On Nov. 4, 2019, the Securities and Exchange Commission announced its intent to draft amendments to modernize the advertising and cash solicitation rules, Rule 206(4)-1 and Rule 206(4)-3, respectively. The goal of these changes was to replace existing rules to better reflect the current digital landscape and the evolution of the investment advice industry.
And about one year later, they delivered – sort of. The first changes made to these rules in more than 40 years were released by the SEC on Dec. 22, 2020. The rule now combines the current advertising and cash solicitation rules into one single rule, Rule 206(4)-1 or the “marketing rule.”
The new marketing rule applies to all investment advisors registered, or required to be registered, with the SEC. This is an important fact to note, and we’ll come back to it further in this article.
The rule release itself is more than 430 pages long, but here are some of the key changes outlined in the new marketing rule. These changes actually begin on page 405.
A change to the definition of “advertisement” to now encompass two prongs. The first prong covers communications traditionally covered by the advertising rule. The second prong pertains to testimonials and endorsements.
The addition of testimonials and endorsements into the definition of an advertisement now creates one merged rule that covers both.
Changes to the definition of an “advertisement” to cover additional communications to prospective private fund investors, and the inclusion of certain activities of a third party to the advisor to be defined as “indirect” advertising.
The establishment of general prohibitions that all advertisements must abide by.
Modifications to the disclosure requirements for advertisements.
The establishment of standards for including performance information in advertisements.
Amendments to the books and records rule.
In addition, advisors are required to amend Item 5, subsection 5.L of their Form ADV to provide additional information regarding their marketing practices. Naturally, there will be requirements for advisor oversight and compliance provisions under the final rule.
The Best Part!
One of the most anticipated aspects of the Rule for many advisors is the ability for investment advisors to use testimonials and endorsements in advertising. Long permitted for insurance agents and broker/dealer representatives (with appropriate controls, of course), testimonials have been prohibited by the SEC for investment advisor firms and representatives, and the new rule gives them the ability to be more creative in their marketing. These changes have been largely positively received, especially the ability for advisors to market themselves through social media. Advisors are excited to “level the playing field” and let others help them tell their story.
But Wait …
But not so fast. These changes are a long time coming and will have a notable impact on many advisors’ practices. But don’t jump the gun. As with most things relating to the SEC, there is a process that must play out before these new changes begin. And in this situation, the SEC will face a few additional hurdles due to the new administration.
In normal circumstances, a rule becomes effective 60 days after it has been published in the Federal Register, and the SEC also typically announces the compliance date as well. In this case, the SEC is providing an 18-month transition period between the effective date of the rule and the compliance date.
But to date, the rule has not been published in the Federal Register. And on Jan. 20, President Joe Biden’s chief of staff issued a memo (Regulatory Freeze Memo) that freezes any new or pending federal rules from going into effect until such rule has been reviewed and approved by personnel appointed by the administration.
In addition, the regulatory freeze memo recommends that agencies postpone the effective date of any rules that have been issued but have not yet taken effect, such as the marketing rule, for 60 days from Jan. 20, and to consider opening an additional 30-day comment period. As such, it is unclear at this time whether the review process initiated by the regulatory freeze memo will delay the effective date and compliance date for the marketing rule.
What About State-Registered Investment Advisors?
Now let me introduce another hurdle for many – the state-registered firm. Because this rule applies only to SEC-registered advisors and firms, those registered with state securities’ divisions will not be able to enjoy the benefits of this new rule until (and unless) one of the following occurs:
The state has currently adopted the SEC rule.
The state(s) where they are registered adopt similar rules, or
They qualify to register with the SEC.
Absent one of these conditions, smaller firms – many independent investment advisor representatives, in particular - will continue to be covered by the old rules instead.
Smaller firms who do qualify for SEC registration may face additional challenges as well. Although the new rule opens the door to new opportunities for advisors, it also adds to the costs of compliance. For example, the definition of advertising now includes more content. And while a large RIA may have the resources to manage enhancements to their compliance programs, smaller advisory firms will need to be careful to ensure they have proper controls and processes in place.
The industry has taken an apparent step in the right direction. However, the rule is still subject to publication, new controls and regulatory scrutiny. Be sure to have your compliance process in place or employ the services of a trusted compliance provider to stay up to date on future changes, revisions and effective dates.
Maureen C. James is cofounder of Summit Compliance Group, Inver Grove Heights, Minn. Maureen may be contacted at [email protected].