Category: Articles & Publications

Compliance With Rules on Advertising and Cash Solicitation

Seeking to Modernize – Has the SEC Made Compliance With Rules on Advertising and Cash Solicitation More Complicated?

The SEC has proposed important amendments to the Investment Advisers Act of 1940 (the “Advisers Act”). Under the proposals, the SEC seeks to amend the following aspects of the Advisers Act: (i) Rule 2016(4)-1 (the “Proposed Advertising Rule”); (ii) Rule 206(4)-3 (the “Proposed Cash-Solicitation Rule”); (iii) Rule 204-2 (the “Proposed Books and Records Rule”); and, (iv) Form ADV.

The Proposed Advertising Rule

Definition of Advertisement
In the Proposed Advertising Rule, the SEC seeks to use a flexible and adaptable definition of Advertisement, that would keep pace with advances in technology as well as industry practices. An Advertisement would be defined as “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser.”

The SEC proposes to exclude certain communications from this definition including: (i) live oral communications that are not broadcast; (ii) responses to certain unsolicited requests for specified information; (iii) advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other SEC rules; and, (iv) information required to be contained in a statutory or regulatory notice, filing, or other communication.

Prohibited Advertising Practices

Under the Proposed Advertising Rule, the following advertisement practices would be prohibited:
1. Untrue Statements – making an untrue statement of a material fact or omission of a material fact necessary that makes the statement misleading under the circumstances in which it was made. For example, the SEC would characterize an advertisement as misleading if the advertisement stated that an adviser’s performance was positive last year, if the advertisement omitted an index of a substantially comparable portfolio of securities that enjoyed significantly higher returns during the same time period1;
2. Unsubstantiated Claims – making an unsubstantiated claim or statement such as statements about guaranteed returns or claims concerning the adviser’s skill or experience that are not supported by facts2;
3. Untrue or misleading implications or inferences – making an untrue or misleading implication about or being reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the investment adviser. The SEC would consider as misleading an advertisement that includes a single investor’s statements that this investor’s account was profitable, which while factual true is atypical and not representative of all the adviser’s investors;3
4. Failure to disclose material risks or other limitations – discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations;
5. Cherry picking investment advice – referring to specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
6. Cherry picking performance – including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and,
7. Otherwise Materially Misleading – a broad catch-all prohibition.

Testimonials, Endorsements and Third-Party Ratings

Unlike the current rule, the Proposed Advertising Rule would permit the use of testimonials. Moreover, non-client endorsements as well as third-party ratings (neither of which are addressed by the current rule) would be permitted. Testimonial is defined as “any statement of a client’s or investor’s experience with the investment adviser or its advisory affiliates.”4 An endorsement is “any statement by a person other than a client or investor indicating approval, support, or recommendation of the investment adviser or its advisory affiliates.”5 Third-Party Rating is a “rating or ranking of an investment adviser provided by a person who is not a related person…and such person provides such ratings or rankings in the ordinary course of its business.”6

Testimonials, endorsements and third-party ratings must include certain disclosures including compensation and related conflicts of interests. As such, testimonials and endorsements must include a disclosure as to who provided the recommendations and whether such person was either monetarily or otherwise compensated. Third-party ratings must include a prominent disclosure of the: (i) date the rating was made; (ii) time period the rating is based upon; and, (iii) identity of the party providing the rating.

It is important to note that not all testimonials, endorsements and third-party ratings are covered by the proposed rule. Rather, they would be subject to the Proposed Rule only to the extent that they fall within the Proposed Rule’s definition of “advertisement” (e.g. they appear in advertisements, they are offered “by or on behalf of” an adviser).

Performance Information

In addition to the general prohibitions (i.e. untrue statements) the Proposed Rule would prohibit including in any advertisement:
1. Gross performance results unless it provides (or offers to provide promptly) a schedule of fees and expenses deducted to calculate net performance;
2. Any statement that the calculation or presentation of performance results has been approved or reviewed by the Commission;
3. Performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered or promoted in the advertisement, with limited exceptions;
4. Performance results of a subset of investments extracted from a portfolio, unless it provides or offers to provide promptly the performance results of all investments in the portfolio; and
5. Hypothetical performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient and the adviser provides certain specified information underlying the hypothetical performance.7

The Proposed Rule also establishes specific conditions depending upon whether the advertisement is: (i) a “non-retail advertisement” disseminated solely to either (a) a “qualified purchaser”8, or a “knowledgeable employee”9; or (ii) a “retail advertisement” which is any advertisement that is not a “non-retail advertisement.”

The Proposed Rule would require that an adviser that utilizes any “non-retail advertisement” adopt and implement policies and procedures that ensure that the advertisement is only disseminated to “qualified purchasers” or “knowledgeable employees.” Also “retail advertisement” must include: (i) a presentation of net performance alongside any presentation of gross performance; and, (ii) a presentation of the performance results of any portfolio or certain composite aggregations across 1-, 5-, and 10-year periods, or for the life of the portfolio, if shorter.10

Compliance issues

Along with the modernizing the advertising rules, the Proposed Rules also impose some new compliance requirements. Most notable, before dissemination, all advertisement must be reviewed and pre-approved in writing by a designated employee of the adviser. The SEC has made it clear that it expects said employee to be competent and knowledgeable.11 The pre-approval requirement has two exceptions: (i) advertisements that are communications disseminated only to a single person or household or to a single investor in a pooled investment vehicle; and, (ii) live oral communications broadcast on radio, television, the internet, or any other similar medium (generally, where it is impractical to preview the communication before it is made).12

The Proposed Solicitor Rule

While not as sweeping as the changes to the rules on advertising, the Proposed Rules make some modifications to Rule 206(4)-3 of the Advisers Act (the “Proposed Solicitor rule”). Currently, Rule 206(4)-3 mandates that an adviser’s cash payment for referrals of clients be governed by a: (i) written agreement between the adviser and the solicitor, except where the solicitation is for impersonal advisory services or the solicitor is an affiliate (i.e. director, officer or employee); and, (ii) written agreement that contains terms which require that the solicitor provide the prospective client with a copy of the investment adviser’s Form ADV disclosure document and a written solicitor disclosure document (which details the solicitor’s compensation).

The Proposed Solicitor Rule expands the definition of compensation to include non-cash such as directed brokerage, awards or prizes; training or education meetings, outings, tours, entertainment, free or discounted advisory services.13 It also expands it reach to include private fund solicitors, rather than just clients intending to establish separately managed accounts with the adviser.

Written Solicitor’s Agreement
The current rules concerning written agreements are generally left intact by the Proposed Solicitor Rule in that a written agreement would not be required for: (i) referrals to impersonal investments; or, (ii) solicitors that are affiliates of the adviser, provided that the relationship is either disclosed or readily apparent to the potential investor.

Disclosure Requirements
The Proposed Solicitor Rule would require that potential investors are provided with a “solicitor disclosure” that would state (A) the name of the investment adviser; (B) the name of the solicitor; (C) a description of the investment adviser’s relationship with the solicitor; (D) the terms of any compensation arrangement, including a description of the compensation provided or to be provided to the solicitor; and (E) any potential material conflicts of interest on the part of the solicitor resulting from the investment adviser’s relationship with the solicitor and/or the compensation arrangement.14 The Proposed Solicitor Rule would, however, eliminates the requirement for advisers to receive a signed and dated written acknowledgment of receipt of the solicitor disclosure from each investor.15

Solicitor Oversight
The Proposed Solicitor Rule would continue the adviser’s oversight obligations and require that the adviser must have a reasonable basis for believing that the solicitor has complied with the written agreement.16 While what actually constitutes a reasonable basis seems vague, the SEC has stated that it believes “that a reasonable basis generally should involve periodically making inquiries of a sample of investors referred by the solicitor in order to ascertain whether the solicitor has made improper representations or has otherwise violated the agreement with the investment adviser.”17

Other Provisions
The Proposed Solicitor Rule adds two exceptions for: (i) de minimis ($100 or less annually) compensation; and, (ii) advisers that participate in certain nonprofit programs. It also includes a change in an adviser’s obligation to not an ineligible solicitor.18 Notably, the Proposed Solicitor Rule no longer contains an absolute bar against an adviser’s use of an ineligible solicitor, but rather applies a reasonable care standard. Thus, an adviser could not use a solicitor that the adviser either knows or in the exercise of reasonable care, should have known is an ineligible solicitor.19

Proposed Books and Records Rule and Revisions to Form ADV

The Proposed Rules also propose amendments to Rule 204-2 the “Books and Records Rule.” These amendments relate the additional books and records contained in the Proposed Advertising Rule and the Proposed Solicitor Rule. The proposed amendments to Form ADV would add a new subsection L (“Advertising Activities”). This would require that advisers provide information about its advertisement content including: (i) performance information; (ii) references to specific investments; (iii) testimonials; (iv) endorsements, and (v) third-party ratings.

Conclusions and Impacts

The Proposed Rules seek to modernize the current Advertising Rule and Solicitor Rule, which have not been significantly revised since they were adopted in 1961 and 1979, respectively. While it remains to be seen what the final form of the Proposed Rules will look like (the Rules are subject to a 60-day review and comment period) it seems clear that the landscape of advertising and cash solicitation is about to change dramatically and this change could have some significant implications. Some of the implications could include:
• The broad definition of “Advertisement” could capture communications that are not currently considered advertisements. For example, while the Proposed Advertising Rule does not consider certain unsolicited requests for information as “Advertisement,” communications relating to responses to “requests for proposal,” “due diligence questionnaires” or other request might be considered solicited and therefor be subject to the Proposed Advertising Rule requirements;
• The different treatment of “non-retail advertisement” versus “retail advertisement” may create logistical issues for advisers who have both retail and non-retail clients. Also, since the Proposed Advertising Rule would apply to communications disseminated to prospective investors the adviser may not have a basis for determining whether an investor meets the non-retail person definition (i.e. a qualified investor) until the time of subscription;
• The Proposed Rules adds new compliance and record keeping requirements (i.e. a designated person to review all advertisements); and,
• The expansion of the solicitation rule to cover solicitation of investors and prospective investors in private funds would subject most private fund solicitors to regulation under both the Advisers Act and the Securities Exchange Act of 1934 (and FINRA rules), as nearly all compensated fund solicitors are broker-dealers. Even though the SEC acknowledges that the application of the Proposed Solicitor to private fund solicitors would result in overlapping regulation of the solicitors, the SEC provided little explanation for the necessity of such duplicative regulation.20

If you have questions about the information provided in this alert, please email us at, call Alaric at 888-243-2448, or visit our website, at

1 Investment Adviser Advertisements; Compensation for Solicitations, Investment Advisers Act Release No. IA-5407 (Nov. 4, 2019) (the “Proposing Release”), pp. 54-55.
2 Id. at p. 56.
3 Id. at p. 58.
4 Proposed Rule 206(4)-1(e)(15).
5 Proposed Rule 206(4)-1(e)(2).
6 Proposed Rule 206(4)-1(e)(16).
7 Proposed rule 206(4)-1(c)(2)(i)(A).
8 As defined in Section 2(a)(51) of the Investment Company Act of 1940.
9 As defined in Rule 3c-5 of the Investment Company Act of 1940.
10 Proposed rule 206(4)-1(c)(2)(i)(A).
11 Proposing Release, p. 192.
12 Proposed rule 206(4)-1(d)(1).
13 Proposing Release, pp. 206-207.
14 Proposed rule 206(4)-3(a)(1)(iii).
15 Rule 206(4)-3(a)(2)(iii)(B).
16 Proposed Rule 206(4)-3(a)(2).
17 Proposing Release, p. 234.
18 A “person who at the time of solicitation is subject to a disqualifying Commission action would be an ineligible solicitor. A disqualifying Commission action would be a Commission opinion or order barring, suspending, or prohibiting a person from acting in any capacity under the Federal securities laws…” Proposing Release, p. 268.
19 Proposing Release, p. 262.
20 Proposing Release, p. 202.

Back to Articles & Publications


Request a Proposal