New investment advisors need to do a better job of making sure the experience and credentials they tout in their marketing materials to investors are rock-solid accurate.
That's just one takeaway from a "risk alert" the Securities and Exchange Commission released on March 27 to
Regulators have been paying particular attention since 2013, says the alert, to industry newcomers, who have been surging in numbers. The SEC reported that the total tally of newly registered investment advisors has grown by 20% over the past half decade. And those newcomers have been falling short in a number of ways.
Parker Evans, an advisor with four decades of experience who founded Successful Portfolios in Clearwater, Florida, 14 years ago, said he took a lot away from the latest risk alert even though it wasn't directed at established advisors like him. Financial planners — newcomers and veterans alike — need to be especially careful when boasting publicly about the performance of past and current investment plans, he said.
Evans, whose firm manages just under $300 million for roughly 300 clients, said he avoids advertising performance results. One big reason, he said, is that he doesn't want to bother with defending his claims to the SEC.
By contrast, "if somebody is this young hotshot and has a big performance number and can't wait to brag about it, it might be worth the risk," Evans said. "But you better substantiate every single bit of it. You had better make sure you can back it up."
The SEC's risk alert confirms that one of the biggest stumbling blocks for new advisors is the federal agency's
The rule went into effect last November, meaning regulators have now had five months to unearth violations. Among other things, the rule sets a new definition of what constitutes an advertisement from financial advisors, allows for the use of testimonials from current clients, adopts new standards for reporting the performance of past investments and permits the use of investment projections in marketing.
The recent alert, which doesn't call out any firms by name, warns: "The staff observed adviser marketing materials that appeared to contain false or misleading information, including inaccurate information about advisory personnel professional experience or credentials, third-party rankings, and performance. Advisers were also unable to substantiate certain factual claims."
At a webinar Wednesday on regulatory compliance, representatives of governance, risk and compliance consultant ACA Group in Chicago said some clients received warnings of possible marketing rule deficiencies in their latest reviews.
Breanna Pollard, an ACA senior principal consultant, said one priority for regulators is a provision concerning when advisors can tout the historical "gross performance" of a particular investment recommendation, meaning the amount of money that recommendation has returned over time. The SEC marketing rule lets advisors do this only if they also take care to show the recommended investment's "net performance" — how much money it made after fees and other costs. Pollard reminded advisors that anytime they provide performance results, they must do so for intervals spanning the past year, 5 years and 10 years.
Jaqueline Hummel, ACA's director of thought leadership and regulatory compliance, said advisors should be particularly careful when they're making predictions. The reason: The SEC has strict requirements about how investors must be told about the methods used to reach hypothetical results.
The SEC seems to think predictions are only suitable for sophisticated investors like institutions, Hummel said.
"So if you are considering doing this with a retail investor, I'd counsel against it," she said.
The marketing rule lets advisors use client testimonials in marketing, as well as endorsements from non-clients and celebrities. Any planner who does, though, has to disclose if the person giving the statement is a current client, was paid for the testimony or has any relationship to the advisor that might constitute a conflict of interest. Testimonials are also subject to bans on false or misleading statements.
The rule also prohibits all material omissions of fact and statements that could give rise to misleading implications or inferences. And it requires advisors to keep records of every advertisement they have authorized, compensation they've paid for ads and testimonials, and data they've used in presentations of investment performance, among other things.
The recent risk alert also called out newly registered advisors for not doing things like disclosing their fees and other forms of compensation, disciplinary histories and any conflicts of interest. Advisors are generally held to the fiduciary conduct standard, which requires them to eliminate all but the most unavoidable conflicts.
"The SEC is really laser-focused on conflicts of interest," Hummel said. "The SEC is interested in the protection of investors, not in making sure advisors stay in business."
Hummel said one step toward compliance is to set up a spreadsheet with one column listing conflicts, another showing steps taken to mitigate them and a third with links to documents that disclose the conflicts to clients. To identify conflicts, she said, firms should make it a habit to look at all of their many sources of revenue with a suspicious eye.
"The best way to deal with conflicts is to show the SEC you have put some thought into it," Hummel said. "You need to have a policy and you need to have documentation. I can't emphasize this enough."
Sometimes staying on the right side of regulators comes down to semantics, Hummel said. She said she knows of instances in which SEC examiners have used keyword searches to hunt down phrases suggesting a firm "may receive" fees or other compensation in return for a certain service. Regulators insisted that to accurately reflect how an advisor made money in the past, the wording should be "did receive" or simply "received."
"They felt it was misleading when you actually did receive those fees," Hummel said.
