SEC Issues Risk Alert Announcing Exams Focused On New Marketing Rule – Financial Services – United States – mondaq.com

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On Monday, September 19, 2022, the SEC’s Division of
Examinations issued a Risk Alert announcing their
intent to conduct targeted reviews of registered investment
advisers regarding compliance with amended Advisers Act Rule
206(4)-1 (the “Marketing Rule”), following the mandatory
compliance date on November 4, 2022.1 Reviews will be conducted both as
part of specific national initiatives (sometimes referred to as “sweep” exams, which often focus on one or several
related topics) as well as through the normal course of its routine
compliance examinations of registered investment advisers.

While such a focus has been long and widely anticipated across
the industry, the SEC’s announcement came as somewhat of a
surprise in that it is unusual for the Division of Examinations to
so prominently highlight a special examination focus area in
advance, outside of the annual announcement of the Division’s
examination priorities.2 The effect is therefore to provide
greater emphasis on what seems likely to be a deep and prolonged
focus by the SEC on investment adviser marketing practices. And in
adopting such a strong examination focus on these issues while
significant interpretive questions remain unanswered,3 the
likelihood increases that the SEC examination staff – or its
individual members – will begin to interpret and apply the
amended Rule during the examination process in unanticipated
ways.

Given the extensive and nuanced changes under the amendments,
all investment advisers should begin surveying their marketing
materials and practices, and their policies and procedures, in
order to determine what changes will be necessary or advisable. In
many respects, these changes will likely be substantial, as we
discussed in our recent installment of “The Bottom Line”
series
.

There is still time for investment advisers to effectively
identify and prioritize the necessary changes to ensure compliance
with these new requirements. Please contact one of our Private
Funds Group partners for more information about the amended
Marketing Rule.

Following is a brief summary of the examination focus areas
highlighted by the Risk Alert:

  • Marketing Rule Policies and Procedures.
    Whether the adviser has adopted adequate policies and procedures,
    as well as compliance controls with objective and testable methods
    such as “internal pre-review and approval of advertisements,
    reviewing a sample of advertisements based on risk, or
    pre-approving templates.”
  • Backup for Factual Statements. Whether the
    adviser can provide substantiation for material factual statements,
    as now required under the amended Marketing Rule.
  • Performance Advertisements. Whether investment
    performance information (i.e., track record) within an
    advertisement meets the requirements under the amended Marketing
    Rule:

    • Net Returns: Net performance must accompany any gross
      performance information;
    • Standard Performance Periods: Non-private fund
      performance information must include one, five, and ten-year
      periods;
    • Statement of SEC Approval: Advisers may not make any
      statement indicating SEC review or approval of performance
      information;
    • Related Performance: Where an advertisement includes
      the performance of any portfolio other than the one being
      advertised, the performance results for all other portfolios with
      substantially similar investment policies, objectives, and
      strategies must also be shown (with narrow exceptions);
    • Extracted Performance: Where the performance of a
      subset of investments extracted from a portfolio is shown, then the
      advertisement must provide, or offer to provide promptly, the
      performance results of the total portfolio;
    • Hypothetical performance: Where showing hypothetical
      performance (i.e., investment performance not achieved by
      any portfolio), the adviser must adopt certain related policies and
      procedures and be accompanied by appropriate disclosures; and
    • Predecessor Performance: Where showing investment
      performance generated at a prior investment advisory firm, the
      relevant investment personnel must have been primarily responsible
      for having generated that performance at the prior firm (per the
      SEC’s historical guidance on this topic, as codified by the
      amendments).
  • Books and Records. Whether the adviser is
    complying with the new books and records requirements adopted under
    the related amendments to Rule 204-2.
  • Form ADV. Whether the adviser is complying
    with the new advertising-related disclosure requirements in Item
    5.L adopted under related amendments to Form ADV (which requires
    the adviser to check off one or more boxes indicating whether it
    employs any of the enumerated advertising practices).4

Footnotes

1. Please
see Proskauer’s February 2021 Alert for additional
information on these amendments.

2. The
Division’s 2022 Examination Priorities
contained very little emphasis on this topic at all, aside from one
reference to “marketing practices” within the entire
32-page document. Please see Proskauer’s April 2022 Alert for additional background
on this annual announcement.

3.
Despite previously acknowledging that
these amendments were likely to result in “practice
changes” for advisers, replacing a regime “on which
advisers have relied for decades”, and despite encouraging
advisers to “actively engage with Commission staff as
questions arise in planning for implementation”, the SEC and
its staff have yet to publish any formal guidance clarifying any
aspect of the amended Rule’s application in specific scenarios
beyond those contained in the 2020 Adopting
Release
.

4.
Investment advisers are only obligated to amend Item 5.L as part of
their annual amendment. Accordingly, advisers generally would not
be obligated to amend their Form ADV to include this information
until the next annual amendment following November 4, 2022
(i.e., by March 31, 2023, for an adviser with a December
31 fiscal year-end).


SEC Issues Risk Alert Announcing Exams Focused on New Marketing
Rule

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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