On December 22, 2020, the Securities and Exchange Commission (SEC) unveiled a new marketing rule for investment advisers. While many firms have begun reviewing and evaluating their existing advertising protocols to make the necessary changes, there is still time to ensure your firm is in compliance with the Modern Marketing Rule before the November 4, 2022 deadline.
The new marketing rule, which modernized the 1961 Advertising Rule 206(4)-1, and combined it with the Rule 206(4)-3, Cash Solicitation Rule, now has two distinct prongs (or parts) for the word “advertisement”.
The first prong refers to traditional communications typically referred to as advertisements.
The first prong of advertisements
The SEC defines the first prong of advertisements as, "any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser's investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors."
However, there are some specific exclusions to this part of the definition including one-on-one communications, required notices and filings, and "extemporaneous, live, oral communications." The exclusions must meet specific guidelines. Otherwise, they are included in the rule.
- One-on-one communications: unless discussing hypothetical performances, one-on-one communications are not included in the new definition of advertising.
- Hypothetical performances: discussion of hypothetical performance in a one-to-one setting is only excluded if the communications meet one of two guidelines. It must be either in response to an unsolicited request from a client or be to a private fund investor.
- Required filings: financial firms are required to send many types of regulatory notices and filings. Information contained in these mandatory communications is not considered advertisements if the material reasonably satisfies the requirements of that type of communication.
- Extemporaneous, live, oral communications: this type of communication is excluded from the advertisement rule, even if [or regardless of whether] it broadcasts to the public. However, any prepared speeches, scripted videos, slides, or other written material are not excluded.
The second prong focuses on endorsements and testimonials, which this type of communication was previously covered under the Cash Solicitation Rule.
The second prong of advertisements
According to the SEC, the second prong of the new definition of advertisements now includes "any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees)."
Testimonials and endorsements are similar. Since they both speak to a firm's expertise, capabilities and are written by someone who is not employed by the firm. However, there are key distinctions between the two, and these are highlighted in the new advertising rule.
Here is a quick look at the two terms:
- Testimonials: written statements by current clients, former clients, or by a private fund investor that share a personal experience with a firm
- Endorsements: statements of approval or support written by people who are not current clients or private fund investors are considered endorsements.
The second prong of advertisements does not offer exclusions for one-on-one communications or extemporaneous, live, oral communications unlike the first prong. These types of communications are both subject to the new marketing rule.
Under the new rule, testimonials and endorsements are both prohibited from advertisements. Unless certain conditions are met concerning disclosures, oversight and written agreements, and disqualifications. Here are more details about the required conditions:
- Disclosure: Unless covered by a specific exception, advertisements must clearly disclose whether the writer of the testimonial or endorsement is a client and if they were compensated (either with cash, gifts, or a non-cash payment). Additionally, this disclosure must be prominently displayed. As an example, one way to meet this requirement would be to state "Paid Testimonial" before the content.
- Oversight and written agreement: Firms utilizing testimonials or endorsements must ensure compliance with this new rule. There must be a written agreement with the promoter unless the promoter is an affiliate or receives $1,000 or less from the firm (or the equivalent value in a non-cash payment) during the previous twelve months.
- Disqualification: The marketing rule clearly prohibits financial services firms from compensating ineligible people for an endorsement or testimonial. This could be people the SEC calls "bad actors" under Rule 506(d) — such as those with relevant criminal convictions. The disqualification rule states, "if the adviser knows, or in the exercise of reasonable care should know, that the person giving the testimonial or endorsement is an ineligible person at the time the testimonial or endorsement is disseminated." This is designed to prevent "bad actors" from getting compensated to act as a promoter.
While the new modern marketing rule took effect May 4, 2021, there is still time to make sure your firm completes any training or provisions necessary to comply before the deadline.
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To learn more about the new Modern Marketing Rule download our whitepaper, What the SEC’s Updated Modern Marketing Rule Means for Financial Services Companies.