One of the most important documents for fund managers is the marketing deck. Whether it’s to raise a new fund or a special purpose vehicle, or just to build relationships with prospective investors, every fund manager has some form of deck that highlights the managing directors, their professional experience and what sets them apart from their peers. We regularly review this all-important document for our clients, and our goal is always to help them remain in compliance with applicable requirements. Depending on a firm’s status as a registered investment adviser (RIA) or an exempt reporting adviser (ERA), the precise requirements differ when it comes to things like showing performance, referencing specific investments and quoting positive statements from founders (for more on this topic, see our blog, Becoming a Registered Investment Adviser: Worth the Costs?). Specifically, RIAs are subject to Rule 206(4)-1 (Marketing Rule) under the Investment Advisers Act of 1940 (Advisers Act), whereas ERAs are not. However, because the general antifraud provisions apply to both RIAs and ERAs alike, and many of the requirements under the Marketing Rule are designed to prohibit misleading advertisements, there is substantial overlap between RIA and ERA requirements.
Last week, the Division of Examinations at the Securities and Exchange Commission (SEC) published a Risk Alert titled, “Initial Observations Regarding Advisers Act Marketing Rule Compliance.” This is the division’s third Risk Alert on the Marketing Rule since RIAs have had to come into compliance with the rule in November 2022, demonstrating the division’s continued focus on advisers’ marketing practices. (See our prior blog post on Marketing Rule compliance – Last-Minute Checklist for Private Fund Managers Complying With Marketing Rule.) In the latest Risk Alert, the division shares numerous observations by its staff regarding advisers’ compliance with the Marketing Rule.
In this post, we highlight some of the staff’s observations that we believe – based on our extensive experience reviewing our clients’ marketing decks – have particular relevance to venture capital fund managers. On their face, most, if not all, of these observations seem like obvious practices to avoid. But we’ve noted below some specific practices by VC firms that may benefit from another review in light of the new Risk Alert. While ERAs are not subject to the Marketing Rule, we encourage all of our clients – ERAs included – to review the practices noted below and be mindful of what the SEC would view as misleading.
1. Personal track record and balance sheet investments
Staff observation
The staff observed “[s]tatements or presentations regarding … advisers’ performance track record with securities that were not purchased by the advisers in a similar manner in their clients’ accounts.”
Cooley take
It is not uncommon for first-time fund managers to show their personal or angel investments as part of their track record, or for corporate VC firms or family offices launching their first third-party fund to show balance sheet investments as their track record. Doing so is not per se prohibited. But such presentations of track record should be accompanied by detailed disclosures around the assumptions made and risks involved in relying on such track record. Depending on what a firm has to work with, the track record may need to be presented as “hypothetical” performance, which too is not per se prohibited but does require policies, procedures and appropriate disclosures.
2. Unfair and unbalanced statements
Staff observation
The staff observed “statements about the potential benefits connected with the advisers’ services or methods of operation that did not appear to provide fair and balanced treatment of any material risks or material limitations associated with the potential benefits.” These included “advertisements on social media that highlighted performance information without also disclosing the material risks and limitations associated with the potential benefits.”
Cooley take
Given the very nature of marketing, it is typical for firms to emphasize the positive, and “balance” is the most common issue we address when reviewing initial drafts of marketing decks. But it also is relatively easy to correct this with the addition of footnotes, qualifiers and other disclosures. For various reasons (including the prohibition on general solicitation and general advertising under the exemption relied on by most VC funds), most of our clients do not use social media to advertise. However, when firms do use social media to highlight a new accolade, achievement or the like, it can be challenging to include the appropriate risks and limitations disclosure in the same post.
3. Cherry-picking and case studies
Staff observation
The staff observed “advertisements that included only the most profitable investments or specifically excluded certain investments without providing sufficient information and context to evaluate the rationale, such as investments that were written off as a loss or were lower-performing investments.”
Cooley take
This is another common theme in initial drafts of marketing decks we review. While the power law is of course a hallmark of VC investing, highlighting only the positive “performers,” “returners” or “drivers” can violate the Marketing Rule. References to specific investments need to be fair and balanced, which can be achieved through various means, and in our experience, firms have different appetites for how they want to comply with this requirement. One common approach is to include a table of all investments in the deck and cross-reference that table when highlighting a subset of investments.
4. Network of personnel
Staff observation
The staff observed advertisements stating material facts about the advisers’ businesses that were inaccurate, including “statements that a network of personnel perform advisory services for clients when a sole individual performs such services.”
Cooley take
We often see marketing decks that highlight venture partners, operating partners and other individuals in a firm’s network who are portrayed as having a role in the investment process. Because the actual role played by any of these individuals can vary from merely being available as consultants to actively engaging in the investment process, firms should consider how they are portraying their various networks and whether the description of the role played by any individual or groups of individuals should be refined. Firms also should take care not to imply that individuals are employed by the management company when they are in fact typically treated as third-party service providers.
5. Formalized screening processes
Staff observation
The staff observed advertisements describing material facts about advisory services or products offered that were inaccurate, including “referencing formalized securities screening processes that did not exist.”
Cooley take
Most marketing decks we review include slides on the investment process executed by a firm (e.g., how deals are sourced, screened, diligenced and voted on). Firms should consider whether the process described in their decks accurately matches what they actually do in practice, and if a formal process is referenced, firms should ensure that such a process is actually formalized.
6. Images of celebrities
Staff observation
The staff observed advertisements that contained untrue or misleading claims, such as “advertising images of celebrities in marketing materials in a manner that implied the celebrities endorsed the firms when such celebrities did not endorse the firms.”
Cooley take
While it is less common to see pop culture icons in VC fund marketing decks, we do from time to time see images of well-known investment personalities, like Warren Buffett and Elon Musk. Firms should take care when using stock images or quotes attributable to famous persons that they are not implying that such persons are endorsing them when that is not, in fact, the case.
7. Unreadable fonts
Staff observation
The staff observed advertisements that could “otherwise be materially misleading, such as presenting disclosures in an unreadable font on websites or in videos.”
Cooley take
We know that footnotes and disclaimers are not necessarily appealing, and there is a commercial desire to limit the real estate these disclosures take up in marketing materials. But using miniscule fonts could be viewed as materially misleading and lead to violations of the Marketing Rule. We are fans of concise, plain English disclosures that are set forth in legible fonts and tailored to each slide of a marketing deck. Additionally, as the Risk Alert indicates, these disclosure requirements apply to marketing materials in all forms of media. So, for example, when recording a marketing video, firms should include proper disclosures that are readable and pause long enough for the audience to be able to read them.
8. Outdated market data
Staff observation
The staff observed performance presentations that contained “outdated market data information only (e.g., market data from more than five years prior)” [emphasis added], or “investment products that were no longer available to clients and included lower investment costs than were available.”
Cooley take
For established firms with long-standing track records, it is quite standard to include performance information related to their older funds. This information can certainly be relevant (for example, to indicate a firm’s length of experience). Yet, context is important, and firms should consider whether the inclusion, or the manner of presentation, of these older funds could be misleading – for example, have the funds’ strategies or terms shifted or the investment team members evolved in such a way that their exclusion or additional explanation would be warranted?
9. ‘Proper’ calculation of net returns
Staff observation
The staff observed advertisements that contained “untrue or misleading performance claims, including … using lower fees in calculations for net of fees performance returns than were offered to the intended audience, and … omitting material information regarding fees and expenses used in calculating returns.” The staff also observed advertisements that “included the performance of only realized investment information in the total net return figure and excluded unrealized investments.”
Cooley take
In our experience, virtually all firms are aware that net returns are required when gross returns are presented. Many firms, however, do not appreciate all the nuances that the Marketing Rule requires, particularly with respect to the specific areas where the SEC or its staff have provided guidance that are not apparent from the rule and differ from industry practice. For example, both the Risk Alert and the adopting release for the Marketing Rule indicate that a RIA marketing its third fund with higher management fees than its first two funds would need to calculate the net returns of the earlier funds using the higher management fee rate to be charged to the third fund – in other words, showing the actual performance of the first two funds would be misleading because those funds charged a lower management fee rate than the fund currently being marketed. This is just one example of net return calculation principles that may not be intuitive. While a comprehensive discussion of properly calculating net returns is outside the scope of this blog post, we note that this is an area where we frequently advise RIAs and ERAs differently depending on their specific facts and circumstances.
A note that may be particularly relevant to our private equity clients: Firms that use subscription lines of credit also should be aware of the FAQ published earlier this year by the staff of the SEC’s Division of Investment Management. Please reach out to us if you have questions about this evolving area.
10. Benchmark index comparisons
Staff observation
The staff observed advertisements that contained “benchmark index comparisons that did not define the index or provide sufficient context to enable an understanding of the basis for such comparison or disclose that the benchmark performance did not include reinvestment of dividends.”
Cooley take
While we find that VC firms typically don’t include benchmark comparisons in their marketing decks, we commonly see the inclusion of benchmark comparisons in other fund asset classes. When incorporating benchmark comparisons, firms should include appropriate disclaimers for the index they are using to compare their performance.
The SEC has been focusing on Marketing Rule compliance for some time. For example, earlier this month, the SEC settled charges against five RIAs for Marketing Rule violations. While we highlighted some of the more VC-relevant issues identified in the Risk Alert above, we think firms would benefit from reviewing the entirety of the alert. As always, we are here to answer any questions and guide our clients through these marketing considerations.
The authors
Stacey Song
Jimmy Matteucci
