SEC Division of Examinations Risk Alert – June 8, 2023

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The Division of Examinations of the SEC issued a Risk Alert on June 8, 2023 expanding its exams to look at how registered investment advisors are using client testimonials and endorsements, third-party ratings and Form ADV disclosures under the Marketing Rule that went into effect November 4, 2022.

Federally registered advisors must comply with the Marketing Rule and some state registered advisors, as well. State registered advisors registered in the following states; Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, New Mexico, North Carolina, Vermont and West Virginia are subject to the federal Marketing Rule.

This Risk Alert outlines that SEC staff is “conducting focused examinations, as well as broad reviews into testimonials and endorsements,” including whether there is clear disclosure of whether the person giving the testimonial or endorsement is a client or investor, if the promoter has been paid and if there are material conflicts of interest, the SEC said.

Examiners will also be looking to see that registered investment advisors have written agreements with any promoter they are using, unless they are affiliates of the advisor or the affiliation is disclosed or the promoters receive compensation of $1,000 or less during the preceding twelve months, the SEC said in the alert.

Investment advisors should also expect the SEC to flag instances “where ineligible persons have been compensated for testimonials or endorsements, if the advisor knew or reasonably should have known the person was ineligible, or a ‘bad actor,’” the agency said.

SEC examiners will also be looking to ensure any third-party ratings in advertisements provide clear and prominent disclosure of the date of the rating, the period of time it covers, the identity of the third party that created the rating and any compensation the third party was paid.

Any questionnaires or surveys the investment advisor uses to collect third-party ratings must be structured to make it equally easy for a participant to provide favorable and unfavorable responses. The agency is also expecting investment advisors to use the amended Form ADV to provide additional information regarding their marketing practices.

On a final note, the Risk Alert reiterates that examiners will continue to focus on whether registered investment advisers have disseminated advertisements that violate any of the following general prohibitions:

  • including an untrue statement of a material fact, or omitting a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading;
  • including 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; • including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the adviser;
  • discussing any potential benefits to clients or investors connected with or resulting from the adviser’s services or methods of operation without providing fair and balanced treatment of any associated material risks or limitations;
  • referencing specific investment advice provided by the adviser in a manner that is not fair and balanced; • including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; or
  • including information that is otherwise materially misleading.