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SEC Charges RIA with Violations of Amended Marketing Rule
On August 21, 2023, the SEC announced that it had charged a registered investment adviser (the “RIA”) with violations of the Investment Advisers Act of 1940[1], including the recently amended Rule 206(4)-1 thereunder (known as the “Marketing Rule”). The SEC adopted significant amendments to the Marketing Rule in December 2020, with a required compliance date for RIAs of November 4, 2022 and an earlier voluntary compliance date any time beginning as of May 4, 2021 (the effective date of the rule). This enforcement action is the first instance of the SEC formally charging an RIA with violating the amended Marketing Rule.
The SEC alleged that the RIA, a fintech firm serving primarily retail clients, violated the Marketing Rule’s requirements for presentation of hypothetical performance and the Marketing Rule’s prohibition on making materially misleading statements. Specifically, the SEC asserted the RIA’s advertisements (A) included hypothetical performance information without the RIA adopting policies and procedures reasonably designed to ensure that the hypothetical performance was relevant to the likely financial situation and investment objectives of the intended audience (in this case, retail investors), and (B) provided the intended audience with insufficient information regarding both (i) the assumptions and criteria used to calculate the hypothetical performance and (ii) the risks and limitations in using hypothetical performance to make investment decisions. While the RIA’s website contained hyperlinks to webpages labeled “Track Record” and “Disclosures”, which included certain assumptions used in generating the performance and general risk disclosures, the SEC alleged that these disclosures were not presented in as “clear and prominent” a manner as the hypothetical performance because users could access this information only though embedded links in the advertisement.
The SEC also charged the RIA with making materially misleading statements regarding hypothetical performance contained in advertisements on its website. The website included an annualized return for the RIA’s crypto strategy of 2,700%, without disclosing that these returns were purely hypothetical, and that the RIA based the calculation on the assumption that the crypto strategy’s performance in its first three weeks would continue, such that the strategy would generate a twenty-one percent return every three weeks for an entire year. The RIA also failed to include in the advertisement disclosure regarding the significant risks associated with the annualized return calculation, and neglected to specify if the annualized return was presented net of fees and expenses.
The alleged Marketing Rule violations occurred between August 11, 2021 and October 3, 2022, before the mandatory compliance date for the amended Marketing Rule. However, because the RIA elected to voluntarily comply with the amended Marketing Rule before November 4, 2022, all provisions of the rule applied to the RIA’s advertisements at such time.
Takeaways
This enforcement action illustrates the SEC’s focus on the amended Marketing Rule. As noted by Osman Nawaz, Chief of Enforcement’s Complex Financial Instruments Unit, “[t]his action serves as a warning for all advisers to ensure compliance.” Viewing this case as evidence of the SEC’s willingness to take formal action to enforce the amended Marketing Rule, RIAs should anticipate that SEC staff examinations will include a thorough review of all marketing materials and related internal policies and procedures.
[1] The SEC also charged the RIA with making misleading statements about the custody of investors’ crypto assets, failing to obtain required client signatures for certain transactions, failing to adopt policies regarding employee trading in crypto assets, and including improper “hedge clauses” in client investment advisory agreements.
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08.24.2023 | PUBLICATION: BulletPoint | TOPICS: Investment Management