On January 11, 2023, the SEC updated its Frequently Asked Questions page for the New Marketing Rule.  There are now three questions and three answers.  The first dealt with the compliance date of November 4, 2022, and an adviser’s ability to comply with the new rule early.  Now all Registered Investment Advisers (“RIAs”) must comply with the New Marketing Rule.  This leaves two questions that the SEC chose to answer.  Both shed light on how the SEC is interpreting the new rule, and the last marks a sea of change for the marketing material of private fund firms. Below, we’ve discussed the two questions, their answers, and possible implications for firms.

Time Period Requirement

An advertisement, except for an advertisement that includes private fund performance information, must include performance results for prescribed time periods ending on a date that is no less recent than the most recent calendar year-end.

The question: My firm is not able to calculate its one-, five-, and ten-year performance data immediately following a calendar year-end, but anticipates having updated performance figures within one month of the calendar year-end. However, my firm has performance information that is current as of the third quarter of that calendar year (“interim performance information”). May my firm instead use the interim performance information in an advertisement?

The answer: The staff believes that a reasonable period of time to calculate performance results based on the most recent calendar year-end generally would not exceed one month. The interim performance information remains subject to the other provisions of the marketing rule, including the general prohibitions.

This means, performance information in advertisements, other than private fund performance, must be updated to December 31, 2022 results by January 31, 2023. For the full response see the FAQ here.

Gross and Net Private Fund Performance

An advertisement that presents extracted performance information (e.g. a case study) must produce performance results of the total portfolio from which the performance was extracted. Furthermore, any performance information that includes gross performance information must also include net performance information with equal prominence to facilitate comparison.

The question: When an adviser displays the gross performance of one investment (e.g., a case study) or a group of investments from a private fund, must the adviser show the net performance of the single investment and the group of investments?

The answer:  Yes.  The staff believes displaying the performance of one investment or a group of investments in a private fund is an example of extracted performance under the New Marketing Rule.  Address the risk of presenting misleadingly selective profitable performance was one of the aims of the extracted performance provision. Accordingly, an adviser may not show gross performance of one private fund investment or subset of investments without also showing net. Tailored disclosure requirements as well as the general prohibition against specific investment advice not presented in a fair and balanced manner must also be satisfied.

The good news is we now have the answer to this question. The bad news is the answer is not what private fund advisers wanted. The SEC has made it clear that they want to see net performance for a single investment or a group of investments.

When it comes to calculating net performance, firms have three options under the New Marketing Rule: using actual performance, creating model performance that is not higher than actual, or using the highest fee tier to model performance.  All of these are still subject to the general prohibitions.  For example, if deeply discounted early investors make your actual performance figures misleading to any new investor who cannot get those low fees, then model performance would be the better choice.  If you have multiple classes of investors with a range of fees, it would be best to look at the intended audience for the advertisement and use the highest fee possibly charged to that intended audience.

Net performance is not the only challenge for case studies or presentations of subsets of investments.  The fifth general prohibition prohibits references to specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced. This means adding more context to avoid cherry-picking a profitable investment. Consider the following best practices that the SEC highlighted in the New Marketing Rule’s adopting release to be sure a reference to specific investment advice is fair and balanced:

• Add context by including some or all of the profitable and unprofitable investments of the same type, kind, grade or classification;
• Choose a list of investments based on non-performance criteria (top by value, rotating most recent investments, working through a complete list alphabetically, etc.); or
• Display the overall net performance for the private fund would bring fairness and balance to a presentation only showing the performance of a single case study.

If you market private funds, now is the time to reexamine your use of case studies and performance. Fairview will continue to update you with in-depth information about the New Marketing Rule and ongoing recommendations as the SEC’s examinations and enforcements begin applying this rule to registrants.

Fairview provides comprehensive and ongoing compliance services, including comprehensive marketing and advertising review and complete examination support. Contact us for additional information about maintaining your compliance program in an ever-changing regulatory environment.