From Hypothetical Performance to Real Consequences: SEC’s Message to Advisers

Apr 15th '24

The U.S. Securities and Exchange Commission (SEC) has sent a clear message to the investment advisory industry with its latest enforcement actions related to the Marketing Rule. Five firms were charged and fined over $200,000 for a range of violations, underscoring the agency’s commitment to ensuring advisers adhere to the rule’s strict compliance requirements.


At the heart of these cases were issues surrounding the use of hypothetical performance data in firm advertising and marketing materials. The SEC found that the five advisory firms had advertised hypothetical performance on their public websites without putting the proper policies and procedures in place. Specifically, the SEC determined that these firms failed to adopt and implement measures designed to ensure the hypothetical performance information was relevant to the likely financial situation and investment objectives of their intended audience. Rather, the performance data was presented to the general public, which the SEC says is generally not permissible under the rule.


“We believe that advisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation. In that case, because the advertisement would be available to mass audiences, an adviser generally could not form any expectations about their financial situation or investment objectives.” Stated in the Sec’s orders


Beyond the hypothetical performance issues, the SEC also cited these firms for various other Marketing Rule violations, including:


  • Failing to maintain copies of advertisements that appeared on their websites
  • Lacking documentation to substantiate the performance claims made in advertisements
  • Not conducting the required annual reviews of their compliance policies and procedures


Interestingly, four of the five firms received reduced penalties due to the corrective steps they had taken prior to being contacted by SEC staff. This “self-report credit” highlights the importance of proactively addressing compliance deficiencies rather than waiting for regulatory action.


The fifth firm was hit with a $100,000 fine, the most significant penalty of the group. The Commission found that the firm violated the rule in multiple ways, showcasing a widespread compliance breakdown. This included making false and misleading claims about its investment performance, failing to present net performance figures alongside reported gross performance as required, and being unable to properly substantiate the advertised performance data.


Beyond the performance issues, the SEC also determined the firm had advertised hypothetical performance on its website without the necessary policies and procedures in place to ensure relevance to the intended audience. The compliance breakdowns at the firm extended to its basic record-keeping obligations as well – the firm failed to maintain copies of the advertisements that appeared on its website. It also lacked the proper books and records to demonstrate how it calculated the performance figures in those ads. Perhaps most troublingly, the firm was cited for neglecting to conduct the annual review of its compliance policies and procedures required under SEC rules.


These enforcement actions send a clear message that the SEC is actively policing the investment advice industry when it comes to marketing and advertising activities. Advisers must have a comprehensive understanding of the Marketing Rule’s requirements and be diligent in maintaining robust compliance programs. Failing to get Marketing Rule compliance right can result in significant regulatory penalties and lasting reputational damage. Investment advisers would be wise to heed the lessons from these enforcement actions and make adherence a top priority.


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Source: Smarsh. Author: Tiffany Magri Regulatory Advisor at Smarsh


About the author: 

As a Regulatory Advisor at Smarsh, Tiffany monitors, evaluates and consults on the financial services regulatory landscape. Tiffany has more than 10 years of experience facilitating compliance with laws and regulations, policies, and risk management. Prior to joining Smarsh, Tiffany was a Senior Associate at Benefit Street Partners and a Compliance Analyst at Broadstone and Manning & Napier Advisors.


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