SEC Charges Five Registered Investment Advisers for Marketing Rule Violations
The US Securities and Exchange Commission (“SEC”) recently settled charges against five registered investment advisers for violations of Rule 206(4)-1 (“Marketing Rule”) under the Investment Advisers Act of 1940, as amended (“Advisers Act”), resulting in $200,000 in combined civil money penalties.1 Following in the footsteps of the September 2023 charges against nine registered investment advisers for similar Marketing Rule violations,2 the SEC found that the five firms advertised hypothetical performance to the general public on their websites, without adopting and implementing policies and procedures reasonably designed to ensure that the hypothetical performance was relevant to the likely financial situation and investment objectives of the intended audience, in violation of the Marketing Rule.
The SEC pointed out in its press release that four of the five firms received reduced penalties (ranging from $20,000 - $30,000) because of the corrective steps they undertook before the SEC staff contacted them. The type of hypothetical performance at issue with respect to each of these four firms consisted of model portfolio performance.
Regarding the fifth firm, however, the SEC imposed a civil penalty of $100,000.3 The type of hypothetical performance at issue with respect to this firm included both model portfolio performance and back-tested performance. But the SEC found that this firm violated other regulatory requirements as well, including making false and misleading statements in advertisements. For example, the firm falsely claimed that, unlike clients of other investment advisers who invest in mutual funds and pay the fund’s management fees as well as advisory fees to their investment advisers, the adviser does not “charge clients twice.” The firm also posted factsheets on its public website that: (i) compared model portfolio performance to a benchmark index, but the benchmark returns were price returns, not total returns with dividends reinvested, which is how the firm had calculated the model performance; (ii) included performance that was consistently inaccurate, with both overstatements and understatements of performance; and (iii) presented gross performance without also presenting net performance. The SEC noted that these factsheets were created by third-party vendors, but the adviser had advertised them.
In addition, the firm was unable to produce, upon the SEC’s demand, records substantiating the performance shown in the factsheets and was not able to substantiate a claim it made on its website that its models “outperform[ed] the market over most time frames, even as we assume less risk over those same periods.” Further, the firm paid more than $1,000 to each of two unaffiliated accounting firms for endorsements to obtain clients through referrals, but did not have a written agreement with either accounting firm.
The SEC also found that the adviser made misleading statements to a registered fund client (“Fund”) about the performance of a tracking account that it advised, which the Fund ended up including in its prospectus. Specifically, the firm represented to the Fund that the performance data for the account showed net performance, when, in fact, advisory fees were not charged to the account. In addition, similar to the factsheets, the firm provided the Fund with performance data that compared the account data to a benchmark index that showed price returns only, rather than showing total returns inclusive of reinvested dividends, which was how the account data had been calculated.
The SEC brought this recent set of cases, as well as a first set of cases in September 2023,4 as part of an ongoing targeted Marketing Rule sweep. Together the two sets of cases, as well as the August 2023 Marketing Rule case (as discussed in our Legal Update), reflect the SEC’s ongoing regulatory interest in Marketing Rule compliance generally, but also reflect the decades of intense regulatory interest in performance advertising by investment advisers, particularly hypothetical performance. These cases also demonstrate the SEC’s continued and growing use of risk-based data analytics and publicly -available information in its examination and enforcement efforts.
Accordingly, investment advisers should scrutinize their policies, procedures and internal controls regarding the use of performance that the SEC and its staff could consider to be hypothetical under the Marketing Rule, particularly on public forums, such as websites and social media platforms and channels. Similarly, investment advisers should consider training (and re-training) marketing and other relevant personnel on the Marketing Rule’s requirements, using these cases to demonstrate the importance of having robust internal controls. Advisers would be best served to do this before an examination starts to give them the best chance to avoid an enforcement proceeding, or potentially reduce any penalties ultimately assessed.
1 SEC Press Release: SEC Charges Five Investment Advisers for Marketing Rule Violations, April 12, 2024; Advisers Act Release No. 6585 (April 12, 2024); Advisers Act Release No. 6586 (April 12, 2024); Advisers Act Release No. 6587 (April 12, 2024); Advisers Act Release No. 6588 (April 12, 2024); and Advisers Act Release No. 6589 (April 12, 2024). This first set of cases also involved the advisory firms advertising on their public websites hypothetical performance in the form of model and/or back-tested performance, resulting in civil penalties ranging from $50,000 to $175,000, for a combined total of $850,000.
2 SEC Press Release: SEC Sweep into Marketing Rule Violations Results in Charges Against Nine Investment Advisers, September 11, 2023 and related Advisers Act releases.
