Although not specifically prohibited, investment advisers should be cautious when using performance data in advertising as the securities regulator may claim that the performance advertisement contains untrue statements of a material fact or is otherwise false or misleading. The U.S. Securities and Exchange Commission (“SEC”) has explained that advertisements shall be considered false or misleading depending on the facts and circumstances involved in its use, including:

The form and context of the advertisement;
The implications or inferences arising out of the advertisement in its total context;
The sophistication of the client or prospective client.

Rule 206(4)-1 – Advertisements by Investment Advisers under the Investment Advisers Act of 1940 does not specifically address performance advertising. However, to assist investment advisers, the SEC has issued a series of no-action letters explaining a number of performance advertising practices that it believes are inappropriate given Rule 206(4)-1’s restrictions. The most influential no-action letter is dated October 28, 1986 and written to Clover Capital Management, Inc. outlining the items that in the SEC staff’s view are prohibited under Rule 206(4)-1 in relation to performance advertising:

A performance advertisement containing either Model or Actual results may be considered misleading if it:

Fails to disclose the effect material market or economic conditions on the results portrayed;
Includes model or actual results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;
Fails to disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
Suggests or makes claims about the potential for profit without also disclosing the possibility of loss;
Compares model or actual results to an index without disclosing all material facts relevant to the comparison;
Fails to disclose any material conditions, objectives, or investment strategies used to obtain the results portrayed.

In connection with Model results, the following additional omissions or practices would be misleading:

Fails to disclose prominently the limitations inherent in model results, particularly the fact that such results do not represent actual trading and that they may not reflect the impact that material economic and market factors might have had on the advisory’s decision-making if the adviser were actually managing the clients’ money;
Fails to disclose, if applicable, that the conditions, objectives, or investment strategies of the model portfolio changed materially during the time period portrayed in the advertisement and, if so, the effect of such change on the results portrayed;
Fails to disclose, if applicable that any of the securities contained in, or the investment strategies followed with respect to, the model portfolio do not relate, or only partially relate, to the type of advisory services currently offered by the adviser;
Fails to disclose, if applicable, that the adviser’s clients had investment results materially different from the results portrayed in the model.

In connection with Actual results, the following additional omission would be misleading:

Fails to disclose prominently, if applicable, that the results portrayed related only to a select group of the adviser’s clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.

The SEC concludes its letter to Clover Capital Management, Inc. by declaring that investment advisers using models or results in advertising must ensure the advertisement is not false or misleading and that the lists above are not intended to be all-inclusive or provide a safe harbor.

Since issuing the Clover Capital Management, Inc. no-action letter, the SEC has published several additional no-action letters clarifying and in some cases relaxing certain standards set forth under Clover Capital Management, Inc. If your investment adviser issues performance advertising, it is important to understand all guidelines and restrictions issued by the SEC in their performance advertising no-action letters.

If you need guidance on the performance advertising rules and other marketing rules and regulations, RIA Compliance Consultants will be conducting a webinar, Performance Advertising for Investment Advisers, on Thursday, March 15, 2012, at 12:00 CST. This webinar satisfies one hour continuing education requirements for CFP designees. Additionally, if you need help implementing performance reporting procedures or reviewing performance advertising materials RIA Compliance Consultants would be happy to assist you; click here to schedule a time to speak with one of our compliance consultants.

Performance Advertising for Investment Advisers

February 22, 2012

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