Funds Talk: October 2017 – SEC Issues Risk Alert Regarding Advertising Rule Compliance Based on Recent OCIE Examinations

On Sept. 14, 2017, the Securities and Exchange Commission (the “SEC”) issued a risk alert outlining certain compliance issues identified by the regulator’s Office of Compliance Inspections and Examinations (“OCIE”) related to Rule 206(4)-1 (the “Advertising Rule”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).

The compliance issues addressed in the alert were most frequently identified by OCIE in deficiency letters sent to registered investment advisers as part of OCIE’s so-called “Touting Initiative,” which focused on registered investment advisers’ use of accolades in their marketing materials.

The Advertising Rule prohibits an investment adviser from, directly or indirectly, publishing, circulating or distributing any advertisement that, among other things, contains any untrue statement of material fact, or that is otherwise false or misleading. For purposes of the Advertising Rule, the term “advertisement” can apply to a wide host of statements, including “any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.”1

Common Compliance Issues

In connection with its recent examinations, the OCIE staff identified several compliance deficiencies under the Advertising Rule with respect to (i) misleading performance results, (ii) misleading one-on-one presentations, (iii) misleading claims of compliance with voluntary performance standards, (iv) cherry-picked profitable stock selections, (v) misleading selections of recommendations, and (vi) compliance policies and procedures.

Misleading performance results

Among the deficiencies identified by the OCIE staff with respect to the advertisement of performance results were (i) the presentation of financial results that were gross of advisory fees, (ii) the comparison of performance results to a benchmark without appropriate disclosures regarding the limitations inherent in such comparison, and (iii) the use of hypothetical and back-tested performance results without an explanation of how the returns were derived and without other potentially material information regarding such results.

Misleading one-on-one presentations

The OCIE staff noted deficiencies in one-on-one presentations where investment advisers advertised performance results gross of fees without providing potentially relevant disclosures, including disclosure that actual returns would be net of such fees.

Misleading claim of compliance with voluntary performance standards

The OCIE staff identified deficiencies where advertisements contained claims of compliance with voluntary performance standards in instances where the stated performance results may not have actually adhered to the relevant performance standard.

Cherry-picked profitable stock selections

The OCIE staff identified advertisements that included only profitable stock selections or recommendations that did not meet the requirements set forth in Advisers Act Rule 206(4)-1(a)(2), which prohibits the publication of any advertisement that refers to “past specific recommendations” of an investment adviser “which were or would have been profitable to any person,” unless the advertisement includes a list of all recommendations made by the investment adviser within a prior period of not less than one year.

Misleading selection of recommendations

The OCIE staff observed deficiencies with respect to advertisements containing a misleading selection of investment recommendations, such as those that (i) include only certain, but not all, recommendations, in order to illustrate a particular investment strategy, and did not satisfy the conditions set forth in the Advisers Act Rule 206 (4)-1(a)(2) and/or (ii) did not satisfy the representations upon which the staff of the SEC’s Division of Investment Management granted no-action relief to the TCW Group and/or Franklin Management Inc.2 In general, these no-action letters allowed investment advisers to provide a limited selection of their prior recommendations so long as these recommendations were chosen using consistently applied, objective, non-performance-based criteria.

Compliance policies and procedures

The OCIE staff reported that some investment advisers had not implemented compliance policies and procedures reasonably designed to prevent deficient advertising practices, as required under Advisers Act Rule 206(4)-7(a). In particular, the OCIE staff identified deficiencies in policies and procedures regarding the process for reviewing and approving advertising materials prior to their publication or dissemination, determining the parameters for which accounts are included from performance calculations in composites, and procedures for confirming the accuracy of performance results in compliance with the Advertising Rule.

Touting Initiative

The risk alert also summarized the OCIE staff’s findings from its 2016 Touting Initiative, through which the staff examined the adequacy of disclosures that investment advisers provided in their marketing materials to clients when touting awards, promoting ranking lists and/or identifying professional designations. The OCIE staff identified deficiencies in the use of such accolades with respect to (i) misleading use of third-party rankings or awards, (ii) misleading use of professional designations, and (iii) testimonials.

Misleading use of third-party rankings or awards

The OCIE staff reported that some investment advisers published potentially misleading advertisements touting awards or rankings conferred by third parties without disclosing all material facts, including, for example, (i) that the relevant accolades had been awarded based on applications containing false or misleading information, (ii) that the referenced ranking or evaluation information was stale, or (iii) the relevant selection criteria for the awards or rankings, who created and conducted the relevant survey, and whether investment advisers paid a fee to participate in or distribute the results of said survey.

Misleading use of professional designations

The OCIE staff observed the use of professional designations in advertisements and in investment advisers’ Form ADV Part 2B Brochure Supplements that were potentially false or misleading, such as references to professional designations that had lapsed or that did not explain the minimum qualifications required to attain such designations.


The OCIE staff reported that some investment advisers published client statements in their advertisements that may constitute prohibited testimonials under of the Advertising Rule.

As a result of this risk alert, investment advisers should review their advertising policies and procedures and current marketing materials to ensure compliance with the Advertising Rule.

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