By now, registered investment advisers (RIAs) know that this is their last week to ensure they come into compliance with the “new” marketing rule under the Investment Advisers Act of 1940. While the Securities and Exchange Commission (SEC) adopted amendments to Rule 206(4)-1 (Marketing Rule) on December 22, 2020, with an effective date of May 4, 2021, the compliance date for the Marketing Rule had been delayed until this Friday, November 4, 2022. Notwithstanding the lead time for transition, however, some firms may still be finding themselves with limited time, limited resources and a deadline to meet. For these firms, below is a last-minute checklist to consider. This checklist is not comprehensive – it has been designed as a “fire drill” approach to tackling the Marketing Rule.

A note to venture capital firms and private fund managers that are exempt reporting advisers (ERAs): The Marketing Rule applies to RIAs. Technically, it does not apply to ERAs. This means that the SEC cannot charge an ERA for violation of the Marketing Rule. However, ERAs are subject to the general antifraud provisions of the Investment Advisers Act. To this end, ERAs might consider the requirements of the Marketing Rule, especially its general principles, as a guide to what the SEC might consider misleading.

1. Advertisements

Determine which materials are advertisements. Marketing decks, firm overviews, and track record information sent to prospective investors are advertisements. Letters and reports sent to existing investors are not advertisements unless they offer new products or services, or they are sent to prospective investors.

2. Data rooms

If using a data room, take down any advertisements that have not been updated to comply with the Marketing Rule. It may be possible to take the view that historical investor communications provided to prospective investors upon request or as supplemental diligence information are not advertisements. Include clear legends on such materials, and understand that there is a risk the SEC may disagree.

3. Track record

Track record presentation should meet the “fair and balanced” standard. There are nuances to presenting a track record. If there are multiple ways to show a return, or when fees and carry differ across prior funds and current funds, it may be necessary to err on the side of using the more conservative returns and including explanatory footnotes to “paint the full picture.” If showing the returns of a subset of investments from a fund, also include the total fund level return. If including the returns of prior funds, do not cherry-pick (e.g., if including same strategy funds, include all same strategy funds).

4. Net returns

Net returns must be presented with equal prominence to gross returns. If including deal level returns, net returns may not be necessary under a plain reading of the Marketing Rule, but understand that there is a risk the SEC may disagree. If including “pro forma” deal level returns, paint the full picture with explanatory footnotes.

5. Targets and projections (hypothetical returns)

Understand that “hypothetical performance” is defined broadly as any performance not actually achieved by a fund or an account. It includes target returns, projected returns, and combined investments from multiple funds or accounts. There are specific requirements to using hypothetical performance, which generally entail:

  • Adopting policies and procedures around providing hypothetical performance only to those who can understand it and to whom it is relevant.
  • Disclosing the criteria and assumptions used in calculating the performance.
  • Including a statement regarding the risks and limitations of using hypothetical returns to make investment decisions.

For the purposes of this last-minute checklist, consider removing hypothetical returns from advertisements and working with counsel to determine what would be required to comply with the Marketing Rule.

6. Substantiation

For any material statements of fact, confirm there is a reasonable basis for believing the statements can be substantiated upon demand by the SEC. Include sources in footnotes and retain copies. Take caution to ensure subjective statements are not presented as facts.

7. Explanatory footnotes

Include all relevant information to explain and give context to the presentation. If including a discussion of potential benefits connected with the manager’s services or methods of operation, include a discussion of material risks and material limitations associated with those benefits. Include a general disclaimer in the front and specific disclaimers in footnotes.

8. Case studies and investment examples

References to specific investments must be “fair and balanced” (i.e., no cherry-picking). Including all investments in a fund will be the simplest way to satisfy this standard (although not the only way). “Early drivers” and “key performers” are red flags for cherry-picking.

9. Ratings or rankings

If including a third-party rating or ranking, the manager must have a reasonable basis for believing (e.g., by reviewing the questionnaire, survey or description of the methodology) that any questionnaire or survey used to prepare the rating or ranking is structured to make it equally easy for a participant to provide favorable or unfavorable responses, and it is not designed or prepared to produce any predetermined result. Clearly and prominently disclose the date of the rating or ranking and the time period covered, the identity of the third party and, if applicable, that compensation has been provided in connection with obtaining or using the rating or ranking.

10. Testimonials and endorsements

Statements that describe a person’s experience with the manager or its personnel, or that refer investors to the manager’s funds, are “testimonials” if made by investors and “endorsements” if made by non-investors. Endorsements include statements by founders from prior portfolio companies and others in the manager’s network that indicate approval, support, or recommendation of the manager. For all unpaid testimonials and endorsements, use a clear and prominent disclaimer stating that the person giving the testimonial or endorsement (promoter) is either a current investor or not a current investor, as applicable, and disclose any conflicts of interests arising from the manager’s relationship with the promoter. For any paid testimonial or endorsement (“paid” can include fee discounts, indirect payments, and non-cash compensation), there are additional disclosure, oversight, and disqualification requirements. To meet these requirements by the compliance date, it may be necessary to remove the testimonial or endorsement until you can consult counsel to determine what would be required to comply with the Marketing Rule.

11. Placement agreements

Placement agents (also known as consultants, finders and introducers) for funds managed by RIAs are considered promoters under the Marketing Rule. If a promoter will be referring investors to the manager as of, or after, the compliance date, including non-US promoters referring non-US investors, and the placement agreement has not already been updated to comply with the Marketing Rule, contact counsel immediately to determine what would be required.

12. Policies and procedures

If policies and procedures have not yet been updated, work with counsel or a compliance consultant to make appropriate revisions.

With the compliance date just a few days away, setting priorities and getting the right players to focus and coordinate is crucial. The Marketing Rule is complex and complicated, and there remain a number of unanswered interpretative questions. The good news is that the industry has been working closely together over the transition period to come up with good faith approaches to complying with the rule. This checklist will help you to assess your immediate needs. Then, work with your counsel and your compliance advisers to resolve the more difficult questions.

Posted by Stacey Song