In December 2020, the U.S. Securities and Exchange Commission (SEC) approved an amendment to Rule 206(4)-1 and rescission of Rule 206(4)-3 of the Investment Advisers Act of 1940 (the Advisers Act).  The amendment creates a single rule that combines elements of the two rules, formerly known as the Advertising Rule and Cash Solicitation Rule (Rules 206(4)-1 and 206(4)-3, respectively).  Pursuant to the amendment, the Cash Solicitation Rule is eliminated, and the Advertising Rule is significantly altered.  New Rule 206(4)-1, known as the “Marketing Rule,” will become fully effective and applicable to all SEC Registered Investment Advisors (RIAs) in November 2022.

Prior to November 2022, SEC RIAs may continue to operate in compliance with the old Advertising and Marketing Rules, but are also authorized to early adopt in its entirety the Marketing Rule (for example, to take advantage of changes to the solicitation rules).  However, an RIA that elects to early adopt may not cherry pick portions of the new Rule while also holding onto elements of the old Advertising and Solicitation Rules.

The effects of the Marketing Rule are not limited to SEC registered firms.  About half of the U.S. states have implemented statutes and rules that reference the Advertising and Marketing Rules.  We’ll dig into this further below where we describe how some state registered investment advisors are affected by the new Marketing Rule.

Effects of the Marketing Rule

When we look at how the new Marketing Rule will affect your firm, we consider the following:

Whereas the old Advertising Rule contains specific and well-known prohibitions, the Marketing Rule’s prohibitions are principles-based that focus less on specific acts and more on ethical comportment.

For example, the Advertising Rule prohibits an RIA from distributing an advertisement that includes any untrue statement of material fact.  The Marketing Rule also prohibits distributing an advertisement that contains any untrue statement of material fact but follows up with a prohibition of making a material statement of fact that the Advisor does not have a reasonable basis for believing it can substantiate.

The seven principles-based prohibitions state an advertisement may not:

1. Include any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in light of the circumstances under which it was made, not misleading;
2. Include a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission;
3. Include information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser;
4. Discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits;
5. Include a reference to specific investment advice provided by the investment adviser where investment advice is not presented in a manner that is fair and balanced;
6. Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced; or
7. Otherwise be materially misleading.

Another example of the difference between the Advertising Rule and the Marketing Rule includes advertising past specific recommendations.  The Advertising Rule has specific requirements with regard to advertising past specific recommendations, and there is an abundance of SEC guidance available to help firms navigate that portion of the Rule.  Past specific recommendations are not specifically addressed in the Marketing Rule and are instead subject to the seven principles based prohibitions.

In contrast, performance advertising, which the Advertising Rule addressed in detail, is specifically mentioned in the sixth general prohibition and also subsection (d) of the Marketing Rule.

Comparing the SEC Advertising Rule Vs. Marketing Rule

One of the most important differences between the Advertising Rule and the Marketing Rule is the definition of “advertisement.”  The Advertising Rule defines an advertisement to include any notice, circular, letter or other written communication addressed to more than one person (or any notice or other written announcement in any publication or by radio or television), which offers, among other things, any investment advisory service with regard to securities.

The Marketing Rule defines an advertisement to include any direct or indirect communication to more than one person, or to one or more persons if the communication contains hypothetical performance, that offers investment advisory services with regard to securities to prospective clients or private fund investors, or offers new investment advisory services to current clients or private fund investors.

Additionally, the Marketing Rule specifically lists advertisements as communications sent through emails, text messages, instant messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, and all manner of social media, as well as by paper, including newspapers, magazines, and the mail.  An advertisement also includes any testimonial or endorsement for which the RIA provides direct or indirect compensation.

The Use of Testimonials and Endorsements

One of the most important changes to Rule 206(4)-1 is that RIAs can now advertise testimonials or endorsements, including testimonials and endorsements made in exchange for compensation (whether direct or indirect).  The SEC borrowed from the old Cash Solicitation Rule by requiring RIAs accepting or advertising testimonials or endorsements to comply with certain conditions, including disclosures, oversight, and compliance.  In addition, the new Rule prohibits an RIA from compensating a promoter if the firm knows or should know that the person giving the testimonial or endorsement is an “ineligible person,” as that term is defined in Rule 206(4)-1(e).  Third-party ratings may also be used in advertisements, subject to the principles based prohibitions and prominent disclosures in the advertisement itself.

For established RIAs and new RIAs alike, we advise holding off on adopting the Marketing Rule until a better body of guidance is released by the SEC.  The decision to early adopt depends on a number of factors, including but not limited to, the extent to which the firm advertises, as well as whether the firm pays for client solicitation or wishes to use testimonials and endorsements.

The Marketing Rule’s Effect on State Registered Investment Advisors

Unbeknownst to most state-registered investment advisors, implementation of the Marketing Rule or rescission of the Cash Solicitation Rule may have a substantial impact on their advertising or solicitation activities and books and records requirements.  All 50 states, as well as the District of Columbia, Puerto Rico, the Virgin Islands, and other U.S. territories, regulate investment advisors under their own set of state statutes and regulations.  Most states have modeled their statutes and regulations after the Uniform Securities Act and NASAA Model Rules.  About half the states have implemented statutes and rules that do not reference the Advisers Act or SEC Rules.  However, the other states do have statutes and rules that directly reference either Rule 206(4)-1 or Rule 206(4)-3, or both.

State registered investment advisers whose home state requires them to adhere to Rule 206(4)-1 or Rule 206(4)-3 now find themselves in a quandary — which rules are they required to follow, the old Advertising Rule and Cash Solicitation Rule or the new Marketing Rule?  Are testimonials and endorsements now fully authorized?  Will the states amend the statutes and rules prior to or after November 2022?  How are books and records affected?

State registered investment advisors located in the following states may be affected by the changes to Rule 206(4)-1 or the rescission of Rule 206(4)-3:

We have begun advising our state registered investment advisor clients located in any of the above states that their advertising programs may be affected by the changes to Rule 206(4)-1 and rescission of Rule 206(4)-3, and that state securities commissioners may soon implement policies or new regulations to address uncertainty.  In some of these states, RIAs can elect to abide by the old Advertising Rule until November 2022 or adopt the new Marketing Rule.

If you would like to learn more about how changes to SEC Rule 206(4)-1 and Rule 206(4)-3 may affect your RIA, or if you need help with your registration or ongoing investment advisor compliance needs, please contact us at Info@AdvisorGuidance.com.