Amid confusion, a blueprint for the SEC's new marketing rule

More than seven months after taking effect, the SEC's new marketing rule is still presenting stumbling blocks to advisors.

The complexities of the rule, which firms first came under on Nov. 4, were attested to both by panelists at Financial Planning's INVEST conference earlier this month in New York and a recent "risk alert" issued by the Securities and Exchange Commission. 

In general, the new marketing rule allows for the use of testimonials from current clients and endorsements from third parties like celebrities; adopts new standards for reporting the performance of past investments; and places firms under a greater obligation to police their promotions for false or misleading information. 

The rule's intricacies had already prompted the SEC to issue a previous risk alert in March warning advisors of the ways they might be falling short.

In its latest alert, the Wall Street regulator calls on firms to remember their obligation to provide support for any claims about investment performance they make in marketing materials. It reminds firms that they are responsible for monitoring statements made on their behalf and for weeding out misleading or false information.

Firms must also disclose payment arrangements with any clients or investors who provide favorable testimonials unless the person making the endorsement is receiving less than $1,000 over a yearlong period. And they must do background checks on third-party endorsers and avoid doing business with people with unsavory histories.

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John Carr, an attorney at Portland, Oregon-based Carr Butterfield and a panelist at the INVEST 2023 conference, said advisors are feeling anxiety in part because they are dealing with the first major changes made to the decades-old rule. The marketing rule, previously known as the advertising rule, dates to 1961.  

"They hadn't updated the marketing rule in 60 years," Carr said. "Microfiche was cutting-edge back then."

John Cataldo, the president of advisory services and chief legal officer at Integrated Partners and another speaker on the panel, said the SEC is also asking firms to draw up detailed written marketing procedures and to make sure those policies are communicated to advisors on staff.

"The marketing rule is 150% where they're going to be looking most keenly because it's a rule that's been materially changed," Cataldo said. "It's an area that's near and dear to them when we're talking about communicating with clients."

Anyone seeking a blueprint for how the SEC might enforce the marketing rule can look to the regulator's recent enforcement of its rules governing electronic communications. The SEC cracked down in September on some of the biggest Wall Street names — to the tune of nearly $2 billion in fines — after advisors failed to keep proper records of their use of text messaging and other app-based services to talk to clients.

Carr and Cataldo said it's not enough for firms to draw up written rules for their staff. They will also have to make sure advisors are trained on the rules and then obtain their acknowledgement that they've undergone the training. Following up is crucial, they said.

The SEC has shown that with its rules on electronic communications. As shown in previous enforcement cases, firms that had provided the required training still got dinged after employees who should have known better nonetheless went on to text longtime clients through unapproved and unmonitored messaging systems.

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"They've been sanctioning firms and investigating firms even though they had a policy in place that required the use of specific means to communicate electronically internally and with clients," Cataldo said. "They had systems in place for people to use. They had acknowledgements in place for their internal personnel where they acknowledged 'I'm aware of your policies.'

"And (the SEC) said despite the fact that you had systems, despite the fact that you had acknowledgements, you can demonstrate that you trained people, people still did it once in a while and you didn't catch it and stop them," Cataldo said.

Third-party compliance experts are also stepping up to help. The compliance consultant ACA Group announced Monday that it is introducing a new Managed Performance Services offering in part to help advisors meet their obligations under the marketing rule for reporting the performance of investments they undertake on clients' behalf.  

Among other things, the new rules allow advisors to advertise the "gross performance" of a particular investment — meaning they can show how much money it returned in total — only if they also mention its "net performance." This refers to how much money was made after the subtraction of fees and other costs. 

Julia Reyes, a partner in ACA's performance services group, said it's not always clear to firm executives which fees should be included in these calculations. ACA's Managed Performance Services can help ensure nothing important is being left out.

The new rule also seeks to prevent advisors from "cherry picking" data to make certain investments seem to have done better than they did in reality. To that end, it requires firms to present performance data for returns for specific periods of time: over one-year, five-year and 10-year intervals. 

"The substantiation of investment performance, and the books and records to support the performance they are showing — that can also be a hurdle for firms," Reyes said.

Carr said at INVEST 2023 the first line of defense is documentation. The SEC's latest risk alert reminds firms that they are now required to provide information on their marketing policies and practices in the registration document known as Form ADV that they file every year.

"Is there a disclosure item or piece in your ADV document? That's a huge thing," Carr said. "And then you backfill it with the agreements you have in place."