Highlights of Investment Adviser Advertising and Marketing FIRMA National Training Conference April 9, 2008 Orlando, FL • Chris Hardy • Partner • Ascendant Compliance Management, Inc.
Investment Adviser Advertising • Definition • Rules and Guidelines • SEC interpretations • Recordkeeping • SEC Examinations
Definition of an Advertisement • “Any written communication addressed to more than one person” that offers investment advisory services related to securities • Broadest definition includes any communication designed to attract new clients or maintain existing clients • Includes electronic and broadcast advertisements
What Is Not an Advertisement? • Oral communications • Customized RFP responses, letters or e-mails (not sent to more than one person) • Personal account information sent to a client • Still possible to violate Section 206 antifraud provision
Investment Adviser Advertising • Specific Guidance • Section 206 (general antifraud provision of Advisers Act) • Rule 206(4)-1 (SEC advertising rule) • No-Action Letters • SEC inspections and enforcement actions • Rules focus solely on disclosure, not calculation of performance
SEC Advertisements • General Antifraud Rule • Applicable to both registered and unregistered investment advisers • Perennially one of the top SEC exam deficiencies “[It is] unlawful to engage in any act, practice or course of conduct which is fraudulent, deceptive or manipulative.”
SEC Advertisements • Specific prohibitions applicable to registered investment advisers: • Testimonials • Third Party Reports • Partial Client Lists • Past specific recommendations • Charts/Formulas • Claim of free service unless it really is
SEC Advertisements • General Prohibitions: • Anti-Fraud Provision Depends On • Form • Content • Inferences that may be drawn by reader • Client sophistication
SEC Performance Advertising • Guiding Principals: • Investment performance is false or misleading if: • it implies, or a reader would infer, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts • Comply with investment performance presentation guidelines • Clover Capital series of No-Action Letters
Clover Capital No-Action Letter • Actual and Model Results • Disclose the effect of market conditions • Disclose relevant facts in comparison to index • Must be net of fees • Must disclose reinvestment of income/dividends • Disclose the possibility of a loss • Disclose material conditions, objectives, or strategies used
Clover Capital No-Action Letter • Model Performance Results • Disclose prominently the limitations inherent in model results • Disclose, if applicable, material changes in the conditions, objectives, or investment strategies of the model portfolio during the period portrayed and the effect of those changes • Disclose, if applicable, that the securities or strategies reflected in the model do not relate, or relate only partially, to services currently offered • Disclose, if applicable, that the adviser's clients had investment results were materially different from those portrayed in the model
Clover Capital No-Action Letter • Actual Results • Disclose prominently, if applicable, that the results portrayed relate only to a select group of the adviser's clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.
Clover Capital Exceptions • Exceptions to Net of Fees • Gross of fees performance • Sophistication of prospect • Must always be shown after transaction costs • Private, one-on-one meeting • Ability to ask questions and negotiate advisory fees
Clover Capital Exceptions • “One-on-One” Presentations must disclose: • Performance does not reflect deduction of advisory fees • The client’s return will be reduced by advisory and other expenses the client may incur in the management of its investment advisory account • Advisory fees are disclosed in Form ADV Part II • A representative example (table, chart, graph or narrative) showing the effect advisory fees, compounded over years, could have on the value of a portfolio
Clover Capital Exceptions • Net vs. Gross of Fees Presentation • Model advisory fees • Side-by-side gross and net • Multi-manager accounts • Model fees • Permissible to use highest fee charged to client in strategy
“Backtested” Performance • Use of theoretical performance developed by applying a particular investment strategy (typically, a quantitative or formula-based strategy) to historical financial data • Viewed as highly suspect as the adviser can run the backtested model again and again until it gets the results it wants. • Does not involve market risk
“Backtested” Performance • In addition to Clover requirements, disclose, at an absolute minimum: • That the adviser only began offering the given service after the performance period depicted by the advertisement • That the results do not represent the results of actual trading but were achieved by means of the retroactive application of a model designed with the benefit of hindsight • All material economic and market factors that might have had an impact on the adviser’s decision-making when using the model to manage actual client accounts;
Portability of Performance • Permitted if following conditions are met: • The person who manages accounts at the successor adviser was also primarily responsible for achieving prior performance • The accounts managed at predecessor are so similar to the accounts currently under management that the performance results would provide relevant information to prospective clients of the successor adviser • All accounts that were managed in a substantially similar manner are advertised unless exclusion of any account would not result in materially higher performance • Advertisement includes all relevant disclosures, including that performance results were from accounts managed at another entity.
Investment Advisor Advertisements • Article Reprints • Permitted, if comply with Advertising Rules • Can’t be false or misleading • Edit problematic statements • Use legends and footnotes to • Correct inaccuracies • Update information • Fill in gaps (e.g., provide net performance if article discusses only gross)
Past Specific Recommendations • SEC concerns re “cherry picking” • Exclusion from Advertising Rule prohibition if advertisement: • Offers to furnish list of all recommendations made by adviser within previous 12 month period • States • name of each security recommended • date and nature of each recommendation • market price of the security at time of recommendation • price at which the recommendation was to be acted on • the market price of each security as of the most recent practicable date • Discloses that “It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities in this list”
Holdings Lists – “Top Ten” • Permissible, but adviser must: • use objective, non-performance based criteria in selecting securities • use same selection criteria for each quarter for each investment category • Ensure report does not discuss extent to which the investments were, or were not, profitable
Investment Advisor Advertisements • Recordkeeping • Client communications and distribution lists • Copies of all written communication • Advertisements and Recommendations • All advertisements sent to more than 10 recipients • Document basis of all recommendations • Document basis of all claims • Retention Periods
Investment Advisor Advertisements • Performance Recordkeeping • Records to support performance calculations • Necessary to form the basis for or demonstrate the calculation of the performance • Internal account statements and worksheets • Prepared contemporaneously • Third party records to substantiate claims • Necessary to support performance: • In articles • From prior firm
SEC Advertising and GIPS • How to avoid false claims of compliance: • Educate marketing staff on appropriate presentation usage • Understand the limitations of verification • Take GIPS compliance seriously • Comply with all guidance statements • Review all applicable Q&A on CFA Institute website
SEC Exams • Recurring Problems: • Cherry picking • Comparing performance to inappropriate index • Representing model or back tested strategy as actual performance • Portability of performance • Submission of misleading information to publications or consultants • Inaccurate assets under management • False GIPS compliance claims
Chris Hardy Tel: (860) 435-2255 firstname.lastname@example.org www.ascendantcompliance.com Questions?