Marketing rule

What Is the Marketing Rule?

The Marketing Rule refers to Rule 206(4)-1 under the Investment Advisers Act of 1940, a key component of financial regulation designed to modernize the standards for advertising and solicitation practices by registered investment advisers. This rule, overseen by the Securities and Exchange Commission (SEC), aims to protect investors by ensuring that communications about investment advisory services are fair, balanced, and not misleading. The Marketing Rule consolidated previous, separate regulations into a single, principles-based framework, reflecting advancements in technology and changes in how financial services are promoted. It addresses various forms of communication, from traditional advertisements to modern digital channels, setting clear guidelines for how advisers can present information to prospective and current clients. Adherence to the Marketing Rule is a critical aspect of an investment adviser's overall compliance program.

History and Origin

The landscape of investment adviser advertising evolved significantly over decades, leading to a need for updated regulatory oversight. Prior to the Marketing Rule, the SEC’s primary guidelines were the Advertising Rule (Rule 206(4)-1), adopted in 1961, and the Cash Solicitation Rule (Rule 206(4)-3), adopted in 1979. These rules, while foundational, became increasingly outdated as technology advanced and marketing practices shifted, particularly with the rise of the internet, social media, and digital advisory services.
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On December 22, 2020, the SEC adopted amendments that effectively merged and modernized these two rules into a single comprehensive Marketing Rule, effective May 4, 2021, with a compliance date of November 4, 2022. ⁴², ⁴³This significant reform was driven by the SEC's recognition that communications with clients and investors had transformed, necessitating a more flexible, principles-based approach that could accommodate evolving marketing channels and techniques. ⁴⁰, ⁴¹The new Marketing Rule replaced the prescriptive prohibitions of the older rules with general principles designed to prevent fraudulent, deceptive, or manipulative acts, while also explicitly permitting certain practices like testimonials and endorsements under specific conditions and disclosures.
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Key Takeaways

• The Marketing Rule is a comprehensive framework for investment advisers' advertising and solicitation practices, unifying previous separate rules.
• It introduces a principles-based approach, emphasizing that all communications must be fair, balanced, and not misleading.
• The rule broadens the definition of "advertisement" to include all direct or indirect communications offering advisory services, encompassing digital and social media.
• It permits the use of testimonials, endorsements, and third-party ratings, provided specific disclosures are made regarding compensation and potential conflicts of interest.
• The Marketing Rule sets strict requirements for the presentation of performance information, including hypothetical performance and net versus gross returns, to ensure transparency and prevent misleading claims.

Interpreting the Marketing Rule

The Marketing Rule significantly impacts how investment advisers communicate their services and performance to clients and prospects. Its principles-based structure requires advisers to exercise judgment in applying its provisions to a wide range of marketing activities. At its core, the rule prohibits any advertisement that contains an untrue statement of a material fact, omits material facts, creates misleading implications, or discusses potential benefits without fair and balanced treatment of associated risks.
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This means advisers must have a reasonable basis for believing they can substantiate any material statement of fact made in an advertisement upon demand by the SEC. ³⁵For example, when presenting performance reporting, the rule mandates specific time periods and requires that gross performance be accompanied by net performance, ensuring investors see results after fees and expenses. ³³, ³⁴Advisers must also be diligent in overseeing the activities of any third parties, such as solicitors, involved in their marketing efforts to ensure compliance with the Marketing Rule's prohibitions and disclosure requirements.
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Hypothetical Example

Consider "Alpha Advisors," an investment advisory firm developing a new automated investment strategy. To illustrate the potential of this strategy, Alpha Advisors wants to use a presentation showing its projected returns based on backtested data. Under the Marketing Rule, Alpha Advisors can present this hypothetical performance to prospective clients, but only with specific conditions and disclosures.

First, the presentation must clearly and prominently disclose that the performance shown is hypothetical, does not represent actual results, and that future returns may differ significantly. Second, Alpha Advisors must describe the methodologies and assumptions used in generating the hypothetical results, including any market conditions that might have influenced the backtested data. Third, the firm needs to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience. For instance, if the strategy is designed for long-term growth, the hypothetical example should not focus solely on short-term gains that might suggest unrealistic expectations. The firm also needs to maintain detailed records of how the hypothetical performance was calculated and disseminated as part of its ongoing recordkeeping obligations.

Practical Applications

The Marketing Rule has broad practical applications across various aspects of an investment adviser's operations, particularly in client acquisition and retention. It dictates the content and presentation of virtually all external communications offering advisory services.

• Marketing Materials: Advisers must ensure that brochures, website content, presentations, and fact sheets comply with the general prohibitions against misleading statements and omissions. ³¹This includes careful review of claims about investment strategies, advisory fees, and firm capabilities.
• Digital Communications: The expanded definition of "advertisement" means that social media posts, emails, videos, and online seminars are subject to the Marketing Rule. Advisers must have robust internal review processes for these dynamic forms of communication.
  ³⁰* Client Testimonials and Endorsements: Advisers can now use client testimonials and third-party endorsements in their marketing, but they must include clear disclosures about whether the person providing the testimonial is a client, whether they were compensated, and any material conflicts of interest.
  ²⁸, ²⁹* Performance Advertising: Stringent rules apply to the presentation of investment performance. This includes requirements for presenting net performance alongside gross performance, using prescribed time periods for historical data, and careful disclosure around backtested performance or model portfolios.
  ²⁶, ²⁷* Solicitor Arrangements: The rule incorporates the former Cash Solicitation Rule, meaning that payments to third parties for client referrals (solicitors) are subject to specific disclosure and oversight requirements, including written agreements and disqualification provisions for "bad actors".
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Limitations and Criticisms

While the Marketing Rule aimed to modernize and simplify advertising regulations, its implementation has presented certain challenges and drawn some criticisms. One primary limitation lies in its principles-based nature, which, while offering flexibility, can also lead to ambiguity in interpretation for firms trying to ensure regulatory compliance. Advisers must apply subjective judgment to determine if a communication is "misleading," which can be a complex task given the diverse forms of modern marketing.
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Another area of concern revolves around the treatment of performance advertising. Despite detailed provisions, the presentation of hypothetical performance and targeted returns, even with disclosures, still carries a heightened risk of creating unrealistic expectations for investors. ²², ²³The SEC has reportedly taken enforcement actions against firms that published hypothetical results without meeting the rule's specific disclosure or procedural requirements. ²¹Furthermore, the complexity of recordkeeping requirements, particularly for digital communications and the substantiation of claims, can be burdensome for smaller advisory firms. ¹⁹, ²⁰The rule's comprehensive scope also requires advisers to continually monitor third-party content where entanglement or adoption could lead to liability.

Marketing Rule vs. FINRA Rule 2210

While both the SEC's Marketing Rule and FINRA Rule 2210 govern financial services advertising, they apply to different entities and have distinct, though often overlapping, scopes.

The key difference lies in the regulatory bodies and the types of firms they oversee. The Marketing Rule is the SEC's standard for investment advisers, while FINRA Rule 2210 governs broker-dealers. Both rules share the overarching goal of investor protection by ensuring that financial communications are fair, accurate, and not misleading, but their specific requirements and permitted practices can vary due to the distinct business models and regulatory histories of advisers versus broker-dealers.
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FAQs

What does "advertisement" mean under the Marketing Rule?

Under the Marketing Rule, an "advertisement" is broadly defined as any direct or indirect communication an investment adviser makes to more than one person that offers their investment advisory services. It also includes any communication that features compensated testimonials or endorsements, even if shared with a single person. This expanded definition covers a wide array of materials, from traditional brochures and websites to social media posts and emails.
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Can investment advisers use testimonials and endorsements?

Yes, the Marketing Rule permits investment advisers to use testimonials and endorsements, a significant change from previous prohibitions. However, certain conditions must be met. Advisers must clearly and prominently disclose whether the person giving the testimonial or endorsement is a client and whether they received compensation (cash or non-cash) for it. Any material conflicts of interest due to the relationship must also be disclosed. Advisers are also required to oversee compliance with these provisions and are generally prohibited from using "bad actors" as promoters.
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Does the Marketing Rule apply to social media?

Yes, the Marketing Rule explicitly applies to communications made through social media and other electronic mediums. The SEC's modernized rule acknowledges that advisers frequently use platforms like firm websites and social media to offer investment advisory services. Therefore, any communication on social media that meets the definition of an "advertisement" must comply with the rule's general prohibitions and specific requirements for testimonials, performance, and other content.
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How does the Marketing Rule affect the presentation of investment performance?

The Marketing Rule has strict requirements for presenting investment performance. Advisers must generally present net performance (after fees and expenses) alongside gross performance. When showing historical performance, it must be for specific time periods (e.g., 1-, 5-, and 10-year periods) if the portfolio existed for those durations. The rule also allows the use of hypothetical performance (such as model portfolios or backtested strategies) but requires extensive disclosures about its hypothetical nature, the assumptions used, and its limitations. The goal is to prevent misleading investors with cherry-picked or unrealistic performance data.
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What are the main objectives of the Marketing Rule?

The main objectives of the Marketing Rule are to improve transparency, ensure fair presentation of information, and better protect investors in today's increasingly digital and diverse investment advisory landscape. By setting clear, principles-based standards, the rule aims to reduce instances of fraud and market manipulation, allowing investors to make more informed decisions based on accurate and balanced information about investment advisory services.¹, ²