Marketing Rule Under the Microscope: New SEC Exam Findings

The SEC's Division of Examinations' staff (Staff) issued a Risk Alert on December 16, highlighting additional observations on investment advisers’ compliance with the amended Marketing Rule (Rule 206(4)-1) under the Investment Advisers Act of 1940 (Advisers Act). The Risk Alert focuses on the use of testimonials, endorsements and third-party ratings in advertisements. 

Key Takeaways

• The Marketing Rule continues to be a top examination priority for the Staff.
• Still a stumbling block: testimonials/endorsements and third-party ratings.
• Cited deficiencies often involve insufficient disclosures and inadequate oversight and compliance practices.
• In particular, the Staff have cited advisers for relying on hyperlinks or diminutive formatting, and instead, recommend that the adviser embed required disclosures within the relevant content — a presentation format that may, in certain situations, result in longer and less reader-friendly text.

Scope

The Risk Alert addresses Staff observations regarding advisers’ compliance with the Marketing Rule’s testimonials and endorsements provisions in Rule 206(4)-1(b) and the third-party ratings provisions in Rule 206(4)-1(c). The Staff’s findings and recommendations are based on a review of advertisements disseminated to current or prospective clients and investors, including websites, social media, referral networks, lead-generation arrangements and third-party platforms. 

Key Observations: Testimonials and Endorsements

First, the Staff observed widespread issues with required “clear and prominent” disclosures. Common failures included not identifying whether a promoter is a current client or a private fund investor, not disclosing cash or non-cash compensation and not disclosing material conflicts. In addition, the Staff raised concerns with placing required disclosures in hyperlinks, smaller or lighter font, or apart from the testimonial/endorsement itself. Incorporation of client reviews from third-party websites without clear and prominent disclosures was also cited. 

Second, advisers often failed to disclose the material terms of compensation to promoters, including the nature and amount of compensation, as well as the structure (e.g., percentage of fees over a specified period). Generic disclosures that omitted material details — particularly for social media influencers and referral arrangements — were flagged. 

Third, advisers failed to disclose material conflicts arising from relationships with promoters or compensation arrangements, including situations where promoters had financial interests in the adviser or where advisory personnel at related firms had significant arrangements with the promoted adviser. 

Fourth, the Staff observed lapses in required oversight and compliance practices. Advisers failed to demonstrate a reasonable basis to believe testimonials and endorsements complied with the rule, lacked or did not implement adequate policies and procedures, and failed to maintain documentation required by the books and records rule to substantiate their reasonable basis for belief. Written agreements with paid promoters above the de minimis threshold were missing or incomplete, and some advisers misapplied the de minimis exemption by failing to aggregate compensation over the preceding 12 months. 

Fifth, some advisers compensated “ineligible persons” (e.g., promoters with disqualifying events) in violation of the restriction in Rule 206(4)-1(b)(3). The Staff also noted failures to satisfy the conditions for the partial exemption applicable to certain affiliated individuals, including insufficient affiliation disclosures and inadequate documentation. 

Finally, the Staff continues to see advisers utilizing lead-generation firms, social media influencers, referral networks and “refer-a-friend” programs for de minimis compensation without recognizing that these arrangements typically constitute endorsements subject to the Marketing Rule’s requirements. 

Key Observations: Third-Party Ratings

The Staff emphasized that advisers may not use third-party ratings in advertisements unless they have a reasonable basis to believe that the ratings survey or questionnaire is structured to elicit balanced feedback (equally easy to give favorable or unfavorable responses) and is not designed to produce predetermined results, and unless clear and prominent disclosures are provided. 

The Staff cited that advisers lacked sufficient information or policies to support the “reasonable basis to believe” element of the Marketing Rule, particularly where ratings were displayed across websites, social media, pitchbooks and email communications without underlying substantiation. The Staff highlighted examples of due diligence that, in its view, would facilitate compliance with respect to the rule’s due diligence requirements, including, for example, reviewing publicly available methodology, obtaining copies of the questionnaires or surveys, and/or securing representations from the rating provider regarding design, structure and administration. 

On disclosures, the Staff observed ratings without required clear and prominent disclosures, including missing identification of the rating date and period, non-identification of the rating provider, and failures to disclose direct or indirect compensation related to obtaining or using the rating (e.g., paid logo use, reprints, priority placement). Additionally, hyperlinked or minimized disclosures (e.g., small font, placement at the bottom of the page) were deemed noncompliant. 

Practical Takeaways

The Risk Alert underscores that advisers should review and update their written policies and procedures to address testimonials, endorsements and third-party ratings, and ensure effective implementation. In addition, documentation should substantiate reasonable basis determinations, required disclosures, promoter agreements, compensation aggregation for de minimis analysis and eligibility checks.