The SEC’s Division of Examinations (the “Division”) recently issued a Risk Alert (the “Alert”) on its findings from private fund adviser examinations that covered compliance with revised Rule 206(4)-1 (the “Marketing Rule”). The specific areas of focus within the Alert reviewed the use of testimonials, endorsements, and third-party ratings in marketing materials.
The Alert indicates that many private fund advisers are falling short of compliance due to lack of proper disclosure practices, among other requirements. In summary, the Division found the following deficiencies:
Testimonials and Endorsements
Hyperlinks – Many advisers were found to be using hyperlinks to disclosures as opposed to providing the disclosures directly with the testimonial or endorsement. Hyperlinked disclosures do not satisfy the “clear and prominent” disclosure standard of the Marketing Rule.
Font Size or Type – Font size or type used in disclosures that is smaller or lighter than the actual text of the testimonial or endorsement is also a violation of the “clear and prominent” disclosure requirement.
Third-party Websites – Some firms were using testimonials or endorsements from third-party websites without any disclosures that they were provided by current or former clients.
Compensation – Many deficiencies were noted regarding compensation to promoters.These included lack of required dollar amounts or fee percentages, omission of referral payment terms, poor conflict disclosures when promoters had a financial interest in the adviser or were affiliated with a subadviser to a fund. In addition, some advisers did not understand that the de minimis threshold regarding compensation included compensation over a 12-month period and were only calculating on a per testimonial basis. This resulted in falling outside the allowable threshold.
Reasonable Basis for Belief – To prove oversight and compliance with the Marketing Rule, advisers must have a reasonable basis for belief that the testimonial or endorsement meets the requirements of the Rule. This can only be proven if the adviser has the appropriate documentation or agreements. Many were found to not be able to provide a “reasonable basis for belief.”
Disciplinary Histories – Some advisers used promoters with state disciplinary histories and were therefore deemed ineligible persons.
Affiliated Promoters – Exemptions exist for the use of promoters affiliated with the adviser, but only if the affiliation is readily apparent. If it is not abundantly clear that the promoter is an affiliate of the adviser, then it must be disclosed at the time of the endorsement or testimonial. Some advisers were not making such disclosures until they were introduced, after the fact.
Third-Party Ratings
Due Diligence – Some advisers could not provide proof of due diligence. An adviser must conduct a certain level of due diligence before utilizing a third-party rating in marketing materials. This is required to prove a reasonable basis for belief that the questionnaire or survey used to gather the data was structured in an unbiased manner. This is often documented by an analysis of the questionnaire used.
Hyperlinks – Links to third-party websites that contained the ratings lacked required disclosures, and the advisers did not include disclosures on their own website. Also, the use of hyperlinks for the required disclosures on advisers’ websites was deemed not sufficient, nor is the use of smaller font for disclosures.
Timelines – The actual timeline of the rating period was at times misleading when date ranges were utilized for the rating. For example, showing an award or ranking for the period 2022-2025 when the adviser was not ranked in 2023.
Logos – Advertisements that include the use of a firm logo for a rating entity but no other identifying information, such as the firm name, to identify the rating entity.
Compensation – Advisers that paid to be included in a ranking did not always have the required disclosure in marketing materials regarding the compensation paid, such as if the compensation was used for obtaining the provider’s logos or reprints, the adviser’s priority placement in the provider’s marketing materials, or if payments were made for referrals.
You will notice some common themes above. Staff is concerned about how private fund advisers use hyperlinks, disclose compensation arrangements, and prove they have a reasonable basis for belief. Now is the time to review your marketing practices, policies, and procedures to determine if your firm may be at risk or in violation of the Marketing Rule.
