Published: 22 February, 2024

5 Considerations For Advisers: SEC’s ‘Marketing Rule’

Advertising performance makes up the bread and butter for fund marketers. However, US-based investment advisers should double check strict requirements of the SEC’s ‘Marketing Rule’ to make sure their processes fall on the right side of the regulatory line.

Effective since May 2021, the directive looked to replace existing rules under the Investment Advisers Act in one single action, addressing the changing nature of investor communications through technology and the expectations of prospective investors. Advisers will be familiar with the Global Investment Performance Standards (GIPS) laying out fair disclosures of fund performance. But it’s no longer enough to end compliance efforts there.

The Marketing Rule gives clear parameters around how advisers can market fund performance. Generally it prohibits untrue, unsubstantiated or omitted statements of facts, anything that purely impicates performance or misleads, and ‘cherry picked’ results that misrepresent a performance or time period.

It also addresses multiple performance types thoroughly, as follows:

Gross and net returns

Advisers using gross performance in an advert must showcase it alongside net performance. Either designed in a clear comparison format, or with both given equal prominence, with the same methodology for their calculations (over the exact same time period) also outlined.

The rule considers model fees, which calculate net performance in the absence of actual results, or if a fund’s multiple share classes offer different fees. If they’re used for marketing purposes, advisers should make sure results from the application of these model fees are no higher than they would be had actual fees been deduced. Private funds with varying classes and fees should show the performance of the highest fee class.

Similarly, an adviser managing multiple investor types should declare model fee performance using the highest fee (or highest intended fee) charged to an investor.

Hypothetical performance

While hypothetical performance is recognised by the SEC – results that aren’t conclusively achieved by an adviser’s portfolio – its potential for spurious information has caused a chequered history with the regulator. The marketing of hypothetical performance is actually prohibited unless anything deemed misleading is addressed by the adviser.

It’s important to note the SEC’s list of performance types considered hypothetical: projected returns, and model or back-tested performance. Elsewhere, exclusions from the hypothetical performance guidelines include interactive analysis tools, the performance of proprietary and seed capital portfolios, and mentions of hypothetical returns in response to a potential client’s unsolicited request or in private communications with existing investors. Both do not constitute ‘advertisements’.

Predecessor performance

Predecessor performance is similarly exempt, albeit potentially misleading unless an adviser (who was personally responsible for performances advertised at a previous firm) is upfront about disclosing detailed information. At the very least, this should run through the performance achieved at the other institution backed up with approved retained records, including any corresponding communications.

Related performance

This could take into account performance for one or more related portfolios with investment policies or strategies that are substantially alike to a product or service offered by an advertisement.

Any related performance must be presented either on a portfolio-by-portfolio basis or as a composite aggregation of all funds that come under the criteria umbrella. They may be emitted only if they don’t result in higher performance, or change or misrepresent a prescribed time period.

Extracted performance

By showing results from investment subsets from one portfolio, extracted performance is prohibited from fund advertising unless it provides gross and net performance as well as the results of the entire portfolio.

Any performance taken from a composite of multiple portfolios (therefore not a subset of an investment from a single portfolio, nor indicative of a holding of an actual investor) does not count. Advisers may present a composite of extracts so long as it’s in line with GIPS.

Of course, the need to compile audits of these written records should be a given to maintain an organised log of fund performance. But it’s not just to achieve a pat on the back! Under the Advisers Act, all written communications (papers, documents, accounts etc) relating to rates of returns and their calculations must be retained.

This also takes into account any of the aforementioned dialogues between firms relating to predecessor performance, and any information offered to the pursuant of hypothetical performance and model free provisions.

While these do not comprise the whole comprehensive list outlined by the SEC, they’re a start to make sure that any investor communications are carried out as they should be. Any action taken against misrepresented performance could seriously harm reputation, so maintaining extra vigilance and transparency about how these performance types are advertised is key to compliance and the wellbeing of any fund marketing practice.

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