The Division of Examinations (“EXAMS”) published a risk alert yesterday to inform investment advisers, including advisers to private funds, that examiners will conduct “a number of specific national initiatives” that focus on the new Marketing Rule.  The November 4^th compliance date is almost here.  After that day, advisers can no longer choose to comply with the previous advertising and cash solicitation rules, nor will they be able to rely on no-action letters set to be withdrawn the same day.

The announced exam initiatives and areas of review are:

Marketing Rule Policies and Procedures – Examiners will review if advisers’ policies and procedures are reasonably designed to prevent violations by the advisers and their supervised persons of the Advisers Act and also the new Marketing rule.

• Adopt any needed amendments by the compliance deadline.
• Include “objective and testable means” such as internal review and pre-approval of advertisements, reviewing sample communication based on risk, or pre-approving template materials.

Substantiation Requirement – The second general prohibition of the new Marketing Rule states that advisers may not “[i]nclude a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission.”  To meet this requirement the Commission suggests in the adopting release:

• Make a record demonstrating the basis for their belief at the same time the advertisement is made, or
• Implement procedures to address how the requirement is met.

If an adviser is unable to substantiate a material claim of fact upon demand, then the Commission will presume the adviser did not have a reasonable basis for belief.

Performance Advertising Requirements

The new Marketing Rule’s requirements around presentations of performance include many prohibitions. The following were listed in the risk alert:

• Gross Performance, unless the advertisement also presents net performance;
• Any performance results, unless they are provided for specific time periods (not applicable to the performance of private funds);
• Any statement that the Commission has approved or reviewed any calculation or presentation of performance results;
• Related performance – to the extent an advertisement includes the performance of portfolios other than the portfolio being advertised, performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as the portfolio being offered in the advertisement, with limited exceptions;
• Extracted Performance – performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio;
• Hypothetical Performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the adviser provides certain additional information; and
• Predecessor Performance, unless the personnel primarily responsible for achieving the prior performance manage accounts at the advertising adviser and the accounts that were managed by those personnel at the predecessor adviser are sufficiently similar to the accounts that they manage at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.

Books and Records, and Form ADV

The new Marketing Rule includes amendments to the Books and Records Rule, which will be reviewed for compliance by Examiners.  Additionally, all advisers are now required to accurately report their marketing activities in Item 5.L of Form ADV in the next annual updating amendment.  The Commission concluded with a reminder of this new reporting obligation.

The new Marketing Rule will be examined and the subject of these national initiatives. This risk alert follows the SEC’s unprecedented mass email earlier this year and the notices sent earlier this month to advisers whose Form ADV Part 2A brochure Item 14 response referenced the soon to expire cash solicitation rule.  Make no mistake, the SEC will aggressively pursue violations of the new Marketing Rule.  Act now to comply.

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