In addition, the new amendments to the solicitation rule would expand the current rule so as to cover solicitation arrangements involving all forms of compensation subject to a new de minimis threshold. Currently these rules apply only to cash compensation. The updated rules also would modernize other aspects, such as who is disqualified from acting as a solicitor under the rule.

The proposed amendments apply to Rules 206(4)-1 and 206(4)-3. In addition, the SEC is proposing changes to Form ADV (the investment adviser registration form) and Rule 204-2 (the books and records rule).

Specifically:

Proposed Amendments to the Advertising Rule

The changes to Rule 206(4)-1 would replace broad definitions and limitations with a more principles-based approach as follows:

• Definition of Advertisement. The definition of “advertisement” would be updated to be flexible enough to remain relevant and effective in the face of technological advances and changes in industry practices. The definition would include any communication, disseminated by any means by or on the behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.

  
  

  There are proposed exclusions for 1) live oral communications that are not broadcast, 2) responses to certain unsolicited requests for specified information, 3) advertisements, other sales material, or sales literature that is about a registered investment company or business development company and is within the scope of other SEC rules, and 4) information that is required to be contained in statutory or regulatory notice, filing, or other
  communication.



• General Prohibitions. The following practices would be prohibited:
  1. Making a false statement of a material fact. This includes omission of material information that is required to make a statement not misleading.
  2. Making a material claim or statement that is unsubstantiated.
  3. Making a false or misleading implication about, or being reasonably likely to cause a false or misleading inference to be drawn concerning, a material fact relating to the investment adviser.
  4. Discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations.
  5. Referring to specific investment advice provided by the adviser that is not presented in a fair and balanced manner.
  6. Including or excluding performance results or presenting performance time periods in a manner that is not fair and balanced.
  7. Being otherwise materially misleading.


• Testimonials and Endorsements. The proposal would permit testimonials and endorsements, subject to specified disclosures, including whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the adviser.


• Third-Party Ratings. The new rule would permit third-party ratings, subject to certain disclosures and criteria pertaining to the preparation of the rating.


• Performance Information Generally. The following would not be permitted to be included in any advertisement:
  • Gross performance results unless the advertisement provides (or offers to provide promptly) a schedule of fees and expenses necessary to calculate net performance,
  • Any statement that the SEC has approved of the calculation or presentation of the performance results,
  • Performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered or promoted in the advertisement,
  • Performance results from a subset of investments from a portfolio, unless the advertisement provides (or offers to provide promptly) the performance results of all investments in the portfolio,
  • Hypothetical performance, unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient and the adviser provides certain specified information underlying the hypothetical performance.


• Performance Information in a Retail Advertisement. The proposed rule provides additional protections for a retail audience when an advertisement targets it by 1) requiring the presentation of net performance alongside any presentation of gross performance, and 2) requiring the presentation of performance results of any portfolio or certain composite aggregations across 1, 5, and 10-year periods.


• Internal Pre-Use Review and Approval. The proposed rule would also require advertisements to be reviewed and approved in writing by a designated employee before dissemination with these exceptions: 1) advertisements that are communications disseminated
  only to a single person or household or to a single investor in a pooled investment vehicle, or 2) live oral communications broadcast on radio, television, the internet, or any other similar medium.

Proposed Amendments to the Solicitation Rule

The changes to Rule 206(4)-1 make refinements in scope, written agreement content, and disclosure requirements. They are as follows:

• Scope.
  
  
  • All Forms of Compensation. The proposed rule would apply regardless of whether an adviser pays cash or non-cash compensation to a solicitor. Non-cash compensation includes directed brokerage, awards, other prizes, and free or discounted services.
  
  
  • Private Fund Solicitors. The new rule would apply to the solicitation of current and prospective investors in private funds, rather than only to the solicitation of current and prospective clients of the adviser.
  
  
  • Exempt Arrangements. In addition to the above, the new rule would substantially retain the current rule’s partial exemptions for: 1) solicitors that refer investors for impersonal investment advice, and 2) solicitors that are employees or otherwise affiliated with the adviser. However, these arrangements would no longer be subject to the current rule’s written agreement requirement. Furthermore, the proposal would add two new full exemptions for: 1) de minimis compensation to solicitors, and 2) advisers that participate in certain nonprofit programs.
  
  
  • Disqualified Solicitors. The new rule expands the list of disciplinary events for which a solicitor can be disqualified.


• Written Agreement. The proposed rule stipulates that an adviser who compensates a solicitor for solicitation activities is required to enter into written agreement with that solicitor unless an exemption applies. This written agreement must include: 1) a description of the solicitation activities and compensation, 2) a requirement that the solicitor perform its solicitation activities in accordance with certain provisions of the Advisers Act, and 3) a requirement that solicitor disclosure be delivered to investors. The proposed rule would eliminate the current rule’s requirements that the solicitor agree to deliver the adviser’s Form ADV brochure and perform its solicitation activities consistent with the instructions of the adviser.


• Disclosure Requirements. The solicitor disclosure required under the proposed rule would continue to highlight the solicitor’s financial interest in the client’s choice of an investment adviser. This proposal would also modify the current solicitor disclosure to include more information about a solicitor’s potential conflict of interests. However, the the current rule’s requirement that the adviser obtain from each investor acknowledgments of receipt of the disclosures would be eliminated.


• Oversight of Solicitors. Under the proposed rule, the adviser must have a reasonable basis for believing that the solicitor has complied with the rule’s written agreement, including complying with the solicitor disclosure requirement.

Proposed Amendments to the Books and Records Rule and to Form ADV

The amendments to Rule 204-2 concern the proposed amendments to the advertising and solicitation rules as stated above. In addition, the proposal would amend Form ADV to provide additional information regarding advisers’ advertising practices to help facilitate the SEC’s inspection and enforcement capabilities. The staff of the SEC’s Division of Investment Management has issued a number of no-action letters and other guidance addressing the application of the current advertising and solicitation rules. The release accompanying the proposed amendments includes a list of the relevant letters and guidance. SEC staff are reviewing these letters to determine whether any should be withdrawn in connection with adoption of the proposed amendments.

The SEC seeks public comment on these new rules. The public comment period will be open for 60 days after publication in the Federal Register. The proposed rule changes can be read here. You can submit comments using the form available on the SEC’s website or by e-mailing rule-comments@sec.gov with the reference number (S7-21-19) in the subject line. You can also use the Federal Rulemaking Portal to submit comments or send your comments by mail to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. Again, please remember to include reference number S7-21-19.

Sources:

SEC Proposes to Modernize the Advertising and Cash Solicitation Rules for Investment Advisers (www.sec.gov)

SEC Release No. IA-5407: Investment Adviser Advertisements; Compensation for Solicitations (www.sec.gov)