Investment Adviser Advertisements; Compensation for Solicitations

Federal RegisterDec 10, 2019

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-5407; File No. S7-21-19]

RIN: 3235-AM08

Investment Adviser Advertisements; Compensation for Solicitations

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission” or the “SEC”) is proposing amendments under the Investment Advisers Act of 1940 (the “Advisers Act” or the “Act”) to the rules that prohibit certain investment adviser advertisements and payments to solicitors, respectively. The proposed amendments to the advertising rule reflect market developments since the rule's adoption in 1961. The proposed amendments to the solicitation rule update its coverage to reflect regulatory changes and the evolution of industry practices since we adopted the rule in 1979. The Commission is also proposing amendments to Form ADV that are designed to provide the Commission with additional information regarding advisers' advertising practices. Finally, the Commission is proposing amendments under the Advisers Act to the books and records rule, to correspond to the proposed changes to the advertising and solicitation rules.

DATES:

Comments should be received on or before February 10, 2020.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an email to

rule-comments@sec.gov.

Please include File Number S7-21-19 on the subject line.

Paper Comments

• Send paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-21-19. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's website (

http://www.sec.gov/rules/proposed.shtml

). Comments also are available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that the Commission does not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available.

Studies, memoranda or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Matthew Cook, Emily Rowland, or James Maclean, Senior Counsels; or Thoreau Bartmann or Melissa Roverts Harke, Senior Special Counsels, at (202) 551-6787 or

IArules@sec.gov,

Investment Adviser Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

The Commission is proposing for public comment amendments to 17 CFR 275.206(4)-1 (rule 206(4)-1), 17 CFR 275.206(4)-3 (rule 206(4)-3), and 17 CFR 275.204-2 (rule 204-2) under the Investment Advisers Act of 1940 [15 U.S.C. 80b-1

et seq.

] (the “Advisers Act”),

and amendments to Form ADV [17 CFR 279.1] under the Advisers Act.

Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we refer to rules under the Advisers Act, or any paragraph of those rules, we are referring to title 17, part 275 of the Code of Federal Regulations [17 CFR part 275], in which these rules are published.

Table of Contents

I. Introduction

A. Advertising Rule Background

B. Cash Solicitation Rule Background

II. Discussion

A. Proposed Amendments to the Advertising Rule

1. Structure of the Rule

2. Scope of the Rule: Definition of “Advertisement”

3. General Prohibitions

4. Testimonials, Endorsements, and Third Party Ratings

5. Performance Advertising

6. Portability of Performance, Testimonials, Third Party Ratings, and Specific Investment Advice

7. Review and Approval of Advertisements

8. Proposed Amendments to Form ADV

B. Proposed Amendments to the Solicitation Rule

1. Scope of the Rule: Who is a solicitor?

2. Expanding the Rule To Address All Forms of Compensation

3. Compensation for the Solicitation of Existing and Prospective Investors

4. Solicitor Disclosure

5. Written Agreement

6. Adviser Oversight and Compliance; Elimination of Additional Provisions

7. Exemptions

8. Disqualification for Persons Who Have Engaged in Misconduct

C. Recordkeeping

D. Existing Staff No-Action Letters and Other Related Guidance

1. Letters To Be Reviewed Concerning Rule 206(4)-1

2. Letters To Be Reviewed Concerning Rule 206(4)-3

E. Transition Period and Compliance Date

III. Economic Analysis

A. Introduction

B. Broad Economic Considerations

C. Baseline

1. Market for Investment Advisers

2. Market for Solicitors

3. RIA Clients

D. Costs and Benefits of the Proposed Rule and Form Amendments

1. General Costs and Benefits of the Advertising Rule

2. Specific Costs and Benefits of the Advertising Rule

3. Costs and Benefits of the Proposed Amendments to the Solicitation Rule

E. Efficiency, Competition, Capital Formation

1. Advertising

2. Solicitation

F. Reasonable Alternatives Considered

1. Reduce Specific Limitations on Investment Adviser Advertisements

2. Not Have an Advertising Rule and Rely on Section 206

3. Define Non-Retail Investors as Accredited Investors or Qualified Clients

4. Further Bifurcate Additional Requirements

5. No Bifurcation

6. Hypothetical Performance Alternatives

7. Alternatives to Proposed Amendments to Rule 206(4)-3

IV. Paperwork Reduction Act Analysis

A. Introduction

B. Rule 206(4)-1

1. Testimonials and Endorsements in Advertisements

2. Third-Party Ratings in Advertisements

3. Performance Advertising

4. Additional Conditions Related to Performance Results in Retail Advertisements

5. Review and Approval of Advertisements

6. Total Hour Burden Associated With Proposed Rule 206(4)-1

C. Rule 206(4)-3

D. Rule 204-2

E. Form ADV

F. Request for Comments

V. Initial Regulatory Flexibility Analysis

A. Reason for and Objectives of the Proposed Action

1. Proposed Rule 206(4)-1

2. Proposed Amendments to Rule 206(4)-3

3. Proposed Rule 204-2

4. Proposed Amendments to Form ADV

B. Legal Basis

C. Small Entities Subject to the Rule and Rule Amendments

1. Small Entities Subject to Amendments to Advertising Rule

2. Small Entities Subject to Amendments to Solicitation Rule

3. Small Entities Subject to Amendments to the Books and Records Rule 206(4)-2

4. Small Entities Subject to Amendments to Form ADV

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

1. Proposed Rule 206(4)-1

2. Proposed Amendments to Rule 206(4)-3

3. Proposed Amendments to Rule 204-2

4. Proposed Amendments to Form ADV

E. Duplicative, Overlapping, or Conflicting Federal Rules

1. Proposed Rule 206(4)-1

2. Proposed Amendments to Rule 206(4)-3

3. Proposed Amendments to Form ADV

F. Significant Alternatives

1. Proposed Rule 206(4)-1

2. Proposed Rule 206(4)-3

G. Solicitation of Comments

VI. Consideration of Impact on the Economy

VII. Statutory Authority

IV. Appendix A: Changes to Form ADV

V. Appendix B: Investor Feedback Flyer

VI. Appendix C: Smaller Adviser Feedback Flyer

I. Introduction

We are proposing reforms of two rules under the Advisers Act relating to how advisers advertise to and solicit clients and investors. First, we are proposing a rule addressing advertisements by investment advisers that would replace the rule that we adopted in 1961, rule 206(4)-1, which we have not changed substantively since adoption.

The proposed rule would replace the current rule's broadly drawn limitations with principles-based provisions. The proposed rule contains general prohibitions of certain advertising practices, as well as more tailored restrictions and requirements that are reasonably designed to prevent fraud with respect to certain specific types of advertisements. This approach permits the use of testimonials and endorsements, and third-party ratings, subject to certain conditions. This approach also permits the presentation of performance with tailored requirements based on an advertisement's intended audience.

The proposal recognizes developments in technology, changing profiles of investment advisers registered with the Commission, and our experience administering the current rule.

The current rule has been amended once, when the Commission revised the introductory text of paragraph (a) as part of a broader amendment of several rules under the Advisers Act to reflect changes made by the National Securities Market Improvement Act of 1996. Rules Implementing Amendments to the Investment Advisers Act of 1940, Release No. IA-1633 (May 15, 1997) [62 FR 28112, 28135 (May 22, 1997)].

As discussed below, we are proposing to define clients and investors that are “qualified purchasers” or “knowledgeable employees” as “Non-Retail Persons” and to define all other clients and investors as “Retail Persons.” Similarly, we are proposing to define advertisements directed at Non-Retail Persons as “Non-Retail Advertisements” and all other advertisements as “Retail Advertisements.”

Additionally, we are proposing to amend the Advisers Act cash solicitation rule, rule 206(4)-3, to update its coverage to reflect regulatory changes and the evolution of industry practices since we adopted the rule in 1979. We are proposing to expand the rule to cover solicitation arrangements involving all forms of compensation, rather than only cash compensation, eliminate requirements duplicative of other rules, and tailor the required disclosures solicitors would provide to investors. The proposed rule would also refine the existing provisions regarding disciplinary events that would disqualify a person or entity from acting as a solicitor.

Finally, we are proposing related amendments to Form ADV that are designed to provide additional information regarding advisers' advertising practices, and amendments to the Advisers Act books and records rule, rule 204-2, related to the proposed changes to the advertising and solicitation rules.

A. Advertising Rule Background

Advertisements are a useful tool for investment advisers seeking to obtain new investors and to retain existing investors.

Investment advisers disseminate advertisements about their services to inform prospective investors and to persuade them to obtain and pay for those services or to learn more about the advisers. Similarly, advertisements can provide existing investors with information about new or revised services. Accordingly, advertisements can provide existing and prospective investors with useful information as they choose among investment advisers and advisory services. At the same time, advertisements present risks of misleading existing and prospective investors because the investment adviser's interest in attracting or retaining them may conflict with their interests, and the adviser is in control of the design, content, format, media, timing, and placement of its advertisements with a goal of obtaining or retaining business. This goal may create an incentive for advertisements to mislead existing and prospective investors about the advisory services they would receive, including indirectly through the services provided to pooled investment vehicles.

As discussed below, we are proposing to apply the rule to advertisements disseminated by investment advisers to their clients and prospective clients as well as to investors and prospective investors in pooled investment vehicles that those advisers manage. For purposes of this release, we refer to any of these advertising recipients as “investors,” unless we specify otherwise.

The Commission recognized the potential harm to investors from misleading advertisements when it adopted the current advertising rule in 1961.

The Commission explained when it proposed the current rule that investment advisers generally must adhere to a stricter standard of conduct in advertisements than that applicable to “ordinary merchants” because securities “are intricate merchandise,” and investors “are frequently unskilled and unsophisticated in investment matters.”

These concerns have motivated the Commission to adopt other rules on advertising investment services and products, including for registered investment companies (“RICs”).

Advertisements by Investment Advisers, Release No. IA-121 (Nov. 1, 1961) [26 FR 10548 (Nov. 9, 1961)] (“Advertising Rule Adopting Release”).

Investment Advisers Notice of Proposed Rulemaking, Release No. IA-113 (Apr. 4, 1961) [26 FR 3070, 3071 (Apr. 11, 1961)] (“Advertising Rule Proposing Release”).

See

17 CFR 230.482 (regulating advertising with respect to securities of RICs and business development companies (“BDCs”)); 17 CFR 230.156 (regulating investment company sales literature).

In adopting the current rule, the Commission used its authority under section 206(4) of the Advisers Act to target advertising practices that it believed were likely to be misleading by imposing four

per se

prohibitions.

First, the current rule prohibits testimonials concerning the investment adviser or its services.

Second, the current rule prohibits direct or indirect references to specific profitable recommendations that the investment adviser has made in the past (“past

specific recommendations”).

Third, the current rule prohibits representations that any graph or other device being offered can by itself be used to determine which securities to buy and sell or when to buy and sell them.

Fourth, the current rule prohibits any statement to the effect that any service will be furnished free of charge, unless such service actually is or will be furnished entirely free and without any condition or obligation.

See

Section 206(4) of the Advisers Act (authorizing the Commission to define and prescribe “means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative”).

Rule 206(4)-1(a)(1) (prohibiting publication, circulation, or distribution of any advertisement “which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser”).

Rule 206(4)-1(a)(2) (prohibiting publication, circulation, or distribution of any advertisement “which refers, directly or indirectly, to past specific recommendations of such investment adviser which were or would have been profitable to any person” but providing that an advertisement may set out or offer to furnish a list of all recommendations within the immediately preceding period of not less than one year under certain conditions).

Rule 206(4)-1(a)(3) (prohibiting publication, circulation, or distribution of any advertisement “which represents, directly or indirectly, that any graph, chart, formula or other device being offered can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; or which represents directly or indirectly, that any graph, chart, formula or other device being offered will assist any person in making his own decisions as to which securities to buy, sell, or when to buy or sell them, without prominently disclosing in such advertisement the limitations thereof and the difficulties with respect to its use”).

Rule 206(4)-1(a)(4) (prohibiting publication, circulation, or distribution of any advertisement “which contains any statement to the effect that any report, analysis, or other service will be furnished free or without charge, unless such report, analysis or other service actually is or will be furnished entirely free and without any condition or obligation, directly or indirectly”).

In addition to the four

per se

prohibitions, the current rule prohibits any advertisement which contains any untrue statement of a material fact, or which is otherwise false or misleading.

This prohibition operates more generally than the specific prohibitions to address advertisements that do not violate any

per se

prohibition but still may be fraudulent, deceptive, or manipulative and, accordingly, be misleading.

Rule 206(4)-1(a)(5).

The concerns that motivated the Commission to adopt the current rule still exist today and are echoed in the rules adopted under other regulatory and self-regulatory regimes governing the use of communications by financial professionals.

However, in the nearly 60 years since the current rule's adoption, issues and questions have arisen about the current rule's application, particularly the application of the prohibitions of testimonials and past specific recommendations. Additionally, some of the most common questions related to the current rule (and the anti-fraud provisions of the Advisers Act) relate to the appropriate presentation of performance in advertisements, which the current rule does not explicitly address. The breadth of the current rule's prohibitions, as well as the lack of explicit prescriptions related to the presentation of performance in the rule, can present compliance challenges and potentially have a chilling effect on advisers' ability to provide useful information in communications that are considered advertisements.

For example, the Financial Industry Regulatory Authority's (“FINRA”) rule 2210 governs broker-dealers' communications with the public, including communications with retail and institutional investors, and provides standards for the content, approval, recordkeeping, and filing of communications with FINRA.

See

Advertising Regulation,

available at http://www.finra.org/industry/advertising-regulation.

The Commodity Futures Trading Commission likewise regulates certain types of advertising by commodity pool operators, commodity trading advisors, and their respective principals. 17 CFR 4.41 Advertising by Commodity Pool Operators, Commodity Trading Advisors, and the Principals Thereof (prohibiting, in part, any advertisements that employ any device, scheme or artifice to defraud any client or prospective client). The Municipal Securities Rulemaking Board regulates advertisements concerning the products or services of certain brokers, dealers, and municipal securities dealers, and, beginning in 2019, will regulate advertisements by municipal advisers. Self-Regulatory Organizations; Municipal Securities Rulemaking Board; Order Granting Approval of a Proposed Rule Change, Consisting to Amendments to Rule G-21, on Advertising, Proposed New Rule G-40, on Advertising by Municipal Advisers, and a Technical Amendment to Rule G-42, on Duties of Non-Solicitor Municipal Advisers, Release No. 34-83177 (May 7, 2018) [83 FR 21794 (May 10, 2018)]. MSRB Rule G-40 became effective on August 23, 2019.

Moreover, changes that have occurred since the current rule's adoption lead us to believe providing a more principles-based approach would be beneficial. Specifically, in our development of the proposed rule, we have considered changes in the technology used for communications, the expectations of investors shopping for advisory services, and the nature of the investment advisory industry, including the types of investors seeking and receiving investment advisory services. These changes have informed not only how we propose to update the rule to address current technology, expectations, and market practice but also our general approach of proposing principles-based rules in order to accommodate the continual evolution and interplay of technology and advice.

See, e.g.,

Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-10668 (Aug. 8, 2019) [84 FR 44358 (Aug. 23, 2019)] (discussing the role of “principles-based” disclosure requirements in articulating a disclosure concept rather than a specific line-item requirement).

Advances in Technology.

Advances in technology have altered the ways in which service providers, including advisers, interface with consumers generally, including with existing and prospective investors. These advances have also changed the manner in which those consumers evaluate products and services. In the decades since the current rule was adopted, the use of the internet, mobile applications, and social media

has become an integral part of business communications. These advances in technology have led to significant growth in the nature and volume of information available to individuals and businesses,

for example, by allowing them to access and share user reviews. However, websites and social media can create challenges in complying with the current rule's prohibition on testimonials, particularly for advisers that rely heavily on electronic platforms to communicate with existing and prospective investors.

“Social media” is an umbrella term that encompasses various activities that integrate technology, social interaction, and content creation. Social media may use many technologies, including, but not limited to, blogs, microblogs, wikis, photos and video sharing, podcasts, social networking, and virtual worlds. The terms “social media,” “social media sites,” “sites,” and “social networking sites” are used interchangeably in this release.

See

Report on the Review of the Definition of “Accredited Investor” (Dec. 18, 2015) (“Accredited Investor Staff Report”),

available at https://www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12-18-2015.pdf,

at 5 (noting “increased informational availability” and “changes in the way investors communicate” since adoption of the “accredited investor” definition in 1982).

See also

Guidance on the Testimonial Rule and Social Media, Division of Investment Management Guidance Update No. 2014-04 (Mar. 2014) (“IM Staff Social Media Guidance”), in which our staff discussed its views on application of the current rule to various situations involving social media. Any staff guidance or no-action letters discussed in this release represent the views of the staff of the Division of Investment Management. They are not a rule, regulation, or statement of the Commission. Furthermore, the Commission has neither approved nor disapproved their content. Staff guidance has no legal force or effect; it does not alter or amend applicable law, and it creates no new or additional obligations for any person.

Expectations of Consumers Shopping for Services.

Consumers today often rely on the internet to obtain information when considering buying goods and services across the world, including advisory services and those of other financial professionals. Many websites allow potential buyers to compare and contrast the goods and services being offered, including through reviews and ratings provided by those who have previously bought the relevant goods and services. We believe that consumers' ability to seek out reviews and other information, as well as their interest in doing so, when evaluating

products and services has changed since the adoption of the current rule.

Profiles of the Investment Advisory Industry.

The variety of advisers subject to the advertising rule has changed since the current rule's adoption. Specifically, the type of advisory services provided by advisers generally has changed over time, from impersonal investment advice distributed to many prospective investors in the form of newsletters and other periodicals to more personalized advisory services. The ways advisers and investors interact and engage has also changed; some investors today rely on digital investment advisory programs, sometimes referred to as “robo-advisers,” for investment advice, which is provided exclusively through electronic platforms using algorithmic-based programs.

In addition, passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”)

required many investment advisers to private funds

that were previously exempt from registration to register with the Commission and become subject to more provisions of the Advisers Act.

See, e.g.,

Robo-Advisers, Division of Investment Management Guidance Update No. 2017-02 (Feb. 2017);

see also

Concept Release on Harmonization of Securities Offering Exemptions, Release No. IA-5256 (June 18, 2019) [84 FR 30460 (June 26, 2019)] (“2019 Concept Release”) (describing the use of robo-advisers as part of the broad availability “in recent years” of investment advisory services to retirement investors).

See

the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) (the “Dodd-Frank Act”).

See

15 U.S.C. 80b-2(a)(29) (defining a “private fund” as “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act”).

As part of the Dodd-Frank Act, the Private Fund Investment Advisers Registration Act of 2010 (enacted as Title IV of the Dodd-Frank Act) repealed the “private fund adviser exemption” from registration under section 203(b)(3) of the Advisers Act, on which many advisers to private funds had relied to remain outside the purview of the Advisers Act. As a result, the Commission saw an increase in the number of registered investment advisers servicing private funds. Based on a review of Form ADV data between June 2012 and August 2019, the number of investment advisers to private funds registered with the Commission increased from approximately 4,050 to approximately 4,856. The number of private funds advised by registered investment advisers has increased during that same time period, from 24,476 in June 2012 to 37,004 in August 2019. The Dodd-Frank Act created a narrower set of exemptions for advisers that advise exclusively venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the United States.

See

section 203(l) and section 203(m) of the Advisers Act.

Additionally, the diversity in types of investors seeking and receiving advisory services has increased since the current rule's adoption.

When adopting the current rule, the Commission stated “clients or prospective clients of investment advisers are frequently unskilled and unsophisticated in investment matters.”

Changes in the investor population since the current rule's adoption suggest we should reconsider some specific provisions of the current rule and consider how best to address new issues. For example, assets under management for institutional clients have increased in recent years.

These types of investors often have their own teams of in-house investment professionals to manage their assets or oversee the retention of outside managers. They therefore often want and have the resources to evaluate information that the current rule may restrict. At the same time, household and individual participation in the capital markets through intermediaries, like investment advisers, has increased. As a result, more individuals who are not themselves professional investors may be seeking or receiving advertisements for these services. Accordingly, rather than the “one-size-fits-all” approach of the current rule, we believe it is appropriate for the rule to reflect the intended audience of the advertisement, including investors' access to resources for assessing advertising content for advisory services, such as presentation of hypothetical performance.

We have previously indicated the diversity in types of clients that receive investment advisory services.

See, e.g.,

Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-5248 (June 5, 2019) (“Standard of Conduct Release”) (noting the large variety of clients served by investment advisers “from retail clients with limited assets and investment knowledge and experience to institutional clients with very large portfolios and substantial knowledge, experience, and analytical resources”).

Advertising Rule Adopting Release,

supra

footnote 5.

As discussed below,

see infra

section III.B.1, a substantial percentage of assets under management at investment advisers is held by institutional clients.

In light of the Commission's decades of experience in administering the current rule and the other developments described above, as well as extensive outreach by Commission staff to investor advocacy groups, adviser groups, legal practitioners, and others, we are proposing significant changes to the current rule as discussed below. Specifically, we are proposing a restructured and more tailored rule that: (i) Modifies the definition of “advertisement” to be more “evergreen” in light of ever-changing technology; (ii) replaces the current four

per se

prohibitions with a set of principles that are reasonably designed to prevent fraudulent or misleading conduct and practices; (iii) provides certain additional restrictions and conditions on testimonials, endorsements, and third-party ratings; and (iv) includes tailored requirements for the presentation of performance results, based on an advertisement's intended audience. The proposed rule also would require internal review and approval of most advertisements and require each adviser to report additional information regarding its advertising practices in its Form ADV.

B. Cash Solicitation Rule Background

Another way that advisers attract clients and investors,

beyond advertising communications, is through compensating firms or individuals to solicit new investors. Some investment advisers directly employ individuals to solicit new investors on their behalf, and some investment advisers arrange for related entities or third parties, such as broker-dealers, to solicit new investors. The person or entity compensated, commonly called the “solicitor,” has a financial incentive to recommend the adviser to the investor. Without appropriate disclosure, this compensation creates a risk that the investor would mistakenly view the solicitor's recommendation as being an unbiased opinion about the adviser's ability to manage the investor's assets and would rely on that recommendation more than he or she otherwise would if the investor knew of the incentive.

As discussed below, we are proposing to apply the rule to compensation by investment advisers to solicitors to obtain clients and prospective clients as well as investors and prospective investors in private funds that those advisers manage. For purposes of this release, we refer to any of these persons as “investors,” unless we specify otherwise.

We adopted rule 206(4)-3, the cash solicitation rule, in 1979 to help ensure that clients become aware that paid solicitors have a conflict of interest.

The current rule makes the adviser's payment of a cash fee for referrals of

advisory clients unlawful unless the solicitor and the adviser enter into a written agreement that, among other provisions, requires the solicitor to provide the client with a current copy of the investment adviser's Form ADV brochure and a separate written solicitor disclosure document.

The solicitor disclosure must contain information highlighting the solicitor's financial interest in the client's choice of an investment adviser.

In addition, the rule prescribes certain methods of compliance, such as requiring an adviser to receive a signed and dated client acknowledgment of receipt of the required disclosures.

The current rule also prohibits advisers from making cash payments to solicitors that have previously been found to have violated the Federal securities laws or have been convicted of a crime.

See

Requirements Governing Payments of Cash Referral Fees by Investment Advisers, Release No. 688 (July 12, 1979) [44 FR 42126 (Jul. 18, 1979)] (the “1979 Adopting Release”). When we proposed the rule, we noted that referral arrangements in the investment advisory industry are “fraught with possible abuses” and we considered prohibiting investment advisers from making referral payments to persons not directly employed by the firm.

See

Requirements Governing Payments of Cash Referral Fees by Investment Advisers, Release No. 615 (Feb. 11, 1978) [43 FR 6095 (Feb. 13, 1978)] (the “1978 Proposing Release”), at 6096; 1979 Adoption Release,

id.,

at 42126. However, we concluded that investors' interests could be protected if the conflicts of interest are properly disclosed to advisory clients and certain other regulatory safeguards are met.

See

1979 Adopting Release,

id.,

at 42126.

See

rule 206(4)-3(a)(2)(iii)(A). When the Commission proposed the solicitation rule, it did not include non-cash compensation in the rule. However, when the Commission adopted the rule, it noted that commenters suggested that a prohibition of cash solicitation fees altogether might lead to use of other, possibly undisclosed, methods of compensation, such as directed brokerage. 1979 Adopting Release,

supra

footnote 27, at n.6.

1978 Proposing Release,

supra

footnote 27.

See

rule 206(4)-3(b)(1) through (6). The solicitor disclosure must also include prescribed information about the cost that the client would bear in the advisory relationship as a result of the compensated referral.

See

rule 206(4)-3(a)(2)(iii)(B). Referrals by solicitors for impersonal advisory services and certain solicitors that are affiliated with the adviser are exempt from these requirements.

See

rule 206(4)-3(a)(2)(i) and (ii).

See

rule 206(4)-3(a)(1)(ii).

The current solicitation rule has not been amended since adoption 40 years ago. In this time, advisory and referral practices have evolved, as has the regulatory framework for investment advisers. For example, advisers use various types of compensation, including non-cash compensation, in referral arrangements. Over time, we have gained a greater understanding of these arrangements, causing us to re-evaluate whether the rule should apply to all forms of compensation for referrals. In addition, as discussed above, the passage of the Dodd-Frank Act required many investment advisers to private funds that were previously exempt from registration to register with the Commission and become subject to additional provisions of the Advisers Act and the rules thereunder. Private funds and their advisers often hire solicitors to obtain investors in the funds.

See

Section 7.B.(1)(A).28 (Private Fund Reporting) of Schedule D to Form ADV Part 1A (requiring advisers to private funds to list, among other things, the name of their marketer (including any solicitor)). As of September 30, 2019, approximately 33% of registered investment advisers that report that they advise one or more private funds on Form ADV also report that the private fund uses the services of someone other than the adviser or its employees for marketing purposes.

Additionally, the Commission has adopted other regulatory requirements for advisers since the current rule's adoption that are more principles-based. For example, the Act's compliance rule could broadly replace some of the rule's prescriptive requirements, such as the requirement to obtain written and signed acknowledgments of each solicitor disclosure.

In addition, the Act's brochure delivery rule may duplicate the current cash solicitation rule's requirement that the solicitor also deliver the adviser's brochure.

Finally, we believe it is appropriate to consider revising the solicitor disqualification provision to address certain types of conduct.

See

rule 206(4)-7; Compliance Programs of Investment Companies and Investment Advisers, Release No. IA-2204 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)] (“Compliance Program Adopting Release”).

The same year we adopted the cash solicitation rule, we adopted for the first time the Form ADV brochure, which we have significantly amended over time.

See

1979 Adopting Release,

supra

footnote 27, at n.14 and accompanying text.

See

Amendments to Form ADV, Release No. IA-3060 (July 28, 2010) [75 FR 155 (Aug. 12, 2010)] (“2010 Form ADV Amendments Release”), at section I. The Commission noted in the 1979 adopting release that “delivery of a brochure by the solicitor will, in most cases, satisfy the investment adviser's obligation to deliver a brochure to the client under Rule 204-3.”

See

1979 Adopting Release,

supra

footnote 27.

Therefore, we are proposing to expand the rule to cover solicitation arrangements involving all forms of compensation, rather than only cash compensation. We are proposing to expand the rule to apply to the solicitation of current and prospective investors in any private fund, rather than only to “clients” (including prospective clients) of the investment adviser. Our proposal would require solicitor disclosure to investors, which alerts investors to the effect of this compensation on the solicitor's incentive in making the referral. In addition, we are proposing changes to eliminate: (i) The requirement that solicitors provide the client with the adviser's Form ADV brochure; and (ii) the explicit reminders of advisers' requirements under the Act's special rule for solicitation of government entity clients and their fiduciary and other legal obligations. Our proposal would also eliminate the requirement that an adviser obtain a signed and dated acknowledgment from the client that the client has received the solicitor's disclosure, and instead would afford advisers the flexibility in developing their own policies and procedures to ascertain whether the solicitor has complied with the rule's required written agreement. We are also proposing two new exceptions to the solicitation rule, an exception for

de minimis

payments (less than $100 in any 12 month period) and one for nonprofit programs designed to provide a list of advisers to interested parties. Finally, we are proposing to refine the rule's solicitor disqualification provision to expand the types of disciplinary events that would trigger the rule's disqualification provision, while also providing a conditional carve-out for certain types of Commission actions.

II. Discussion

A. Proposed Amendments to the Advertising Rule

1. Structure of the Rule

The proposed advertising rule is organized as follows, as a means reasonably designed to prohibit fraudulent, deceptive or manipulative acts: (i) General prohibitions of certain advertising practices applicable to all advertisements;

(ii) tailored restrictions or conditions on certain practices (testimonials, endorsements, and third-party ratings) applicable to all advertisements;

(iii) tailored requirements for the presentation of performance results, based on the advertisement's intended audience;

and (iv) a compliance requirement that most advertisements be reviewed and approved in writing by a designated employee before dissemination.

The proposed rule would apply to all investment advisers registered, or required to be registered, with the Commission.

See

proposed rule 206(4) 1(a).

See

proposed rule 206(4) 1(b).

See

proposed rule 206(4) 1(c).

See

proposed rule 206(4) 1(d).

The proposed rule would not apply to advisers that are not required to register as investment advisers with the Commission, such as exempt reporting advisers or state-registered advisers.

2. Scope of the Rule: Definition of “Advertisement”

a. Proposed Definition

The proposed rule would define “advertisement” as “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser's investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser.” The proposed

definition of “advertisement” would not include the following four categories of communications:

(A) Live oral communications that are not broadcast on radio, television, the internet, or any other similar medium;

(B) A communication by an investment adviser that does no more than respond to an unsolicited request for specified information about the investment adviser or its services, other than (i) any communication to a Retail Person that includes performance results or (ii) any communication that includes hypothetical performance;

(C) An advertisement, other sales material, or sales literature that is about an investment company registered under the Investment Company Act of 1940 (the “Investment Company Act”) or about a business development company (“BDC”) and that is within the scope of rule 482 or rule 156 under the Securities Act of 1933 (the “Securities Act”); or

(D) Any information required to be contained in a statutory or regulatory notice, filing, or other communication.

The proposed rule is intended to define “advertisement” so that it is flexible enough to remain relevant and effective in the face of advances in technology and evolving industry practices.

This proposed definition reflects several differences from the current rule. One difference is the expansion of the types of communications addressed to reflect evolving methods of communication, rather than the methods that were most common when the current rule was adopted (

e.g.,

newspapers, television, and radio).

Second, the proposed definition applies explicitly to advertisements disseminated to investors in pooled investment vehicles, with a carve-out for publicly offered investment companies. Third, the proposed definition does not retain the current rule's “more than one person” element, but, consistent with the effect of that element, does not apply to non-broadcast live oral communications or responses to certain unsolicited requests.

Finally, the rule carves out information required by existing statutory or regulatory requirements. These differences are intended to update the current rule to reflect modern methods of communication and to be sufficiently flexible to address future methods of dissemination, as well as clarify investment advisers' obligations with respect to all communications intended to obtain or retain investors in pooled investment vehicles. We discuss below the specific provisions of and specific exclusions from the proposed rule's definition.

The proposed definition of “advertisement” is distinct from a communication that would be considered general solicitation or general advertising of an offering for purposes of Regulation D under the Securities Act.

See

17 CFR 230.502(c) (describing limitations on the manner of offering or selling securities under Regulation D). The proposed definition would also be distinct from a communication that would be considered a public offering for purposes of section 4(a)(2) of the Securities Act.

See

17 U.S.C. 77d(a)(2). However, in determining whether a communication would constitute a general solicitation, the Commission has historically interpreted the term “offer” broadly, and has explained that “the publication of information and publicity efforts, made in advance of a proposed financing which have the effect of conditioning the public mind or arousing public interest in the issuer or in its securities constitutes an offer.”

See

Securities Offering Reform, Release No. 33-8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)], at n. 88. Thus an advertisement under the proposed rule would need to be assessed to determine whether it may be a communication that is considered a general solicitation, advertising, or a public offering for purposes of Regulation D or section 4(a)(2).

See

proposed rule 206(4)-1(e)(1) (defining “advertisement” as, in part, “any communication, disseminated by any means”). In contrast, the current rule defines “advertisement,” in part, to include “any 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.” Rule 206(4)-1(b).

See

proposed rule 206(4)-1(e)(1) (defining “advertisement” as, in part, any communication “that offers or promotes the investment adviser's investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser”). In contrast, the current rule defines “advertisement,” in part, to include “any notice, circular, letter or other written communication addressed to more than one person.” Rule 206(4)-1(b).

We request comment generally on the proposed rule's definition of “advertisement,” with more specific requests on particular elements of the proposed definition in the sections that follow.

• Generally, does the proposed rule's definition of “advertisement” sufficiently describe the types of communications that should be subject to the requirements of the proposed rule? Are there types of communications that should be subject to the requirements of the proposed rule but are excluded from the proposed definition?

• Conversely, does the proposed rule's definition of “advertisement” include communications that should not be subject to the requirements of the proposed rule?

b. Specific Provisions

i. Dissemination by Any Means

The proposed rule would define “advertisement” to include communications “disseminated by any means.” This would replace the current rule's requirement that it be a “written” communication or a notice or other announcement “by radio or television.” This proposed revision would change the scope of the rule to encompass all promotional communications regardless of how they are disseminated, with the exception of certain communications discussed below. Communications may be disseminated through emails, text messages, instant messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, and all manner of social media, as well as by paper, including in newspapers, magazines and the mail. We recognize that electronic media (including social media and other internet communications) and mobile communications play a significant role in current advertising practices. While we considered including specific references to such media in the proposed definition, we believe that “by any means” incorporates such media while better focusing the proposed rule on the goal of the communication, and not its method of delivery. We also believe this revision will help the proposed definition remain evergreen in the face of evolving technology and methods of communication.

We request comment on the proposed definition's inclusion of a communication disseminated by any means.

• Would the proposed definition's approach have our intended effect of being evergreen in the face of changing technologies? Is there an alternative approach that would better produce this intended effect?

• The proposed rule's restrictions would not distinguish between, for example, a print advertisement and a social media post. Is our approach in this respect appropriate or should we treat communications differently depending on the medium? If so, how should we reflect that treatment? Would additional definitions be appropriate or useful? If we adopt a definition that lists specific media, how should we address our goal of having the definition apply to new media in the future?

• The proposed definition would capture advertisements that are nominally directed at one person but in fact widely disseminated (such as robo-calls or emails), in order to prevent any evasion of a rule covering communications “addressed to” one person. Would the proposed rule's approach have this intended anti-evasion effect? Is there an alternative approach to the proposed definition that would better produce this intended effect?

• Should we have different requirements for advertisements depending on how broadly the adviser disseminates them? For example, the FINRA communications rule differentiates between “retail communications,” which are those available to more than 25 investors, and “correspondence,” which are those available to 25 or fewer investors. Would this kind of differentiation be useful or appropriate in rule 206(4)-1?

ii. By or on Behalf of an Investment Adviser

The proposed rule would define “advertisement” to include all communications “by or on behalf of an investment adviser.”

We understand that investment advisers often provide to intermediaries, such as consultants and solicitors, advertisements for dissemination,

and the proposed rule would treat those as communications “by or on behalf of” the advisers.

Communications disseminated by an affiliate of the investment adviser would similarly be treated as communications “by or on behalf of” the adviser. For example, a communication prepared by the adviser to an affiliated private fund but disseminated for the adviser by the private fund through its consultants would be a communication “by or on behalf of” the adviser for purposes of the proposed rule. If an advertisement were disseminated without the adviser's authorization, however, such an unauthorized communication would not be “by or on behalf” of the adviser.

Proposed rule 206(4)-1(e)(1).

See, e.g.,

Investment Company Institute, SEC Staff No-Action Letter (Sept. 23, 1988) (“ICI Letter”) (staff stated that it would not recommend enforcement action regarding an investment adviser's provision of performance information to consultants for advisory clients under certain conditions).

See infra

section II.B for a discussion of the proposed solicitation rule. In many cases, a compensated testimonial or endorsement would be subject to both the proposed advertising rule and the proposed solicitation rule. This could be the case even if the adviser does not give the adviser's advertising content to the person providing the testimonial or endorsement.

See infra

section II.B.

That is, we intend “by or on behalf of” to require affirmative steps by the adviser.

We believe communications that investment advisers use to offer or promote their services have an equal potential to mislead—and should be subject to the proposed rule—regardless of whether the adviser disseminates such communications directly or through an intermediary. Including communications “on behalf of” an investment adviser also is intended to reflect the application of the current rule to communications provided by investment advisers through intermediaries.

Accordingly, we believe that investment advisers should be able to comply with this element of the proposed rule through the practices they currently use in communicating with prospective clients through intermediaries.

See, e.g., In re

Profitek, Inc., Release No. IA-1764 (Sept. 29, 1998) (settled order) (the Commission brought an enforcement action against an investment adviser, asserting that it directly or indirectly distributed materially false and misleading advertisements, including by submitting performance information in questionnaires submitted to online databases that were made available to subscribers nationwide and by providing misleading performance information to newspaper that reported the performance in article);

see also

ICI Letter.

The Commission has previously indicated an expectation that an adviser's policies and procedures, at a minimum, should address certain issues to the extent they are relevant to that adviser, which may include marketing advisory services, including the use of solicitors.

See

Compliance Program Adopting Release,

supra

footnote 33.

Additionally, content created by or attributable to unaffiliated third parties, such as investors, could be considered by or on behalf of an investment adviser, depending on the investment adviser's involvement. Whether a communication is “by or on behalf of” an investment adviser when the communication involves content from an unaffiliated third party would require a facts and circumstances analysis. We believe that whether third-party information is attributable to an adviser under the “by or on behalf of” standard depends upon whether the adviser has involved itself in the preparation of the information or explicitly or implicitly endorsed or approved the information.

This issue may commonly arise in the context of an adviser's use of its website or other social media. For example, an adviser might incorporate third-party content into the adviser's communication by including a hyperlink to an independent web page on which third-party content sits in the adviser's communication. Or an adviser might allow third parties to post commentary on the adviser's website or social media page. In both cases, the third-party content may be a communication “by or on behalf of” the adviser, and therefore an “advertisement” subject to the restrictions in the proposed rule.

We believe third-party content is “by or on behalf of” an adviser when the adviser takes affirmative steps with respect to the third-party content. For example, third-party content could be by or on behalf of the investment adviser if the investment adviser: (i) Drafts, submits, or is otherwise involved substantively in the preparation of the content; (ii) exercises its ability to influence or control the content, including editing, suppressing, organizing, or prioritizing the presentation of the content; or (iii) pays for the content. If an investment adviser helps draft comments that an investor posts on a third-party website or social media page, the comments could be an advertisement under the proposed definition, and the proposed rule's requirements could apply. For instance, if the adviser edits a third party's discussion of the adviser on a third-party website, then the content could be a communication by or on behalf of the adviser. As noted above, if the adviser pays for the content—including if the adviser provides non-cash compensation such as rewards or other incentives for a third party to provide content—the content could be considered to be by or on behalf of the adviser.

Such incentives could include, for example, compensated advisory services and cross-referrals (

e.g.,

the adviser refers investors to the third-party site).

For many advertisements, paid content also may be considered a paid testimonial or endorsement, which would be subject to specific disclosure requirements (

see

proposed rule 206(4)-1(b)(1)).

See infra

section II.A.4.b.

On the other hand, there are several circumstances in which we generally would not view third-party content as by or on behalf of an adviser, and therefore the content would not be within the proposed rule's scope. For example, an adviser's hyperlink to third-party content within the adviser's press release generally would not, by itself, make the hyperlinked content part of the advertisement, provided that the third party, and not the adviser or its affiliate, drafted the hyperlinked content and is free to modify it.

At the same time, an adviser's hyperlink to third-party content that the adviser knows or has reason to know contains an untrue statement of material fact or materially misleading information would be fraudulent or deceptive under section 206 of the Act.

We previously stated that an adviser should consider the application of rule 206(4)-1, including the prohibition on testimonials, before including hyperlinks to third-party websites on its website or in its electronic communications.

See

Interpretive Guidance on the Use of Company websites, Release No. IC-28351 (Aug. 1, 2008) [73 FR 45862 (Aug. 7, 2008)]. The proposed rule would provide an approach that is more flexible than our 2008 interpretive guidance to evaluating the use of hyperlinks to third-party content, as the proposed rule would not prohibit testimonials.

Content regarding the investment adviser on third-party hosted platforms that solicit users to post information, including positive and negative reviews of the adviser, generally would not be

“by or on behalf of” the investment adviser unless the adviser took affirmative steps to influence the content of those reviews or posts, such as providing a user with wording to submit as a review or editing the content of a post.

The provision of investment advisory services would not constitute such affirmative steps.

Determining whether content posted by third parties on an adviser's own website or social media page is by or on behalf of the investment adviser will thus turn on the extent to which the adviser has involved itself in the presentation of such content.

For example, the fact that an adviser permits all third parties to post public commentary to the adviser's website or social media page would not, by itself, render such content attributable to the investment adviser, so long as the adviser does not selectively delete or alter the comments or their presentation. We believe such treatment for third-party content on the adviser's own website or social media page is appropriate even if the adviser has the ability to influence control over the commentary but does not exercise it.

Likewise, we would not consider an adviser that merely permits the use of “like,” “share,” or “endorse” features on a third-party website or social media platform to implicate the proposed rule.

Other content on an adviser's own website or social media page would likely meet the definition of “advertisement” in the proposed rule.

For example, if the social media platform allows the investment adviser to sort the third-party content in such a way that more favorable content appears more prominently, but the investment adviser does not actually do such sorting, then the ability to sort content would not render such content attributable to the adviser.

Conversely, if the investment adviser took affirmative steps to involve itself in the preparation of the comments or to endorse or approve the comments, those comments could be communications “by or on behalf of” the adviser. For example, if an adviser substantively modifies the presentation of comments posted by others by deleting negative comments or prioritizing the display of positive comments, then we believe the adviser is exercising sufficient control over third-party comments with the goal of promoting its advisory business that the content would be “by or on behalf of” the investment adviser and would likely be considered an advertisement under the proposed rule. We request comment on the proposed definition's inclusion of communications “on behalf of” an investment adviser, including our views above on when third-party content would be considered a communication by or on behalf of an investment adviser.

• Is the “on behalf of” element of the proposed definition sufficiently clear based on our description above? Should we further clarify any specific indicia to determine when a communication is disseminated “on behalf of” an investment adviser, particularly circumstances when an adviser might have exercised sufficient influence over third-party content? Should we use a different standard such as, for example, the prohibition in rule 156 under the Securities Act of “directly or indirectly” using sales literature?

• Should the proposed rule explicitly define or provide examples when third-party content would be considered an advertisement for which the investment adviser is responsible and when it is not? How should we incorporate such provisions?

• Do investment advisers routinely use intermediaries or other third parties to disseminate communications to the advisers' clients and prospective clients? How do investment advisers to private funds and other pooled investment vehicles currently use intermediaries, for example through capital introduction programs, to advertise those vehicles? Do commenters agree that investment advisers would be able to comply with the “on behalf of” element through practices they currently use in communicating through intermediaries?

• Should the proposed rule apply specific criteria to circumstances where investment advisers provide information to third-party news organizations? Are there circumstances under which investment advisers interact with third-party news organizations under the current rule that should be addressed specifically in the proposed rule? Are there specific challenges that investment advisers have encountered under the current rule in providing information to third-party news organizations? To what extent do investors rely on information provided by third-party news organizations in assessing the capabilities and experience of investment advisers that may be hired?

• In our view, if an adviser were to modify the presentation of third-party comments, such an action would likely make the communication by or on behalf of the adviser. Should we consider providing additional guidance to allow an adviser to edit third-party content solely on the basis that it is profane or unlawful without such editing causing the content to be “by or on behalf” of the adviser? If so, how should we define profane or unlawful content? Would it be necessary to give an audience notice that such third-party content had been edited in such a way, and if so, how would such notice best be provided? Would such guidance have the effect of evading the intent of the proposed rule, considering that comments with profane content may indicate negative views of the adviser?

• Should we provide that editing the presentation of third-party comments pursuant to a set of neutral pre-established policies and procedures would not make such content “by or on behalf of the adviser”? For example, should we allow an adviser to determine in advance that it will delete all comments that are older than five years, or that include spam, threats, personally identifiable information, or demonstrably factually incorrect information? If so, should we require advisers to publically disclose the pre-established criteria for editing such comments?

iii. Offer or Promote Advisory Services or Seek To Obtain or Retain Clients or Investors

The proposed rule would define “advertisement” to include communications that are disseminated “to offer or promote” the investment adviser's investment advisory services or that seek to “obtain or retain” investors.

The “offer or promote” clause is meant to focus the proposed definition on the goal of the communication and on communications that we believe are commonly considered advertisements. The “offer or promote” clause reflects the current rule's application, which has excluded communications that do not “offer” advisory services from advertisements under rule 206(4)-1.

Such communications are still subject to the anti-fraud provisions in sections 206(1), (2), and (4) and rule 206(4)-8.

See supra

footnote 4.

For example, our staff has indicated that it would not recommend enforcement action under the current rule with respect to written communications by an adviser to an existing client about the performance of securities in the client's account because such communications would not be “offers” of advisory services, and instead are “part of” those advisory services (unless the context in which the communication is provided suggests otherwise).

See

Investment Counsel Association of America, Inc., SEC Staff No-Action Letter (Mar. 1, 2004) (“ICAA Letter”).

Unlike the “offer” clause, the “promote” clause is not included in the text of the current rule. We believe that it is appropriate to include in the proposed definition communications that promote advisory services because we believe that advertisements are generally considered to be promotional materials, even if the communication

does not explicitly “offer” services.

Other rules governing financial firms similarly regulate “promotional” communications.

See SEC

C.R. Richmond & Co.,

565 F.2d 1101, 1105 (9th Cir. 1977) (“SEC v Richmond”) (“Investment advisory material which promotes advisory services for the purpose of inducing potential clients to subscribe to those services is advertising material within [the current rule].”);

see also

Denver Investment Advisors, Inc., SEC Staff No-Action Letter (July 30, 1993) (indicating the staff's view that a communication provided to consultants, but not necessarily to prospective clients, to allow the consultants to evaluate the adviser as part of the consultants' own services to their own clients is an “advertisement” under the current rule because the communication is provided “for the ultimate purpose of maintaining existing clients and soliciting new ones”).

see also

Amendments to Investment Company Advertising Rules, Release No. IC-26195 (Oct. 3, 2003) [68 FR 57760 (Oct. 6, 2003)] (“Final Investment Company Advertising Release”) (noting that when an investment company offers its shares to the public, “its promotional efforts become subject to the advertising restrictions of the Securities Act”).

Additionally, we believe that defining an “advertisement” as a communication that “offers or promotes” services would allow investment advisers to continue to deliver to existing investors account statements or transaction reports that are intended to provide only details regarding those accounts and investments without those communications being considered advertisements.

In the usual course, a communication to an existing investor about the performance of the investor's account would not be for promoting the adviser's services or be used to obtain or retain investors.

Accordingly, we would not view information typically included in an account statement, such as inflows, outflows, and account performance, as qualifying as advertisements under the proposed rule.

Their exclusion from the proposed definition would not prevent these account statements or transaction reports from being subject to the other provisions of the Federal securities laws, including section 17(a) of the Securities Act or section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) (and rule 10b-5 thereunder), to the extent those provisions would otherwise apply.

See also

ICAA Letter (stating the staff's view that, “[i]n general, written communications by advisers to their existing clients about the performance of the securities in their accounts are not offers of investment advisory services but are part of the adviser's advisory services.”). A communication to an existing investor in a pooled investment vehicle about the performance of the pooled investment vehicle would not be treated as promoting the adviser's services or be used to obtain or retain investors for purposes of rule 206(4)-1.

In addition, we would not view materials that provide general educational information about investing or the markets as offering or promoting an adviser's services or seeking to obtain or retain investors. For example, an adviser that disseminates a newspaper article about the operation of investment funds or the risks of certain emerging markets would generally be circulating educational materials and not offering or promoting the adviser's own services.

However, investment advisers also may choose to deliver to existing investors communications that include promotional information that is neither account information nor educational material. Such additional promotional information may make the communication an advertisement, if that additional information “offers or promotes” the adviser's advisory services under the facts and circumstances. For example, a communication to existing investors that includes the adviser's own market commentary or a discussion of the adviser's investing thesis may be considered to be “offering or promoting” the adviser's services depending on the facts and circumstances of the relevant communication.

See

ICAA Letter (indicating that where an adviser writes a letter that discussed its past specific recommendations concerning securities not held or not recently held by some of the clients to whom the letter was directed “would suggest that a purpose of the communication was to promote the advisory services of the adviser”).

The proposed definition of “advertisement” includes communications disseminated “to obtain or retain” investors. We would expressly include communications that are intended to retain existing investors because communications to existing investors may be used to mislead or deceive in the same manner as communications to prospective investors.

Accordingly, we believe it is appropriate to regulate the use of such communications as a means reasonably designed to prevent fraudulent, deceptive, or misleading acts, practices, or courses of business.

Our staff has indicated its view that materials designed to maintain existing clients should be considered to be advertisements under the current rule's definition,

see

Munder Capital Management, SEC Staff No-Action Letter (May 17, 1996), and we are proposing to incorporate this approach in the proposed rule.

see also

Comment Letter of the Investment Company Institute on the 2019 Concept Release (Sept. 24, 2019), at n.62 (“We recommend that the Commission adopt restrictions for private fund advertising beyond the anti-fraud requirements of Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. If those regulations alone were enough to dispel investor confusion and prevent misleading solicitation, then the myriad rules and staff guidance applicable to regulated funds that the Commission and staff as well as FINRA have developed over decades would not be necessary.”).

See

Rule 206(4)-8 Adopting Release,

supra

footnote 64.

The proposed rule would exclude advertisements, other sales materials, or sales literature about RICs and BDCs that are within the scope of rule 482 or rule 156 under the Securities Act, as described below.

This would result in a departure from rule 206(4)-8, which applies to investment advisers with respect to any “pooled investment vehicle,” including RICs and BDCs.

We are proposing to exclude certain communications about RICs and BDCs, which are already subject to specific restrictions and requirements for communications to their investors under the Securities Act and the Investment Company Act, including rules that cover the same areas addressed by the proposed rule and that are designed to protect investors in those funds. For example, rule 482 under the Securities Act and the applicable registration form impose specific requirements on the presentation and computation of performance results for certain registered funds.

Rule 156 under the Securities Act describes certain practices that may be misleading when used in sales literature in connection with the offer or sale of securities issued by an investment company.

See infra

section II.A.2.c.iii. The proposed rule would exclude from the “advertisement” definition only those communications within the scope of rule 482 or rule 156 under the Securities Act.

See supra

footnote 63.

17 CFR 230.482(b)(3) (imposing disclosure requirements on advertisements that include performance data of an open-end management investment company or a trust account); 17 CFR 230.482(d) (imposing requirements on performance information in the case of an open-end management investment company or a trust account); 17 CFR 230.482(e) (imposing requirements on performance data for money market funds); 17 CFR 230.482(g) (establishing standards for the timeliness of performance data in advertisements).

17 CFR 230.156.

See also

17 CFR 270.34b-1 (imposing requirements on sales literature for investment companies).

When we adopted rule 206(4)-8, we noted its similarity to existing anti-fraud laws and rules that “depending upon the circumstances, may also be applicable to the same investor communications,” including those applicable to RICs and BDCs.

We expressed assurance that investment advisers to pooled investment vehicles would be able to comply with rule 206(4)-8 and those existing laws and rules, in part because rule 206(4)-8 was adopted to impose obligations similar to those imposed under sections 206(1) and 206(2) of the Advisers Act.

We also noted that “the nature of the duty to communicate without false statements [was] so well developed in current law” that the similar duty imposed by rule 206(4)-8 would neither be unduly broad nor have a “chilling effect” on investor communications.

See

Rule 206(4)-8 Adopting Release,

supra

footnote 64 (citing, in part, rule 156 under the Securities Act and section 34 of the Investment Company Act).

Rule 206(4)-8 Adopting Release,

supra

footnote 64 (noting that sections 206(1) and 206(2) were “commonly accepted as imposing similar requirements on communications with investors in a fund”).

Id.

Rule 206(4)-8 establishes a broad anti-fraud standard on communications

with investors in pooled investment vehicles, whether publicly or privately offered, that we believe can exist comfortably alongside the specific prohibitions and restrictions that govern the public offering of funds. The proposed rule, in contrast, applies specific prohibitions and restrictions that address the same areas already governed by specific requirements in rule 482 and rule 156. Accordingly, we believe excluding from the proposed rule certain communications about RICs and BDCs, as described below, is appropriate.

We request comment on the proposed definition of “advertisement” expressly including communications that are disseminated to obtain or retain “investors in pooled investment vehicles.”

• Are there any particular burdens or difficulties that investment advisers may bear in treating as “advertisements” communications designed for investors in pooled investment vehicles—that is, investors who may not be clients of the investment advisers?

• Are there communications that investment advisers currently disseminate to investors in pooled investment vehicles that otherwise satisfy the proposed definition of “advertisement” but should not be treated as such? What types of communications, and why should they not be treated as advertisements?

• Would investment advisers to pooled investment vehicles prefer that we address our concerns regarding advertisements through an amendment to rule 206(4)-8 instead of through the proposed rule? For example, should we incorporate the proposed rule's requirements and prohibitions into rule 206(4)-8? Would there be any costs or benefits if we used that approach or a similar approach instead?

• Should the proposed rule apply to communications to investors in pooled investment vehicles other than those that are “pooled investment vehicles” as defined in rule 206(4)-8—

e.g.,

funds that are excluded from the definition of “investment company” by reason of section 3(c)(5) or 3(c)(11) of the Investment Company Act? Which other vehicles, and why or why not? Should we consider not defining “pooled investment vehicle” for purposes of the proposed rule?

Why or why not?

See, e.g.,

rule 206(4)-2(a)(5).

c. Specific Exclusions

The proposed rule would specifically exclude four types of communications from the definition of “advertisement”: (i) Non-broadcast live oral communications; (ii) responses to certain unsolicited requests; (iii) communications relating to RICs and BDCs; and (iv) information required by statute or regulation. Although these types of communications would not be “advertisements” for purposes of the proposed rule, they would remain subject to all other applicable provisions in the Advisers Act and the rules thereunder and other applicable provisions of the Federal securities laws.

In particular, any such communication to a client or prospective client would remain subject to the general anti-fraud prohibitions of section 206 of the Advisers Act. In addition, communications that are excluded from the definition of “advertisement” would remain subject to any other applicable provisions in the Federal securities laws.

See, e.g.,

15 U.S.C. 77q(a); 15 U.S.C. 78(j)(b); 17 CFR 240.10b-5.

i. Non-Broadcast Live Oral Communications

We are proposing to exclude from the definition of “advertisement” live oral communications that are not broadcast on radio, television, the internet, or any other similar medium. If such communications are broadcast, for example by webcast, social media, video blog, or similar media, they would be “advertisements” under the proposed rule's definition.

This proposed exclusion is generally consistent with the approach under the current rule's definition of “advertisement,” which also excludes oral communications that are not “on radio or television.”

However, the proposed definition of “advertisement” is broader than the current rule's definition because it would capture oral communications that are widely disseminated, or “broadcast,” not just via radio or television (as under the current rule), but also via “the internet or any other similar medium.”

We believe this broader definition is appropriate in light of the continuously evolving means of mass communication available to advisers and should allow the proposed rule to remain evergreen in light of changing technologies. Accordingly, the proposed exclusion would not apply to communications that are “broadcast,” or widely disseminated. For example, an adviser that engages in a “Facebook Live” Q-and-A session that is available to the general public would be “broadcasting” the communication on the internet and that communication would not qualify for the proposed exclusion. Alternatively, a “Facebook Live” Q-and-A session that is available only to one person or a small group of people invited by the adviser would not be “broadcast” and so would qualify for the proposed exclusion.

See, e.g.,

rule 206(4)-(1)(b).

Rule 206(4)-1(b) (defining as an advertisement certain notices or other announcements “by radio or television”).

See

ICAA Letter (stating the staff's view that “[t]he rule also applies to announcements in publications and to radio and television broadcasts, but does not apply to any other oral communications”). For the reasons discussed in this release, the Commission is proposing a different approach. As discussed in Section II.D., staff in the Division of Investment Management is reviewing staff no-action and interpretative letters to determine whether any such letters should be withdrawn in connection with any adoption of this proposal. If the rule is adopted, some of the letters may be moot, superseded, or otherwise inconsistent with the rule and, therefore, would be withdrawn.

We have also proposed to limit the exclusion to “live” oral communications to ensure that previously recorded oral communications are included in the proposed definition of “advertisement.” The live oral communication exclusion is designed to address situations where advisers are communicating to investors directly and where employee review and the other provisions of the proposed rule cannot be practically applied.

In cases where an adviser pre-records a message and then disseminates it, such a message would not be “live” and thus should be treated as an advertisement if it otherwise meets the requirements of the proposed definition.

Similarly, any script or storyboards, or other written materials prepared in advance for use during a live oral communication, as well as any slides or other written materials presented alongside or distributed as part of the live oral communication, would fall within the proposed definition of “advertisement” if those materials otherwise meet the definition of “advertisement.”

We believe that prepared written materials intended for use during a live oral communication are eligible for pre-use review and approval and should be subject to the other requirements of the proposed rule.

See infra

section II.A.7 (discussing proposed employee review requirements). Communication need not be made “face-to-face” to qualify for the exclusion so long as it is live and oral. For example, a phone call or FaceTime communication between an adviser and a client could qualify for this exclusion.

However, a voicemail message would qualify for the proposed exclusion (and thus would not be an advertisement), if the voicemail message was made “live” and the recording is not further disseminated by or on behalf of the adviser.

This approach would mirror that under FINRA rule 2210(f), which distinguishes between certain public communications, including any “radio or television interview,” and the “scripts, slides, handouts or other written (including electronic) materials used in connection with” such communications.

See

FINRA Rule 2210(f)(1) and (f)(4);

See also

Standard of Conduct Release,

supra

footnote 23, at n.20.

We discuss below each of these practices, and the reasons we believe they should be prohibited.

110

We developed the proposed list of prohibited practices from our experience with the current rule, our review and consideration of investment adviser advertisements, FINRA rule 2210,

111

Securities Act rule 156, and our experience with private fund advertising practices. Rule 156 identifies certain pertinent factors that may be relevant to the question of whether a particular statement is, or might be, misleading in investment company sales literature.

112

110

We believe these practices, which are each discussed in detail below, are associated with a significant risk of being false or misleading. We therefore believe it is in the public interest to prohibit these practices, rather than permit them subject to specified conditions.

111

FINRA rule 2210 contains content standards that prohibit misleading claims or statements in certain communications.

112

Rule 156 describes statements, representations, illustrations, and other information found in fund sales literature that could be considered false or misleading in violation of the anti-fraud provisions in the securities laws applicable to sales of funds. 17 CFR 230.156. In the proposing and adopting releases for rule 156, the Commission explained that rule 156 is not a “legislative rule designed to prescribe law or policy.” The releases emphasize that the rule's general prohibition against the use of misleading sales literature “merely reiterated pertinent statutory provisions of the federal securities laws applicable to sales literature” and that the factors found in rule 156 are “particular factors which could be among those considered” when determining whether a statement is false or misleading. Mutual Fund Sales Literature Interpretive Rule, Release Nos. 33-6140 and 34-16299 (Nov. 6. 1979).

a. Untrue Statements and Omissions

The proposed rule prohibits advertisements that include any untrue statements of a material fact, or that omit a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading.

113

This provision of the proposed rule retains the substance of current rule 206(4)-1(a)(5), which prohibits an advertisement that contains any untrue statement of a material fact and uses similar wording as other anti-fraud provisions in the Federal securities laws.

114

As with similar anti-fraud provisions in the securities laws, whether a statement is false or misleading depends on the context in which the statement or omission is made. For example, as under the current rule, advertising that an adviser's performance was positive during the last fiscal year may be misleading if the adviser omitted that an index or benchmark consisting of a substantively comparable portfolio of securities experienced significantly higher returns during the same time period. To avoid making a misleading statement, the adviser in this example could include the relevant index or benchmark or otherwise disclose that the adviser's performance, although positive, significantly underperformed the market.

113

See

proposed rule 206(4)-1(a)(1).

114

See, e.g.,

17 CFR 240.10b-5; 15 U.S.C. 77q(a)(2); 17 CFR 230.156(a); rule 206(4)-8.

The current rule contains an explicit prohibition on advertisements that contain statements to the effect that a report, analysis, or other service will be furnished free of charge, unless the analysis or service is actually free and without condition.

115

We believe that this practice would be captured by the proposed rule's prohibition on untrue statements or omissions. As a result, the proposed rule would not contain a separate explicit prohibition of such statements.

115

See

current rule 206(4)-1(a)(4);

see also

Dow Theory Forecasts, Inc., SEC Staff No-Action Letter (May 21, 1986) (“Dow Theory Letter”) (staff declined to provide no-action recommendation where an offer for “free” subscription was subject to conditions).

We request comment on this proposed prohibition of untrue statements and omissions.

• As discussed above, such provisions appear in other areas of the securities laws, including rule 206(4)-8. Are there any particular aspects specific to its application to the proposed advertising rule that would need clarification?

• Do commenters agree that the proposed rule's prohibition of untrue statements or omissions captures the current rule's explicit prohibition of advertisements that contain statements to the effect that a report, analysis, or other service will be furnished free of charge, unless the analysis or service is actually free and without condition, or should such prohibition continue to be explicit? If not, why?

b. Unsubstantiated Material Claims and Statements

The proposed rule also prohibits advertisements that include any material claim or statement that is unsubstantiated.

116

This provision would prohibit as misleading, for example, statements about guaranteed returns and claims about the adviser's skills or experience that the adviser cannot substantiate. Rule 156 and FINRA rule 2210 both contain a similar provision.

117

In particular, rule 156 provides that a statement about the characteristics of an investment company could be misleading because of exaggerated or unsubstantiated claims about management skill or techniques, characteristics of the investment company or an investment in securities issued by such company, service, security of investment or fund, effects of government supervision, or other attributes.

118

We believe that prohibiting advisers from making any material claim that is unsubstantiated when promoting their services is appropriate and not overly broad or burdensome.

116

Proposed rule 206(4)-1(a)(2).

117

Rule 156(b)(3)(ii). FINRA rule 2210(d)(1)(A) (stating that no member may make any false, exaggerated, unwarranted, promissory, or misleading statement or claim in any communication).

118

Rule 156(b)(3)(ii).

Today an adviser's use of graphs, charts, or formulas is explicitly

prohibited in the current rule absent certain disclosures.

119

Under the proposed rule's prohibition against unsubstantiated material claims and statements, it may be false or misleading to imply or state in an advertisement that any graph, chart, or formula can by itself be used to determine which securities to buy or sell, depending on the disclosures provided and the extent to which an adviser in fact does provide investment advice solely based on such materials.

120

119

See

current rule 206(4)-1(a)(3) (requiring that the investment adviser also disclose in any such advertisements the limitations and difficulties with regard to such use).

120

Id.

We request comment on this application of the general prohibition.

• Should we take a similar approach to rule 156 and specify the particular attributes to which the standard would apply (

e.g.,

claims about an investment adviser's management skills or techniques, services, or other attributes)? If so, why? To which particular characteristics or attributes should the provision apply and how?

• Do commenters believe that statements about the characteristics of an investment adviser are useful in advertisements? How difficult is it to substantiate these types of statements?

• Is the prohibition on unsubstantiated claims necessary?

• We believe exaggerated claims or statements of material fact would be prohibited under the proposed rule.

121

However, should we explicitly prohibit exaggerated claims or statements, consistent with rule 156 and FINRA rule 2210?

121

See

proposed rule 206(4)-1(a)(1) and (3).

• Should we retain the current rule's explicit prohibition on advertisements that represent that any graph, chart, or formula can by itself be used to determine which securities to buy or sell, or when to buy or sell them? If so, should we modify it? Are there practices that are prohibited under the current provision that would not be covered by the proposed prohibition or other prohibitions in the proposed rule?

• Should we modify this application of the general prohibition in any way for advisers with algorithms or other methodologies that may be considered formulas?

c. Untrue or Misleading Implications or Inferences

We are also proposing to prohibit any advertisement that includes an untrue or misleading implication about, or is reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to an investment adviser.

122

For example, this provision would prohibit an adviser from making a series of statements in an advertisement that are literally true when read individually, but whose overall effect creates an untrue or misleading implication about the investment adviser.

123

Another example of an untrue or misleading inference would be an advertisement that includes a single investor testimonial stating that investor's account was profitable, which is factually true for that particular investor but nonetheless atypical among all the adviser's investors. If the communication did not disclose the extent to which most other investor accounts were not profitable, this testimonial would create an untrue or misleading impression about the adviser's performance history.

124

Additionally, an advertisement that states an adviser was rated “the top investment adviser” by a publication would create a misleading inference if the adviser omitted the fact that this was a group rating, and several other investment advisers rated by the publication achieved the same rating. As discussed in further detail in section II.A.3.e. below, we believe this provision (along with other provisions discussed below) would prohibit “cherry picking” of past investments or investment strategies of the adviser—that is, including favorable results while omitting unfavorable ones in a manner that is not fair and balanced.

122

Proposed rule 206(4)-1(a)(3). Staff has previously provided its views regarding when an advertisement would be otherwise false or misleading under section (a)(5) of the current rule.

See, e.g.,

Clover Capital Mgmt., Inc., SEC Staff No-Action Letter (Oct. 28, 1986) (stating the use of performance results in an advertisement in the staff's view would be false or misleading 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) (“Clover Letter”); Stalker Advisory Services, SEC Staff No-Action Letter (Jan. 18, 1994) (stating that copies of articles printed in independent publications that contain performance information of an adviser would be prohibited if they implied false or misleading information absent additional facts) (“Stalker Letter”); F. Eberstadt & Co., Inc., SEC Staff No-Action Letter (Jul. 2, 1978) (stating that advertisements could be misleading if they imply positive facts about the adviser when additional facts, if also provided, would cause the implication not to arise) (“Eberstadt Letter”).

123

See

Spear,

supra

footnote 61 (the Commission brought an enforcement action against an investment adviser, asserting, in part, that the adviser's advertisements, which recounted a number of factually accurate stories highlighting the outstanding investment success of certain selected clients collectively created “illusory hopes of immediate and substantial profit”).

124

See infra

section II.A.4.b.

We request comment on this provision.

• Do commenters agree with including this provision? Is this provision necessary, or do the other provisions of section 206(4)-1(a) of the proposed rule effectively prohibit conduct such as cherry picking?

• Should we consider limiting this provision? For example, should the prohibition be limited to untrue statements or misleading inferences concerning the adviser's competence or skills or the experience of investors?

• Do commenters agree that this proposed prohibition would help limit cherry picking in advertisements? If not, how should the proposed prohibition be modified to limit cherry picking in advertisements?

d. Failure To Disclose Material Risks or Other Limitations

The proposed rule prohibits advertisements that discuss or imply any potential benefits connected with or resulting from the investment adviser's services or methods of operation without clearly and prominently

125

discussing associated material risks or other limitations associated with the potential benefits.

126

Rule 156 and FINRA rule 2210 contain similar provisions.

127

We believe that in advertising their services, advisers might be incentivized to make, and investors might be misled by, statements that highlight financial upside and gain, without discussing the attendant risks or other limitations. Accordingly, we believe it is appropriate to prohibit the practice under the proposed rule.

125

The Commission has used a similar “prominent” standard in other rules and forms. For example, Form N-1A requires that open-end management companies disclose certain information on their websites in a “clear and prominent format.”

See

Form N-1A Item 12(a)(5).

126

See

proposed rule 206(4)-1(a)(4).

127

See

rule 156(b)(3)(i); FINRA rule 2210 (d)(1).

The proposed requirement to “clearly and prominently” disclose material risks would necessitate formatting and tailoring based on the form of the communication. For example, an advertisement intended to be viewed on a mobile device may meet the standard in a different way than one intended to be seen as a print advertisement. For instance, a person viewing a mobile device could be automatically redirected to the required disclosure before viewing the substance of an advertisement. However, it would not be consistent with the clear and prominent standard to merely include a hyperlink to disclosures available elsewhere.

128

For example, a post on

social media advertising the benefits of an adviser's investment methods, but which only included relevant disclosures about the material risks in a hyperlinked “additional information available here” or similar web link, would not meet this standard. Such hyperlinked disclosures may not be seen or read by investors, as they may not click through to the additional information necessary to make an informed decision.

128

However, it may be consistent with the clear and prominent standard if the adviser has reasonable assurance that the investor will access

or otherwise view the disclosures, such as by providing them before the relevant content and requiring the investor to acknowledge their review before accessing the substance of the advertisement.

We request comment on this aspect of the proposed prohibitions.

• Should the proposed rule contain additional specifications regarding the required disclosure (

e.g.,

requiring the disclosure to be of equal prominence in size and location to discussion of potential benefits)?

• The proposed rule would require that investment advisers disclose “associated material risks or other limitations associated with the potential benefits.” Is the proposed approach too narrow? For example, should the provision require advisers to disclose all material risks, and not just those associated with potential benefits?

• Should the rule identify specific risks that any advertisement must address to be considered not misleading? For example, should it require disclosure that provides balanced treatment of risks and potential benefits, consistent with the risks related to fluctuating prices and the uncertainty of dividends, rates of return and yield, as is required by FINRA rule 2210(d)(1)(D)?

• Should the rule provide additional details on how an advertisement could meet the clear and prominent standard?

• Should the rule permit hyperlinked disclosures in cases where the adviser can be assured that the investor has accessed the information? How should an adviser be able to do so?

• Should the rule permit hyperlinked disclosures subject to other conditions? If so, what types of conditions could ensure that the disclosure meets the clear and prominent standard? How do advisers believe they could meet the clear and prominent standard in mobile communications, social media posts, or other space-limited media? The FTC provides guidance on how to make effective disclosures through hyperlinks, which provide that if a hyperlink: (i) Is obvious; (ii) is labeled to appropriately convey the importance, nature, and relevance of the disclosures it leads to; (iii) is placed as close as possible to the relevant information it qualifies; and (iv) takes investors directly to the relevant disclosures on the click-through page, that such hyperlinked disclosures may be effective.

129

Should we consider imposing similar requirements on an adviser's use of hyperlinked disclosures?

129

See

Federal Trade Commission, “.com Disclosures: How to Make Effective Disclosures in Digital Advertising,” press release (March 2013),

available at https://www.ftc.gov/sites/default/files/attachments/press-releases/ftc-staff-revises-online-advertising-disclosure-guidelines/130312dotcomdisclosures.pdf.

e. Anti-Cherry Picking Provisions: References to Specific Investment Advice and Presentation of Performance Results

The proposed rule contains two other provisions designed to address concerns about investment advisers' potentially cherry-picking information that is presented to investors in advertisements.

i. References to Specific Investment Advice

The proposed rule would prohibit a reference to specific investment advice where such investment advice is not presented in a manner that is fair and balanced.

130

The factors relevant to when a presentation of specific investment advice is fair and balanced, as well as certain examples, are discussed below.

130

See

proposed rule 206(4)-1(a)(5). The wording “fair and balanced “is also used in FINRA rule 2210, which requires, among other things, that broker-dealer communications “must be fair and balanced and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service.” See FINRA rule 2210(d)(1)(A).

Consistent with the current rule, this prohibition is intended to address concerns of advisers presenting “cherry-picked” advice that they have provided on specific investments. When the Commission adopted the current rule's general prohibition of past specific recommendations, it expressed concern about the “inherently misleading” nature of advertisements that include references to past specific profitable recommendations, while omitting other recommendations that were not profitable.

131

The Commission believed that cherry picking profitable recommendations implied that the selected recommendations were representative of the experiences of all of the investment adviser's clients.

132

For this reason, the rule prohibited investment advisers from distributing advertisements that refer directly or indirectly to past specific recommendations which were, or would have been, profitable to anyone unless the advertisement sets out or offers to furnish information about all recommendations made by the adviser during the preceding period of not less than one year.

131

See

Advertising Rule Adopting Release,

supra

footnote 5.

132

See id.

Over the years since the advertising rule was adopted, however, our experience has led us to believe that some information about an adviser's past advice could be presented without misleading investors. For instance, we understand that some investment advisers may produce communications such as “thought pieces,” which are intended to illustrate the investment adviser's philosophy and process to investors and prospective investors and often contain references to specific investments, such as their largest holdings within a given strategy or recommendations during a certain time period, as well as general views about the market. These advisers may hesitate to share such thought pieces with investors in light of the current rule's prohibition on past specific recommendations. Out of the same concerns, an adviser may also hesitate to illustrate in an advertisement the investment adviser's specific investment advice in response to a major market event or crisis, such as a natural disaster in a region where the adviser made or suggested investments for its investors.

The proposed rule would replace the current prohibition with a principles-based restriction on the presentation of specific investment advice. In particular, the proposed rule would require advertisements that include specific investment advice to be presented by the investment adviser in a manner that is fair and balanced. The factors that are relevant to whether a reference to specific investment advice is presented in a fair and balanced manner for purposes of paragraph (a)(5) of the proposed rule will vary based on the facts and circumstances. The proposed rule would not include specific requirements regarding disclosure about specific recommendations. We believe the proposed approach would allow investment advisers to better tailor the information that they include in advertisements that contain references to specific investment advice in a manner that does not mislead investors. While we are not prescribing any particular presentation or specific disclosure, which we believe would be unduly limiting on advisers, we believe several factors, discussed below, may be relevant to whether an adviser should

be considered to have presented specific investment advice in a fair and balanced manner.

133

A reference to specific investment advice may also be prohibited under other provisions of the general prohibition of false or misleading advertisements.

133

For selecting and presenting performance information, these factors are in addition to the requirements and restrictions on presentation of performance, which are discussed in Section II.A.5.

See

proposed rule 206(4)-1(c).

We believe an advertisement that references favorable or profitable specific investment advice without providing sufficient information and context to evaluate the merits of that advice would not be fair and balanced. The current rule identifies particular information that must be disclosed when furnishing a list of all past specific recommendations made by the adviser within the immediately preceding period of not less than one year: (i) 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) a specific cautionary legend on the first page of the advertisement.

134

An adviser may find this list to be helpful guidance; however, the proposed rule would not require these disclosures, and the inclusion of such disclosures would not be the only way of satisfying paragraph (a)(5).

134

See

rule 206(4)-1(a)(2).

We believe that instead of including a requirement for a particular presentation, advisers, when determining how to present this information in a fair and balanced manner, should consider the facts and circumstances of the advertisement, including the nature and sophistication of the audience. For example, our staff has stated that it would not recommend enforcement action under the current rule with respect to charts in an advertisement containing an adviser's best and worst performers if: (i) The adviser's calculation takes into account consistently the weighting of every holding in the relevant account that contributed to the account's performance during the measurement period, and the charts reflect consistently the results of the calculation; (ii) the charts' presentation of information and number of holdings is consistent from measurement period to measurement period; and (iii) the charts include the holdings that contributed most positively and negatively to the relevant account's performance during the measurement period.

135

We are not prescribing these factors under the proposed rule. Although we believe that an advertisement that includes this information would likely meet the proposed fair and balanced standard, we do not believe this is the only way to present specific investment advice in a manner that would comply with this provision of the proposed rule.

135

See

the TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008) (“TCW Letter”).

Under the proposed rule, unlike under the current rule, the adviser may be able to describe the specific investment advice it provided to an investor in response to a previous major market event, provided the investment recommendations included in the advertisement were fair and balanced illustrations of the adviser's ability to respond to major market events and accompanying disclosures provided investors with appropriate contextual information to evaluate those recommendations (

e.g.,

the circumstances of the market event, such as its nature and timing, and any relevant investment constraints, such as liquidity constraints, during that time). However, we believe that an advertisement that contains this specific investment advice without disclosing contextual information would not be consistent with the proposed rule's fair and balanced standard.

We recognize that an investment adviser might provide a list of certain investments it recommended based upon certain selection criteria, such as the top holdings by value in a given strategy at a given point in time. The criteria investment advisers use to determine such lists in an advertisement, as well as how the criteria are applied, should produce fair and balanced results. We believe that consistent application of the same selection criteria across measurement periods limits an investment adviser's ability to reference specific investment advice in a manner that unfairly reflects only positive or favorable results.

Our staff has stated that under current rule 206(4)-1 it would not recommend enforcement action relating to an advertisement that includes performance-based past specific recommendations if: (i) The adviser uses objective, non-performance based criteria to select the specific securities that it lists and discusses in the advertisement; (ii) the adviser uses the same selection criteria for each quarter for each particular investment category; (iii) the advertisements do not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, of any of the specific securities; and (iv) the adviser maintains appropriate records, which would be available for inspection by Commission staff.

136

An adviser may find these criteria helpful guidance in complying with the proposed rule, but the proposal would not require them.

136

See

Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998) (“Franklin Letter”).

The current rule prohibits references to past specific recommendations in an advertisement that do not set out or offer to furnish a list of all recommendations made by such investment adviser in the last year.

137

We considered, but are not proposing, to maintain this requirement from the current rule. We believe that it may not be practical for many investment advisers to disclose all purchases, sales, or recommendations made during the preceding one-year period (

e.g.,

including in such a list potentially thousands of investments). For example, we understand that the current requirement of offering to provide all investments has a chilling effect on adviser communications with pooled investment vehicle investors because providing such information would reveal proprietary strategies. Therefore, we believe that requiring presentations of references to specific investment advice in an advertisement to be fair and balanced could provide more useful information to investors than the current requirement of a comprehensive list of investments.

138

However, if an adviser chooses to provide a list of all specific investment advice made in a period of no shorter than the preceding year, we believe that such a list would meet the proposed rule's “fair and balanced” standard.

137

See

current rule 206(4)-1(a)(2).

138

In some instances, however, an investment adviser should consider listing some, or all, of the specific investment advice of the same type, kind, grade, or classification as those specific investments presented in the advertisement in order for a presentation to be fair and balanced.

Finally, the proposed rule uses the phrase “reference to specific investment advice” rather than the current rule's reference to “past specific recommendations . . . which were or would have been profitable . . . .”

139

This change substantively broadens the scope of the provision and eliminates confusion that we understand may exist in interpreting the current rule.

140

The

proposed provision applies to any reference to specific investment advice given by the investment adviser, regardless of whether the investment advice remains current or occurred in the past. This provision applies regardless of whether the advice was acted upon, or reflected actual portfolio holdings, or was profitable. Finally, the modified provision includes investments in discretionary portfolios, even if an adviser is not making a non-discretionary “recommendation” to the investor. We believe that including current or past references to specific investment advice in the scope of the proposed rule is appropriate because it avoids questions about when a current recommendation becomes past. In addition, we believe that selective references to current investment recommendations could mislead investors in the same manner as selective references to past recommendations.

139

Compare

proposed rule 206(4)-1(a)(5)

with

current rule 206(4)-1(a)(2).

140

See, e.g.,

Comment letter of Investment Counsel Association of America (Aug. 2001). We understand that industry participants have raised

concerns regarding what qualifies as a

past

recommendation versus a

current

recommendation and whether there is a meaningful distinction. We also understand that industry participants have questioned the meaning of

recommendation

in the current rule and whether this phrasing includes portfolio holdings more generally. Finally, we do not believe it is necessary to limit the provision to “profitable” recommendations. We believe that there may be instances where an investment adviser seeks to reference investments for reasons other than to demonstrate its ability to generate profits (

e.g.,

ability to select low volatility investments).

ii. Presentation of Performance Results

The proposed rule would prohibit any investment adviser from including or excluding performance results, or presenting time periods for performance, in a manner that is not fair and balanced.

141

This prohibition responds to concerns similar to the Commission's concerns discussed above regarding “cherry-picking” of investments for inclusion in advertisements.

142

Similarly, the potential exists for an adviser to “cherry-pick” the time periods used to generate performance results in advertisements. In addition, an advertisement that includes only favorable performance results or excludes only unfavorable performance results would be “misleading” to the extent that such an advertisement implies something about or is likely to cause an inference to be drawn concerning the investment adviser that would not be implied or inferred were certain additional facts—

i.e.,

any performance results excluded from the advertisement—disclosed.

143

141

Proposed rule 206(4)-1(a)(6).

142

See

Advertising Rule Adopting Release,

supra

footnote 5 (stating that “material of this nature, which may refer only to recommendations which were or would have been profitable and ignore those which were or would have been unprofitable, is inherently misleading and deceptive”);

see also

Clover Letter (stating that, in the staff's view, an advertisement containing performance results would be false or misleading if it failed 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).

143

See

proposed rule 206(4)-1(a)(3).

As with specific investment advice, the factors that are relevant to whether a reference to performance information is presented in a fair and balanced manner for purposes of the rule's general prohibition will vary based on the facts and circumstances. For example, presenting performance results over a very short period of time, or over inconsistent periods of time, may result in performance portrayals that are not reflective of the adviser's general results and thus generally would not be fair and balanced.

144

Portrayals of performance results that do not include sufficient information for an investor to assess how the results were determined, or which do not provide sufficient context for the investor to evaluate the utility of the results, would not be consistent with the fair and balanced standard we are proposing here.

144

However, such information may be presented in response to specific requests from Non-Retail Persons under the proposed exclusion for responses to unsolicited requests.

See supra

section II.A.2.c.ii.

In section II.A.4 below we discuss further specific requirements and conditions for portrayals of certain types of performance to different audiences that we are also proposing here. In those cases, however, the fair and balanced standard for performance that we are proposing here would also apply.

We request comment on the proposed rule's provision regarding references to specific investment advice and presentation of performance:

• Do commenters agree with the proposed treatment of references to specific investment advice in advertisements? Is fair and balanced an appropriate standard? Can advisers apply this standard? Are there other standards we should use? Are there alternative or additional requirements that would reduce the risk of cherry picking or other misleading or deceitful practices while providing advisers the ability to appropriately include such information?

• Should the proposed rule include specific presentation requirements, such as requiring advertisements with references to specific investment advice to include an equal number of best- and worst-performing holdings, or use an objective, non-performance based criterion, such as the largest dollar amount of purchases or sales? Are there additional presentation requirements we should consider? Should the presentation requirements be the same for advertisements for which an adviser has adopted and implemented policies and procedures reasonably designed to ensure that the advertisements are disseminated solely to “qualified purchasers” and certain “knowledgeable employees” (defined as “Non-Retail Advertisements” in paragraph (e)(7) of the proposed rule) and all other advertisements (defined as “Retail Advertisements” in paragraph (e)(13) of the proposed rule)?

• Should advertisements including a reference to specific investment advice be required to disclose or offer to provide a complete list of specific investments? If so, should the list be limited to investments of the same type, kind, grade, or classification as those specific investments presented in the advertisements? If not, how else should this list be limited?

• Should we require investment advisers that include a reference to specific investment advice to disclose the criteria used to select the specific investment?

• While the proposed rule does not contain a list of prescriptive requirements, to provide additional guidance the proposal discusses several factors that advisers should consider when determining whether a presentation is fair and balanced. Should we include any or all of these factors in the rule text itself? Do any of these factors need further clarification? Are the factors we discussed relevant? Are there any additional or alternative factors we should discuss?

• Does using the term “reference to specific investment advice” instead of “past specific recommendations” clarify the scope of the provision? If not, is there another term that should be used?

• Should the rule have separate requirements for references to specific investment advice in Retail Advertisements and Non-Retail Advertisements?

• Should the rule have separate general provisions for advisers advertising to different types of investors (

e.g.,

separate provisions for advertisements to Retail Persons and Non-Retail Persons)? Why or why not? If so, what different requirements should apply to what types of investors? Should the requirements for Retail Advertisements include additional restrictions and/or prescribed disclosures? If so, what should they be? Would additional restrictions and prescribed disclosures be meaningful to

Retail Persons but not Non-Retail Persons? Would additional restrictions and prescribed disclosures be meaningful to only a subset of Non-Retail Persons? Why or why not?

• Should the proposed requirement for fair and balanced presentation for references to specific investment advice vary based on the type of communications?

• Should we specify in some way what “favorable” or “unfavorable” mean? Why or why not?

f. Otherwise Materially Misleading

Finally, we are proposing to prohibit any advertisement that is otherwise materially misleading.

145

Rule 206(4)-1 currently has a broad catch-all provision prohibiting advertisements that are “otherwise false or misleading.”

146

We are generally proposing to retain a catch-all provision like this aspect of the current rule. We believe this catch-all would ensure that certain materially misleading practices that are not specifically covered by the other prohibitions would be addressed. For example, if an adviser provided accurate disclosures, but presented them in an unreadable font, such an advertisement would be materially misleading and prohibited under this catch-all.

145

Proposed rule 206(4)-1(a)(7).

146

Rule 206(4)-1(a)(5).

However, because we are also prohibiting a variety of specific types of advertisement practices within the general prohibitions, most of which include an element of materiality, as discussed above, we are proposing to focus the catch-all provision on only those advertisements that are otherwise

materially

misleading. We believe that limiting the catch-all to materially misleading advertisements would be more appropriate within the overall structure of the proposed prohibitions while still achieving our goal of prohibiting misleading conduct that may affect an investor's decision-making process. We also believe that, in light of the proposed rule's prohibitions on making untrue statements and omissions of material fact, including “false” is unnecessary in the catch-all provision as it is already covered by the previous prohibition.

147

We request comment on this provision of the proposed rule.

147

Rule 156 under the Securities Act similarly prohibits investment company sales literature which is “materially misleading.”

• Should we include this catch-all provision? If not, why not? Would the other general prohibitions capture all types of conduct that would otherwise result in an advertisement being materially misleading? If not, should we instead seek to specifically identify all potentially misleading conduct that an adviser might seek to engage in within the rule rather than include such a catch-all?

• Should the provision prohibit all false and misleading advertisements as under the current rule, not just materially misleading ones, as proposed? Are there situations where an advertisement would be immaterially false or misleading?

• Does the proposed rule's prohibitions on making untrue statements and omissions of material fact make the term “false” unnecessary in the catch-all? Should the proposed provision also apply to materially false advertisements?

g. General Request for Comment and Alternate Approaches

We request comment on the proposed prohibitions discussed above.

• The proposed rule prohibits certain advertising practices as a means reasonably designed to prevent fraud within the meaning of section 206(4) of the Act. Is this approach effective? Would the list of practices in the proposed rule be helpful for investment advisers in evaluating whether their advertisements are or might be misleading?

• Are there other practices that we should include, such as any additional factors listed in rule 156? Or should we extend all of the anti-fraud guidance in rule 156 to investment adviser advertisements?

• Should any of the practices that we are proposing to prohibit instead be reframed as factors to consider similar to the approach in rule 156? Should we modify the rule to incorporate any of these factors to consider in lieu of the prohibitions under the proposed rule?

• Should we include any specific prohibitions related to the presentation of information in advertisements? For example, should we prohibit including disclosures in too small of a font? Should we specifically requir

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