The Securities and Exchange Commission accused nine firms of marketing rule violations, with the companies paying a combined $850,000 for allegedly using hypothetical performance metrics in advertising without following the requirements of the rule.
SEC Enforcement Division Director Gurbir S. Grewal said hypothetical performance ads could pose an “elevated risk” for potential investors due to “their attention-grabbing power,” and urged industry registrants to make sure their policies and procedures mirrored the rule before moving forward on such ads.
“Until that is the case, we will remain vigilant and continue our ongoing sweep to ensure that investment advisors comply with the marketing rule, including the requirements for hypothetical performance advertisements,” he said.
Most of the nine affected firms had assets under management ranging from around $40 to $400 million, according to the orders detailing the settled charges. Two of the firms, Elm Partners Management and Linden Thomas Advisory Services, had AUM totaling $1.28 billion and $1.14 billion, respectively.
The other charged businesses included Banorte Asset Management, BTS Asset Management, Hansen and Associates Financial Group, Macroclimate, McElhenny Sheffield Capital Management, MRA Advisory Group and Trowbridge Capital Partners.
The amended marketing rule took effect in May 2021, with the final compliance date arriving in late 2022. The rule mandates when and how advisors can use testimonials and endorsements in advertising, as well as the kind of portfolio metrics firms can use to sell their services. In June, the commission released a risk alert detailing deficiencies SEC examiners had seen thus far.
In the rule, the commission defined hypothetical performance as results “not actually achieved by any portfolio” the advisor has, including model portfolio performance, performance with a backtested strategy to data from prior time periods, and target or projected performance returns.
In the case of Elm Partners Management, the firm allegedly published communications on its public website that constituted advertisements, according to the SEC. These ads include hypothetical performance derived from model portfolios, as well as performance metrics taken by backtesting a certain strategy against data from a prior time period, with the ads disseminated to the general public rather than a “particular intended audience,” according to the order.
The firm also failed to put into place policies and procedures “reasonably designed” to make sure it was relevant to the financial situation and objectives of its audience, according to the SEC. The Elm Partners allegations mirrored details included in the other eight orders.
Thayne Gould, a director of the compliance consulting firm Vigilant, told WealthManagement.com that firms need to be thinking about the “story you’re trying to tell” clients, and to have the appropriate documentation as to why you opted for using hypothetical performance metrics with certain clients; maybe, Gould suggested, the clients expressed interest in it.
"That's a much easier story and more prudent rationale to use than putting something on a website where anyone can see it. Obviously, the SEC is most concerned with the general public," he said. "If you have some rationale with the audience you’re using it with, even if you may be presenting to very similar types of clients all of the time, and they’re asking similar questions, it keeps it in a certain box of how it’s being used.”
For several years running, the ad rule has been a top concern for advisors in the industry, according to annual surveys from the Investment Adviser Association. In a separate survey, the IAA found that despite the rule going into effect with allowances for testimonials in ads under certain circumstances, only 5% of respondents said they’d increase their use of the practice (in the same survey, 41% of respondents said the rule was “somewhat impactful” to their firm, while 23% did not find it impactful at all and 32% found it “significantly impactful”).
Last month, the commission settled its first charges related to the amended rule, focusing on the New York-based fintech investment advisory firm Titan Global Capital Management. In the settlement, the SEC charged the firm with allegedly making misleading statements in marketing materials touting hypothetical performance based on its crypto strategy.
To settle the charges without admitting or denying the allegations, the nine firms cited this week agreed to censures and cease-and-desist orders from the commission, and paid civil penalties ranging from $50,000 to $175,000.
Thus far, the ad rule violations haven't included details about third-party metrics or firms' use of testimonials and endorsements in advertising, but Gould believed the SEC's guidance through its risk alert indicated that enforcement actions focusing on those parts of the rule were likely.
"They’re clearly signaling here’s what’s coming, and they’re going to take a closer look," he said. "And without prior guidance on how to implement all of these things, there are going to be folks that have stubbed toes."
