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What investment advisers should know about the SEC’s proposed advertisement solicitation rule updates

Julie Hellmich Tyler Ash December 10, 2019

In early November, the Securities and Exchange Commission (the “SEC”) proposed amendments to its advertising and cash solicitation rules (Rules 206(4)-1 and 206(4)-3) under the Investment Advisers Act of 1940 (as amended, the “Advisers Act”) to address changes in the technological landscape since the rules were first adopted and the resulting changes in client expectations.

Advertising rule

The SEC stated that, in its current form, the advertising rule has overly broad restrictions and unnecessarily prevents advisers from providing useful information to investors. The proposed rule would replace the specified limitation approach with what the SEC calls a “principles-based” approach. Below are the key changes proposed by the SEC.

  1. The proposed rule redefines “advertisement” as any communication on behalf of an investment adviser that promotes its advisory services or that seeks to obtain or retain one or more investment advisory clients. This replaces a prescriptive categorization of publications using investment recommendations, graphical representations or any other investment advisory service as advertisements. However, live oral communications (not broadcast) and responses to certain unsolicited requests are excluded from the definition of advertisement. The SEC stated that the old categories could be simultaneously over- and under-inclusive, and it anticipates that the revised definition will give some needed flexibility to the rule.

  2. The proposed rule would allow for the use of testimonials, endorsements and third-party ratings in advertising—scrapping the outright ban that exists on these today. The SEC notes that consumers in various marketplaces often utilize statements by a client concerning the client’s experience with the adviser (testimonials), statements by non-clients approving of an adviser (endorsements) and third-party ratings to make informed purchasing decisions in other contexts. The SEC proposal would replace the outright ban with broader, more general prohibitions on false or misleading advertisements. The SEC stated that this alternative approach will allow investors to access more information while still maintaining appropriate advertising safeguards.

  3. The proposed rule permits the use of performance advertising. The specific requirements that the investment adviser must meet when using performance advertising depend on the target audience—performance data presented to retail investors must show certain time periods and must be displayed in certain ways.

Compensation for referrals & solicitations rule

Recognizing that payment for referrals and other solicitations can be made in forms other than cash, the SEC also proposed to amend the cash solicitation rule. The proposed rule encompasses a broader scope of activity, including (1) both cash and non-cash payments, (2) solicitations aimed at existing clients, not solely those aimed at prospective clients, and (3) private fund solicitors, not solely persons making solicitations on behalf of public funds. The SEC stated that, post-Dodd-Frank, private fund advisers are now more likely to be subject to provisions of the Advisers Act, and therefore the solicitation rule should be updated to include such advisers.

The proposed rule also updates solicitors’ disclosure requirements. A solicitor would be required to disclose in writing not only its name and the name of the investment adviser, a description of their relationship and the terms of any compensation arrangement (including a description of the compensation, the amount and whether and for how long any “trailing fees” are paid), but also a separate written disclosure of any potential material conflicts of interest on the part of the solicitor resulting from the relationship between the solicitor and adviser. Either the solicitor or adviser could deliver this disclosure, rather than only the solicitor as under the current rule. Advisers would still be required to have a reasonable basis for believing that the solicitor has complied with the disclosure requirement.

This article will be updated to reflect the final rule(s), if and when finalized by the SEC. If you have any questions regarding these rule changes or would like to discuss further, please feel free to contact us.

Julie Hellmich and Tyler Ash are attorneys in Thompson Coburn’s Corporate Finance & Securities group.