§ 5.07 Marketing and Advertising

• Jurisdiction: United States
• Publication year: 2022

§ 5.07 Marketing and Advertising

[1]—Overview

Section 206(4) of the Advisers Act⁴¹² not only serves as a general anti-fraud measure, but also states that the SEC shall prescribe rules and regulations reasonably designed to prevent activities deemed to be "fraudulent, deceptive, or manipulative." Rule 206(4)-1⁴¹³ (the "Advertising Rule") governs advertising and marketing activities of registered investment advisers.

In December 2020, the SEC adopted amendments to the Advertising Rule (the "Amended Marketing Rule") that will affect many aspects of private fund marketing.⁴¹⁴ The Amended Marketing Rule amends and consolidates the current Advertising Rule and Cash Solicitation Rule, which had not been substantively amended since they were adopted in 1961 and 1979, respectively. While the Amended Marketing Rule largely takes a principles-based approach, there are some specific requirements and prohibitions.

Notably, the SEC is rescinding the Cash Solicitation Rule and therefore the related staff no-action letters will be nullified. Additionally the staff stated that other no-action letters, or portions thereof, that address topics covered by the Final Rule will be withdrawn because those positions are either incorporated into the Final Rule, or will no longer apply.⁴¹⁵ On October 29, 2021, the Division of Investment Management staff published a list of no-action letters and staff statements that will be withdrawn or modified, effective November 4, 2022.⁴¹⁶

While the Amended Marketing Rule became effective May 5, 2021, Advisers have until November 4, 2022 to comply with the Rule's requirements, although advisers may choose to comply the Rule before that date. The SEC staff has taken the position that complying with the Amended Marketing Rule requires advisers to take an "all or nothing approach," in that an adviser cannot chose to selectively comply with certain parts of the Rule while not complying with others.⁴¹⁷ In the interim, advisers may continue to rely on the Advertising Rule and related no-action letter guidance discussed in Sections [3] and [4] below.

[2]—Key Elements of the Amended Marketing Rule

The Amended Marketing Rule revises the definition of an advertisement to specifically address communications with prospective or existing private fund investors and has two prongs. The first prong includes any direct or indirect communication an adviser makes to more than one person that (1) offers the adviser's investment advisory services to prospective clients or investors in a private fund advised by the investment adviser ("private fund investors"); or (2) offers new or additional investment advisory services to current clients or private fund investors. This prong is intended to capture traditional advertising.⁴¹⁸

The new second prong includes any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly. This applies to a compensated testimonial or endorsement made orally or in writing to one or more persons.⁴¹⁹ This second prong is designed to capture advertisements that include traditional endorsements and testimonials as well as activity traditionally covered by the Cash Solicitation Rule. Under the Amended Marketing Rule, an "endorsement" now includes a placement agent's referral of an investor to a private fund.⁴²⁰ This is a substantial change for advisers in comparison to the Cash Solicitation Rule, which only covers separately managed account referrals and not private fund placement agent arrangements.

The Amended Marketing Rule replaces the Advertising Rule's per se prohibition on past specific performance with a principles-based restriction. Case studies and similar information about the performance of individual investments are considered specific investment advice and may be used in an advertisement provided they are presented in a fair and balanced manner.⁴²¹

The use of hypothetical performance also is permitted under the Amended Marketing Rule in circumstances where the adviser (1) provides sufficient information to enable the recipient to understand the criteria and assumptions underlying the performance and (2) provides (or, if the intended audience is an investor in a private fund, provides or offers to provide promptly) sufficient information addressing the risks and limitations of the use of hypothetical performance in making investment decisions.⁴²² The Amended Marketing Rule provides for the first time clear guidance on the use of "extracted performance" so long as the advertisements contain or offer to promptly furnish the performance results of all investments in the larger portfolio from which this information was extracted.⁴²³ The Amended Marketing Rule also will allow the use of performance of a "related portfolio"; however such presentations need to show the performance of all related portfolios either on a portfolio-by-portfolio basis or as a composite aggregation.⁴²⁴

[3]—Current Advertising Rule Practices

Rule 206(4)-1(b) of the Advisers Act defines "advertisements" to include any notice, circular, letter or other written communication addressed to more than one person, or any notice or other pronouncement 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 such securities.⁴²⁵ For hedge funds, "advertisements" should be interpreted broadly to include, without limitation, flip books, marketing presentations, letters to investors, periodic performance reports, due diligence questionnaires, websites, press releases, press interviews, speeches, etc.

Advertisements, however, generally would not include specific, unsolicited requests for information from clients, prospective clients or consultants (for example, through a request for proposals, or "RFP").⁴²⁶ However, if the investment manager is providing substantially the same information to multiple investors (even though directed to one investor at a time) through materials such as due diligence questionnaires and examples of quarterly letters to investors, such materials may need to conform to the requirements of the Advertising Rule.

Rule 206(4)-1 contains a general prohibition on fraudulent advertising, noting that advertisements that contain untrue statements of material fact, or that are otherwise false or misleading, will cause a registered adviser to violate Section 206(4)'s prohibitions on fraudulent, deceptive, or manipulative conduct.⁴²⁷ Rule 206(4)-1 also delineates certain conduct prohibited for registered advisers.

Registered advisers are generally prohibited from:

• The use of testimonials about the adviser or about any services provided by the adviser;

• References to past specific recommendations that are not properly qualified;

• Representations that graphs, charts, formulas or other devices can be used as tools for making investment decisions without explaining the limitations on their use; and

• Statements suggesting that reports, analyses or other services are, or will be, furnished free of charge, unless actually free and without condition or obligations.

[a]—Testimonials

The prohibition on the use of testimonials is generally understood to include any statement by a former or current advisory client that endorses the adviser or refers to the client's favorable investment experience with the adviser.⁴²⁸ Testimonials are prohibited on the ground that they are deemed likely to create a deceptive or mistaken inference that all of the adviser's clients have typically experienced the same favorable results as those of the person providing the testimonial. The SEC staff generally interprets this prohibition broadly to apply to any investment advisory services and to reprints of articles containing client testimonials.⁴²⁹

The SEC staff has indicated, however, that restrictions on the use of testimonials would not prohibit an adviser from including a partial client list in an advertisement, provided that: (1) the adviser does not use performance-based data to determine which clients to include on the list; (2) each list includes a disclaimer that it is not known whether the listed clients approve or disapprove of the adviser or the advisory services provided; and (3) each list includes disclosure about the objective criteria used to determine which clients were included on the list.⁴³⁰ In addition, the SEC staff has clarified that an adviser may include a testimonial in a communication that does no more than respond to an unsolicited request for information.⁴³¹ A request is unsolicited if an adviser does not directly or indirectly make any affirmative effort that is intended or designed to induce a request. A manager in any case should not use the name of any client or fund investor in any advertisement or other communication without the prior written consent of such client or investor.

An adviser can also include in its advertising unbiased third-party reports about the adviser's past performance if the advertisement does not contain specific client testimonials or endorsements of the adviser and is not otherwise misleading.⁴³² Examples of bona fide news publications include Barron's, the Wall Street Journal, Business Week, and the New York Times. Another form of testimonial that may be relevant to hedge fund managers is industry awards. If a manager wins such an award, using that fact in marketing may be viewed as an impermissible testimonial. However, the SEC has allowed the use of such awards in marketing when there is sufficient disclosure with respect to the criteria for the award.⁴³³

[b]—Past Specific Recommendations

The limitation on references...