm from the performance results. On a cumulative basis, this had the effect of overstating the performance of the strategy by more than thirteen percent. The firm also included performance numbers that were calculated erroneously.

In re LBS Capital Management, Inc., SEC Release No. IA-1644 (July 18, 1997)

In the case against LBS Capital Management, Inc., the SEC sanctioned an investment adviser who had developed a mutual fund timing and selection service by using historical financial data, but failed to “disclose with sufficeint prominence or detail that the advertised results … did not represent the results of actual trading using client assets”.

The advertisement disclosed in a footnote that the performance results were “pro-forma,” that “model” performance was “no guarantee of future results,” that the timing service “ went live” in January 1994, and that “actual results” were “available upon request.”

The SEC found that the footnote disclosure was inadequate under the  facts and circumstances.  Citing In the Matter of Jesse Rosenbaum (IA Release No. 913, May 17, 1984), the SEC pounded on the table and stated that a misleading statement in an advertisement cannot be “cured by the disclaimers buried in the [smaller print] text [of the advertisement].”

The SEC also noted that the advertisement was distributed to the adviser’s existing and prospective retail clients “without regard for their investment sophistication or acumen.” Using the facts and circumstances test, the SEC used the standard of an unskilled and unsophisticated investor.

In re Market Timing Systems, Inc. et al., SEC Release No. IA-2047 (Aug. 28, 2002)

In the case against Market Timing Systems, the SEC alleged that Market Timing Systems, Inc. promoted returns for its model of over 70% for a 13 year time period. However, the advertisements did not disclose that the performance results were hypothetical and were generated by the retroactive application of the mode. The advertisements with 13 years of performance were distributed in 1999 and Market Timing did not begin business until 1998.

One point in this case clarifies the problem with using hypothetical models. The actual performance of client accounts during its first quarter of operations was materially less than the model’s hypothetical results for the same period.

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Turning Your PowerPoint into an Advertisement

Once a fund manager is registered, Rule 206(4)-1 imposes additional restrictions on advertising that the SEC has determined would be fraudulent deceptive or manipulative. That means public presentations could be considered an advertisement.

First I want to look back at the definition of an “advertisement” for purposes of the rule. An advertisement for purposes of the rule 206(4)-1 is:

“[A]ny notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.”

In meeting with potential investors, invariably, someone will pull out a Powerpoint presentation to discuss the fund manager, their past performance, and future business plan. In looking at the definition of advertisement, a purely oral presentation would not be an advertisement. One the projector lights up, the presentation starts moving into the realm of an advertisement.

The final straw is leaving a copy of the presentation behind. Now the presentation is clearly a “written communication.”

And don’t forget about the requirements of Regulation D regarding advertising and disclosure requirements for privately-offered securities.

Fees and Performance Results for Advisers and Fund Managers

Section 206 of the Investment Advisers Act prohibits fraud, deception or manipulation, regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1 imposes additional restrictions on advertising that the SEC has determined would be fraudulent, deceptive or manipulative.

The first item on the list of fraudulent, deceptive or manipulative practices is testimonials, which I wrote about earlier. The second item in the advertising rule is a prohibition on using past performance in an advertisement, subject to some limitations. I also wrote about that last week.

One of the controversial standards when using performance results is that they must be shown net of fees.

In a 1986 No Action Letter to Clover Management the SEC said it was their view that “Rule 206(4)-1(a)(5) prohibits an advertisement that: … (2) Includes model or actual results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid; ”

Can you just include a description of your fees? No.

[B]ecause advertisements typically present adviser performance results over a number of
years, narrative disclosure of the existence and range of advisory fees, in our view, would
not be an adequate substitute for deducting advisory fees because of the compounding
effect on performance figures that occurs if advisory fees are not deducted. In our view it is
inappropriate to require a reader to calculate the compounding effect of the undeducted
expenses on the advertised performance figures. Investment Company Institute No Action Letter (1987)

But you can include gross returns, as long as they are side-by-side with net of fees results. See Association of Investment Management and Research (1996). Both the net and gross performance figures need to be presented in an equally prominent manner. The “advertisement” must contain sufficient disclosure to ensure that the performance figures are not misleading. For example, when showing a performance figure gross of fees there should be a disclaimer that the figures do not reflect the payment of investment advisory fees and other expenses.

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Performance Results in Fund Brochures

Section 206 of the Investment Advisers Act prohibits fraud, deception or manipulation, regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1 imposes additional restrictions on advertising that the SEC has determined would be fraudulent, deceptive or manipulative.

The first item on the list of fraudulent, deceptive or manipulative practices is testimonials, which I wrote about earlier.

The second item in the advertising rule is prohibition on using past performance in an advertisement, subject to some qualification:

206(4)-1(a)(2): Which refers, directly or indirectly, to past specific recommendations of such investment adviser which were or would have been profitable to any person:

Provided, however, That this shall not prohibit an advertisement which sets out or offers to furnish a list of all recommendations made by such investment adviser within the immediately preceding period of not less than one year if such advertisement, and such list if it is furnished separately:

(i) State the name of each such security recommended, the date and nature of each such recommendation (e.g., whether to buy, sell or hold), the market price at that time, the price at which the recommendation was to be acted upon, and the market price of each such security as of the most recent practicable date, and

(ii) contain the following cautionary legend on the first page thereof in print or type as large as the largest print or type used in the body or text thereof: “it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list”

Of course, all advertising is still subject to the prohibition on advertising that is otherwise false or misleading in Rule 206(4)-1(a)(5).The SEC has adopted a facts-and-circumstances test to determine whether the use of performance results is false or misleading.

[W]e believe the use of model or actual results in an advertisement would be false or misleading under Rule 206(4)-1(a)(5) if it implies, or a reader would infer from it, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts. Any adviser using such an advertisement must ensure that the advertisement discloses all material facts concerning the model or actual results so as to avoid these unwarranted implications or inferences. Because of the factual nature of the determination, the staff, as a matter of policy, does not review any specific advertisements. Clover Capital Management, Inc. 1986 No Action Letter

A facts-and-circumstances test is not one that helps a compliance officer sleep at night. That means judgment calls and disagreements with management on what can be included and how it can be included.

There are many SEC no action letters out setting some lines in the sand. A 1986 No Action Letter to Clover Management lays out a series practices that are bad for disclosing model and actual results:

(1) Fails to disclose the effect of material market or economic conditions on the results portrayed (e.g., an advertisement stating that the accounts of the adviser’s clients appreciated in the value 25% without disclosing that the market generally appreciated 40% during the same period);

(2) Includes model or actual results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;

(3) Fails to disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;

(4) Suggests or makes claims about the potential for profit without also disclosing the possibility of loss;

(5) Compares model or actual results to an index without disclosing all material facts relevant to the comparison (e.g. an advertisement that compares model results to an index without disclosing that the volatility of the index is materially different from that of the model portfolio);

(6) Fails to disclose any material conditions, objectives, or investment strategies used to obtain the results portrayed (e.g., the model portfolio contains equity stocks that are managed with a view towards capital appreciation);

(7) Fails to disclose prominently the limitations inherent in model results, particularly the fact that such results do not represent actual trading and that they may not reflect the impact that material economic and market factors might have had on the adviser’s decision-making if the adviser were actually managing clients’ money;

(8) Fails to disclose, if applicable, that the conditions, objectives, or investment strategies of the model portfolio changed materially during the time period portrayed in the advertisement and, if so, the effect of any such change on the results portrayed;

(9) Fails to disclose, if applicable, that any of the securities contained in, or the investment strategies followed with respect to, the model portfolio do not relate, or only partially relate, to the type of advisory services currently offered by the adviser (e.g., the model includes some types of securities that the adviser no longer recommends for its clients);

(10) Fails to disclose, if applicable, that the adviser’s clients had investment results materially different from the results portrayed in the model;

(11) [for actual results] Fails to disclose prominently, if applicable, that the results portrayed relate only to a select group of the adviser’s clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.

The other important thing to keep in mind when deciding to use performance results is that you must keep all of the accounts, books, internal working papers and other records necessary to demonstrate the calculation of the performance results. SEC Rule 204-2(a)(16)

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Ratings and Fund Managers

Investment advisers, and therefore fund managers once they register as investment advisers, are limited in how they advertise. Section 206 of the Investment Advisers Act already prohibits fraud, deception or manipulation, regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1 imposes additional restrictions on advertising that the SEC has determined would be fraudulent deceptive or manipulative.

The first item on the list of restrictions is testimonials. This prohibition reflects the concern that the experience of one customer is not necessarily typical of the experience for all customers.

To some extent this also covers third party ratings since they are relying on the testimonials of clients. If you have a good rating you may want to include that rating as part of your fundraising materials. That means you are indirectly including a testimonial in your advertising and are staring squarely at the prohibitions in the advertising rule.

However, the SEC has recognized that the distribution of unbiased third-party ratings may not be fraudulent. In a 1982 No Action Letter to New York Investors Group, Inc., the SEC allowed the investment adviser to include an article from a financial publication that “lauds the Company/ and or the Company president’s success in picking stocks that do well under both favorable and unfavorable market conditions.”

The SEC ruled that “an article by an unbiased-third party concerning an investment adviser’s performance, however, is not a testimonial unless it includes a statement of a customer’s experience or endorsement. ” While clarifying that the article is not a testimonial, it is still an advertisement.

The more detailed discussion about the use of ratings is in a 1998 No Action Letter to DALBAR, Inc. The company conducted a survey to measure the effectiveness of investment advisers and their representatives.  Based on the survey, DALBAR would assign a numerical ranking. Since the investment adviser was paying for the survey, presumably they would want to publish a good result to attract more clients. That means the ratings would be part of an advertisement.

The SEC said that the DALBAR rating is a testimonial because the rating carries an implicit statement of clients’ experiences. The DALBAR rating is testimonial, made indirectly.

But the SEC turns around and and blesses the DALBAR rating, granting the sought after “we would not recommend enforcement action.” The SEC lists these factors:

  • DALBAR rating does not emphasize the favorable client responses or ignore the unfavorable responses.
  • The rating represents all or a statistically significant sample of an adviser’s clients.
  • The client questionnaire has not been prepared to produce any pre-determined results.
  • The client questionnaire makes it easy for a client to give negative or positive responses.
  • DALBAR does not perform any subjective analysis of the survey results, but merely assigns numerical ratings after averaging client responses.
  • DALBAR is not affiliated with any advisers.
  • DALBAR charges a uniform fee, paid in advance.
  • Survey results clearly identify the percentage of survey participants who received each designation and the total number of survey participants.

While the SEC blesses the DALBAR rating system, they took the opportunity to point out that an adviser’s use of the rating in their advertisement materials could still be a violation of Section 206(4) and Rule 206(4)-1(a)(5). The SEC provided some guidance that advisers should consider when using a DALBAR or similar rating:

1. Whether the advertisement discloses the criteria on which the rating was based;

2. Whether an adviser or IAR advertises any favorable rating without disclosing any facts that the adviser or IAR knows would call into question the validity of the rating or the appropriateness of advertising the rating (e.g., the adviser or IAR knows that it has been the subject of numerous client complaints relating to the rating category or in areas not included in the survey);

3. Whether an adviser or IAR advertises any favorable rating without also disclosing any unfavorable rating of the adviser or IAR (or the adviser that employs the IAR);

4. Whether the advertisement states or implies that an adviser or IAR was the top-rated adviser or IAR in a category when it was not rated first in that category;

5. Whether, in disclosing an adviser’s or IAR’s rating or designation , the advertisement clearly and prominently discloses the category for which the rating was calculated or designation determined, the number of advisers or IARs surveyed in that category, and the percentage of advisers or IARs that received that rating or designation;

6. Whether the advertisement discloses that the rating may not be representative of any one client’s experience because the rating reflects an average of all, or a sample of all, of the experiences of the adviser’s or IAR’s clients;

7. Whether the advertisement discloses that the rating is not indicative of the adviser’s or IAR’s future performance; and

8. Whether the advertisement discloses prominently who created and conducted the survey, and that advisers and IARs paid a fee to participate in the survey.

If you are using third-party ratings as part of your fundraising materials, DALBAR presents you with a laundry list of things you can and cannot do with those ratings.
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Client Lists and Private Fund Managers

Section 206 of the Investment Advisers Act prohibits fraud, deception or manipulation, regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1 imposes additional restrictions on advertising that the SEC has determined would be fraudulent deceptive or manipulative.

The first item on the list of restrictions is testimonials. This prohibition reflects the concern that the experience of one customer is not necessarily typical of the experience for all customers.

Merely including a list of client names is not a testimonial, but could still be considered fraudulent. You can see that in the example of Reservoir Capital Management. Reservoir provided prospective clients a client list, which Reservoir described as “representative,” that consisted of the names of eight institutional investors. In the SEC’s view this created the impression that a substantial portion of Reservoir’s client base was institutional clients. The truth was that no more than fifteen percent of Reservoir’s assets under management were assets of institutional clients.

A list of all clients would unlikely to be considered a testimonial in violation of the rule. Once you start producing a partial list, the SEC gets considered that the inclusion or exclusion of clients on the list could be fraudulent or manipulative.

The SEC offered some additional guidance on including a partial list of clients in a 1993 No Action Letter to Denver Investment Adviser Associates. They came up with three conditions that need to be satisfied:

1. You can’t use performance based criteria in determining which clients to include in the list

2. The client list has a disclaimer similar to this: “It is not known whether the listed clients approve or disapprove of the adviser or the advisory services provided.

3. The client list includes a statement disclosing the objective criteria used to determine which clients to include in the list.

For a fund manager, the funds are the clients. However, I could easily see how this limitation could be taken the next step to investors in the funds.

Also keep in mind that the fact that a particular customer or consumer is a client could be considers nonpublic personal information, making it subject to Regulation S-P. Several states prohibit an investment adviser from disclosing a client’s identity
without consent.

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Intent and the Advertising Rule for Investment Advisers

In it’s prohibition against fraud, deceit and manipulation, Section 206 of the Investment Advisers Act is strict. There is no requirement of intent. You can argue that you didn’t mean to mean to commit fraud. That may affect whether you get referred to enforcement instead of merely getting hit with a deficiency letter or an injunction.

Under common law there us generally some requirement of intent. That is not so true under securities laws.

In SEC v. Capital Gains Research, Inc. 375 U.S. 180 (1963) (.pdf 16 pages), the Supreme Court allowed an injunction without a finding of intent to commit fraud.

The foregoing analysis of the judicial treatment of common-law fraud reinforces our conclusion that Congress, in empowering the courts to enjoin any practice which operates “as a fraud or deceit” upon a client, did not intend to require proof of intent to injure and actual injury to the client. Congress intended the Investment Advisers Act of 1940 to be construed like other securities legislation “enacted for the purpose of avoiding frauds,” not technically and restrictively, but flexibly to effectuate its remedial purposes.

The limitations in Rule 206(4)-1 on investment adviser advertising approach the communication from the view of a client or prospective client, not the adviser. The limitations are designed to prevent an adviser from doing things that could be perceived as fraudulent even if the adviser is acting with good intent.

The use of testimonials and ratings are an example of this. More on that subject later.

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