With the deadline for the SEC's new marketing rule fast approaching, many industry officials are expressing confidence that financial planners are well prepared for compliance.

But that doesn't mean everyone is clear on what they should be doing in all circumstances to stay on the right side of the law.

Financial planners are required to start abiding by the Securities and Exchange Commission's final rule on Investment Adviser Marketing by Nov. 4. Among other things, the rule sets a new definition for 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 rule officially took effect on May 4, 2021, but then advisors received 18 months to come into compliance. In general, it's meant to revise SEC regulations in light of changes in communication technology, while also gathering in a single place the many interpretations the SEC has provided on its original advertising rule since adopting it in 1961. The rule, for instance, consolidates the SEC's prohibitions and guidance relating to false and misleading advertising.

Jen Klass, co-chair of regulation and enforcement practices at the law firm Baker McKenzie, said the clients she has worked with on the marketing rule all appear to be taking it seriously and to be in a good spot with compliance. She said the rule largely fulfills the SEC's goal of consolidating the agency's interpretations and guidance on marketing. And because much of the rule consists of a summarization of existing practice, it shouldn't be entirely unfamiliar territory.

Still, Klass and others foresee situations in which advisors won't have a clear idea how to proceed. For instance, 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 include its "net performance." This refers to how much money was made after the subtraction of fees and other costs.

The ambiguity comes in when advisors try to decide which fees should be used for this purpose. Say, for example, that advisors are presenting performance results for a portfolio with multiple asset classes, each with its own fees. At such times, the rule allows them to simplify their calculations by relying on a single "model fee." These fees are supposed to be set as high as the highest actual fee the advisor would charge to the intended client. But with all the variables that influence fee structures, it can be far from obvious what the correct amount is.

"Is it the highest fee for a particular program or for all programs?" Klass said. "Is it the highest for the existing client base, or historically over some time period? So there is this interpretive question around model fees."

Sanjay Lamba, associate general counsel at the Investment Adviser Association, agreed that some of the greatest ambiguities in the new rule have to do with knowing what fees advisors should be using when they cite investment performance in their advertisements. Despite his group's repeated requests for elucidation, the SEC so far has proved reluctant to provide further guidance, Lamba said.

That means advisors will have to use their best judgment when advertising investment performance results. Fortunately, Lamba said, the SEC has shown leniency in the past when rolling out rules. In general, he said, regulators tend to avoid a "gotcha" approach in the months following implementation of a new rule and instead look for signs that a regulated entity is making a good faith effort to comply.

Such was the case when the SEC implemented a new rule on June 30, 2020, requiring registered advisors and broker-dealers to send a Customer Relationship Summary, or Form CRS, to clients every year. Regulators were at first just as interested in making sure industry professionals were trying to fulfill their responsibilities with the forms — which firms use to provide information about their services, client relationships and fees — as they were with enforcing compliance. The expectation of strict compliance came with time.

When SEC regulators perform their first round of exams on advisors expected to abide by the new rule, Lamba said, he expects them to encounter a number of compliance questions with no easy answers. Most likely, he said, those experiences will prompt the SEC to issue further guidance or to otherwise clarify what advisors should be doing in specific situations.

"It's also fair to say that SEC staff will probably be sharing their observations from their exams with the industry," Lamba said. "But what the timing of that will be, I don't know."

Lamba said the Investment Adviser Association has been holding weekly meetings on the new rule for well over a year. Rather than panicking about the new regulations, most firms seem to be taking an "all-hands-on" approach to ensuring they are in compliance, he said.

Lamba agreed that the new rule comes as a giant step in the right direction. Besides amending the SEC's advertising rule from 1961, the marketing rule also incorporates parts of the agency's cash solicitation rule from 1979. That's where the new permission for testimonials comes in.

Client testimonials
Previously, the SEC had not allowed advisors to make use of client testimonials in their marketing. That prohibition, said Bill Simpson, compliance principal at the compliance-technology company Hearsay Systems, was unpopular in the industry.

Advisors were looking with envy at insurance and banking professionals who could place client testimonials in their marketing and wondering why they couldn't do the same. The SEC's new marketing rule will allow them to use testimonials, as well as endorsements from non-clients or former clients, as long as they meet certain conditions. They, for instance, will have 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.

Simpson said he thinks, unlike many new SEC regulations, small firms will have an easier time complying with this aspect of the rule than their large rivals. With relatively few staff soliciting testimonials, small firms are unlikely to be overburdened ensuring every one of their marketing communications complies with the law.

"It's easy to do that when you know the five people you are supervising," he said. "You are pretty much in their day-to-day lives."

Large firms, Simpson predicted, will have to turn to technology to stay on top of their responsibilities. Simpson said Hearsay Systems offers a service that uses a two-step screening process to flag possibly questionable testimonials. First it asks if an advisor sought a testimonial for an existing client or former client, whether compensation was paid for the testimonial and whether there are any conflicts of interest with the testimonial provider. After that, it uses technology to scan the testimonial's language to flag possibly problematic words. Only then, if red flags are spotted, are the firm's compliance officials brought in for further review.

Although monitoring testimonials will no doubt prove complex and burdensome, firms that refuse to do it could pay a price, Simpson said. If the number of advisors who have been asking the SEC for permission to use them is any indication, he said, companies that choose to forgo them could risk losing talented professionals to competitors.

"Especially in a remote-work environment, the best way to create a presence online and to be perceived as trustworthy is often to create testimonials and allow testimonials," Simpson said.

Online reviews
Along with consulting testimonials, many clients search for advisors using online reviews published on sites like Yelp and Google. In such cases, the new rule makes it clear that advisors are not responsible for the content of the reviews as long as they make no attempt to influence their content; as soon as they do, Simpson said, they could be held to account for any false or misleading interpretation. For that reason, Simpson recommends advisors take a hands-off approach with online reviews.

The new rule also allows firms to hire outside firms to conduct surveys of current and former clients and use the results in their marketing. But firms that do this have to be careful to disclose how much they paid for the polling and the methods used in the data collection. They also must make sure that the third party enlisted did not set out to obtain a particular result and that it presents its survey results in a fair and accurate manner.

Other provisions of the new marketing rule:

  • Defines an advertisement as a communication an advisor sends to two or more current or potential clients about new advisory services. One-on-one communications are exempted.
  • Prohibits not only false statements and material omissions of fact but also statements that could give rise to misleading implications or inferences.
  • Excludes statements that are unrelated to advisory services but are instead about a firm's community or philanthropic activity or are merely displays of its name.
  • 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.
  • Calls on advisors to answer a series of questions about their advertising practices when annually amending their Form ADV — used to register with the SEC.

Lamba said the marketing rule has certainly given advisors plenty to think about over the past 18 months. Fortunately, he said, most appear to be taking their new responsibilities seriously.
"Based on all the meetings I've had with our membership," he said, "we should be ready to go."

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