On December 16, the SEC’s Division of Examinations (EXAMS) issued a Risk Alert on the Marketing Rule.
EXAMS previously published a Risk Alert in April 2024 to share initial observations related to adviser compliance with the Marketing Rule, including policies and procedures, books and records, Form ADV disclosures, and violations of the Marketing Rule’s General Prohibitions.
This new Risk Alert primarily addresses the staff’s observations regarding advisers’ compliance with the Testimonials and Endorsements Provisions and the Third-Party Ratings Provisions of the Marketing Rule. In particular, EXAMS highlighted observations regarding adviser compliance with applicable disclosure requirements and oversight and compliance practices under the Testimonials and Endorsements Provisions, as well as advisers’ due diligence and disclosure requirements under the Third-Party Ratings Provisions.
Observations Related to the Testimonials and Endorsements Provisions
Investment advisers who hire third-party marketers or promoters are typically impacted by the rules governing the use of testimonials or endorsements.
EXAMS highlighted some common deficiencies in connection with advisers’ use of testimonials and endorsements:
- Failure to provide appropriate disclosures at the time the testimonial or endorsement was disseminated, particularly on an adviser’s or related persons’ website.
- Use of lead-generation firms, social media influencers, adviser referral networks, and “refer-a-friend” programs offering de minimis compensation to current clients without recognizing that certain arrangements created an endorsement or testimonial.
- Failure to update compliance policies and procedures or to effectively implement updated policies and procedures, particularly in the areas of:
- Failure to provide clear and prominent disclosures
- Improper disclosure of material terms of compensation arrangements and material conflicts
- Lack of written agreements with promoters
- Use of persons ineligible to provide a testimonial or endorsement due to disciplinary histories
- Use of promoters affiliated with the adviser
Third Party Ratings
The Marketing Rule’s Third-Party Rating Provisions prohibit the use of third-party ratings in advertisements, unless an adviser has a reasonable basis for believing that any questionnaire or survey used in the preparation of the third-party ratings meets certain criteria and that certain information related to the ratings is disclosed.
In particular, EXAMS observed advisers who failed to update their policies to address the use of third-party ratings, as well as those advisers who had updated their policies and procedures but did not put those policies into practice.
EXAMS also cited two areas where advisers particularly ran afoul of SEC guidance regarding the use of Third-Party Ratings. These included a) due diligence, and b) third-party disclosures.
- Due Diligence
EXAMS observed advisers who did not appear to have sufficient information to form a reasonable basis about the design or structure of questionnaires used in the preparation of third-party ratings included in advertisements. In these instances, advisers generally had neither developed policies and procedures for satisfying the due diligence requirement nor otherwise taken steps to meet this requirement, such as obtaining or reviewing a copy of the questionnaires or surveys used in preparation of the ratings.
- Clear and Prominent Disclosures
Some advisers included third-party ratings in advertisements without providing some or all of the required clear and prominent disclosures. These advisers also did not appear to have a reasonable belief that the third-party ratings presented such disclosures clearly and prominently.
Additional observations included:
- Improper reliance on third-party websites to disclose ratings
- Unclear dates or time period in which ratings were granted
- Failure to disclose compensation of ratings providers
Takeaway:
The SEC’s Risk Alerts are intended to highlight deficiencies the Staff has identified so firms can address or strengthen their compliance programs by making necessary changes to their supervisory, compliance, and/or other risk management systems. Compliance with the Marketing Rule is still an EXAMS priority. We also note that despite policy changes in the SEC’s rulemaking approach over the past year, EXAMS continues to leverage current rules that are “on the books” during examinations of investment advisers to find deficiencies in compliance programs.