The Securities and Exchange Commission’s new adviser marketing rule, finalized in November 2022, saw its first enforcement action on August 21, when a $1 million fine was levied against Titan Global Capital Management USA LLC, an investment advisory firm, for deceptive marketing materials related to hypothetical performance.
The marketing rule applies to all communications delivered to more than one person and offering or describing an adviser’s services, unless it is “extemporaneous live communication”—off-the-cuff or “truly bespoke” communication—according to Dan Bresler, a partner in the law firm Seward & Kissel LLP. Even if the same talking points are delivered to individuals one at a time, it still counts as more than one person, and would also qualify as prepared remarks and would therefore be subject to the rule.
Communication involving hypothetical performance, though, is subject to the marketing rule even if communicated only to a single person. Bresler says the SEC believes that “hypothetical performance raises significant enough concerns from a misleading and conflicts perspective that those communications should go through the required compliance oversight.”
Hypothetical performance can include forward-looking projections, but it more commonly features hypothetical application of past data to a new product, portfolio or strategy that did not previously exist.
Advisers should avoid looking for creative ways to evade the marketing rule’s restrictions on hypothetical performance and instead find ways to follow it, Bresler recommends. For example, advisers should not worry if what they are saying is technically hypothetical or not, or what the size of their audience is or might be in the future. Instead, the “more common approach is just to accept that it is an advertisement.”
Bresler says advisers should “have a process for preparing materials” that would meet SEC marketing requirements and, “once you have that process running, you can generate materials pretty quickly, and you don’t need to worry if you get into hypothetical performance.”
Even though the SEC charged Titan with violations related to hypothetical performance, Titan was cited for infractions that would have been problematic under the previous marketing rule, according to Bresler. Specifically, citing a 2,700% annual return without mentioning that the figure was based on a cherry-picked three-week window extrapolated to one year was “egregious” and “under any regime, that would be misleading.”
Bresler says the SEC avoided some of the more controversial elements of the marketing rule in the Titan settlement, such as the requirement that marketing materials featuring gross performance must also show net performance by accounting for related fees.
Bresler explains that some advisers may advertise performance of a portfolio by sector or by region and may struggle to aggregate the fee structures among various investments into one number in order to calculate net performance. Because of this ambiguity, “enforcement for those issues would be a big concern for market actors,” and he believes advisers are hoping for additional “guidance before enforcement.”