How Does the SEC’s RIA Marketing Rules Affect RIA Compliance?

In today's digital age, marketing—especially digital marketing—is crucial to any business strategy. As marketing evolves, so do the regulations designed to prevent fraud and ensure fair practices. So, what does this mean for RIAs regarding their marketing efforts and staying compliant?

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Definitions

The updated rules from the SEC about what counts as an "advertisement" have two main parts:

1. Advertising Communications: This includes any promotional messages, whether they are direct ads or indirect ads, with other types of messages meant to attract clients or investors.
2. Solicitations: This part deals with how advisors encourage people to become clients or investors, including any testimonials or endorsements they might use.

The updated rules cover traditional ads and how advisors contact people to get them to sign up or invest. These updates provide clearer guidelines for RIAs to ensure they stay compliant with their marketing practices.

Below is a list of definitions in the rules and regulations of the Investment Advisors Act of 1940 that were updated in this most recent edition. 

Advertisement 

An advertisement is any message from an adviser sent to more than one person or one person if it includes hypothetical results.

What counts as an advertisement:

• When an adviser promotes their services to potential or current clients or offers new services to existing clients.

What does not count as an advertisement:

• Casual, in-person conversations that happen in real time.
• Official documents or filings are required by law and designed to meet those legal requirements.
• If a client or potential client asks for information on hypothetical performance and receives it in response, this isn’t considered an advertisement.
• Endorsements or testimonials for which the adviser has paid, as long as these are included in official notices or filings that meet legal requirements.

To simplify, advertisements are when an advisor promotes their services on different platforms. They are not considered advertisements if they are live conversations or require legal documents, hypothetical questions, or paid endorsements. 

Testimonial 

A testimonial is when a current client or investor states their experience with an adviser. This can include:

1. Sharing their personal experience with the adviser or their team.
2. Encouraging others to become clients or investors with the adviser.
3. Referring others to the adviser’s services.

It's a way to share their positive experiences and recommend the adviser to others.

Endorsement 

An endorsement is when someone who isn’t a current client or investor of an RIA makes a claim. This can mean:

1. Showing the endorser's approval or support or sharing their experience with them.
2. Trying to convince others to become clients or investors with the adviser.
3. Referring others to the adviser’s services.

In short, someone outside the adviser’s current circle is giving a positive recommendation or a referral is considered an endorsement.

Third-party rating

A third-party rating means a rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms). This independent party regularly provides these ratings or rankings as part of their business.

A disqualifying event

A disqualifying event is a severe issue that can affect someone's ability to give endorsements or testimonials. Here’s what counts as a disqualifying event if it happened within the last ten years:

1. If someone was convicted of a serious crime, like a felony or certain misdemeanors, within the U.S.
2. If they were convicted of specific types of misconduct as listed in certain legal sections.
3. If a regulatory body or court issued a final order against them for specific types of misconduct.
4. If there’s an ongoing court order against them for certain violations.
5. If they were ordered to stop committing violations related to fraud under U.S. securities laws.

However, not all legal issues count as disqualifying events. For instance, if a person is under certain types of orders but is following the rules set by those orders, and discloses this in their endorsements or testimonials, it might not be a disqualifying event.

If someone has had serious legal problems or violations, it might prevent them from giving endorsements or testimonials.

Ineligible person

An ineligible person is someone who has had serious legal issues or sanctions. This includes:

1. Anyone who works for, manages, or is an officer or director of the ineligible person.
2. If the ineligible person is a business partner, all the general partners are also considered ineligible.
3. If the ineligible person is a Limited Liability Company (LLC) with elected managers, all managers are also considered ineligible.

The ineligible person is not the only one affected; those closely connected to them are also considered ineligible.

General prohibitions

Advisors must adhere to strict guidelines when creating advertisements to ensure their messages are clear, honest, and accurate. 

These rules prevent misleading information, ensure a balanced representation of benefits and risks, and require truthful presentation of performance data. Understanding and following these general prohibitions is crucial for advisors to maintain trust with their clients. 

Let’s explore what these prohibitions entail to ensure that advertisements are compliant and transparent.

Don’t:

1. Be False or Misleading: It can’t include false information or leave out essential details that would make the information misleading.
2. Make Unsubstantiated Claims: It can’t state something as a fact unless the adviser can back it up with proof if asked.
3. Imply Incorrect Information: It shouldn’t give a false or misleading impression about any vital fact related to the adviser.
4. Ignore Risks: If the document discusses the benefits of the adviser’s services, it must also mention any risks or limitations.
5. Misrepresent Specific Advice: If it mentions specific advice given by the adviser, it should present that advice reasonably and rationally.
6. Mislead with Performance Data: It can’t present performance results or time periods in a misleading way.
7. Be Generally Misleading: It mustn’t be misleading in any other way.

Testimonials and endorsements

In the complex world of RIAs, ensuring that advertisements are clear, honest, and compliant with regulations is crucial for maintaining trust and credibility.

Here’s a quick, detailed breakdown of what advisors need to know about required disclosures, oversight, disqualification, exemptions, third-party ratings, and performance to ensure their testimonials and endorsements meet regulatory expectations for advertising.

If you would like to read more about how these affect advisors' social media compliance, read our previous article on the updates to SEC rule 206(4)-1.

Required disclosures

When using testimonials or endorsements in advertisements, the adviser must:

• Identify:
  • If the testimonial is from a current client or another person.
  • If any payment or compensation was given for the testimonial.
  • Any conflicts of interest related to the testimonial or endorsement.
• Describe Compensation:
  • Provide details about any payments made for the testimonial or endorsement.
• State Conflicts of Interest:
  • Disclose any potential conflicts of interest that might affect the testimonial or endorsement.

Adviser oversight and compliance

The adviser must:

• Ensure Compliance:
  • Have a reasonable belief that the testimonial or endorsement follows the rules.
• Have Written Agreements:
  • Maintain a written agreement detailing the scope of activities and compensation for the testimonial or endorsement.

Disqualification

An adviser cannot pay someone for a testimonial or endorsement if it is an Ineligible Person. The person is disqualified or ineligible based on their past actions or legal issues known to the adviser. (See disqualifying events above.)

Exemptions

Certain situations don’t require strict compliance:

• Minimal Compensation:
  • Some rules exclude a testimonial or endorsement given with no or minimal compensation.
• Affiliated Persons:
  • Testimonial or endorsement from the adviser’s partners, employees, or affiliated entities, as long as the relationship is disclosed.
• Registered Brokers:
  • Testimonials or endorsements from registered brokers or dealers may be exempt from specific disclosure requirements.
• Specific Securities Offerings:
  • Testimonials or endorsements related to specific securities offerings might be exempt from disqualification rules.

An Example Of Misrepresentation in Advertising

An investment advisor, Jane, decides to attract new clients through her website. She posts a series of claims about her services, highlighting past performance results of various investment strategies she has used. Specifically, she posts a chart showcasing significant returns from these strategies over the past five years. 

However, Jane fails to include any disclaimers or context, such as the fact that these results are hypothetical and not guaranteed.

Jane's website advertisement, meant to attract new clients, includes the following message: "Our investment strategies have achieved average returns of 20% annually over the past five years. Our clients consistently see impressive gains when they invest with us!"

In this case, Jane’s advertisement could be seen as a misrepresentation because it provides an unrealistic and misleading view of potential returns without the required legal disclaimers.

If you want to read more examples of potential misrepresentations that advisors can make under the Sec Marketing rule, check out ‘Marketing Compliance Under Advertising Rule 206(4)-1 And Avoiding (Accidental) Testimonials’ by Les Abromovitz.

What does this mean going forward for Financial Advisors?

In the digital age, where marketing is integral to business success, advisors must navigate increasingly stringent regulations to ensure their promotional practices remain compliant. 

Advertisements must avoid misleading content, provide balanced information on benefits and risks, and disclose any compensation or conflicts of interest. Additionally, advisors must be vigilant about who they engage for testimonials and endorsements, ensuring that all endorsements are from eligible, compliant individuals and that third-party ratings are transparently obtained. 

By adhering to these updated rules, advisors can uphold the integrity of their marketing efforts and build lasting trust with clients while staying within legal boundaries.