On December 22, 2020, the Securities and Exchange Commission (SEC) released an amended, “modernized” Rule 206(4)-1 of the Investment Adviser’s Act of 1940 (the “Marketing Rule”) citing advancements in technology, changes in investors’ expectations, and the diversification of the investment advisory industry. It has been forty years since the Marketing Rule was substantially amended. Much has changed since 1980.
Although the amended Marketing Rule contains a number of revisions to its many parts, perhaps the most impactful change for investment advisers providing advisory services to retail clients is the elimination of the prohibitions on client testimonials and endorsements, namely the “Testimonial Rule.”
Previously, Rule 206(4)-1 prohibited “any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report, or other service rendered by such investment adviser.” A 2012 Risk Alert published by the SEC made clear, importantly, that the Testimonial Rule applied to statements made by advisers, their reps, and third parties on social media. In 2014, the SEC released further guidance regarding testimonials on social media stating that any public commentary made directly by a client or third party could be testimonial in nature where the adviser or a rep played a role directly or indirectly obtaining or requesting such commentary. But, our advice to advisers over the years to deactivate the “comments” section in their business Facebook pages to prevent any appearance of a potential violation of the Testimonial Rule is now obsolete.
The new Marketing Rule separates compensated and uncompensated testimonials, but both fall under the Rule. Both types of testimonials must meet the general prohibitions for advertisements. In an example, the SEC stated that a testimonial that touts profitability must be representative of the experience of all the adviser’s clients to comply with the Rule. Further, for both compensated and uncompensated testimonials and endorsements, the advertisement must “clearly and prominently” disclose (1) whether the testimonial is from a client or non-client; (2) whether cash or non-cash compensation was given in exchange for the testimonial; and (3) any conflicts of interest that may exist. For compensated testimonials or endorsements, the Marketing Rule includes heighted requirements. For example, certain persons are ineligible from providing a compensated testimonial and an agreement must be in place for testimonials that meet a certain payment threshold.
All in all, the updates to the Marketing Rule are a step in the right direction for the industry. Almost every industry utilizes testimonials and endorsements in some shape or form to promote their product and services (i.e. Yelp ratings, Amazon product reviews, Uber driver reviews). The retail public craves this type of vindication and the SEC acknowledged that in its rulemaking. Given that the SEC will require advisers to fully disclose their marketing efforts in their Form ADV to assist them in inspection and enforcement, the industry can expect the amended Rule to be an exam priority immediately. Advisers should use the generous 18 month grace period provided by the SEC to become familiar with the Rule and put the necessary compliance procedures in place to make sure they can effectively monitor their advertising material and those advertisements made on their behalf by their work force and third party marketing firms.