The New Marketing Rule’s Impact on the Presentation of Performance
The long-awaited modernization of the Securities and Exchange Commissions’ (SEC) Rule 206(4)-1 (Marketing Rule) under the Investment Advisers Act of 1940 was added to the Federal Register on March 5, 2021. Not only does the final Marketing Rule consolidate the Advertising and Cash Solicitation Rules, it also (among other things) categorizes certain considerations for presenting investment performance, effectively streamlining guidance currently found across multiple staff letters. Interestingly, the final Marketing Rule overlaps with the GIPS® standards in a number of ways and in fact mentions or references the GIPS standards over 25 times. A forthcoming white paper will cover the components of the final Marketing Rule that relate to performance advertising in more detail, but a preview of some of the topics follow here.
Gross and net returns displayed with equal prominence
The updated Marketing Rule expressly prohibits the presentation of gross performance if net performance is not also included. The rule also applies to all advertisements. Model fees are allowable in the presentation of net performance, but the discussion is quite in depth and will therefore be covered in the aforementioned white paper. Both hypothetical and extracted gross performance are also subject to these requirements.
Prescribed time periods (1-, 5-, and 10-year performance)
The new Marketing Rule dictates the minimum time periods that must be shown if a firm is presenting performance in an advertisement. While private funds are exempt from the requirement to show prescribed time periods, certain other vehicles that would not normally show such time periods (say, a composite of separate accounts showing money-weighted returns) are not. Advertisements must include 1-, 5-, and 10-year performance with an end date no less than the most recent calendar year-end.
Related performance is defined as “the performance results of one or more related portfolios.” Related portfolios have substantially similar investment policies, objectives, and strategies, and advisers that present performance within an advertisement must show performance for all related portfolios either on a portfolio-by-portfolio basis or as a composite aggregation. The ability of an adviser to show representative account performance is not eliminated, but certain conditions do apply.
Extracted performance is defined as the presentation of a subset of investments from a single portfolio. Advertisements are prohibited from including extracted performance unless the advertisement includes, or offers to promptly provide, the performance results from the total portfolio from which the performance was extracted. This is not to be confused with what many firms claiming GIPS compliance will know as ‘carve-out’ performance, which falls under the category of hypothetical performance.
The Marketing Rule prohibits the presentation of hypothetical performance (model, back-tested, targeted, and projected) unless the following criteria are met:
- The adviser develops and implements policies and procedures to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience.
- The adviser must disclose all relevant criteria used and assumptions made in calculating the hypothetical performance.
- The adviser must disclose (or, for private fund investors, offer to provide) sufficient information to allow the intended audience to understand the risks and limitations associated with hypothetical performance.
Portability of performance
A firm must meet the following requirements to present predecessor performance:
- The person or team primarily responsible for the prior performance manages accounts at the advertising adviser.
- The accounts managed at the predecessor investment adviser are sufficiently similar to the accounts managed at the advertising adviser.
- All accounts managed at the predecessor investment adviser and the advertising adviser that are managed in a substantially similar manner are advertised unless the exclusion of any related portfolios would not result in materially higher performance and the exclusion of any account(s) does not alter the presentation of any prescribed time periods.
- The advertisement clearly and prominently includes all relevant disclosures including that the performance results were from accounts managed at another entity.
The portability of performance from the GIPS standards perspective includes some nuanced differences, so advisers will need to fully consider all requirements.
With regard to the ‘first prong’ of the final Marketing Rule (associated with more traditional advertising) the recordkeeping provisions are amended to also require the maintenance of all advertisements disseminated by the advisor. The rule now explicitly states advisers must maintain all written communications relating to the performance or rate of return of any portfolios. This includes accounts, books, internal working papers, and other documents necessary to form the basis for, or demonstrate the calculation of performance of, any portfolios. This also includes any communication related to predecessor performance. It should also be noted that advisers will need to maintain any information provided or offered for hypothetical performance along with a record of who the “intended audience” is.
Investment advisers will need to create or update their policies and procedures to address how they will comply with any relevant portions of the final Marketing Rule. In addition, advisers will need to inventory all marketing materials to assess any risks associated with current marketing practices and materials. For example, when showing representative account performance, advisers will need to be certain that the currently marketed performance is not materially higher than that of the composite. This exercise will include identifying all marketing materials that qualify as an advertisement and applying the necessary changes to satisfy the Marketing Rule.
How we help
ACA can explain the requirements of the final Marketing Rule as they relate to any current marketing practices. Our risk and compliance management solutions incorporate consulting, managed services, technology, and education to provide our clients with a holistic approach to addressing risk, increasing operational efficiencies, and meeting regulatory requirements while adhering to industry best practices.
- Marketing Rule Performance Gap Analysis: Assists your firm in assessing the gaps between current performance advertising practices and the new Marketing Rule. The review covers disclosure help, books and records, policies and procedures development, gross and net return calculation methodologies, and composite construction (related portfolio) consulting.
- PAS Dashboard: Assists your firm in meeting the new requirement pertaining to marketing related performance by providing a technology solution that will conduct outlier analysis, strategy drift analytics, and scoring metrics to allow for adequate oversight.
- Customized Training: Provides your firm with customized trainings that cover and define many of the key definitions within the new Marketing Rule.
- ComplianceAlpha® Marketing Review Solution: Helps your firm’s marketing and legal teams easily manage workflows for submitting, reviewing, approving, and archiving marketing and advertising materials. Learn more.
- Marketing and Advertising Review Assistance: Allows your firm to significantly reduce the amount of time and resources devoted to the marketing and advertising review process. ACA’s skilled compliance professionals can step in during periods of high volume or assist your firm with enhancing collateral review workflows and protocols. Learn more.
Join ACA and K&L Gates for a detailed explanation of the specific performance requirements, how they differ from prior no-action letters, and what steps a firm should take now in order to be ready by the deadline.
For more information
If you have any questions about the new Marketing Rule or how ACA can help your firm evaluate and update its advertising and solicitation procedures to comply or to assess your broader compliance review resourcing, please reach out to your ACA consultant or contact us below.