The Securities and Exchange Commission is updating guidance related to its Marketing Rule, which regulates investment advisers’ marketing communications and advertisements.
The SEC released responses to frequently asked questions about the rule, which was modernized in December 2020 with the adoption of amendments to rule 206(4)-1 under the Investment Advisers Act of 1940.
The staff of the Division of Investment Management prepared the responses and said it expects to update this document from time to time to include responses to additional questions. According to ThinkAdvisor, the staff answers FAQs on the net performance requirement of the rule as it relates to abstracted performance as well as determining whether certain portfolio or investment characteristics are performance.
The following is one example of a question and the response:
Q. The marketing rule does not define “performance” and, as a result, investment advisers may need to determine whether certain portfolio or investment characteristics (“characteristics”) are performance under the marketing rule. If such characteristics are performance, would the staff recommend enforcement action if an adviser displays characteristics calculated without reflecting the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio(s) (“gross characteristics”), without also showing the corresponding characteristics calculated after the deduction of all fees and expenses (“net characteristics”)?
A. The staff recognizes that advisers may be unsure whether certain characteristics (e.g., yield, coupon rate, contribution to return, volatility, sector or geographic returns, attribution analyses, the Sharpe ratio, the Sortino ratio, and other similar metrics are “performance” under the rule. In addition, even if such characteristics were to qualify as performance, calculating these characteristics net of fees and expenses may be impossible or lead to misleading or confusing results. However, in the staff’s view, when an adviser prominently displays the gross and net performance of the total portfolio calculated pursuant to the requirements of the marketing rule and presented in a manner that is not otherwise materially misleading, and provides appropriate accompanying information about the characteristic and how it is calculated, there is little risk that prospective clients and prospective investors will be misled about the impact of fees and expenses on their returns when viewing such a characteristic.
Accordingly, the staff would not recommend enforcement action to the Commission under rule 206(4)-1(d)(1) if an adviser chooses to present in an advertisement one or more gross characteristics of a portfolio or investment, even if it does not include the corresponding net characteristic(s), if:
- the gross characteristic is clearly identified as being calculated without the deduction of fees and expenses;[9]
- the characteristic is accompanied by a presentation of the total portfolio’s gross and net performance consistent with the requirements of the rule;
- the total portfolio’s gross and net performance is presented with at least equal prominence to, and in a manner designed to facilitate comparison with, the gross characteristic, and
- the gross and net performance of the total portfolio is calculated over a period that includes the entire period over which the characteristic is calculated.
Because time periods over which characteristics are calculated may not easily align with the time periods required by Rule 206(4)-1(d)(2), the staff would not recommend enforcement action to the Commission under Rule 206(4)-1(d)(2) if the characteristic presented as described above is calculated over a single, clearly disclosed period.
The staff notes that any advertisement that presents characteristics in accordance with this FAQ remains subject to the general prohibitions of Rule 206(4)-1(a) (as well as section 206(1) and 206(2) of the Advisers Act).
The list of frequently asked questions is “welcome guidance would remove impediments to advisers sharing important information with investors and reduce the risk of investor confusion,” said Gail Bernstein, Investment Advisor Association general counsel and head of policy. “The updated guidance would permit advisers to advertise the performance of individual investments as well as portfolio and investment characteristics on a gross basis if the net and gross performance of the entire portfolio is also included prominently in the advertisement.”
It was noted that the responses to the questions represent the views of the staff of the Division of Investment Management and are not a rule, regulation, or statement of the SEC. The FAQs have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person.
The attorneys at Lewitas Hyman were formerly senior attorneys in the SEC’s Division of Enforcement. We have represented clients in regulatory matters while working at Morgan Stanley and in private practice at some of the world’s largest law firms. Therefore, we understand the complexities that come with being the subject of a regulatory inquiry, and we have the experience to guide and advise you through any type of regulatory investigation. If you are the subject of a regulatory proceeding, contact Lewitas Hyman at (888) 655-6002 or through our online contact form for a free consultation.
