Publications

2023 Risk Alert

Specifically, the staff will focus on whether:

THSH’s Practical Observations

In practice, the following areas are worth noting:

adequate disclosures are being provided in the testimonial or endorsement, including clear and prominent disclosure of whether the person giving the testimonial or endorsement (the “promoter”) is a client or investor, that the promoter is compensated (if applicable), and of material conflicts of interest.

The required disclosure has three aspects of requirements:

Timing: the disclosure should be made at the time the testimonial or endorsement is disseminated;

Contents: the disclosure should describe (i) the relationship with the RIA, (ii) any compensation, and (iii) any material conflicts of interest; and

Format: the disclosure should be “clear and prominent,” which typically requires such disclosure to be close to the applicable testimonial or endorsement, for example, on the same page.

oversight conditions are being met, such as whether an RIA has a reasonable basis for believing that the testimonials or endorsements disseminated in fact comply with the Marketing Rule.

The corresponding Rule 204-2 (“Books and Records Rule”) requires an RIA to keep books and records of (i) each compensated testimonial and endorsement (or for each oral testimonial and endorsement, a record of the disclosures provided to clients or investors) and (ii) documentation substantiating the RIA’s “reasonable basis for believing” that a testimonial or endorsement complies with the Marketing Rule. Therefore, it is necessary for RIAs to document sources of their belief and keep supporting files of their due diligence; otherwise, they may use alternative supportable testimonial(s) or endorsement(s).

written agreements are being entered into, when required (e.g., written agreements with promoters), unless the promoter is an affiliate of the RIA and the connection is disclosed or readily apparent, or the promoter receives de minimis compensation, meaning $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months.

Placement agents are a category of promotors. For RIAs of private funds marketing through placement agents, except for the enumerated exceptions, it is necessary to (i) enter into written private placement agreements with such placement agents setting forth compensation and agreed-upon scope of services, (ii) disclose that the placement agents’ endorsements are made by non-clients and non-investors and satisfy other disclosure requirements, and (iii) ensure investors receive the required disclosures.

ineligible persons have been compensated for testimonials or endorsements, if the RIA knew or reasonably should have known the person was ineligible at the time the testimonial or endorsement is disseminated, unless such promoters meet certain exemptions.

Before compensating for a testimonial or endorsement, an RIA needs to exercise reasonable care to ensure the person giving the testimonial or endorsement is not an “ineligible person”, meaning a person who is subject either to a “disqualifying Commission action” or to any “disqualifying event” defined under Sections 206(4)-1(e)(3) and (4). It would be helpful if an RIA can conduct more thorough due diligence of such person’s background and require such person makes necessary representations and warranties in the written agreement, if any. In addition, Compensation provided for a testimonial or endorsement includes both cash compensation and non-cash compensation, such as advisory fee waivers and gifts, which may pose special challenges for RIAs to properly keep track of and disclose such types of compensation.

2023 Risk Alert

Specifically, the staff will examine:

THSH’s Practical Observations

In practice, the following areas are worth noting:

whether the RIA provides, or reasonably believes the third-party rating provides, clear and prominent disclosure of (i) the date on which the rating was given and the period of time upon which the rating was based, (ii) the identity of the third party that created and tabulated the rating, and, (iii) if applicable, that compensation has been provided (either directly or indirectly) by the adviser in connection with obtaining or using the third-party rating.

The required disclosure has two aspects of requirements:

Contents: the disclosure should describe (i) the date and time period of the rating, (ii) the identity of the third party and (iii) any compensation; and

Format: “clear and prominent” typically requires such disclosure to be close to the third-party rating in an advertisement, for example, on the same page.

whether any questionnaires or surveys used in preparation of a third-party rating meet the requirements under the rule, such as that the adviser has a reasonable basis for believing that the questionnaire or survey is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed/prepared to produce a predetermined result.

The corresponding Books and Records Rule requires an RIA to keep books and records of (i) a copy of any questionnaire or survey (if available) used in the preparation of a third-party rating and (ii) documentation substantiating the RIA’s “reasonable basis for believing” that the third-party rating complies with the Marketing Rule. RIAs need to document sources of their belief and keep supporting files of their due diligence; otherwise, they may give up using the applicable third-party rating in their advertisements.

2023 Risk Alert

THSH’s Practical Observations

The 2023 Risk Alert indicated that the staff will review RIAs’ responses on Form ADV to see whether RIAs accurately completed the new questions about their marketing practices in their annual Form ADV amendments.

In addition to providing information for questions listed in Item 5.L of Form ADV, Part 1A, RIAs also need to review whether their previous Form ADV Part 2A (“Brochure”) contained any references to the prior cash solicitation rule. If so, RIAs need to update the relevant language, because the cash solicitation rule is no longer in effect.

As indicated in Form ADV General Instructions and the 2022 Risk Alert, RIAs are only required to provide information in Item 5.L of Part 1A in annual amendments. Form ADV does not require RIAs to file other-than-annual amendments to update Item 5.L of Part 1A promptly.

RIAs whose most recent fiscal year ended on December 31, 2022 should have filed their Form ADV annual updates by March 31, 2023, which would be the targets of the SEC staff’s review. If an RIA has not filed its Form ADV annual update because its fiscal year ends later, such RIA should carefully complete Item 5.L of Part 1A and update language in the Brochure as necessary.

RIAs should ensure disclosures on their marketing practices are consistent among Form ADV, private placement memoranda and other disclosures. If not, conforming updates are needed.