Navigating the marketing rule: Lessons from recent SEC enforcement action

In the fast-moving regulatory landscape, taking a proactive approach to regulatory compliance is crucial to long-term success. For investment advisors registered with the Securities and Exchange Commission, the SEC’s recent enforcement action involving the Modernized Marketing Rule, 206(4)-1, serves as a timely reminder of the importance of compliance in the industry.

RIAs must understand the implications of this enforcement action and how they can navigate the complexities of the marketing rule going forward.

SEC's recent enforcement action

On Sept. 11, the SEC announced charges filed against nine RIAs for marketing rule violations.

One of many components to the rule prohibits the inclusion of hypothetical performance in advertisements unless certain policies and procedures are adopted and implemented. The purpose of this is to help ensure that such performance aligns with the financial situation and investment objectives of the intended audience as well as the satisfaction of various disclosure obligations and content standards.

“Hypothetical performance” is defined as “performance results that were not actually achieved by any portfolio of the investment adviser” and includes, but is not limited to:

• Performance derived from model portfolios.
• Performance that is back-tested by the application of a strategy to data from prior time periods when the strategy was not actually used during those time periods.
• Targeted or projected performance returns with respect to any portfolio or to the investment advisory services about securities offered in the advertisement.

The charged firms advertised hypothetical performance on their websites, which the SEC indicated targets a broad audience, without having the required policies and procedures in place. The rule release explicitly indicated that “hypothetical performance directed to mass audiences generally will not be able to meet this standard.”

Significance of the Modernized Marketing Rule

The Modernized Marketing Rule took effect in 2021. RIAs who don’t fully assess and update their policies and procedures and align their advertising and marketing efforts to the obligations of this new rule may face regulatory scrutiny down the road.

Navigating the regulatory landscape

The recent enforcement action underscores the SEC's commitment to enforcing the obligations outlined under the Modernized Marketing Rule. RIAs should consider and assess how well they have addressed the following areas.

• Compliance manual updates: Robust and specific written policies and procedures are imperative and the first step to confirming compliance with any regulatory obligation. An RIA’s manual should not use out-of-date terminology, incorrectly cover obligations under the prior rules, or otherwise fall short of requirements to establish how the advisor complies with all the various obligations under the new rule.
• Training: Invest in employee training so that everyone associated with the advisor understands the nuances of the Modernized Marketing Rule and is aware of their responsibilities. Whether through a social media post, email blast or other external communication, the potential for untrained personnel to run afoul of the rule’s obligations creates exposure for the RIA.
• Supervisory reviews: As outlined under the rule, RIAs are required to establish a supervisory framework reasonably designed to ensure compliance with the various obligations. Be sure to assess what this needs to look like in order to comply with the RIA’s supervisory obligations.
• Proper disclosures: There are numerous components of the marketing rule in which proper disclosures are explicitly required to satisfy the rule. These need to be tailored, so copying and pasting outdated disclosures will likely fail to satisfy these obligations.
• Documentation and books and records obligations: The books and records obligations in connection with the marketing rule are robust and routinely overlooked. Become familiar with what advisors are required to maintain in connection with marketing and advertising efforts, and confirm reasonable controls are in place to maintain such materials.

Going forward

The SEC's recent sweep serves as a stark reminder that investment advisors must remain vigilant in adhering to regulatory requirements, particularly those introduced under the Modernized Marketing Rule. RIAs who proactively address compliance issues, implement robust policies and procedures, and prioritize investor protection will be better positioned to navigate the regulatory landscape successfully as well as to build trust and credibility with their clients. In an industry where reputation is paramount, adherence to the rule is a path to long-term success.

RIAs should consider reaching out to qualified regulatory compliance professionals who can help them comply with the marketing rules and stay on top of other requirements in this ever-changing and complex regulatory environment.

Alex Egan is a director in the risk advisory services practice at the CPA and advisory firm Kaufman Rossin. Contact him at [email protected]

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