Investment Adviser Marketing, 13024-13147 [2020-28868]

Download as PDF 13024 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations Advisers Act. The Commission is rescinding 17 CFR 275.206(4)–3 (rule 206(4)–3) under the Advisers Act. SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 275 and 279 Table of Contents [Release No. IA–5653; File No. S7–21–19] RIN 3235–AM08 Investment Adviser Marketing Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (the ‘‘Commission’’ or the ‘‘SEC’’) is adopting amendments under the Investment Advisers Act of 1940 (the ‘‘Advisers Act’’ or the ‘‘Act’’) to update rules that govern investment adviser marketing. The amendments will create a merged rule that will replace both the current advertising and cash solicitation rules. These amendments reflect market developments and regulatory changes since the advertising rule’s adoption in 1961 and the cash solicitation rule’s adoption in 1979. The Commission is also adopting amendments to Form ADV to provide the Commission with additional information about advisers’ marketing practices. Finally, the Commission is adopting amendments to the books and records rule under the Advisers Act. DATES: Effective date: This rule is effective May 4, 2021. Compliance dates: The applicable compliance dates are discussed in section II.K. FOR FURTHER INFORMATION CONTACT: Juliet Han, Emily Rowland, Aaron Russ, or Christine Schleppegrell, Senior Counsels; Thoreau Bartmann or Melissa Roverts Harke, Senior Special Counsels; or Melissa Gainor, Assistant Director, at (202) 551–6787 or IM-Rules@sec.gov, Investment Adviser Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to 17 CFR 275.206(4)–1 (rule 206(4)–1) and 17 CFR 275.204–2 (rule 204–2) under the Investment Advisers Act of 1940 [15 U.S.C. 80b–1 et seq.],1 and amendments to 17 CFR 279.1 (Form ADV) under the jbell on DSKJLSW7X2PROD with RULES2 SUMMARY: 1 Unless otherwise noted, when we refer to the Advisers Act, or any section of the Advisers Act, we are referring to 15 U.S.C. 80b, at which the Advisers Act is codified. When we refer to rules under the Advisers Act, or any section of those rules, we are referring to title 17, part 275 of the Code of Federal Regulations [17 CFR part 275], in which these rules are published. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 I. Introduction Advertising and Solicitation Rules and Proposed Amendments Merged Marketing Rule II. Discussion A. Scope of the Rule: Definition of ‘‘Advertisement’’ 1. Overview 2. Definition of Advertisement: Communications Other Than Compensated Testimonials and Endorsements 3. Definition of Advertisement: Compensated Testimonials and Endorsements, Including Solicitations 4. Investors in Private Funds B. General Prohibitions 1. Untrue Statements and Omissions 2. Unsubstantiated Material Statements of Fact 3. Untrue or Misleading Implications or Inferences 4. Failure To Provide Fair and Balanced Treatment of Material Risks or Material Limitations 5. Anti-Cherry Picking Provisions: References to Specific Investment Advice and Presentation of Performance Results 6. Otherwise Materially Misleading C. Conditions Applicable to Testimonials and Endorsements, Including Solicitations 1. Overview 2. Required Disclosures 3. Adviser Oversight and Compliance 4. Disqualification for Persons Who Have Engaged in Misconduct 5. Exemptions D. Third-Party Ratings E. Performance Advertising 1. Net Performance Requirement; Elimination of Proposed Schedule of Fees Requirement 2. Prescribed Time Periods 3. Statements About Commission Approval 4. Related Performance 5. Extracted Performance 6. Hypothetical Performance F. Portability of Performance, Testimonials, Endorsements, Third-Party Ratings, and Specific Investment Advice G. Review and Approval of Advertisements H. Amendments to Form ADV I. Recordkeeping J. Existing Staff No-Action Letters K. Transition Period and Compliance Date L. Other Matters III. Economic Analysis A. Introduction B. Broad Economic Considerations C. Baseline 1. Market for Investment Advisers for the Advertising Rule 2. Market for Solicitation Activity 3. RIA Clients D. Costs and Benefits of the Final Rule and Form Amendments 1. Quantitative Estimates of Costs and Benefits 2. Definition of Advertisement PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 3. General Prohibitions 4. Conditions Applicable to Testimonials and Endorsements, Including Solicitations 5. Third-Party Ratings 6. Performance Advertising 7. Amendments to Form ADV 8. Recordkeeping E. Efficiency, Competition, Capital Formation 1. Efficiency 2. Competition 3. Capital Formation F. Reasonable Alternatives 1. Reduce or Eliminate Specific Limitations on Investment Adviser Advertisements 2. Bifurcate Some Requirements 3. Hypothetical Performance Alternatives 4. Alternatives to the Combined Marketing Rule 5. Alternatives to Disqualification Provisions IV. Paperwork Reduction Act Analysis A. Introduction B. Rule 206(4)–1 1. General Prohibitions 2. Testimonials and Endorsements in Advertisements 3. Third-Party Ratings in Advertisements 4. Performance Advertising 5. Total Hour Burden Associated With Rule 206(4)–1 C. Rule 206(4)–3 D. Rule 204–2 E. Form ADV V. Final Regulatory Flexibility Analysis A. Reason for and Objectives of the Final Amendments 1. Final Rule 206(4)–1 2. Final Rule 204–2 3. Final Amendments to Form ADV B. Significant Issues Raised by Public Comments C. Legal Basis D. Small Entities Subject to the Rule and Rule Amendments 1. Small Entities Subject to Amendments to Marketing Rule 2. Small Entities Subject to Amendments to the Books and Records Rule 204–2 3. Small Entities Subject to Amendments to Form ADV E. Projected Reporting, Recordkeeping and Other Compliance Requirements 1. Final Rule 206(4)–1 2. Final Amendments to Rule 204–2 3. Final Amendments to Form ADV F. Duplicative, Overlapping, or Conflicting Federal Rules 1. Final Rule 206(4)–1 2. Final Amendments to Form ADV G. Significant Alternatives 1. Final Rule 206(4)–1 Statutory Authority Appendix A: Changes to Form ADV Appendix B: Form ADV Glossary of Terms I. Introduction We are adopting an amended rule, rule 206(4)–1, under the Advisers Act, which addresses advisers marketing their services to clients and investors (the ‘‘marketing rule’’). The marketing rule amends existing rule 206(4)–1 (the ‘‘advertising rule’’), which we adopted E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 in 1961 to target advertising practices that the Commission believed were likely to be misleading.2 The rule also replaces rule 206(4)–3 (the ‘‘solicitation rule’’), which we adopted in 1979 to help ensure clients are aware that paid solicitors who refer them to advisers have a conflict of interest.3 We have not substantively updated either rule since adoption.4 In the decades since the adoption of both rules, however, advertising and referral practices have evolved. Simultaneously, the technology used for communications has advanced, the expectations of investors shopping for advisory services have changed, and the profiles of the investment advisory industry have diversified. Our marketing rule recognizes these changes and our experience administering the advertising and solicitation rules. Accordingly, the rule contains principles-based provisions designed to accommodate the continual evolution and interplay of technology and advice. The rule also contains tailored restrictions and requirements for certain types of advertisements, such as performance advertising, testimonials and endorsements, and third-party ratings. Compensated testimonials and endorsements, which include traditional referral and solicitation activity, will be subject to disqualification provisions. We believe the final marketing rule will allow advisers to provide existing and prospective investors with useful information as they choose among investment advisers and advisory services, subject to conditions that are reasonably designed to prevent fraud. Finally, we are adopting related amendments to Form ADV that are designed to provide the Commission with additional information about advisers’ marketing practices, and related amendments to the Advisers Act books and records rule, rule 204–2. 2 Advertisements by Investment Advisers, Release No. IA–121 (Nov. 1, 1961) [26 FR 10548 (Nov. 9, 1961)] (‘‘Advertising Rule Adopting Release’’). 3 See Requirements Governing Payments of Cash Referral Fees by Investment Advisers, Release No. 688 (July 12, 1979) [44 FR 42126 (Jul 18, 1979)] (‘‘1979 Adopting Release’’). 4 The advertising rule has been amended once, when the Commission revised the introductory text of paragraph (a) as part of a broader amendment of several rules under the Advisers Act to reflect changes made by the National Securities Market Improvement Act of 1996. Rules Implementing Amendments to the Investment Advisers Act of 1940, Release No. IA–1633 (May 15, 1997) [62 FR 28112, 28135 (May 22, 1997)] (‘‘Release 1633’’). We have not amended the solicitation rule since adoption. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 Advertising and Solicitation Rules and Proposed Amendments Advertisements can provide existing and prospective investors with useful information as they contemplate whether to utilize and pay for investment advisory services, whether to approach particular investment advisers, and how to choose among their available options. At the same time, advertisements present risks of misleading investors because an investment adviser’s interest in attracting investors may conflict with the investors’ interests, and the adviser is in control of the design, content, format, media, timing, and placement of its advertisements. As a consequence, advertisements may mislead existing and prospective investors about the advisory services they will receive, including indirectly through the services provided to private funds.5 The advertising rule was designed to address the potential harm to investors from misleading advertisements. Advisers also attract investors by compensating individuals or firms to solicit new investors. Some investment advisers directly employ individuals to solicit new investors on their behalf, and some investment advisers arrange for related entities or third parties, such as broker-dealers, to solicit new investors. The person or entity compensated has a financial incentive to recommend the adviser to the investor.6 Without appropriate disclosure, this compensation creates a risk that an investor would mistakenly view the recommendation as being an unbiased opinion about the adviser’s ability to manage the investor’s assets and would rely on that recommendation more than the investor would if the investor knew of the incentive. The solicitation rule was designed to help 5 The final rule covers marketing activities by investment advisers to clients and prospective clients as well as investors and prospective investors in private funds that those advisers manage. See 15 U.S.C. 80b–2(a)(29) (defining a ‘‘private fund’’ as ‘‘an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act’’). Unless we specify otherwise, for purposes of this release, we refer to any of these persons generally as ‘‘investors,’’ and we refer specifically to investors in private funds managed by those advisers as ‘‘private fund investors.’’ 6 While we traditionally referred to those who engaged in compensated solicitation activity under the current solicitation rule as ‘‘solicitors,’’ we use the term ‘‘promoter’’ in this release to refer to a person providing a testimonial or endorsement, whether compensated or uncompensated. We also use the term ‘‘provider’’ at times when discussing a person providing an uncompensated testimonial or endorsement. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 13025 expose to clients the conflicts of interest posed by cash compensation. The concerns that motivated the Commission to adopt the advertising and solicitation rules still exist today, but investment adviser marketing has evolved with advances in technology. In the decades since the adoption of both the advertising and solicitation rules, the use of the internet, mobile applications, and social media has become an integral part of business communications. Consumers today often rely on these forms of communication to obtain information, including reviews and referrals, when considering buying goods and services. Advisers and third parties also rely on these same types of outlets to attract and refer potential customers. The nature and profiles of the investment advisory industry and investors seeking those advisory services have also changed since the Commission adopted the advertising and solicitation rules. Some investors today rely on digital investment advisory programs, sometimes referred to as ‘‘robo-advisers,’’ for investment advice, which is provided exclusively through electronic platforms using algorithmic-based programs. In addition, passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’) required many investment advisers to private funds that were previously exempt from registration to register with the Commission and become subject to additional provisions of the Advisers Act and the rules thereunder. Private funds and their advisers often hire promoters to obtain investors in the funds. Referral practices also have expanded to include, for example, various types of compensation, including non-cash compensation, in referral arrangements. In light of these developments, we proposed amendments to the advertising rule to: (i) Modify the definition of ‘‘advertisement’’ to be more ‘‘evergreen’’ in light of everchanging technology; (ii) replace four per se prohibitions with general prohibitions of certain advertising practices applicable to all advertisements; (iii) provide certain restrictions and conditions on testimonials, endorsements, and thirdparty ratings; and (iv) include tailored requirements for the presentation of performance results, based on an advertisement’s intended audience.7 7 See Investment Adviser Advertisements; Compensation for Solicitations, Release No. IA– 5407 (Nov. 4, 2019) [84 FR 67518 (Dec. 10, 2019)] (‘‘2019 Proposing Release’’). E:\FR\FM\05MRR2.SGM 05MRR2 13026 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 The proposed rule also would have required internal review and approval of most advertisements. Finally, we proposed amendments requiring each adviser to report additional information regarding its advertising practices in its Form ADV. Additionally, we proposed amendments to the solicitation rule to: (i) Expand the rule to cover solicitation arrangements involving all forms of compensation, rather than only cash compensation; (ii) expand the rule to apply to the solicitation of current and prospective investors in any private fund, rather than only to ‘‘clients’’ (including prospective clients) of the investment adviser; (iii) eliminate requirements duplicative of other rules; (iv) include exceptions for de minimis payments and certain non-profit programs; and (v) expand the types of disciplinary events that would trigger the rule’s disqualification provisions. We received more than 90 comment letters on the proposal.8 The Commission also received feedback flyers from individual investors on investment adviser marketing and from smaller advisers on the proposal’s effects on small entities.9 Commenters generally supported modernizing these rules and agreed with our general approach. Many commenters, however, expressed concern that several aspects of the proposed amendments to the advertising rule would increase an investment adviser’s compliance burden.10 For example, some commenters suggested removing the proposed internal pre-use review and approval requirement and narrowing the proposed definition of ‘‘advertisement.’’ 11 Others requested that we provide additional guidance on various topics, such as how the general prohibitions will apply in certain scenarios.12 Commenters also expressed concern that the proposed amendments to the solicitation rule would 8 The comment letters on the 2019 Proposing Release (File No. S7–21–19) are available at https:// www.sec.gov/comments/s7-21-19/s72119.htm. 9 The feedback forms are available in the comment file at https://www.sec.gov/comments/s721-19/s72119.htm. 10 See, e.g., Comment Letter of Wellington Management Company LLP (Feb. 10, 2020) (‘‘Wellington Comment Letter’’); Comment Letter of Fidelity Management Research Company LLC (Feb. 10, 2020) (‘‘Fidelity Comment Letter’’); 11 See, e.g., Comment Letter of Investment Adviser Association (Feb. 10, 2020) (‘‘IAA Comment Letter’’); Comment Letter of the National Society of Compliance Professionals (Feb. 7, 2020) (‘‘NSCP Comment Letter’’). 12 See, e.g., Comment Letter of LinkedIn Corporation (Feb. 10, 2020) (‘‘LinkedIn Comment Letter’’); Comment Letter of the North American Securities Administrators Association (NASAA) (Feb. 10, 2020) (‘‘NASAA Comment Letter’’). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 significantly expand several aspects of the existing rule. For example, some commenters argued that the proposed definition of ‘‘solicitor’’ was too broad and suggested alternatives or limitations.13 Others disagreed with the proposed expansion of the rule to include non-cash compensation and solicitations of private fund investors.14 Commenters also recommended modifications to the disqualification provisions, such as aligning them with disqualification provisions in our other rules and limiting the scope of affiliate disqualification.15 Commenters generally supported our approach to permit testimonials and endorsements; 16 however, they highlighted the difficulty in assessing when compensated testimonials and endorsements under the proposed advertising rule would also trigger the application of the proposed solicitation rule.17 Commenters argued that applying both rules to the same conduct is duplicative and burdensome.18 Some commenters suggested that we regulate endorsements and testimonials only under the advertising rule,19 whereas others suggested various ways to limit the conduct that would be subject to both rules.20 Merged Marketing Rule After considering comments, we are adopting a rule with several modifications.21 We believe it is 13 See, e.g., Comment Letter of Financial Services Institute (Feb. 12, 2020) (‘‘FSI Comment Letter’’); Comment Letter of SIFMA Asset Management Group on proposed solicitation rule (Feb. 10, 2020) (‘‘SIFMA AMG Comment Letter I’’). 14 See, e.g., Comment Letter of Fried, Frank, Harris, Shriver & Jacobson LLP (Feb. 10, 2020) (‘‘Fried Frank Comment Letter’’); Comment Letter of Sidley Austin LLP (Feb. 10, 2020) (‘‘Sidley Austin Comment Letter’’). 15 See, e.g., Comment Letter of Credit Suisse Securities (USA) LLC (Feb. 10, 2020) (‘‘Credit Suisse Comment Letter’’); SIFMA AMG Comment Letter I. 16 See, e.g., Comment Letter of the Small Business Investor Alliance (Feb. 7, 2020) (‘‘SBIA Comment Letter’’); Comment Letter of the Consumer Federation of America (Feb. 10, 2020) (‘‘Consumer Federation Comment Letter’’). 17 See, e.g., Comment Letter of SIFMA Asset Management Group on proposed advertising rule (Feb. 10, 2020) (‘‘SIFMA AMG Comment Letter II’’); Comment Letter of Joseph H. Nesler (Jan. 15, 2020) (‘‘Nesler Comment Letter’’). 18 See e.g., FSI Comment Letter; SIFMA AMG Comment Letter II. 19 See, e.g., IAA Comment Letter; SIFMA AMG Comment Letter II; Comment Letter of Mercer Advisors (Feb. 10, 2020) (‘‘Mercer Comment Letter’’). See also FSI Comment Letter. 20 See e.g., SIFMA AMG Comment Letter II; FSI Comment Letter; IAA Comment Letter; Comment Letter of the Money Management Institute (Feb. 10, 2020) (‘‘MMI Comment Letter’’); Nesler Comment Letter. 21 The final rule will apply to all investment advisers registered, or required to be registered, PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 appropriate to regulate investment adviser advertising and solicitation activity through a single rule: The marketing rule. This approach is designed to balance the Commission’s goals of protecting investors from misleading advertisements and solicitations, while accommodating current marketing practices and their continued evolution. • The final marketing rule will include an expanded definition of ‘‘advertisement,’’ relative to the current advertising rule, that will encompass an investment adviser’s marketing activity for investment advisory services with regard to securities. We have determined not to expand the definition of advertisement to include communications addressed to one person as proposed, and instead will retain the current rule’s exclusion of one-on-one communications from the definition, except with regard to compensated testimonials and endorsements and certain communications that include hypothetical performance information.22 In addition, the definition will not include communications designed to retain existing investors. The final definition also will include exceptions for extemporaneous, live, oral communications; and information contained in a statutory or regulatory notice, filing, or other required communication. • Largely as proposed, the final rule will apply to certain communications sent to clients and private fund investors, but will not apply to advertisements about registered investment companies or business development companies. • A set of seven principles-based general prohibitions will apply to all advertisements. These are drawn from historic anti-fraud principles under the Federal securities laws and are tailored specifically to the type of communications that are within the scope of the rule. • The final rule will permit an adviser’s advertisement to include testimonials and endorsements, subject generally to the following conditions: Required disclosures; adviser oversight and compliance, including a written with the Commission. Like the proposal, the final rule will not apply to advisers that are not required to register as investment advisers with the Commission, such as exempt reporting advisers or state-registered advisers. 22 Hypothetical performance information that is provided in response to an unsolicited investor request or to a private fund investor in a one-onone communication is excluded from the first prong of the definition of advertisement. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations agreement for certain promoters; and, in some cases, disqualification provisions. We are adopting partial exemptions for de minimis compensation, affiliated personnel, registered broker-dealers, and certain persons to the extent they are covered by rule 506(d) of Regulation D under the Securities Act with respect to a securities offering. • An adviser’s advertisement may include a third-party rating, if the adviser forms a reasonable belief that the third-party rating clearly and prominently discloses certain information. • The final rule will apply to performance advertising and will require presentation of net performance information whenever gross performance is presented, and performance data over specific periods. In addition, the final rule will impose requirements on advisers that display related performance, extracted performance, hypothetical performance, and—in a change from the proposal— predecessor performance. We are not adopting, however, the proposed separate requirements for performance advertising for retail and non-retail investors. • We are amending the recordkeeping rule and Form ADV to reflect the final rule and enhance the data available to support our staff’s enforcement and examination functions. • In a change from the proposal, the final rule will not require investment advisers to review and approve their advertisements prior to dissemination. • Finally, certain staff no-action letters will be withdrawn in connection with the final rule as those positions are either incorporated into the final rule or will no longer apply. II. Discussion jbell on DSKJLSW7X2PROD with RULES2 A. Scope of the Rule: Definition of ‘‘Advertisement’’ 1. Overview Under the final marketing rule, the definition of an advertisement includes two prongs.23 The first prong includes any direct or indirect communication an investment adviser makes that: (i) Offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser (‘‘private fund investors’’), or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors.24 This prong will capture traditional advertising, and will 23 See 24 See final rule 206(4)–1(e)(1)(i) and (ii). final rule 206(4)–1(e)(1)(i). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 not include one-on-one communications, unless the communication includes hypothetical performance information that is not provided: (i) In response to an unsolicited investor request or (ii) to a private fund investor. It also excludes (i) extemporaneous, live, oral communications; and (ii) information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication.25 The new second prong will cover compensated testimonials and endorsements, which will include a similar scope of activity as traditional solicitations under the current solicitation rule.26 This prong will include oral communications and oneon-one communications to capture traditional one-on-one solicitation activity, in addition to solicitations for non-cash compensation. It will exclude certain information contained in a statutory or regulatory notice, filing, or other required communication.27 2. Definition of Advertisement: Communications Other Than Compensated Testimonials and Endorsements Proposed rule 206(4)–1(e)(1) would have defined an advertisement as any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or private fund investors, subject to certain enumerated exclusions. Although some commenters supported the proposed definition,28 most commenters stated that it was overly broad.29 Some commenters stated that the proposed definition would chill adviser communications to existing investors, increase compliance burdens for advisers, and complicate 25 See final rule 206(4)–1(e)(1)(i)(A) and (B). final rule 206(4)–1(e)(1)(ii). As discussed below, uncompensated testimonials and endorsements that are included in certain adviser communications would meet the first prong of the definition of advertisement. See infra ‘‘Adoption and entanglement’’ section. 27 See final rule 206(4)–1(e)(1)(ii). 28 See, e.g., SBIA Comment Letter; Consumer Federation Comment Letter; Comment Letter of the Institutional Limited Partners Association (Feb. 10, 2020) (‘‘ILPA Comment Letter’’). 29 See, e.g., Wellington Comment Letter; Pickard Djinis Comment Letter; Comment Letter of Managed Funds Association and Alternative Investment Management Association (Feb. 10, 2020) (‘‘MFA/ AIMA Comment Letter I’’). 26 See PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 13027 communications with various third parties.30 After considering comments, we are making several modifications to hone the scope of the rule to the communications that have a greater risk of misleading investors, ease compliance burdens that commenters suggested would result from the proposed rule’s scope, and facilitate communications with existing investors. a. Specific Provisions In a textual (but not substantive) change from the proposal, the final rule will not include the phrase ‘‘disseminated by any means’’ and instead will reference any direct or indirect communication the adviser makes. We believe these two formulations carry the same meaning, but understand from commenters that the phrase ‘‘direct or indirect’’ is more familiar to advisers. This reference to direct or indirect communications will replace the current advertising rule’s requirement that an advertisement be a ‘‘written’’ communication or a notice or other announcement ‘‘by radio or television.’’ We are deleting references in the current advertising rule to specific types of communications to ensure that the final rule reflects modern communication methods, rather than the methods that were most common when the Commission adopted the current rule (e.g., newspapers, television, and radio). Commenters generally did not oppose omitting the current rule’s references to specific methods of communication and supported such modernization of the current rule.31 This revision will expand the scope of the current rule to encompass all offers of an investment adviser’s investment advisory services with regard to securities regardless of how they are disseminated, with the limited exceptions discussed below. An adviser may disseminate such communications through emails, text messages, instant messages, electronic presentations, videos, films, podcasts, digital audio or video files, blogs, billboards, and all manner of social media, as well as by paper, including in newspapers, magazines, and the mail. We recognize that electronic media (including social media and other internet communications) and mobile communications play a significant role in current advertising practices. We also believe this revision will help the 30 See, e.g., Fidelity Comment Letter; NSCP Comment Letter; IAA Comment Letter. 31 See, e.g., NYC Bar Comment Letter; Comment Letter of the Financial Planning Association (Feb. 10, 2020) (‘‘FPA Comment Letter’’). E:\FR\FM\05MRR2.SGM 05MRR2 13028 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations definition remain evergreen in the face of evolving technology and methods of communication. i. Any Direct or Indirect Communication an Investment Adviser Makes jbell on DSKJLSW7X2PROD with RULES2 The first prong of the final marketing rule’s definition of ‘‘advertisement’’ includes an adviser’s direct or indirect communications. In addition to communicating directly with prospective investors, we understand that investment advisers often provide intermediaries, such as consultants, other advisers (e.g., in a fund-of-funds or feeder funds structure), and promoters, with advertisements for dissemination. Those advertisements are indirect communications because they are statements provided by the adviser for dissemination by a third party. This aspect of the definition also will capture certain communications distributed by an adviser that incorporate statements or other content prepared by a third party.32 The final rule text reflects a change from the proposal, which would have applied to any communications ‘‘by or on behalf of’’ an adviser.33 Commenters generally suggested that we remove the ‘‘on behalf of’’ clause from the definition, citing concerns that advisers would not be able to collaborate with third parties to prepare and disseminate advertising materials and that it would stifle communications between advisers and certain third parties.34 Certain commenters requested safe harbors for communications with the press and removal of profane or illegal materials.35 Commenters also requested clarification on how the rule would apply to fundsof-funds, model providers, solicitors, and employee use of social media.36 We believe communications that investment advisers use to offer their advisory services have an equal potential to mislead—and should be subject to the rule—regardless of whether the adviser communicates directly or indirectly through a third party, such as a consultant, 32 See infra ‘‘Adoption and entanglement’’ section. 33 See proposed rule 206(4)–1(e)(1). 34 See, e.g., SIFMA AMG Comment Letter II; FSI Comment Letter; Comment Letter of the CFA Institute (Feb. 24, 2020) (‘‘CFA Institute Comment Letter’’); Comment Letter of ICE Data Pricing & Reference Data, LLC (Feb. 10, 2020) (‘‘ICE Comment Letter’’). 35 See, e.g., LinkedIn Comment Letter; Comment Letter of Resolute Investment Managers (Feb. 10, 2020) (‘‘Resolute Comment Letter’’); IAA Comment Letter. 36 See, e.g., Comment Letter of the American Investment Council (Feb. 10, 2020) (‘‘AIC Comment Letter’’); Nesler Comment Letter; SIFMA AMG Comment Letter II; CFA Institute Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 intermediary, or related person.37 Likewise, an adviser should not be able to avoid application of the rule when it incorporates third-party content into its communications.38 To address commenters’ concerns about the clarity of the standard, however, we replaced ‘‘on behalf of’’ with ‘‘directly or indirectly.’’ Our view is that these phrases largely have the same meaning, but that ‘‘directly or indirectly’’ is more commonly used, broadly understood, and consistent with the language in the current rule. In addition, we believe that the phrase ‘‘direct or indirect communication an investment adviser makes’’ better focuses on an adviser’s participation in making a particular communication subject to the rule. Whether a particular communication is a communication made by the adviser is a facts and circumstances determination. Where the adviser has participated in the creation or dissemination of an advertisement, or where an adviser has authorized a communication, the communication would be a communication of the adviser. For example, if an adviser provides marketing material to a third party for dissemination to potential investors, the communication is a communication made by the adviser. In addition, we would generally view any advertisement about the adviser that is distributed and/or prepared by a related person as an indirect communication by the adviser, and thus subject to the final rule.39 Although the final marketing rule will not require an adviser to oversee all activities of a third party, the adviser is responsible for ensuring that its advertisements comply with the rule, regardless of who creates or disseminates them. An adviser might collaborate with a third party to prepare marketing materials in other circumstances that 37 Section 208 of the Advisers Act states that ‘‘[i]t shall be unlawful for any person indirectly, or through or by any other person, to do any act or thing which it would be unlawful for such person to do directly . . .’’ See, e.g., In the Matter of Profitek, Inc., Release No. IA–1764 (Sept. 29, 1998) (settled order) (The Commission brought an enforcement action against an investment adviser, asserting that it directly or indirectly distributed materially false and misleading advertisements, including by submitting performance information in questionnaires submitted to online databases that were made available to subscribers nationwide and by providing misleading performance information to a newspaper that reported the performance in an article.). 38 See infra ‘‘Adoption and entanglement’’ section. 39 An adviser’s ‘‘related person’’ is defined in Form ADV’s Glossary of Terms as ‘‘[a]ny advisory affiliate and any person that is under common control with [the adviser’s] firm.’’ Italicized terms are defined in the Form ADV Glossary. See Form ADV Glossary. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 would not constitute dissemination by an adviser. If an adviser provides comments on a marketing piece, but a third party does not accept the adviser’s comments or the third party makes unauthorized modifications, the adviser will not be responsible for the third party’s subsequent modifications that were made independently of the adviser and that the adviser did not approve.40 This analysis would be based on the facts and circumstances. Formal authorization of dissemination, or lack thereof, by the adviser is not dispositive, although it would be considered part of the analysis. Commenters sought clarification on how the definition of ‘‘advertisement’’ would apply in the fund-of-funds and master-feeder contexts.41 If an adviser to an underlying fund provides marketing materials to the adviser of a fund-offunds (or a feeder fund) and the adviser to the fund-of-funds (or a feeder fund) provides those materials to investors, the underlying fund adviser would be responsible for the material it prepared or authorized for distribution.42 The underlying fund adviser would not be responsible for modifications the adviser of the fund-of-funds made to the underlying fund adviser’s original advertisement if the underlying fund adviser did not approve the adviser’s edits. Similarly, a third-party model provider would not be responsible for modifications the end-user adviser made to the third-party model used in an advertisement if done without the model provider’s involvement or authorization. Adoption and Entanglement Depending on the particular facts and circumstances, third-party information also may be attributable to an adviser under the first prong of the final rule. For example, an adviser may distribute information generated by a third party or a third party could include information about an adviser’s investment advisory services in the third party’s materials. In these scenarios, whether the third-party information is attributable to the adviser 40 However, the adviser will remain responsible for the accuracy of the marketing material provided to and disseminated by the third party even if the third party makes formatting changes that do not affect the content of that marketing material or prominence of particular disclosures therein. 41 See, e.g., AIC Comment Letter; Comment Letter of JG Advisory Services, LLC (Jan. 9, 2020) (‘‘JG Advisory Comment Letter’’). 42 In this discussion, the acquiring fund adviser (or the adviser to, or sponsor of, a feeder fund in a master-feeder structure) generally would be treated as an intermediary and not as an investor in the underlying fund (or the master fund in a master-feeder structure). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 will require an analysis of the facts and circumstances to determine (i) whether the adviser has explicitly or implicitly endorsed or approved the information after its publication (adoption) or (ii) the extent to which the adviser has involved itself in the preparation of the information (entanglement).43 An adviser ‘‘adopts’’ third-party information when it explicitly or implicitly endorses or approves the information.44 For example, if an adviser incorporates information it receives from a third party into its performance advertising, the adviser has adopted the third-party content, and the third-party content will be attributed to the adviser.45 An adviser is liable for such third-party content under the marketing rule just as it would be liable for content it produced itself.46 In addition, an adviser may have ‘‘entangled’’ itself in a third-party communication if the adviser involves itself in the third party’s preparation of the information.47 Nevertheless, we would not view an adviser’s edits to an existing third-party communication to result in attribution of that communication to the adviser if the adviser edits a third party’s communication based on preestablished, objective criteria (i.e., editing to remove profanity, defamatory or offensive statements, threatening language, materials that contain viruses or other harmful components, spam, unlawful content, or materials that infringe on intellectual property rights, or editing to correct a factual error) that are documented in the adviser’s policies and procedures and that are not designed to favor or disfavor the 43 See Interpretive Guidance on the Use of Company websites, Release No. IC–28351 (Aug. 1, 2008) [73 FR 45862 (Aug. 7, 2008)] (‘‘2008 Release’’) (‘‘[W]hether third-party information is attributable to a company depends upon whether the company has: (1) involved itself in the preparation of the information, or (2) explicitly or implicitly endorsed or approved the information.’’); Use of Electronic Media, Release No. 34–42728 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)] (‘‘2000 Release’’) at nn.52, 54; Use of Electronic Media for Delivery Purposes, Release No. 34–36345 (Oct. 6, 1995) [60 FR 53458 (Oct. 13, 1995)] (‘‘1995 Release’’). 44 See 2008 Release, supra footnote 43. 45 See, e.g., In the Matter of BB&T Securities, LLC, Release No. IA–4506 (Aug. 25, 2016) (settled order) (The Commission brought an enforcement action against an SEC-registered investment adviser alleging that it negligently relied on a third party’s materially inflated, and hypothetical and backtested, performance track record in preparing advertisements that the adviser sent to advisory clients and prospective clients.). 46 See infra section II.B. 47 See 2000 Release, supra footnote 43 (‘‘[L]iability under the ‘entanglement’ theory would depend upon an issuer’s level of pre-publication involvement in the preparation of the information.’’). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 adviser.48 In these circumstances, we would not view the adviser as endorsing or approving the remaining content by virtue of such limited editing. Guidance on Social Media Questions about whether a communication is attributable to an adviser may commonly arise in the context of an adviser’s use of websites or other social media. For example, an adviser might include a hyperlink in an advertisement to an independent web page on which third-party content sits. An adviser should consider the adoption and entanglement concepts discussed above to determine whether the hyperlinked third-party content would be attributed to the adviser.49 At the same time, an adviser’s hyperlink to third-party content that the adviser knows or has reason to know contains an untrue statement of material fact or materially misleading information would also be fraudulent or deceptive under section 206 of the Act and other applicable anti-fraud provisions. Whether content posted by third parties on an adviser’s own website or social media page would be attributed to the investment adviser also depends on the facts and circumstances surrounding the adviser’s involvement.50 For example, permitting all third parties to post public commentary to the adviser’s website or social media page would not, by itself, render such content attributable to the adviser, so long as the adviser does not selectively delete or alter the comments or their presentation and is not involved in the preparation of the content.51 We believe such treatment of third-party content on the adviser’s own website or social media page is appropriate even if the adviser has the ability to influence the commentary but does not exercise this authority. For example, if the social media platform allows the investment adviser to sort the third-party content in such a way that more favorable content appears more prominently, but the investment adviser does not actually do such sorting, then the ability to sort content would not, by itself, render such 48 For example, an adviser could not have a policy to remove only negative comments about the adviser. 49 We previously stated that an adviser should consider the application of rule 206(4)–1, including the existing prohibition of testimonials, before including hyperlinks to third-party websites on its website or in its electronic communications. See 2008 Release, supra footnote 43. 50 Other content that offers or promotes the adviser’s services on an adviser’s own website or social media page would likely meet the definition of ‘‘advertisement’’ under the final rule. 51 See supra ‘‘Adoption and entanglement’’ section (discussing an adviser’s ability to edit thirdparty material based on objective criteria). PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 13029 content attributable to the adviser. In addition, if an adviser merely permits the use of ‘‘like,’’ ‘‘share,’’ or ‘‘endorse’’ features on a third-party website or social media platform, we would not interpret the adviser’s permission as implicating the final rule. Conversely, if the investment adviser takes affirmative steps to involve itself in the preparation or presentation of the comments, to endorse or approve the comments, or to edit posted comments, those comments would be attributed to the adviser. This would apply to the affirmative steps an adviser takes both on its own website or social media pages, as well as on third-party websites. For example, if an adviser substantively modifies the presentation of comments posted by others by deleting or suppressing negative comments or prioritizing the display of positive comments, then we would attribute the comments to the adviser (i.e., the communication would be an indirect statement of the adviser) because the adviser would have modified third-party comments with the goal of marketing its advisory business. However, as discussed above, we would not view an adviser’s merely editing profane, unlawful, or other such content according to a neutral pre-existing policy as the adviser adopting the content. Some commenters sought assurances that the definition of advertisement would not cover an adviser’s associated persons’ activity on their personal social media accounts.52 We have concerns that, under certain circumstances, it could be difficult for an investor to differentiate a communication of the associated person in his/her personal capacity from a communication the associated person made for the adviser. With respect to social media postings to associated persons’ own accounts, it would be a facts and circumstances analysis relating to the adviser’s supervision and compliance efforts. If the adviser adopts and implements policies and procedures reasonably designed to prevent the use of an associated person’s social media accounts for marketing the adviser’s advisory services, we generally would not view such communication as the adviser marketing its advisory 52 See, e.g., SIFMA AMG Comment Letter II; LinkedIn Comment Letter; IAA Comment Letter. We believe that our modifications to the first prong of the definition of advertisement also will alleviate commenters’ concerns as there are now fewer scenarios in which communications on employee social media accounts would meet the definition of advertisement. E:\FR\FM\05MRR2.SGM 05MRR2 13030 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations services.53 To achieve effective supervision and compliance, an adviser may consider also prohibiting such communications, conducting periodic training, obtaining attestations, and periodically reviewing content that is publicly available on associated persons’ social media accounts. ii. To More Than One Person jbell on DSKJLSW7X2PROD with RULES2 Consistent with the current rule’s exclusion of one-on-one communications, the first prong of the final definition of ‘‘advertisement’’ generally does not include communications to one person. While our proposed rule would have treated communications directed to ‘‘one or more’’ persons as advertisements, commenters generally opposed this expansion.54 In particular, commenters argued that subjecting one-on-one communications to the requirements of the proposed rule would create untenable burdens given the proposed review and approval obligation (including enhanced recordkeeping requirements).55 Commenters also stated that it would chill adviser/ investor communications.56 According to commenters, scoping a one-on-one communication into the rule would require advisers to review each communication to determine whether it is an advertisement, which could prevent an adviser from providing timely information to investors and satisfying its fiduciary obligations.57 We received comments that communications to existing investors are already subject to the anti-fraud provisions of the Advisers Act, and therefore communications to existing 53 An associated person who, notwithstanding these policies and procedures, engages in communications inconsistent with the rule may, depending on the facts and circumstances, be held responsible for violations of the rule. 54 See, e.g., IAA Comment Letter; AICPA Comment Letter. 55 See, e.g., Comment Letter of Commonwealth Financial Network (Feb. 10, 2020) (‘‘Commonwealth Comment Letter’’) (stating that the lack of complete overlap with FINRA rules would make compliance especially burdensome for dual registrants); Comment Letter of the National Regulatory Services (Feb. 10, 2020) (‘‘NRS Comment Letter’’). Commenters also noted that advisers have adopted long-standing practices in reliance on the existing exclusion of one-on-one communications. See, e.g., Comment Letter of the New York City Bar (Feb. 10, 2020) (‘‘NYC Bar Comment Letter’’). 56 See, e.g., IAA Comment Letter (stating that the proposed rule ‘‘would blur the line between client servicing and marketing’’); Wellington Comment Letter; Fidelity Comment Letter; MFA/AIMA Comment Letter I. 57 See, e.g., CFA Institute Comment Letter; Comment Letter of the Council of Institutional Investors (Feb. 11, 2020) (‘‘CII Comment Letter’’). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 investors need not be subject to the final rule.58 After considering the comments, we have determined to exclude one-on-one communications from the first prong of the definition and retain the ‘‘more than one’’ language in the current advertising rule, unless such communications include hypothetical performance information that is not provided: (i) In response to an unsolicited investor request or (ii) to a private fund investor. We have made this change to avoid the possibility that the rule would impede typical communications between advisers and their existing and prospective investors. An adviser might have been dis-incentivized to communicate regularly with its investors if it believed it would have to analyze every communication for compliance with the proposed rule.59 Because we are excluding one-on-one communications from the first prong of the definition of advertisement under most circumstances, we are modifying the proposed exclusion for an adviser’s responses to unsolicited requests.60 Although commenters generally supported the exclusion and recommended expanding it,61 we believe excluding most one-on-one communications addresses commenter concerns in a more comprehensive manner than the unsolicited request exclusion would have addressed them. The definition will exclude an adviser’s responses to an unsolicited investor request for hypothetical performance information, as well as hypothetical performance information provided to a private fund investor in a one-on-one communication, as discussed below. Unless subject to this or another exclusion, the definition of advertisement will capture communications that include hypothetical performance information even in a one-on-one communication.62 We also recognize that advisers have one-on-one interactions with prospective investors and that prospective investors may ask questions of an adviser or ask for additional 58 See, e.g., SIFMA AMG Comment Letter II. discussed below, we also have eliminated the element of the proposed rule that would apply to communications to retain investors. 60 See proposed rule 206(4)–1(e)(1)(ii). We proposed to exclude from the definition of ‘‘advertisement’’ any communication by an investment adviser ‘‘that does no more than respond to an unsolicited request’’ for ‘‘information specified in such request about the investment adviser or its services’’ other than a communication to a retail person that includes performance results or a communication that includes hypothetical performance. 61 See, e.g., Wellington Comment Letter; MFA/ AIMA Comment Letter I; IAA Comment Letter. 62 See final rule 206(4)–1(e)(1)(i)(A)–(C). 59 As PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 information. In adopting the current advertising rule, the Commission limited the definition of ‘‘advertisement’’ due to concerns that a broad definition could encompass even ‘‘face to face conversations between an investment counsel and his prospective client.’’ 63 The Commission stated that it would not include a ‘‘personal conversation’’ with a client or prospective client.64 We believe that the same concerns that influenced the Commission’s prior approach continue to exist. We also believe that the remaining provisions of the definition, as well as other provisions of the Federal securities laws, are adequate to satisfy our investor protection goals with respect to communications directed only to a single individual or entity.65 The one-on-one exclusion in the definition’s first prong applies regardless of whether the adviser makes the communication to a natural person with an account or multiple natural persons representing a single entity or account.66 The exclusion applies to a single adviser and a single investor. For example, if an adviser’s prospective investor is an entity, the exclusion permits the adviser to provide communications to multiple natural persons employed by or owning the entity without those communications being subject to the rule. For purposes of this exclusion, we also interpret the term ‘‘person’’ to mean one or more investors that share the same household. For example, a communication to a married couple that shares the same household would qualify for the one-onone exclusion.67 Some commenters advocated that we increase the ‘‘more than one’’ threshold from the current rule to communications with ‘‘more than ten’’ or ‘‘more than 25’’ persons.68 They argued that such a change would reduce compliance costs and better align with traditional concepts of advertising.69 We decline to make this change. The 63 See Prohibited Advertisements, Release No. IA–119 (Aug. 8, 1961) [26 FR 7552, 7553 (Nov. 15, 1961)]. 64 Id. 65 See, e.g., section 206 of the Act; rule 206(4)– 8 under the Act. 66 See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter (stating that the Commission should ‘‘make clear in the adopting release that the same communication to multiple natural persons representing a single institution or client/account counts as a communication to a single person’’). 67 See, e.g., rule 30e–1(f) under the Investment Company Act. 68 See, e.g., IAA Comment Letter (suggesting the more than 25 person threshold because FINRA rule 2210 uses this approach and stating that consistency would ease compliance burdens). 69 See, e.g., FPA Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations exclusion from the first prong of the definition of advertisement for one-onone communications will allow an adviser to engage in routine investor communications and have personal conversations with prospective investors, without subjecting those communications to the final marketing rule’s requirements. However, we continue to believe that the final rule should cover typical marketing communications, even if sent to a limited number of persons. Creating a higher threshold, as suggested by commenters, may incentivize advisers to limit communications to just below the threshold number of persons, and may defeat the purposes of our final rule. While the first prong of the final rule will generally not apply to communications to one person, changes in technology since the adoption of the existing rule permit advisers to create communications that appear to be personalized to single investors and are ‘‘addressed to’’ only one person, but are actually widely disseminated to multiple persons. While communications such as bulk emails or algorithm-based messages are nominally directed at or ‘‘addressed to’’ only one person, they are in fact widely disseminated to numerous investors and therefore would be subject to the final rule.70 Similarly, customizing a template presentation or mass mailing by filling in the name of an investor and/or including other basic information about the investor would not result in a one-on-one communication. Likewise, an adviser cannot use duplicate inserts in an otherwise customized communication in an effort to circumvent application of the rule.71 For example, if an adviser maintains a database of performance information inserts or tables that it uses in otherwise customized investor communications, the adviser must treat the duplicated inserts as advertisements subject to the rule. Of course, if the adviser provides an existing investor with performance information pertaining to the investor’s account, the rule would not apply because this is a one-on-one communication.72 70 See, e.g., NSCP Comment Letter. fact that there may be some similarities in the information provided in one-on-one communications, however, will not result in the application of the rule to those communications. 72 In addition, the communication does not fall within the definition of advertisement because the purpose of the communication is not to offer services to a new investor or to provide new services to an existing investor. See infra section II.A.2.a.iv. jbell on DSKJLSW7X2PROD with RULES2 71 The VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 One commenter expressed concern that the public dissemination of a seemingly one-on-one communication could subject the communication to the final rule.73 We believe that if, for example, an adviser responds to a request for proposal (‘‘RFP’’) from an entity and the entity subsequently makes such responses available to the public pursuant to a Freedom of Information Act request or other public disclosure requirements, this would not be an advertisement merely by virtue of the entity’s disclosure.74 An adviser should consider adopting compliance policies and procedures that are reasonably designed to determine whether a communication nominally directed to a single person is actually a communication to more than one person, or contains duplicated inserts as part of that communication. In these circumstances, the duplicated information is an advertisement because it is sent to more than one person and would not qualify for the exclusion. Because of the specific concerns raised by hypothetical performance, hypothetical performance information would not qualify for the one-on-one exclusion unless provided in response to an unsolicited investor request or to a private fund investor.75 Hypothetical performance included in all other oneon-one communications that offer investment advisory services with regard to securities must be presented in accordance with the requirements discussed below. We proposed a similar approach for hypothetical performance provided in response to an unsolicited request under the proposed definition of advertisement.76 Some commenters suggested that the Commission permit an adviser to provide hypothetical performance in response to unsolicited requests to eliminate the need to assess the requirements related to hypothetical 73 See Resolute Comment Letter (seeking clarification on the treatment of ‘‘account statements and similar reports intended for NonRetail Persons, such as public entities, that are required to make such information publicly available’’). If the entity is an existing investor of the adviser, communications to the entity would not be considered an advertisement unless the communications offer or promote new advisory products or services of the adviser. 74 See also supra section II.A.2.a.i for a discussion of an adviser’s direct or indirect communications. 75 See infra section II.E.6. These communications would be eligible for the exclusions from the definition of advertisement for extemporaneous, live, oral communications and regulatory notices in final rule 206(4)–1(e)(1)(i)(A) and (B). 76 See 2019 Proposing Release, supra footnote 7, at section II.A.2. (proposing that communications to any person that contain hypothetical performance would not qualify for the unsolicited request exclusion to the extent they contain such results); proposed rule 206(4)–1(e)(1)(ii)(B). PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 13031 performance.77 These commenters stated that the need to assess these requirements would slow down the flow of information to investors, require investors to provide more information earlier in the diligence process, or limit the hypothetical performance information shared in response to such an unsolicited request. Some commenters stated that private fund investors often seek hypothetical performance information, particularly targets and projections, to evaluate private fund investments.78 After considering these comments, we believe that, in most circumstances, the protections for hypothetical performance should be available to investors receiving communications that include offers of investment advisory services with regard to securities, to the extent such offers include hypothetical performance information. We believe our modifications to the first prong of the definition of advertisement and to the requirements for presenting hypothetical performance, discussed below, will reduce the associated compliance burdens for providing hypothetical performance information to investors and will, therefore, alleviate some of commenters’ concerns. However, where an investor affirmatively seeks hypothetical performance information from an investment adviser and the investment adviser has not directly or indirectly solicited the request, hypothetical performance information provided in response to the request will be excluded from the definition of advertisement under the final rule.79 In the case of an unsolicited request, an investor seeks hypothetical performance information for the investor’s own purposes, rather than responding to a communication disseminated by an adviser offering its investment advisory services with regard to securities. Similarly, where the hypothetical performance information is provided in a one-on-one communication to a private fund investor, we believe a private fund investor will have the ability and opportunity to ask questions and assess the limitations of this information. In these limited circumstances, we do not believe it is necessary to treat the hypothetical performance information 77 See IAA Comment Letter; ILPA Comment Letter. 78 See IAA Comment Letter; Comment Letter of Managed Funds Association and Alternative Investment Management Association (Sept. 11, 2020) (‘‘MFA/AIMA Comment Letter III’’). 79 Any affirmative effort by the investment adviser intended or designed to induce an investor to request hypothetical performance information would render the request solicited and thus not eligible for this exclusion. E:\FR\FM\05MRR2.SGM 05MRR2 13032 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations as an advertisement subject to the rule.80 jbell on DSKJLSW7X2PROD with RULES2 iii. Offers Investment Advisory Services With Regard to Securities to Prospective Clients or Investors in a Private Fund Advised by the Investment Adviser The marketing rule’s definition of ‘‘advertisement’’ includes communications that offer the investment adviser’s investment advisory services. As discussed in more detail below, we are implementing a number of changes from the proposal, which would have defined advertisements to include communications that offer or promote the investment adviser’s investment advisory services or that seek to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser.81 First, we are limiting the application of this element of the definition to communications directed to prospective clients or prospective private fund investors, rather than existing clients or private fund investors to avoid an overbroad application of the rule. Accordingly, this aspect of the final rule will retain the current rule’s scope. Second, we also are not adopting the ‘‘or promote’’ wording from the proposed definition of advertisement. Commenters generally opposed including the term ‘‘promote,’’ suggesting that this term could expand the definition of ‘‘advertisement’’ to cover certain materials not subject to the current rule,82 the text of which is limited to communications that ‘‘offer’’ advisory services.83 As we indicated in the proposal, the ‘‘offer or promote’’ clause reflects the current rule’s application and was designed to capture communications that are commonly considered advertisements.84 We added the ‘‘or promote’’ wording to the proposed definition for clarity, but after considering comments we realize this wording may instead cause confusion. For example, commenters sought clarification that statements about an 80 The hypothetical performance information would be subject to the Advisers Act’s anti-fraud provisions and rule 206(4)–8 under the Advisers Act. 81 See proposed rule 206(4)–1(e)(1). 82 See, e.g., MFA/AIMA Comment Letter I; Comment Letter of Association for Corporate Growth (Feb. 10, 2020) (‘‘ACG Comment Letter’’). 83 Under the current advertising rule, an ‘‘advertisement’’ includes any written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers ‘‘any other investment advisory service with regard to securities.’’ See current rule 206(4)–1. 84 See 2019 Proposing Release, supra footnote 7, at section II.A.2. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 advisory firm’s culture, philanthropy, or community activity would not fall within the definition of advertisement.85 We did not intend for our proposed definition and the inclusion of the term ‘‘promote’’ to include such communications. Accordingly, the final rule will not include the term ‘‘promote’’ as it is our intent to retain the current rule’s scope in this respect.86 Third, consistent with the current rule, we are limiting the application of the definition to offers about an investment adviser’s investment advisory services with regard to securities. We were persuaded by commenters who urged us to retain the current rule’s scope, arguing that expanding the definition to cover services that are not related to securities could result in an overbroad application of the rule.87 Importantly, however, the anti-fraud provisions of the Act and related rules continue to apply to an adviser’s advertisements and other communications about its other nonsecurities related services.88 Finally, the definition will not include communications that seek to obtain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser. We determined that this clause was superfluous of the rest of the definition; we believe these communications are captured within an adviser’s offer of investment advisory services with regard to securities to prospective investors in a private fund advised by the adviser.89 85 See SIFMA AMG Comment Letter II; FSI Comment Letter. 86 See SEC v. C.R. Richmond & Co., 565 F.2d 1101, 1105 (9th Cir. 1977) (‘‘Investment advisory material which promotes advisory services for the purpose of inducing potential clients to subscribe to those services is advertising material within [the current rule].’’). 87 See NYC Bar Comment Letter; ACG Comment Letter. 88 See section 206 of the Act; rule 206(4)–8 under the Act. See also Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA–5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)] (‘‘Fiduciary Interpretation’’) (stating that ‘‘[t]he investment adviser’s fiduciary duty is broad and applies to the entire adviserclient relationship.’’), at n.17 (citing SEC v. Lauer, 2008 WL 4372896, at 24 (S.D. Fla. Sept. 24, 2008) ‘‘ ‘Section 206 of the Advisers Act does not require that the activity be ‘in the offer or sale of any’ security or ‘in connection with the purchase or sale of any security.’ ’ ’’). 89 As discussed below, the definition of advertisement in the final rule also will not include communications designed to ‘‘retain’’ investors. See infra section II.A.2.a.iv. PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 iv. Offers New Investment Advisory Services With Regard to Securities to Current Clients or Investors in a Private Fund Advised by the Investment Adviser The proposed definition of ‘‘advertisement’’ included communications that seek ‘‘to obtain or retain’’ investors. Commenters generally stated that the ‘‘or retain’’ clause would unnecessarily include communications made in the ordinary course of an adviser providing services to current investors as all communications with current investors are, at least in part, designed to both service and retain investors.90 Several commenters asked us to confirm the scope of the definition as applied to communications with existing investors.91 For example, some commenters suggested an exclusion for all communications with existing investors,92 while others supported a more limited exclusion for routine investor communications.93 Commenters generally agreed that the rule should treat communications with existing investors that offer new or additional advisory services as advertisements.94 Commenters that supported a complete or partial exclusion for communications to existing investors stated that such communications are part of the advisory service and not advertisements.95 90 See, e.g., Wellington Comment Letter; IAA Comment Letter; JG Advisory Comment Letter (stating that ‘‘the rule should treat communications to existing investors differently from communications to prospective investors’’). 91 See, e.g., SIFMA AMG Comment Letter II (discussing market commentary, investment outlooks, performance reviews); JG Advisory Comment Letter (seeking clarification on whether the proposed definition would scope in monthly or quarterly letters to existing investors where such letters discuss account performance and include market commentary). 92 See, e.g., MFA/AIMA Comment Letter I. 93 See, e.g., MMI Comment Letter. 94 See, e.g., Wellington Comment Letter; IAA Comment Letter; Pickard Djinis Comment Letter. 95 Our staff has indicated that it would not recommend enforcement action under the current rule with respect to written communications by an adviser to an existing investor about the performance of securities in the investor’s account because such communications would not be ‘‘offers’’ of advisory services, and instead are ‘‘part of’’ those advisory services (unless the context in which the communication is provided suggests otherwise). See Investment Counsel Association of America, Inc., SEC Staff No-Action Letter (Mar. 1, 2004) (‘‘ICAA Letter’’). Any staff guidance or noaction letters discussed in this release represent the views of the staff of the Division of Investment Management. They are not a rule, regulation, or statement of the Commission. Furthermore, the Commission has neither approved nor disapproved their content. Staff guidance has no legal force or effect; it does not alter or amend applicable law, and it creates no new or additional obligations for any person. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations We agree that the rule should treat only those communications that offer new or additional advisory services with regard to securities to current investors as advertisements because they raise the same concerns as other advertisements. Our intent is not to chill ordinary course communications with current investors. We believe that other protections prevent advisers from engaging in activities that mislead or deceive existing investors.96 For example, existing and prospective advisory clients receive the anti-fraud protections of the Advisers Act and an adviser’s fiduciary duty.97 Accordingly, under the final rule a communication to a current investor is an advertisement when it offers new or additional investment advisory services with regard to securities. We believe that this modification will allow advisers to continue to provide current investors with timely information regarding their accounts and the market without subjecting those communications to the marketing rule.98 In summary, we view an adviser seeking to offer new or additional investment advisory services with regard to securities to current investors as posing the same risks to investors as an adviser seeking to offer such services to new investors and therefore we believe this activity warrants the same treatment under the final marketing rule. jbell on DSKJLSW7X2PROD with RULES2 v. Brand Content, General Educational Material, and Market Commentary Other commenters asked us to confirm that brand content, general educational material, and market commentary are not advertisements under the rule.99 Whether a communication is an advertisement depends on the facts and circumstances (e.g., whether the communication ‘‘offers’’ the adviser’s investment 96 See, e.g., section 206 of the Advisers Act; rule 206(4)–8 under the Advisers Act. 97 See Fiduciary Interpretation, supra footnote 88. See also IAA Comment Letter; Pickard Djinis Comment Letter. 98 Their exclusion from the definition of advertisement will not prevent these account statements or transaction reports from being subject to the other provisions of the Federal securities laws, including section 17(a) of the Securities Act or section 10(b) of the Exchange Act (and rule 10b–5 thereunder), to the extent those provisions would otherwise apply. Likewise, regardless of whether a communication to an existing or prospective investor is an ‘‘advertisement’’ under the marketing rule, the communication is subject to the anti-fraud provisions of section 206 of the Act and the aforementioned provisions of the Federal securities laws. 99 See, e.g., SIFMA AMG Comment Letter II; JG Advisory Comment Letter; MMI Comment Letter; IAA Comment Letter; MFA/AIMA Comment Letter I. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 advisory services with regard to securities). Generally, generic brand content, educational material, and market commentary would not meet the revised definition of an advertisement. Brand content. Determining whether a communication including ‘‘brand’’ content (e.g., displays of the advisory firm name in connection with sponsoring sporting events, supporting community service activities, or supporting philanthropic efforts) is an advertisement would depend on the facts and circumstances.100 If such a communication is designed to raise the profile of the adviser generally, but does not offer any investment advisory services with regard to securities, the communication would not fall within the definition of an advertisement under the rule. For example, a communication that simply notes that an event is ‘‘brought to you by XYZ Advisers’’ would not qualify as an advertisement, as it is not offering any advisory services with regard to securities. General educational information and market commentary. We believe that the same analysis applies for communications that provide only general educational information and market commentary.101 Educational communications that are limited to providing general information about investing, such as information about types of investment vehicles, asset classes, strategies, certain geographic regions, or commercial sectors, do not constitute offers of an adviser’s investment advisory services with regard to securities. Similarly, materials that provide an adviser’s general market commentary (including during press interviews) are unlikely to offer advisory services with regard to securities. Market commentary aims to inform current and prospective investors, including private fund investors, of market and regulatory developments in the broader financial ecosystem. These materials also help current investors interpret market and regulatory shifts by providing context when reviewing investments in their portfolios, and educate investors.102 In contrast, for example, we would view an article or white paper that provides general market commentary and concludes with a description of how the adviser’s securities-related services can 100 See SIFMA AMG Comment Letter II. e.g., SIFMA AMG Comment Letter II; Mercer Comment Letter; IAA Comment Letter; Wellington Comment Letter. 102 See, e.g., MMI Comment Letter (emphasizing the importance of allowing general market commentary to provide investors with the tools to challenge the assumptions of those who counsel them on financial management). 101 See, PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 13033 help prospective investors invest in the market as offering the adviser’s services. Accordingly, that portion of the white paper would be an advertisement. b. Exclusions The rule will generally exclude two types of communications from the first prong of the definition of advertisement: (i) Extemporaneous, live, oral communications; and (ii) information required by statute or regulation.103 i. Extemporaneous, Live, Oral Communications In a change from the proposal, the definition of advertisement will not include extemporaneous, live, oral communications, regardless of whether they are broadcast and regardless of whether they take place in a one-on-one context and involve discussion of hypothetical performance. We proposed an exclusion for live, oral communications that are not broadcast on radio, television, the internet, or any other similar medium. Commenters generally supported the exclusion, but had questions about certain aspects. For example, some commenters expressed concern about the treatment of written materials that accompany or are used to prepare for oral presentations, stating that treating such materials as advertisements would hamper an adviser’s ability to prepare for a presentation.104 Other commenters questioned the scope of the exclusion, with some arguing that it was too narrow 105 and others arguing that it was too broad.106 The goal of the exclusion for live, oral communications was to avoid treating extemporaneous statements as advertisements, in light of the difficulties in ensuring that they comply with the requirements of the rule, and to avoid chilling adviser communications with investors. If 103 As discussed above, the rule also excludes from the first prong of the advertisement definition a communication that includes hypothetical performance that is provided in response to an unsolicited investor request for such information or to a private fund investor in a one-on-one communication. See final rule 206(4)– 1(e)(1)(i)(C)(1) and (2). 104 See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter (stating that ‘‘written materials prepared in conjunction with any live oral communications should not be considered ‘advertisements’ and should be able to rely on the exclusion if (i) they are in draft form, (ii) they are internal documents not created for distribution, or (iii) all or portions of their content may not be provided to any prospective or current investor.’’). 105 See SIFMA AMG Comment Letter II (arguing that it is not clear how to define communications that are broadcast and widely disseminated versus those that are not); AIC Comment Letter. 106 See, e.g., NASAA Comment Letter; CFA Comment Letter; ILPA Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 13034 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 remarks are extemporaneous, they cannot be simultaneously monitored for regulatory compliance, and to require otherwise may simply cause advisers to cease extemporaneous speech to the overall detriment of investors. However, we believe that communications prepared in advance can and should be subject to the rule. Accordingly, the final exclusion will apply only to extemporaneous, live, oral communications.107 Extemporaneous communications do not include prepared remarks or speeches, such as those delivered from scripts.108 In addition, slides or other written materials that are distributed or presented to the audience would also be included as advertisements if they otherwise meet the definition. On the other hand, live, extemporaneous, oral discussions with a group of investors or interviews with the press that are not based on prepared remarks will be eligible for the exclusion. This approach aligns with the purpose of the exclusion, which is to avoid a chilling effect on extemporaneous, oral speech that might occur if such communications were required to comply with the requirements of the final rule. Some commenters recommended that we further expand the exclusion to apply to certain written communications.109 While we appreciate that other modern communication methods facilitate instantaneous written conversations (e.g., text messages, chat), this exclusion is limited to extemporaneous, live, oral communications, because in those circumstances a speaker often does not have sufficient time to edit and reflect on the content of the communication.110 107 A communication need not be in-person to qualify for the exclusion so long as it is live and oral. For example, a phone call or live video communication between an adviser and an investor could qualify for this exclusion. 108 As discussed in the recordkeeping section below, a live, oral communication by an adviser that is not extemporaneous (but that otherwise satisfies the definition of advertisement) would be an advertisement and a record of the advertisement must be maintained pursuant to rule 204– 2(a)(11)(i)(A). The record of the advertisement could be a copy of the prepared remarks, other written preparatory materials, or a recording of the oral communication. 109 See, e.g., AIC Comment Letter (stating that live written communications (e.g., live text chats) should also qualify for the exclusion in order to reflect modern communication methods). 110 We consider a communication to still be ‘‘oral’’ even if closed captioning is used, but not if the oral communication is transcribed and the transcription is then directly or indirectly redistributed by the adviser. See, e.g., Mercer Comment Letter (seeking clarification that closed captioning would not prevent a communication from qualifying for the exclusion). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 Some commenters suggested that we exclude all broadcast communications and adopt an approach similar to FINRA.111 Commenters also sought guidance on the meaning of the following terms: ‘‘broadcast’’ 112 and ‘‘widely disseminated.’’ 113 In response to commenters’ concerns, we are not adopting the requirement that the live, oral communication is ‘‘not broadcast.’’ We believe the concerns that prompted this exclusion apply equally to extemporaneous, live, oral communications regardless of whether they are broadcast. We also believe that the exclusion should not allow an adviser to avoid application of the rule for a previously prepared live, oral communication in a non-broadcast setting, such as a luncheon seminar designed to attract new investors. In addition, commenters raised a variety of concerns with identifying whether a communication is broadcast in light of modern media tools, suggesting that line drawing as to when a communication is broadcast may be challenging in practice.114 As a result, the exclusion will apply to a broadcast communication, such as a webcast, that is an extemporaneous, live, oral communication. The exclusion will apply to ‘‘live’’ oral communications, as proposed. Accordingly, previously recorded oral communications disseminated by the adviser would not qualify as live because the adviser had time to review and edit the recording before such dissemination and thus can ensure compliance with the marketing rule. In these circumstances, an adviser would need to treat its subsequent dissemination of the recording as an advertisement under the rule if the recording offers the adviser’s investment advisory services with regard to securities. However, we believe that an oral communication would be ‘‘live’’ even if there is a time lag (e.g., streaming delay), a translation program is used, or adaptive technology is used to create a personal transcription (e.g., voice to text technology or other tools 111 See, e.g., SIFMA AMG Comment Letter II; Fidelity Comment Letter. 112 See, e.g., Fidelity Comment Letter (noting that (i) advisers may use various forms of technology to communicate with clients, including web chats or videos and (ii) further limiting the exclusion ‘‘would capture routine communications between advisers and their clients merely because of the medium in which they are being conducted.’’); SIFMA AMG Comment Letter II (arguing that it is not clear how to define communications that are broadcast and widely disseminated versus those that are not). 113 See, e.g., SIFMA AMG Comment Letter II; Consumer Federation Comment Letter. 114 See, e.g., SIFMA AMG Comment Letter II; Fidelity Comment Letter. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 that assist the deaf, hard-of-hearing, or hearing loss communities). ii. Information Contained in a Statutory or Regulatory Notice, Filing, or Other Required Communication The final rule excludes from the definition of advertisement ‘‘[i]nformation contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication.’’ 115 In response to commenters, we have broadened the proposed exclusion, which would have applied to ‘‘[a]ny information required to be contained in a statutory or regulatory notice, filing, or other communication.’’ 116 Commenters generally supported the proposed exclusion,117 but recommended we expand it to ease compliance burdens and avoid duplicative regulation that would have resulted from applying another layer of review to mandatory filings.118 Specifically, commenters stated that compliance personnel would have difficulty determining exactly which information contained in a regulatory filing is strictly and explicitly required by applicable law versus which information is not (and would therefore be subject to the rule). In response to these comments, we broadened the exclusion to cover information in a statutory or regulatory, notice, filing or other required communication, provided the information is reasonably designed to satisfy the requirements, rather than information required to be contained in such a communication.119 For example, information reasonably designed to satisfy the requirements of Form ADV Part 2 or Form CRS will not be an advertisement.120 115 Final rule 206(4)–1(e)(1)(i)(B). As with the exclusion for extemporaneous, live, oral communications, the exclusion for regulatory notices will apply regardless of whether the notice includes a discussion of hypothetical performance. 116 Proposed rule 206(4)–1(e)(1)(iv). 117 See, e.g., Mercer Comment Letter; NRS Comment Letter. 118 See, e.g., Comment Letter of Ropes & Gray LLP (Feb. 10, 2020) (‘‘Ropes & Gray Comment Letter’’); (noting that the proposal raises questions as to what information is required in Commission filings, especially for publicly traded advisers); Comment Letter of BlackRock, Inc. (Feb. 10, 2020) (‘‘BlackRock Comment Letter’’) (same); SIFMA AMG Comment Letter II (noting that advisers are already subject to legal duties and potential liability for information included in regulatory filings making it unlikely that advisers would include excess information in such filings). 119 See final rule 206(4)–1(e)(1)(i)(B). 120 See Form CRS Relationship Summary; Amendments to Form ADV, Release No. IA–5247 (June 5, 2019) [88 FR 33573 (July 12, 2019)] (‘‘Form E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations This exclusion will apply to information that an adviser provides to an investor under any statute or regulation under Federal or state law, including rules promulgated by regulatory agencies. We generally do not believe that communications that are prepared as a requirement of statutes, rules, or regulations should be viewed as advertisements under the final rule.121 However, if an adviser includes in such a communication information that is not reasonably designed to satisfy its obligations under applicable law, and such additional information offers the adviser’s investment advisory services with regard to securities, then that information will be considered an ‘‘advertisement’’ for purposes of the rule. 3. Definition of Advertisement: Compensated Testimonials and Endorsements, Including Solicitations To reflect the merger of the two rules, the final rule’s definition of ‘‘advertisement’’ includes a new second prong that applies to ‘‘any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly’’ subject to an exclusion for certain regulatory notices, filings, and other required communications.122 A compensated testimonial or endorsement will meet the definition of advertisement’s second prong regardless of whether the communication is made orally or in writing, to one or more persons.123 By contrast, an uncompensated testimonial or endorsement would have to meet the elements of prong one in order to be considered an ‘‘advertisement.’’ a. Definitions of Testimonial and Endorsement jbell on DSKJLSW7X2PROD with RULES2 The final definition of testimonial includes any statement by a current client or private fund investor about the client’s or private fund investor’s experience with the investment adviser CRS Adopting Release’’) (noting that the relationship summary is designed to serve as disclosure, rather than marketing material). 121 However, information that is required to be provided or offered by the final rule will not qualify for this exclusion. For example, final rule 206(4)– 1(d)(2) requires an adviser to provide performance results over one-, five-, and ten-year periods. This information is part of the advertisement and subject to the rule. 122 Final rule 206(4)–1(e)(1)(ii). 123 See id. The definition of advertisement’s second prong includes a testimonial or endorsement for which an adviser directly or indirectly provides de minimis compensation (as defined below). However, these types of testimonials and endorsements will be exempt from some of the final rule’s prescribed conditions for testimonials and endorsements. See infra section II.C.5. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 or its supervised persons.124 The definition of endorsement includes any statement by a person other than a current client or private fund investor that indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons.125 This scope of how these activities are defined is similar to the proposal, with a few changes described below, including adding solicitation and referral activities drawn from the proposed definition of solicitor. These definitions include statements about the adviser’s ‘‘supervised persons,’’ rather than the proposed inclusion of statements about the adviser’s ‘‘advisory affiliates.’’ 126 One commenter recommended this change, stating that an endorsement or testimonial regarding a supervised person is more likely to provide relevant information to an investor than a statement about an adviser’s advisory affiliate.127 We received a variety of comments about the statements these definitions would capture. One commenter supported a broad approach that would include statements about an adviser’s traits, such as trustworthiness, to reflect the commenter’s belief that prospective clients typically select an adviser based on emotion.128 Another commenter requested that we limit the definitions to include only statements that explicitly discuss the adviser’s services or capabilities as an adviser.129 124 Final rule 206(4)–1(e)(17)(i). We proposed to define ‘‘testimonial’’ as ‘‘any statement of a client’s or investor’s experience with the investment adviser or its advisory affiliates, as defined in the Form ADV Glossary of Terms.’’ See proposed rule 206(4)–1(e)(15). 125 Final rule 206(4)–1(e)(5)(i). We proposed to define ‘‘endorsement’’ as ‘‘any statement by a person other than a client or investor indicating approval, support, or recommendation of the investment adviser or its advisory affiliates, as defined in the Form ADV Glossary of Terms.’’ See proposed rule 206(4)–1(e)(2). To align the definitions of testimonial and endorsement better, and address situations where an endorser who is not a client nevertheless provides statements about the endorser’s experience with the adviser, the final definition of endorsement includes any statement made by a non-investor that describes the endorser’s experience with the adviser or its supervised persons, like under the definition of testimonial. 126 Final rule 206(4)–1(e)(5)(i) and (17)(i). Under the final rule, supervised person has the same meaning as in section 2(a)(25) of the Act. Final rule 206(4)–1(e)(16). See also proposed rule 206(4)– 1(e)(2) and (15) (referring to advisory affiliates). 127 See Pickard Djinis Comment Letter. 128 See Comment Letter of William A. Jacobson, Esq., Clinical Professor of Law, Cornell Law School, and Director, Cornell Securities Law Clinic (Feb. 3, 2020) (‘‘Prof. Jacobson Comment Letter’’). 129 See SIFMA AMG Comment Letter II. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 13035 Under the final marketing rule, testimonials and endorsements will include opinions or statements by persons about the investment advisory expertise or capabilities of the adviser or its supervised persons.130 Testimonials and endorsements also include statements in an advertisement about an adviser or its supervised person’s qualities (e.g., trustworthiness, diligence, or judgment) or expertise or capabilities in other contexts, when the statements suggest that the qualities, capabilities, or expertise are relevant to the advertised investment advisory services. We believe that an investor would likely perceive these statements as relevant to the adviser’s investment advisory services.131 The definitions of testimonial and endorsement under the final rule also include solicitation and referral activities drawn from the proposed definition of solicitor.132 After considering comments on the overlapping scope of testimonials, endorsements, and solicitations under the proposed advertising and solicitation rules, we are adding solicitation activities to the definitions of testimonial and endorsement. The definition of testimonial includes any statement by a current client or private fund investor that directly or indirectly solicits any investor to be the adviser’s client or a private fund investor, or refers any investor to be the adviser’s client or a private fund investor. The definition of endorsement includes any such statements by a person other than a current client or private fund investor. This change will address compensated 130 Complete or partial client lists that do no more than identify certain of the adviser’s clients or private fund investors will not be treated as testimonials. See also 2019 Proposing Release, supra footnote 7, at 78. 131 See Dan Gallagher, Staff No-Action Letter (pub. avail. July 10, 1995) (stating that the staff could not assure that it would not recommend enforcement action for a violation of rule 206(4)– 1 if the letter writer used client testimonials describing its character and skills in relation to matters other than the letter writer’s role as an investment adviser). See also Guidance on the Testimonial Rule and Social Media, Division of Investment Management Guidance Update No. 2014–04 (Mar. 2014) (‘‘IM Staff Social Media Guidance’’) (withdrawing staff position in the Gallagher Staff No-Action Letter). See infra section II.J. 132 Final rule 206(4)–1(e)(5)(ii) and (iii), and (e)(17)(ii) and (iii). See also proposed rule 206(4)– 3(c)(4) (proposing to define ‘‘solicitor’’ as ‘‘any person who, directly or indirectly, solicits any client or private fund investor for, or refers any client or private fund investor to, an investment adviser’’). Both the proposal’s definition of ‘‘solicitor’’ and the final rule’s inclusion of solicitation and referral activities are drawn from the current cash solicitation rule’s definition of ‘‘solicitor,’’ with the exception that the current rule does not apply to solicitation of private fund investors. See rule 206(4)–3(d)(1). E:\FR\FM\05MRR2.SGM 05MRR2 13036 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations testimonials and endorsements under one rule with one set of conditions. For example, a person providing an endorsement or testimonial under the final rule might be a firm that solicits for an adviser (such as a broker-dealer or a bank), an individual at a soliciting firm who engages in solicitation activities for an adviser (such as a bank representative or an individual registered representative of a brokerdealer), or both. Other examples could be an unaffiliated fund-of-funds or a feeder fund that solicits investors in an underlying fund or a master fund, respectively. b. Cash and Non-Cash Compensation jbell on DSKJLSW7X2PROD with RULES2 The second prong of the final marketing rule’s definition of advertisement is triggered by any form of compensation—whether cash or noncash—that an adviser provides, directly or indirectly, for an endorsement or testimonial. This mirrors the types of compensation that we stated would trigger the proposed solicitation rule and the proposed advertising rule’s compensation disclosure requirement in connection with a testimonial, endorsement, or third-party rating.133 As we stated about both proposed rules, compensation an adviser provides, directly or indirectly, for these activities can incentivize a person to provide a positive statement about, solicit an investor for, or refer an investor to, the investment adviser.134 Therefore, we believe that the marketing rule’s protections should apply. Some commenters agreed that noncash compensation creates the same conflicts of interest as cash compensation for solicitation.135 These commenters also agreed that investors should be made aware of the solicitor’s conflict of interest regardless of the form of compensation. Other commenters, however, raised concerns about extending the rule to cover certain forms of non-cash compensation, such as gifts 133 See 2019 Proposing Release, supra footnote 7, at section II.A.4 and II.B.2 and text accompanying n.172. 134 See id. at n.372. The proposed solicitation rule would have applied to an adviser’s direct and indirect compensation to a solicitor for any solicitation activities. See proposed rule 206(4)– 3(a). The current cash solicitation rule also covers direct and indirect cash compensation. See rule 206(4)–3(a). Similarly, our proposed advertising rule would have required disclosure, if applicable, that cash or non-cash compensation has been provided by or on behalf of the adviser in connection with obtaining or using the testimonial or endorsement. See proposed rule 206(4)– 1(b)(1)(ii). 135 See Consumer Federation Comment Letter; Mercer Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 and entertainment,136 or nontransferable advisory fee waivers in connection with refer-a-friend arrangements.137 Some commenters argued that the final rule should only apply to solicitations for which the adviser provides incentive-based compensation tied to the funding of an advisory account and the solicitation activities are directed at specific clients.138 Commenters generally opposed applying the proposed solicitation rule to communications to investors in private funds, which we address below.139 Forms of compensation under the final marketing rule will include fees based on a percentage of assets under management or amounts invested, flat fees, retainers, hourly fees, reduced advisory fees, fee waivers, and any other methods of cash compensation, and cash or non-cash rewards that advisers provide for endorsements and testimonials, including referral and solicitation activities.140 They also include directed brokerage that compensates brokers for soliciting investors,141 sales awards or other prizes, gifts and entertainment, such as outings, tours, or other forms of entertainment that an adviser provides as compensation for testimonials and endorsements. In addition, compensated endorsements and testimonials may or may not be contingent on the endorsement or testimonial resulting in 136 See MFA/AIMA Comment Letter I; MMI Comment Letter (stating that the rule should not apply to an adviser that sends a gift to a third-party adviser or broker-dealer with which it routinely does business, and such third party completely unrelatedly refers a client to the adviser, unless the third party has a reasonable expectation that it will receive some form of compensation from the adviser in exchange for that referral). 137 See IAA Comment Letter (also recommending that the rule exclude refer-a-friend programs that involve a small amount of compensation per referral). While the final marketing rule will apply to all compensated refer-a-friend programs (regardless of the form of compensation), we expect that many advisers that engage in these programs will fall under the de minimis exemption, and be subject to fewer conditions than other compensated testimonials and endorsements. See infra footnote 481. 138 See SIFMA AMG Comment Letters I & III; FSI Comment Letter. 139 See infra section II.A.4. 140 See 2019 Proposing Release, supra footnote 7, at nn.357 and 358 and accompanying text (discussing, for example, refer-a-friend programs). 141 Advisers are currently required to disclose to clients in the Form ADV brochure if they consider, in selecting or recommending broker-dealers, whether they or a related person receives client referrals from a broker-dealer or third party. As proposed, broker-dealers or dual registrants that receive brokerage for solicitation of client accounts in wrap fee programs that they do not sponsor will be subject to the final marketing rule if they solicit those clients to participate in the wrap fee program. See 2019 Proposing Release, supra footnote 7, at section II.B.2. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 a new advisory relationship or a new investment in a private fund. We believe that non-cash compensation, including forms of entertainment, can incentivize persons to provide a positive statement about an adviser, or make a referral or solicitation on an adviser’s behalf and should be included in the rule to make clients aware of such incentive. Whether an adviser provides cash or non-cash compensation in exchange for a testimonial or endorsement depends on the particular facts and circumstances.142 Some commenters requested that we exclude training or meetings that educate solicitors about the adviser’s services, even if there are some incidental benefits associated with such training.143 We continue to believe, as we stated in the 2019 Proposing Release, that attendance at training and education meetings, including company-sponsored meetings such as annual conferences, will not be noncash compensation, provided that attendance at these meetings or trainings is not provided in exchange for solicitation activities.144 Some commenters also raised concerns about potentially conflicting regulations for advisers dually registered as broker-dealers with respect to the inclusion of sales awards as noncash compensation under the proposed solicitation rule.145 While we acknowledge that other Commission rules for broker-dealers address concerns underlying non-cash compensation in the context of recommendations, the final marketing rule covers a broader range of activities and types of promoters.146 Thus, we do 142 Although commenters did not specifically address to what extent compensation paid to an adviser’s personnel, such as an employee, would implicate the proposed solicitation rule, we are clarifying that compensation for purposes of prong two of the definition of advertisement will not include regular salary or bonuses paid to an adviser’s personnel for their investment advisory activities or for clerical, administrative, support or similar functions. 143 See, e.g., MMI Comment Letter; MFA/AIMA Comment Letter I (discussing training for certain fund-of-funds arrangements); SIFMA AMG Comment Letter III (encouraging the Commission to draw from a FINRA 2016 proposal relating to noncash compensation, which the commenter states includes conditions such as prior approval, attendance not being preconditioned on the achievement of certain sales targets, appropriate location (whether an office or other facility) and no payment for additional guests). 144 See 2019 Proposing Release, supra footnote 7, at n.360. 145 See SIFMA AMG Comment Letters I & III (requesting alignment with FINRA’s 2016 non-cash compensation rule proposal); FSI Comment Letter. 146 See, e.g., Regulation Best Interest, Release No. 34–86031 (June 5, 2019) [84 FR at 33400 (July 12, 2019)] (‘‘Regulation Best Interest Release’’) (adopting rule 15l–1 under the Exchange Act, E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 not believe that an exemption for sales awards or contests from the final marketing rule would be appropriate on these grounds. As discussed further below, however, we are adopting a partial exemption for broker-dealers from the rule’s disqualification provisions. We are also adopting partial exemptions from the disclosure provisions when a broker-dealer provides a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation Best Interest (‘‘Regulation BI’’) under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’) and from certain disclosure requirements when a brokerdealer provides a testimonial or endorsement to a person that is not a retail customer (as that term is defined in Regulation BI).147 Other commenters stated non-cash compensation could capture benefits that advisers provide in the ordinary course of business unrelated to any solicitation activity.148 Relatedly, some commenters considered our proposed view of ‘‘indirect’’ compensation overly broad, particularly with respect to noncash compensation.149 These commenters recommended that we apply the final rule only to compensation an adviser provides to a solicitor after its solicitation activities, unless the solicitation agreement between the adviser and solicitor specifically includes compensation provided prior to the solicitation; or replace the solicitation rule’s reference to compensation that an adviser provides ‘‘indirectly’’ with compensation that is direct or ‘‘in connection with solicitation requiring broker-dealers to establish written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or the sale of specific types of securities within a limited period of time, noting that these compensation practices create high-pressure situations for associated persons to increase the sales of specific securities or specific types of securities within a limited period of time and thus compromise the best interests of their retail customers). The policies and procedures required thereunder must also be reasonably designed to identify and mitigate any conflicts of interest associated with the brokerdealer’s recommendations to retail customers that create an incentive for the broker-dealer’s associated persons to place their interest or the interest of the broker-dealer ahead of the retail customer’s interest. Id. 147 See id. Regulation BI defines a retail customer as a ‘‘natural person, or the legal representative of such natural person.’’ See id., at 768. 148 See, e.g., MFA/AIMA Comment Letter I; Fidelity Comment Letter; Fried Frank Comment Letter; IAA Comment Letter; Mercer Comment Letter; SIFMA AMG Comment Letter I. 149 See, e.g., SIFMA AMG Comment Letters I & III; FSI Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 activities.’’ 150 Others expressed concerns that, under our proposed solicitation rule, every mutually beneficial arrangement between an investment adviser and a potential facilitator of client relationships would be subject to scrutiny for indicia of quid pro quo solicitation.151 We believe the timing of compensation relative to an endorsement or testimonial is relevant in determining whether an adviser is providing compensation for the testimonial or endorsement. In addition, we believe that there will be a mutual understanding of a quid pro quo, whether explicit or inferred based on facts and circumstances, for most compensated endorsements or testimonials.152 However, we decline to draw bright lines around either the timing of the compensation or the establishment of a mutual understanding. We believe such bright lines would unnecessarily limit the final rule and would encourage advisers to structure their arrangements to avoid application of the rule in situations where it would otherwise apply. In addition, we believe that in many cases compensation will be in connection with testimonials and endorsements. We decline to remove the word ‘‘indirectly’’ from the rule for the same reasons discussed above.153 c. Activities That Constitute a Testimonial or Endorsement Some commenters requested guidance on whether certain activities would constitute solicitation or referral activities under the proposed amendments to the solicitation rule.154 Since the combined marketing rule includes statements that solicit investors for, or refer investors to, an investment adviser as testimonials or endorsements, we are addressing these comments in the context of these definitions. SIFMA AMG Comment Letter III. e.g., MFA/AIMA Comment Letter I; Mercer Comment Letter. 152 We would expect that, where required, the written agreement would be evidence of such a mutual understanding in most circumstances. See infra section II.C.3. 153 For example, an adviser will be subject to the rule’s provisions for compensated testimonials and endorsements when the adviser’s parent company pays a third party to endorse the adviser to the third party’s network of members that are prospective clients. See final rule 206(4)–1(b). Such indirect compensation could include the adviser’s parent company providing representatives to the third party and compensating them to promote the adviser’s business. 154 See, e.g., FSI Comment Letter; SIFMA AMG Comment Letter I; MFA/AIMA Comment Letter I; Fried Frank Comment Letter; IAA Comment Letter. 13037 For example, some commenters questioned whether lead-generation firms or adviser referral networks (collectively, ‘‘operators’’) would fall into the scope of the rule. One commenter described these operators as networks operated by non-investors where an adviser compensates the operator to solicit investors for, or refer investors to, the adviser.155 Another commenter described these operators as for-profit or non-profit entities that make third-party advisory services (such as model portfolio providers) accessible to investors, and stated that the operators do not promote or recommend particular services or products accessible on the platform.156 In both examples, the operator’s website likely meets the final marketing rule’s definition of endorsement. An operator may tout the advisers included in its network, and/or guarantee that the advisers meet the network’s eligibility criteria. In addition, because operators typically offer to ‘‘match’’ an investor with one or more advisers compensating it to participate in the service, operators typically engage in solicitation or referral activities.157 Similarly, a blogger’s website review of an adviser’s advisory service would be a testimonial or an endorsement under the final marketing rule because it indicates approval, support, or a recommendation of the investment adviser, or because it describes its experience with the adviser.158 If the adviser directly or indirectly compensates the blogger for its review, for example by paying the blogger based on the amount of assets deposited in new accounts from client referrals or the number of accounts opened, the testimonial or endorsement will be an advertisement under the definition’s second prong.159 Depending on the facts and circumstances, a lawyer or other service provider that refers an investor to an adviser, even infrequently, may 150 See 151 See, PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 155 See Commonwealth Comment Letter. This commenter stated that such operators typically offer to ‘‘match’’ an investor with an adviser. When an investor clicks on a link, the investor provides information to the operator (e.g., age, investable assets, and goals) and the operator matches the investor to one or more advisers participating in the service. Advisers generally pay a flat fee and/or a per-lead fee to receive matches of potential investors from the operator. 156 See MMI Comment Letter (stating that in some cases, the operator charges an administrative or service fee to the investment advisers whose products and services are accessible through the operator). 157 See final rule 206(4)–1(e)(5)(ii) and (iii) and (17)(ii) and (iii). 158 See final rule 206(4)–1(5)(i) and (17)(i). 159 See final rule 206(4)–1(e)(1)(ii). E:\FR\FM\05MRR2.SGM 05MRR2 13038 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 also meet the rule’s definition of testimonial or endorsement. On the other hand, where an adviser pays a third-party marketing service or news publication to prepare content for and/or disseminate a communication, we generally would not treat this communication as an endorsement under the second prong of the definition of ‘‘advertisement.’’ 160 Similarly, a noninvestor selling an adviser a list containing the names and contact information of prospective investors typically would not, without more, meet the definition of endorsement.161 This activity typically would not fall within the plain text of the definition of endorsement (e.g., the seller does not indicate approval, support, or recommendation of the investment adviser, or describe its experience with the adviser, or engage in the solicitation or referral activities described therein). One commenter requested an exclusion from the definition of solicitor under the proposed solicitation rule for an investment consultant that administers a RFP to aid one or more investors in selecting an investment adviser or a private fund investment vehicle.162 The commenter stated that the investor typically hires the consultant (the ‘‘agent’’), subject to the understanding that the investor will only enter into a transaction with an investment adviser that agrees to pay the expenses of the agent for providing this service.163 In these circumstances, we do not believe the adviser typically compensates the agent to endorse the adviser because the investor engages the agent to evaluate the adviser based on criteria that the investor provides.164 160 However, such a communication would be an advertisement under the first prong of the definition of ‘‘advertisement.’’ See supra section II.A.2. 161 See Nesler Comment Letter. 162 See IAA Comment Letter (alternately requesting, in the absence of an exclusion, clarification as to status under the proposed solicitation rule). This commenter stated that these agents facilitate submissions by investment advisers in the RFP process and prepare reports for prospective investors regarding investment advisers under consideration. Furthermore, in many cases the adviser must enter into an agreement with the agent to participate in the RFP process. 163 We understand that the consultant is typically not an advisory client of the advisers it selects to participate in the RFP process, and therefore the final rule’s testimonial provision would usually not apply. 164 Though a quid pro quo is not always determinative of whether the compensation element of this prong of the definition of advertisement is satisfied, these facts suggest a lack of quid pro quo and, without more, would not implicate the second prong of the definition. The adviser in this scenario will likely also not implicate the first prong of the definition of advertisement because the adviser is not making a direct or indirect communication to more than one person that offers the investment adviser’s investment advisory services with regard VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 d. Exclusion for Regulatory Communications; Inclusion of One-onOne and Extemporaneous, Live, Oral Communications The second prong of the definition of advertisement excludes any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication.165 As with the same exclusion in the first prong of the definition, this exclusion reflects our belief that communications that are prepared as a requirement of statutes, rules, or regulations should not be viewed as advertisements under the rule. Unlike the first prong of the definition of advertisement, however, this prong does not exclude extemporaneous, live, oral communications or one-on-one communications. These types of communications are precisely what the second prong of the definition seeks to address, along with other types of endorsement and testimonial activities. The current solicitation rule has also addressed these types of communications. In addition, the second prong does not exclude communications that include hypothetical performance information. Compensated testimonials and endorsements have the potential to mislead given a promoter’s financial incentive to recommend the adviser. Without appropriate safeguards, a compensated testimonial or endorsement creates a risk that the investor would mistakenly view the promoter’s recommendation as being an unbiased opinion about the adviser’s ability to manage the investor’s assets and would rely on that recommendation more than the investor otherwise would if the investor knew of the promoter’s incentive. Finally, some commenters requested an exclusion from the proposed solicitation rule for persons registered with the Commission as broker-dealers under the Exchange Act.166 We continue to believe that the final rule’s investor protections should apply to compensated endorsements and testimonials by any person, including a registered broker-dealer. However, we are adopting a partial exemption from to securities to investors. See final rule 206(4)– 1(e)(1)(i). See also supra section II.A.2. 165 See final rule 206(4)–1(e)(1)(ii). 166 See Credit Suisse Comment Letter (citing the ‘‘robust regulatory framework’’ already applicable to SEC-registered broker-dealers); MFA/AIMA Comment Letter I. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 the rule’s disqualification provisions for certain compensated testimonials and endorsements made by a registered broker-dealer.167 We also are adopting a partial exemption from the rule’s disclosure provisions when a brokerdealer provides a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation BI.168 e. Investment Adviser and Broker-Dealer Status and Registration for Persons Who Provide Endorsements or Testimonials We proposed to withdraw our position that a solicitor who engages in solicitation activities in accordance with paragraph (a)(2)(iii) of the cash solicitation rule will be, at least with respect to those activities, an associated person of an investment adviser and therefore will not be required to register individually under the Advisers Act solely as a result of those activities (the ‘‘1979 position’’).169 Although the 1979 position will no longer apply upon the rescission of the current solicitation rule, we are not adopting a similar position with respect to endorsements and testimonials under the final marketing rule. A promoter may, depending on the facts and circumstances, be acting as an investment adviser within the meaning of section 202(a)(11) of the Act.170 Investment adviser status and registration questions require analysis of the applicable facts and circumstances, including, for example, whether a person is ‘‘advising’’ others within the meaning of section 202(a)(11) of the Act.171 A promoter also may be acting as a broker or dealer within the meaning 167 See infra section II.C.5. id. 169 See 2019 Proposing Release, supra footnote 7, at n.346. Two commenters argued that, as a matter of statutory interpretation, solicitors fall within the Act’s definition of ‘‘person associated with an investment adviser.’’ See SIFMA AMG Comment Letter II; Credit Suisse Comment Letter. 170 Depending on the facts and circumstances, a promoter may also be acting as an investment adviser under applicable state law. 171 Commission staff previously stated that a person providing advice to a client as to the selection or retention of an investment manager or managers also, under certain circumstances, would be deemed to be ‘‘advising’’ others within the meaning of section 202(a)(11) of the Act. See Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons Who Provide Investment Advisory Services as a Component of Other Financial Services, Release No. IA–1092 (Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)], at footnote 6 and accompanying text. However, solicitation of clients may not involve providing investment advice on behalf of an adviser. See Release 1633, supra footnote 4, at text accompanying n.123. See also Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion to the Definition of Investment Adviser, Release No. IA–5249 (June 5, 2019) [84 FR 33669 (July 12, 2019)]. 168 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 of section 3(a)(4) or 3(a)(5) of the Exchange Act, for example, when soliciting investors for, or referring investors to, an adviser or a private fund advised by the adviser. Any promoter must determine whether it is subject to statutory or regulatory requirements under Federal law, including the requirement to register as an investment adviser pursuant to the Act and/or as a broker-dealer pursuant to section 15(a) of the Exchange Act, respectively. If the promoter is a supervised person of the adviser for which it is providing a testimonial or endorsement, the promoter does not need to separately register with the Commission as an investment adviser solely as a result of his or her activities as a promoter.172 A promoter also must determine whether it is subject to certain state law and certain FINRA rules, including any applicable state licensing requirements applicable to individuals.173 To be clear, we are not making a presumption that a person providing an endorsement or testimonial meets the definition of investment adviser or broker-dealer and must register under the Act or the Exchange Act, respectively. Nor are we making a presumption that such person may or may not be an associated person of a registered investment adviser. Indeed, we agree that some promoters may meet the definition of associated person of an investment adviser depending on the facts and circumstances.174 Others may not.175 Under the final marketing rule, if an adviser determines that a person 172 An adviser’s registration with the Commission covers its supervised persons, provided that their advisory activities are undertaken on the adviser’s behalf. 173 Most states impose registration, licensing, or qualification requirements on investment adviser representatives who have a place of business in the state, regardless of whether the investment adviser is registered with the Commission or the state. See Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011), available at https:// www.sec.gov/news/studies/2011/913studyfinal.pdf, at 86. See also rule 203A–3(a)(1) (definition of ‘‘investment adviser representative’’). In some states, a third-party solicitor will be subject to state qualification requirements to the extent state investment adviser statutes apply to solicitors. See Release 1633, supra footnote 4, at text accompanying n.125. 174 See Nesler Comment Letter (arguing that an SEC-registered adviser should be entitled to treat a non-employee solicitor as an ‘‘associated person’’ as long as the adviser exercises control and supervision over such solicitor in connection with the performance of its solicitation activities). 175 See Pickard Djinis Comment Letter (describing that solicitors that perform paid unscripted media campaigns on behalf of advisers, may not be under the adviser’s control). Such a paid solicitor may not be a ‘‘person associated with the investment adviser,’’ depending on the facts and circumstances. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 providing an endorsement or testimonial is an associated person, the adviser should have requisite control of such person.176 4. Investors in Private Funds Both prongs of the definition of ‘‘advertisement’’ will expressly include marketing communications to private fund investors. The term ‘‘private fund’’ is defined in section 202(a)(29) of the Advisers Act and means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (‘‘Investment Company Act’’), but for section 3(c)(1) or 3(c)(7) of that Act. This is consistent with the scope of the proposed amendments to the solicitation rule.177 We are not adopting the broader scope of the proposed amendments to the advertising rule, which generally would have applied to advertisements sent to investors in ‘‘pooled investment vehicles,’’ as defined in rule 206(4)–8 under the Act.178 In connection with these changes, we have eliminated the need for the proposed exclusion for advertisements, other sales materials, and sales literature of registered investment companies (‘‘RICs’’) and business development companies (‘‘BDCs’’) that are within the scope of rule 482 or 156 under the Securities Act of 1933 (‘‘Securities Act’’).179 Although we used different terms in each proposal, the scope of the proposals effectively would have covered only certain communications to private fund investors. In our advertising rule proposal, we included all pooled investment vehicles and then excepted RIC or BDC advertisements that were subject to rule 482 or 156 176 See rule 204A–1(a) (requiring adviser codes of ethics that, among other things, require supervised persons to comply with applicable Federal securities laws). 177 See proposed rule 206(4)–3(c)(2). 178 See proposed rule 206(4)–1(e)(9). See also definition of ‘‘pooled investment vehicle’’ in rule 206(4)–8 under the Act. 179 Commenters recommended that the final rule exclude all communications to investors in RICs and BDCs because the statutory anti-fraud provisions and other Commission rules apply to these communications. See, e.g., IAA Comment Letter; Comment Letter of the European Fund and Asset Management Association (Feb. 13, 2020) (‘‘EFAMA Comment Letter’’) (suggesting that the final rule also exclude non-U.S. funds that are publicly offered (including UCITS)); ICI Comment Letter (recommending that the Commission exclude all registered fund communications from the scope of the rule, including sales literature subject to rule 34b–1 under the Investment Company Act and generic advertisements subject to rule 135a under the Securities Act). Given the regulatory framework applicable to communications to investors in RICs and BDCs, we do not believe the additional protections of the Advisers Act marketing rule are necessary. PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 13039 under the Securities Act.180 We did not seek to apply the proposed solicitation rule to promotional activity involving RICs and BDCs because we believed that the primary goal of the proposal was already satisfied by other regulatory requirements.181 Most notably, prospective investors in RICs and BDCs sold through a broker-dealer or other financial intermediary already receive disclosure about the conflicts of interest that may be created due to the fund or its related companies paying the intermediary for the sale of its shares and related services.182 Commenters generally opposed applying the two rules to communications to private fund investors.183 They stated that existing, general anti-fraud provisions provide sufficient protection and any additional regulation would be unnecessary and duplicative.184 Other commenters supported explicitly including private funds in the scope of the rules, arguing that doing so would provide important protections to investors in these funds.185 We recognize that rule 206(4)–8 prohibits advisers to private funds from making misstatements or materially misleading statements to investors in those vehicles.186 An adviser’s general anti-fraud obligations to investors in private funds under rule 206(4)–8 parallel an adviser’s general anti-fraud 180 See 2019 Proposing Release, supra footnote 7, at section II.A.; proposed rule 206(4)–1(e)(9). 181 See 2019 Proposing Release, supra footnote 7, at section II.B.3. 182 See Item 8 of Form N–1A. See also FINRA rule 2341(l)(4) (generally prohibiting member firms from accepting any cash compensation from an investment company, an adviser to an investment company, a fund administrator, an underwriter or any affiliated person (as defined in section 2(a)(3) of the Investment Company Act) of such entities unless such compensation is described in a current prospectus of the investment company). 183 See, e.g., AIC Comment Letter; MFA/AIMA Comment Letter I; Comment Letter of the National Venture Capital Association (Feb. 14, 2020) (‘‘NVCA Comment Letter’’); IAA Comment Letter. 184 See, e.g., AIC Comment Letter (citing rule 206(4)–1(a)(5) and rule 206(4)–8 under the Advisers Act); NVCA Comment Letter (citing rule 156(b)(3)(ii) under the Securities Act). 185 See, e.g., ILPA Comment Letter; SBIA Comment Letter. See also Consumer Federation Comment Letter; EFAMA Comment Letter (supporting additional protections for investors in pooled investment vehicles, but seeking an exception for certain non-U.S. domiciled funds). 186 Section 206(4) of the Advisers Act authorizes the Commission to adopt rules and regulations that ‘‘define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.’’ 15 U.S.C. 80b–6(4). See rule 206(4)– 8(a)(1). We are adopting this rule under the same authority of section 206(4) of the Advisers Act on which we relied in adopting rule 206(4)–8. See Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Release No. IA–2628 (Aug. 3, 2007) [75 FR 44756 (Aug. 9, 2007)]. E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13040 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations obligations to all clients and prospective clients under section 206 of the Act. Accordingly, although the final marketing rule overlaps with the prohibitions in rule 206(4)–8 in certain circumstances, just as it overlaps with section 206 with respect to an adviser’s clients and prospective clients, we believe it is important from an investor protection standpoint to delineate these obligations to all investors in the advertising context and provide a framework for an adviser’s advertisements to comply with these obligations. By including marketing communications to private fund investors, the final rule will provide more specificity (and certainty) regarding what we believe to be untrue or misleading statements that advisers must avoid in their advertisements.187 The general prohibitions, for example, will provide advisers with a principlesbased framework to assess private fund advertisements and will provide greater clarity, compared to the anti-fraud provisions of the Act, on marketing practices that are likely misleading.188 This approach is consistent with some commenters who stated that the Commission should finalize rules in a manner that provides guidance to advisers on how to comply with a principles-based approach without creating overly prescriptive requirements that can be difficult to apply in practice.189 We understand that many private fund advisers already consider the current staff positions related to the current advertising rule when preparing their marketing communications.190 As a result, we believe that our application of the final rule to advertisements to private fund investors would result in limited additional regulatory or compliance costs for many of these advisers. We also believe that the modifications from the proposal will reduce potential costs and alleviate commenters’ concerns regarding the application of the final rule to an adviser’s advertisements to private fund investors. For example, the first prong of the definition of advertisement will not include one-on-one communications to private fund investors or communications with existing investors; as such, those communications will be subject to rule 206(4)–8 and not the advertising rule.191 The first prong of the definition of advertisement also excludes live, oral, extemporaneous communications. Further, we are not adopting a requirement for an adviser to pre-review all advertisements prior to dissemination or requirements for retail versus non-retail advertisements, as discussed below.192 Collectively, we believe these changes appropriately scope advertisements that would be subject to the rule. Not all communications to private fund investors would be advertisements under the final rule. Most commenters stated that private placement memoranda (‘‘PPMs’’) should not be treated as advertisements.193 We agree that information included in a PPM about the material terms, objectives, and risks of a fund offering is not an advertisement of the adviser.194 Private fund account statements, transaction reports, and other similar materials delivered to existing private fund investors, and presentations to existing clients concerning the performance of funds they have invested in (for example, at annual meetings of limited partners) also would not be considered advertisements under the final rule. However, pitch books or other materials 187 For example, rule 206(4)–8 prohibits investment advisers to pooled investment vehicles from engaging in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle. The final rule will include more specific provisions in the context of advertisements. See final rule 206(4)–1(b) through (d). To the extent that an advertising practice would violate a specific restriction imposed by the final rule, rule 206(4)– 8 may already prohibit the practice. 188 We recognize that a single investor could invest in both private funds managed by the adviser and other products (e.g., separately managed accounts) managed by the adviser. The final rule would ensure that advisers apply the same principles-based framework across products and services, which could reduce advisers’ compliance burdens. 189 See MFA/AIMA Comment Letter III. But see supra footnotes 183–184. 190 See SBIA Comment Letter; NRS Comment Letter. 191 These communications also are subject to various statutory and regulatory anti-fraud provisions, such as section 17(a) of the Securities Act, section 10(b) of the Exchange Act, and rule 10b–5 thereunder. 192 See infra sections II.E. and II.G. See also NYC Bar Comment Letter (discussing the administrative and compliance burdens and costs associated with applying the standards for Retail Advertisements and Non-Retail Advertisements (each as defined below) for private funds under the proposed advertising rule). 193 See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter; Proskauer Comment Letter. 194 PPMs are subject to the anti-fraud provisions of the Federal securities laws. See also supra footnote 88 (discussing an adviser’s fiduciary duties). Whether particular information included in a PPM constitutes an advertisement of the adviser depends on the relevant facts and circumstances. For example, if a PPM contained related performance information of separate accounts the adviser manages, that related performance information is likely to constitute an advertisement. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 accompanying PPMs could fall within the definition of an advertisement. Some commenters sought clarification that due diligence rooms and their contents would not be considered advertisements.195 While due diligence rooms themselves are not advertisements, it is possible that some of the information they contain could qualify as an advertisement if the materials satisfy the requirements of the advertisement definition. Some commenters recommended expanding the final rule to other types of unregistered pooled investment vehicles, and one commenter specified which other types of unregistered pooled investment vehicles should be subject to the rule.196 While these commenters generally supported the idea of extending the scope of the rule, they did not explain why. Accordingly, we believe that the scope of the final rule is appropriate at this time. A commenter specifically sought confirmation that the proposed rules would not apply to an adviser whose principal office and place of business is outside the United States (offshore adviser) with regard to any of its nonU.S. clients even if the non-U.S. client is a fund with U.S. investors.197 This commenter and others also asked the Commission to clarify the application of the proposals to communications with non-U.S. investors in funds domiciled outside of the United States.198 We have previously stated, and continue to take the position, that most of the substantive provisions of the Advisers Act do not apply with respect to the non-U.S. clients (including funds) of a registered offshore adviser.199 This 195 See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; ILPA Comment Letter (seeking clarification that non-promotional material contained in a data room would not be subject to the rule). 196 See, e.g., EFAMA Comment Letter (supporting the Commission’s proposal to increase protections to investors in collective investment schemes, but recommending that the Commission exclude (i) non-U.S. domiciled publicly offered, closed-end and open-end investment funds, including UCITS, and (ii) alternative investment funds and other nonU.S. domiciled funds that would be an investment company, as defined in section 3 of the Investment Company Act, but for sections 3(c)(1) or 3(c)(7) of that Act); ILPA Comment Letter (recommending expanding to funds excluded from the definition of investment company by reason of section 3(c)(5) or 3(c)(11) of the Investment Company Act). 197 See Sidley Austin Comment Letter; see also Registration Under the Advisers Act of Certain Hedge Fund Advisers, Release No. IA–2333 (Dec. 2, 2004) [69 FR 72054, 72072 (Dec. 10, 2004)] (‘‘Hedge Fund Adviser Release’’). 198 See IAA Comment Letter; EFAMA Comment Letter. 199 See Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, Release No. IA–3222 E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations B. General Prohibitions We are adopting, largely as proposed, the general prohibitions of certain marketing practices as a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts. We believe these practices are associated with a significant risk of being false or misleading. We therefore believe it is in the public interest to prohibit these practices, rather than permit them subject to specified conditions. The general prohibitions will apply to all advertisements to the extent that an adviser directly or indirectly disseminates such advertisement. Specifically, in any advertisement, an adviser may not: (1) Include any untrue statement of a material fact, or omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading; (2) Include a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission; (3) Include information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser; (4) Discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits; (5) Include a reference to specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced; (6) Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced; or (7) Otherwise be materially misleading. As noted in the proposal, to establish a violation of the rule, the Commission will not need to demonstrate that an investment adviser acted with scienter; negligence is sufficient.202 Many commenters supported the prohibitions’ principles-based framework.203 However, other commenters found the proposed general prohibitions confusing and redundant and suggested streamlining them into fewer standards (or eliminating them altogether) and relying on the general anti-fraud standard instead.204 After (June 22, 2011) [76 FR 39645 (July 6, 2011)] (Most of the substantive provisions of the Advisers Act do not apply to the non-U.S. clients of a non-U.S. adviser registered with the Commission.); Hedge Fund Adviser Release, supra footnote 197 (stating that the following rules under the Advisers Act would not apply to a registered offshore adviser, assuming it has no U.S. clients: Compliance rule, custody rule, and proxy voting rule and stating that the Commission would not subject an offshore adviser to the rules governing adviser advertising [17 CFR 275.206(4)–1], or cash solicitations [17 CFR 275.206(4)–3] with respect to offshore clients); American Bar Association, SEC Staff No-Action Letter (Aug. 10, 2006) (confirming that the substantive provisions of the Act do not apply to offshore advisers with respect to those advisers’ offshore clients (including offshore funds) to the extent described in those letters and the Hedge Fund Adviser Release); IM Information Update No. 2017–03. 200 See Hedge Fund Adviser Release, supra footnote 197 (noting that U.S. investors in an offshore fund generally would not expect the full protection of the U.S. securities laws and that U.S. investors may be precluded from an opportunity to invest in an offshore fund if their participation would result in full application of the Advisers Act and rules thereunder, but that a registered offshore adviser would be required to comply with the Advisers Act and rules thereunder with respect to any U.S. clients it may have). 201 See, e.g., Hedge Fund Adviser Release supra footnote 197. 202 See SEC v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992). As we noted when we adopted rule 206(4)–8, the court in Steadman analogized section 206(4) of the Advisers Act to section 17(a)(3) of the Securities Act, which the Supreme Court had held did not require a finding of scienter (citing Aaron v. SEC, 446 U.S. 680 (1980)). See also Steadman at 643, n.5. In discussing section 17(a)(3) and its lack of a scienter requirement, the Steadman court observed that, similarly, a violation of section 206(2) of the Advisers Act could rest on a finding of simple negligence. See also Fiduciary Interpretation, supra footnote 88, at n.20. 203 See, e.g., Wellington Comment Letter; ILPA Comment Letter; IAA Comment; NRS Comment Letter; and NAPFA Comment Letter. 204 See, e.g., MFA/AIMA Comment Letter I; Comment Letter of Managed Funds Association and Alternative Investment Management Association (May 8, 2020) (‘‘MFA/AIMA Comment Letter II’’). One commenter also argued that withdrawing the SEC staff no-action letters would create confusion and lack of guidance. NYC Bar Comment Letter (citing, for example, Clover Capital Mgmt., Inc., SEC Staff No-Action Letter (Oct. 28, 1986) (‘‘Clover Letter’’), Stalker Advisory Services, SEC Staff NoAction Letter (Jan. 18,1994) (Stalker Letter’’), F. Eberstadt & Co., Inc., SEC Staff No-Action Letter (July 2, 1978) (‘‘Eberstadt Letter’’), TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008) (‘‘TCW Letter’’), and Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998) (‘‘Franklin Letter’’). However, we do not view the principles of the general prohibitions to be substantive jbell on DSKJLSW7X2PROD with RULES2 approach was designed to provide appropriate flexibility where an adviser has its principal office and place of business outside of the United States.200 We believe it is appropriate to continue to apply this approach in this context. For an adviser whose principal office and place of business is in the United States (onshore adviser), the Advisers Act and rules thereunder apply with respect to the adviser’s U.S. and nonU.S. clients.201 VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 13041 considering comments, we are making certain modifications, as discussed below. We continue to believe that prohibiting certain marketing practices is appropriate and that the final provisions provide important requirements for investment advisers and protections for investors. In our view, the general prohibitions provide greater clarity on marketing practices that are likely misleading compared to just relying on the anti-fraud provisions of the Act. We also believe that the general prohibitions we are adopting provide appropriate flexibility and regulatory certainty for advisers considering how to market their investment advisory services. In applying the general prohibitions, an adviser should consider the facts and circumstances of each advertisement. The nature of the audience to which the advertisement is directed is a key factor in determining how the general prohibitions should be applied.205 For instance, the amount and type of information that may need to be included in an advertisement directed at retail investors may differ from the information that may need to be included in an advertisement directed at sophisticated institutional investors. We discuss below each of the general prohibitions and the comments we received. 1. Untrue Statements and Omissions As proposed, the final rule will prohibit advertisements that include any untrue statements of a material fact, or that omit a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading.206 One commenter argued that this prohibition would be duplicative of sections 206(1) and (2) of the Advisers Act, which prohibit advisers from ‘‘employ[ing] any device, scheme or artifice to defraud any client or prospective client’’ and ‘‘engag[ing] in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective departures from the positions in existing staff noaction letters and guidance. 205 The nature of the audience would be relevant if an adviser chooses to tailor the content of an advertisement to a specific audience because the content is not appropriate for a broader audience. FINRA has a similar requirement under its General Standards regarding Communications with the Public. See FINRA rule 2210(d)(1)(E) (‘‘Members must consider the nature of the audience to which the communication will be directed and must provide details and explanations appropriate to the audience.’’). 206 Final rule 206(4)–1(a)(1). E:\FR\FM\05MRR2.SGM 05MRR2 13042 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 client.’’ 207 However, we view this prohibition as complementary to, rather than duplicative of, the statutory antifraud prohibitions cited by the commenter.208 We continue to believe that this prohibition, together with the other general prohibitions under the rule, is appropriately designed to prevent fraud under the Act, specifically in the context of marketing. Moreover, this provision retains the substance of current rule 206(4)–1(a)(5).209 As with similar anti-fraud provisions in the Federal securities laws, whether a statement is false or misleading depends on the context in which the statement or omission is made.210 For example, as under the current rule, advertising that an adviser’s performance was positive during the last fiscal year may be misleading if the adviser omitted that an index or benchmark consisting of a substantively comparable portfolio of securities experienced significantly higher returns during the same period. To avoid making a misleading statement, the adviser in this example could include the relevant index or benchmark or otherwise disclose that the adviser’s performance, although positive, significantly underperformed the market.211 207 NYC Bar Comment Letter. This commenter also noted that section 206(4) prohibits investment advisers from ‘‘engag[ing] in any act, practice, or course of business which is fraudulent, deceptive, or manipulative.’’ 208 While we acknowledge there may be circumstances that are covered by both the antifraud prohibitions and this provision, we believe that this provision helps provide specificity when addressing an adviser’s marketing activities. In addition, to the extent possible, this rule can serve as a resource for identifying an adviser’s obligations with respect to marketing generally, and thus we believe that retaining this general prohibition will serve to assist advisers in meeting their compliance obligations. 209 Current rule 206(4)–1(a)(5) prohibits an advertisement that contains any untrue statement of a material fact and uses similar wording as other anti-fraud provisions in the Federal securities laws. See, e.g., 17 CFR 240.10b–5; 15 U.S.C. 77q(a)(2); 17 CFR 230.156(a); rule 206(4)–8. 210 When we use the phrase ‘‘false or misleading statements’’ in this release, we are referring to this general prohibition against advertisements that include any untrue statements of a material fact, or omissions of a material fact necessary in order to make a statement, in the light of the circumstances under which it was made, not misleading. 211 Although one commenter stated that an adviser should be required to show returns of an appropriate benchmark for the same periods as presented for the adviser’s performance, we do not believe that it is necessary to prescribe such disclosures and that such decisions should be left at the discretion of the adviser, subject to the general prohibitions of the final rule and the general anti-fraud provisions of the Federal securities laws. See CFA Institute Comment Letter. Accordingly, we are not requiring the inclusion of a relevant index or benchmark to avoid making any presentation of performance misleading. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 Under the final rule, it would be misleading for an adviser to compensate a person to refer investors to the adviser by stating that the person had a ‘‘positive experience’’ with the adviser when such person is not a client or private fund investor of the adviser for its advisory services. To avoid making such a statement misleading, the adviser could disclose that the experience does not relate to any advisory services. It would also be misleading for an adviser to use a promoter’s testimonial or endorsement that the adviser knows or reasonably should know to be fraudulent, misleading, or untrue, regardless of whether the adviser compensates the promoter. For instance, an adviser may not provide a testimonial on its website where a client falsely claims that the client has worked with the adviser for over 20 years when the adviser has only been in business for five years. The current rule contains an explicit prohibition on advertisements that contain statements to the effect that a report, analysis, or other service will be furnished free of charge, unless the analysis or service is actually free and without condition.212 We continue to believe that this practice will be captured by the final rule’s prohibition on untrue statements or omissions. As a result, the final rule will not contain separate explicit prohibitions of such statements. In addition, depending on the disclosures provided and the extent to which an adviser in fact does provide investment advice solely based on such materials, it may be false or misleading under this provision to represent, directly or indirectly, in an advertisement that any graph, chart, or formula can by itself be used to determine which securities to buy or sell.213 2. Unsubstantiated Material Statements of Fact The proposed rule would have prohibited advertisements that include 212 See current rule 206(4)–1(a)(4); see also Dow Theory Forecasts, Inc., SEC Staff No-Action Letter (May 21, 1986) (‘‘Dow Theory Letter’’) (staff declined to provide no-action recommendation where an offer for ‘‘free’’ subscription was subject to conditions). 213 An adviser’s use of graphs, charts, or formulas to represent, directly or indirectly, that such graphs, charts, or formulas can in and of themselves be used to determine which securities to buy or sell, or when to buy or sell them, is explicitly prohibited in the current rule. See current rule 206(4)–1(a)(3) (also prohibiting an advertisement from representing, directly or indirectly, that any graph, chart, formula or other device being offered will assist any person in making his own decisions as to which securities to buy, sell, or when to buy or sell them, without disclosing the limitations and difficulties with respect to the use of such a graph, chart, formula or other device). PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 any material claim or statement that is unsubstantiated.214 Commenters argued that the proposed ‘‘substantiation’’ requirement would be overly burdensome.215 For example, two commenters argued that it would require advisers to obtain evidence to support every claim or statement in an advertisement out of uncertainty as to what might be ‘‘material.’’ 216 Commenters also found the requirement unclear, questioning whether, for example, such a prohibition would effectively foreclose any statements of opinion.217 We are sensitive to commenters’ concerns regarding the burdens and lack of clarity of this proposed provision. As a result, we are making two changes to the requirement. First, we are limiting the substantiation requirement to matters of material fact rather than any material claim or statement. We do not believe that this would be unduly burdensome for advisers as such material statements of fact, as opposed to opinions, should be verifiable. For instance, material facts might include a statement that each of its portfolio managers holds a particular certification or that it offers a certain type or number of investment products. Claims about performance would also be statements about material facts.218 Conversely, statements that clearly provide an opinion would not be statements of material fact. Second, we are requiring advisers to have a reasonable basis to believe that they can substantiate material claims of fact upon demand by the Commission.219 This change is designed 214 See proposed rule 206(4)–1(a)(2). e.g., MFA/AIMA Comment Letter I (stating that this requirement would greatly increase cost and operational burdens and curb the flow of information to clients and investors); FPA Comment Letter; NVCA Comment Letter; Fried Frank Comment Letter. 216 See MFA/AIMA Comment Letter I; Fried Frank Comment Letter. 217 See, e.g., MFA/AIMA Comment Letter I; FPA Comment Letter; Fried Frank Comment Letter. 218 For example, we would view performance returns included in an advertisement to be material statements of fact that an adviser would need a reasonable basis for believing that it will be able to substantiate. Because current rule 204–2(a)(16) already requires the maintenance of records ‘‘to support the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any . . . advertisement,’’ we believe that any recordkeeping burden related to performance information included in an advertisement will not be significantly new or altered. See current rule 204–2(a)(16). Final rule 204–2(a)(16) will similarly require advisers to retain records or documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts, portfolio or securities recommendations presented in any advertisement. See final rule 204–2(a)(16). 219 Final rule 206(4)–1(a)(2). Demand by the Commission includes demand by the Commission’s 215 See, E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations to reduce burdens on advisers and allow them to avoid the need to develop and maintain a file of substantiating materials for every advertisement.220 Advisers would be able to demonstrate this reasonable belief in a number of ways. For example, they could make a record contemporaneous with the advertisement demonstrating the basis for their belief.221 An adviser might also choose to implement policies and procedures to address how this requirement is met. However, if an adviser is unable to substantiate the material claims of fact made in an advertisement when the Commission demands it, we will presume that the adviser did not have a reasonable basis for its belief. We believe that the burden on advisers to have a reasonable basis for believing they will be able to substantiate a material statement of fact upon demand by the Commission is justified by the importance of ensuring that advisers do not advertise material claims of fact that cannot be substantiated and the need to facilitate our staff’s examination of advisers. jbell on DSKJLSW7X2PROD with RULES2 3. Untrue or Misleading Implications or Inferences The proposed rule would have prohibited any advertisement that includes an untrue or misleading implication about, or is reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to an investment adviser.222 After considering comments, we are adopting this prohibition but modifying it to add the reasonableness standard to ‘‘implication,’’ and not only to ‘‘inference.’’ 223 Accordingly, the final rule will prohibit an adviser from including, in any advertisement, information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to an investment adviser.224 examiners or other representatives. The adviser’s obligation to produce such materials on demand will last as long as the relevant advertisement needs to be retained under the recordkeeping rule. See current rule 204–2(e)(1). 220 See, e.g., MFA/AIMA Comment Letter I; NVCA Comment Letter. 221 Some advisers likely will (and some already do) maintain records to substantiate nonperformance material statements of fact included in an advertisement when the advertisement is created; however, this is not required as long as the adviser has a reasonable basis for believing it will be able to substantiate the information upon demand by the Commission. 222 See proposed rule 206(4)–1(a)(3). 223 See Flexible Plan Investments Comment Letter II. 224 Final rule 206(4)–1(a)(3). An adviser’s statements in an advertisement also are subject to section 208(a) of the Act, which generally states that VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 One commenter suggested eliminating this prohibition altogether and instead relying on the prohibition against untrue statements or omissions, stating that it is difficult to enforce when something is ‘‘implied’’ or ‘‘inferred.’’ 225 However, we continue to believe that this prohibition appropriately addresses certain activities that would not be subject to the first prohibition, such as those raised in previous staff no-action letters.226 For example, this provision will prohibit an adviser from making a series of statements in an advertisement that literally are true when read individually, but whose overall effect is reasonably likely to create an untrue or misleading inference or implication about the investment adviser.227 For instance, if an adviser were to state accurately in an advertisement that it has ‘‘more than a hundred clients that have stuck with me for more than ten years,’’ we believe it may create a misleading implication if the adviser actually has a very high turnover rate of clients. Additionally, this provision will prohibit an adviser from stating that all of its clients have seen profits, even if true, without providing appropriate disclosures if it only has two clients, as it may be reasonably likely to cause a misleading inference by potential clients that they would have a high it is unlawful for a registered investment adviser to represent or imply that it has been sponsored, recommended, or approved by any agency of the United States. Section 208(b) of the Act generally states that Section 208(a) shall not be construed to prohibit a person from stating that he is registered with the Commission as an investment adviser if the statement is true and if the effect of his registration is not misrepresented. Nevertheless, an adviser’s use of the phrase ‘‘registered investment adviser’’ (or the initials ‘‘RIA’’ or ‘‘R.I.A.’’) to state or imply that it has a level of professional competence, education or other special training could be misleading under the final rule. 225 CFA Institute Comment Letter. 226 See, e.g., Clover Letter (stating the use of performance results in an advertisement in the staff’s view would be false or misleading if it implies, or a reader would infer from it, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts); Stalker Letter (stating that copies of articles printed in independent publications that contain performance information of an adviser would be prohibited if they implied false or misleading information absent additional facts); Eberstadt Letter (stating that advertisements could be misleading if they imply positive facts about the adviser when additional facts, if also provided, would cause the implication not to arise). 227 See In the Matter of Spear & Staff, Inc., Release No. IA–188 (Mar. 25, 1965) (settled order) (the Commission brought an enforcement action against an investment adviser asserting, in part, that the adviser’s advertisements, which recounted a number of factually accurate stories highlighting the outstanding investment success of certain selected clients collectively created ‘‘illusory hopes of immediate and substantial profit’’). PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 13043 chance of profit by hiring the adviser as well. Commenters requested more guidance regarding when advertised testimonials would comply with this general prohibition.228 Two commenters argued that it would effectively eliminate an adviser’s ability to use testimonials if advisers had to present negative testimonials alongside positive ones, particularly in the context of online and social media platforms.229 We do not believe that the general prohibition requires an adviser to present an equal number of negative testimonials alongside positive testimonials in an advertisement, or balance endorsements with negative statements in order to avoid giving rise to a misleading inference, as certain commenters suggested.230 Rather, the general prohibition requires the adviser to consider the context and totality of information presented such that it would not reasonably be likely to cause any misleading implication or inference. General disclaimer language (e.g., ‘‘these results may not be typical of all investors’’) would not be sufficient to overcome this general prohibition. However, one approach that we believe would generally be consistent with the general prohibitions would be for an adviser to include a disclaimer that the testimonial provided was not representative, and then provide a link to, or other means of accessing (such as oral directions to go to the relevant parts of an adviser’s website), all or a representative sample of the testimonials about the adviser. As discussed in further detail in section II.B.5. below, we believe this provision (along with the other provisions discussed below) will prohibit ‘‘cherry picking’’ of past investments or investment strategies of the adviser—that is, including favorable results while omitting unfavorable ones in a manner that is not fair and balanced. 4. Failure To Provide Fair and Balanced Treatment of Material Risks or Material Limitations The proposed rule would have prohibited advertisements that discuss 228 See AIC Comment Letter (‘‘The Proposing Release does not suggest how an adviser may ascertain whether a testimonial is representative of that adviser’s investors. Such a determination may require that an adviser poll or survey a material sample of its investors.’’); IAA Comment Letter; SIFMA AMG Comment Letter I; Comment Letter of Truth in Advertising, Inc. (Feb. 10, 2020) (‘‘TINA Comment Letter’’). 229 See SIFMA AMG Comment Letter II and IAA Comment Letter. 230 See, e.g., IAA Comment Letter; SIFMA AMG Commenter Letter I. E:\FR\FM\05MRR2.SGM 05MRR2 13044 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations or imply any potential benefits connected with or resulting from the investment adviser’s services or methods of operation without clearly and prominently discussing associated material risks or other limitations associated with the potential benefits.231 We are generally retaining this requirement with some modifications in response to comments.232 Some commenters suggested eliminating this prohibition, arguing that it is redundant since Form ADV Part 2 already requires the disclosure of material risks.233 Commenters also expressed concern that this prohibition would expand the amount of required disclosures, dramatically lengthen advertisements, and overwhelm the content included in the advertisement.234 One commenter recommended removing ‘‘or imply’’ from this prohibition, stating that it would be difficult for the Commission staff to prove something is implied.235 Several commenters requested that the Commission permit the use of hyperlinks and layered disclosures to satisfy the requirement that the necessary disclosures be made ‘‘clearly and prominently,’’ arguing that such an approach would be consistent with the Commission’s stated goal of modernizing the advertising rule.236 Commenters also suggested that requiring an adviser to include detailed risk disclosures required under the proposed general prohibition in a clear and prominent manner may not be feasible in certain formats without the use of hyperlinks.237 In response to these concerns, we have modified this provision to prohibit advertisements that discuss any potential benefits connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits.238 We continue to believe that advertisements should provide an accurate portrayal of both 231 Proposed rule 206(4)–1(a)(4). final rule 206(4)–1(a)(4). 233 See, e.g., Ropes & Gray Comment Letter and MFA/AIMA Comment Letter I. 234 See MFA/AIMA Comment Letter I. 235 CFA Institute Comment Letter. 236 See, e.g., Fidelity Comment Letter; Ropes & Gray Comment Letter; IAA Comment Letter; Comment Letter of T. Rowe Price (Feb. 10, 2020) (‘‘T. Rowe Price Comment Letter’’); LinkedIn Comment Letter; SIFMA AMG Comment Letter II. 237 See, e.g., MFA/AIMA Comment Letter I; LinkedIn Comment Letter; Ropes & Gray Comment Letter. 238 Final rule 206(4)–1(a)(4). For the sake of clarity, the materiality standard will explicitly apply to both the risks and the limitations. jbell on DSKJLSW7X2PROD with RULES2 232 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 the risks and benefits of the adviser’s services. However, as proposed, the prohibition may have led advisers to provide overly voluminous disclosure of associated material risks, as well as overly inclusive disclosure of ‘‘other limitations.’’ We believe this could have resulted in lengthy, boilerplate disclosure that could reduce the salience of the risk and limitation information for investors. Because we are requiring fair and balanced treatment of material risks or material limitations associated with the benefits advertised, we no longer believe the requirement to ‘‘clearly and prominently’’ provide material risk disclosures is necessary.239 The proposed prohibition was designed to mitigate the risk that an adviser’s advertisement might discuss only the benefits of its services but not include sufficient information about the material risks that the client may face. We believe that the requirement to provide benefits and material risks in a fair and balanced manner similarly achieves this goal. In addition, it will promote a more digestible discussion for investors by making clear that advisers need not discuss every potential risk or limitation in detail, but must instead discuss the material risks and material limitations associated with the benefits in a fair and balanced manner.240 We expect that this approach will help facilitate layered disclosure. For example, an advertisement could comply with this requirement by identifying one benefit of an adviser’s services, accompany the discussion of the benefit with fair and balanced treatment of material risks associated with that benefit within the four corners of that advertisement, and then include a hyperlink 241 to additional content that discusses additional benefits and additional risks of the adviser’s services in a fair and balanced manner. So long as each layer of a layered advertisement complies with the requirement to provide benefits and risks in a fair and balanced manner, providing hyperlinks 239 As we discussed in the proposal, this general prohibition was drawn from FINRA rule 2210’s general standards. See FINRA rule 2210(d)(1)(D). The final rule’s use of ‘‘fair and balanced’’ is more closely aligned with FINRA 2210, and accordingly, we believe that advisers that are familiar with those standards may be able to use that experience as a guide in complying with this requirement. 240 For example, if an adviser states that it will reduce an investor’s taxes through its tax-loss harvesting strategies, the adviser should also discuss the associated material risks or material limitations, including that any reduction in taxes would depend on an investor’s tax situation. 241 In addition to hyperlinks, advisers may use other tools to provide investors with layered disclosure, including QR codes or mouse-over windows. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 to additional content would meet the requirement of this general prohibition. However, an adviser should not use layered disclosure or hyperlinks to obscure important information. For instance, it would not be sufficient to advertise only an adviser’s past profits on a web page and then include a hyperlink to another page that included all material risks and material limitations as that would violate the fair and balanced presentation requirement. We are also removing the term ‘‘imply’’ from this general prohibition, which a commenter found unclear.242 Removing the term imply will make this provision more consistent with similar requirements with which many advisers are already familiar.243 In addition, we believe that the other general prohibitions (including the prohibition on information that could cause a misleading implication or inference to be drawn), address the concerns that led us to include the term imply in this general prohibition at proposal. We believe this prohibition differs in scope from the disclosures required by Form ADV. For example, Item 8 of Form ADV Part 2A requires material risk disclosures more specifically with respect to investing in securities and certain investment strategies and risks involved. Moreover, an investment adviser must provide its brochure prepared in accordance with Form ADV to its clients, but not to investors in private funds it manages. The marketing rule’s prohibition requires risk disclosures related to any potential benefits advertised to both clients and private fund investors. We believe that providing such disclosures in advertisements is necessary in order to avoid misleading potential investors as well as existing investors in connection with new services or investments. 5. Anti-Cherry Picking Provisions: References to Specific Investment Advice and Presentation of Performance Results The final rule contains, as proposed, two other provisions designed to address concerns about investment advisers presenting potentially cherrypicked information in advertisements. a. References to Specific Investment Advice As proposed, the final rule will prohibit a reference in an advertisement to specific investment advice that is not presented in a fair and balanced manner.244 Commenters supported 242 See CFA Institute Comment Letter. rule 156(b)(3)(i); FINRA rule 2210(d)(1). 244 See final rule 206(4)–1(a)(5). 243 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations replacing the current rule’s per se prohibition against past specific recommendations with this principlesbased restriction on the presentation of specific investment advice.245 One commenter also supported the new fair and balanced standard.246 However, some commenters requested more guidance on how to satisfy the fair and balanced standard.247 Other commenters requested clarification that the principles from certain staff noaction letters would not be the sole means to comply with the fair and balanced standard.248 One commenter asked whether we intend to incorporate the body of judicial or administrative decisions regarding FINRA rule 2210 and other similar provisions.249 We continue to believe this limitation requiring advertisements to have only fair and balanced inclusions of, or references to, specific investment advice is appropriate. The factors relevant to when an advertisement’s presentation of specific investment advice is fair and balanced will vary depending on the facts and circumstances. We provide examples of such factors below to illustrate the principles.250 While in some cases advisers may wish to consider FINRA’s interpretations related to the meaning of ‘‘fair and balanced’’ for issues we have not specifically addressed, FINRA Rule 2210 and its body of decisions are not controlling or authoritative interpretations with respect to our final rule. jbell on DSKJLSW7X2PROD with RULES2 i. Examples Regarding the Presentation of Past Specific Investment Advice An advertisement that references favorable or profitable past specific investment advice without providing 245 See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; T. Rowe Price Comment Letter. 246 NRS Comment Letter. 247 See, e.g., ILPA Comment Letter (requesting clarification in the context of private equity funds); NASAA Comment Letter; Consumer Federation Comment Letter. 248 See MFA/AIMA Comment Letter I; T. Rowe Price Comment Letter (noting that an adviser could mention security selections in a fair and balanced manner without complying with past staff positions). 249 See NASAA Comment Letter. The phrase ‘‘fair and balanced’’ is used in FINRA rule 2210, which requires, among other things, that broker-dealer communications ‘‘must be fair and balanced and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service.’’ See FINRA rule 2210(d)(1)(A). 250 For selecting and presenting performance information, these factors are in addition to the requirements and restrictions on presentation of performance discussed in section II.A.5. See final rule 206(4)–1(c). In addition, other provisions of the general prohibitions may prohibit a reference to specific investment advice, depending on the facts and circumstances. See 2019 Proposing Release, supra footnote 7. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 sufficient information and context to evaluate the merits of that advice is not fair and balanced. For example, an adviser may wish to share a ‘‘thought piece’’ to describe the specific investment advice it provided in response to a major market event. This would be permissible under the final rule, provided the advertisement included disclosures with appropriate contextual information for investors to evaluate those recommendations (e.g., the circumstances of the market event, such as its nature and timing, and any relevant investment constraints, such as liquidity constraints, during that time). One practice currently used by advisers is to provide unfavorable or unprofitable past specific investment advice in addition to the favorable or profitable advice.251 An adviser also may consider listing some, or all, of the specific investment advice of the same type, kind, grade, or classification as those specific investments presented in the advertisement. As an example, an investment adviser might provide a list of certain investments it recommended based upon certain selection criteria, such as the top holdings by value in a given strategy at a given point in time. The criteria investment advisers use to determine such lists in an advertisement, as well as how the criteria are applied, should produce fair and balanced results. We continue to believe that consistent application of the same selection criteria across measurement periods limits an investment adviser’s ability to reference specific investment advice in a manner that unfairly reflects only positive or favorable results.252 For example, in deciding what to include in an advertisement, an adviser may wish to apply non-performance related selection criteria across portfolio holdings, such as listing them on an alphabetical or rotational basis.253 251 As stated in the proposal, an adviser may consider the current rule’s required disclosures when furnishing a list of all past specific recommendations made by the adviser within the immediately preceding period of not less than one year. See rule 206(4)–1(a)(2). However, the final rule will not require that an adviser include such disclosures, and such disclosures will not be the only way of satisfying paragraph (a)(4). 252 An investment adviser should be mindful of the general prohibitions when selecting the measurement periods as well. 253 Our staff has previously stated that it would not recommend enforcement action under rule 206(4)–1 relating to an advertisement that includes performance-based past specific recommendations based on certain representations, including that the adviser would use objective, non-performance based criteria to select the specific securities that it lists and discusses in the advertisement. See Franklin Letter. Although an adviser may find such staff positions helpful in complying with the final PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 13045 Some commenters questioned whether this aspect of the final rule would permit case studies, which are popular in the private equity industry.254 We believe that case studies and any other similar information about the performance of portfolio companies are specific investment advice, subject to this general prohibition. For example, it would not be fair and balanced for an adviser to present, in an advertisement, case studies only reflecting profitable investments (when there are also similar unprofitable investments). To meet the fair and balanced standard, an adviser may, for example, disclose the overall performance of the relevant investment strategy or private fund for at least the relevant period covered by the list of investments. Case studies that include performance information also will be subject to the final rule’s restrictions and requirements for performance advertising.255 In determining how to present information in a fair and balanced manner, advisers should consider the facts and circumstances of the advertisement, including the nature and sophistication of the audience. For example, in an advertisement intended for a retail investor, an adviser may include certain disclosures to help the investor understand that past specific investment advice does not guarantee future results such as an explanation of the particular or unique circumstances of the previous investment advice and how those circumstances are no longer relevant. Less detailed disclosure may be needed in an advertisement solely for sophisticated institutional investors, who more likely understand the risks associated with past specific investment advice. In response to the commenters who asked for clarification that the methods described in past staff no-action letters on presenting past specific recommendations would not be the only way to meet the fair and balanced standard,256 we are not prescribing any of the factors in those letters under the final rule. While advisers may wish to refer to these letters for examples, we agree with commenters that an adviser may satisfy the fair and balanced standard in other ways.257 rule, the final rule does not include requirements corresponding to the specific representations in the Franklin letter. 254 See AIC Comment Letter; ILPA Comment Letter. 255 See final rule 206(4)–1(d). 256 See MFA/AIMA Comment Letter I; T. Rowe Price Comment Letter. 257 For example, our staff has stated that it would not recommend enforcement action under the E:\FR\FM\05MRR2.SGM Continued 05MRR2 13046 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations The final rule applies to any reference in an advertisement to specific investment advice given by the investment adviser, regardless of whether the investment advice is current or occurred in the past. This provision will apply regardless of whether the advice was acted upon, or reflected actual portfolio holdings, or was profitable. In addition, the provision applies to discretionary investments because the adviser is implementing its recommendation or advice in such a context.258 We continue to believe that including current as well as past references to specific investment advice in the final rule is appropriate because it avoids questions about when a current recommendation becomes past, which arise under the current advertising rule. In addition, we continue to believe that selective references to current investment recommendations in advertisements could mislead investors in the same manner as selective references to past recommendations. jbell on DSKJLSW7X2PROD with RULES2 b. Presentation of Performance Results As proposed, the final rule will prohibit an investment adviser from including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced in an advertisement.259 One commenter supported the proposed prohibition,260 while two others argued that the fair and balanced standard is subjective and difficult to enforce in this context.261 Some commenters requested more guidance by way of example to demonstrate how performance advertising could comply with the fair and balanced standard.262 current rule with respect to charts in an advertisement containing an adviser’s best and worst performers in certain circumstances. See the TCW Letter. Our staff has also stated that it would not recommend enforcement action under current rule 206(4)–1 relating to an advertisement that includes performance-based past specific recommendations if the adviser uses objective, nonperformance based criteria to select the specific securities that it lists and discusses in the advertisement in certain circumstances. See Franklin Letter. 258 We understand there has been confusion under the current advertising rule’s prohibition against past specific ‘‘recommendations’’ as to whether an adviser makes a ‘‘recommendation’’ when it implements its strategy in a discretionary account because an adviser would not contact its client to make a recommendation that the client then either chooses to implement or decline. We believe an adviser’s recommendation, or investment advice, is implicit in the exercise of discretion. 259 See final rule 206(4)–1(a)(6). 260 See Ropes & Gray Comment Letter. 261 Consumer Federation Comment Letter; NASAA Comment Letter. 262 CFA Institute Comment Letter; Ropes & Gray Comment Letter; NASAA Comment Letter; ILPA Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 We continue to believe that this prohibition appropriately addresses the concern that an adviser may ‘‘cherrypick’’ the periods used to generate performance results in advertisements.263 As with specific investment advice, the factors that are relevant to whether an advertisement’s reference to performance information is presented in a fair and balanced manner will vary based on the facts and circumstances. For example, presenting performance results over a very short period of time (e.g., two months), or over inconsistent periods of time, may result in performance portrayals that are not reflective of the adviser’s general results and thus generally would not be fair and balanced. Additionally, an advertisement that highlights one period of extraordinary performance with only a footnote disclosure of unusual circumstances that have contributed to such performance may not be fair and balanced, depending on whether there are other sufficient clear and prominent disclosures, as discussed below.264 In cases where additional information is necessary for an investor to assess performance results, failure to provide such information in an advertisement is not consistent with the fair and balanced standard. For example, in order to provide investors with a fair and balanced portrayal of its performance results, an adviser should consider providing information related to the state of the market at the time, any unusual circumstances, and other material factors that contributed to such performance. In section II.E, we discuss further specific requirements and conditions for portrayals of certain types of performance in advertisements that we are also adopting as part of this final rule. 6. Otherwise Materially Misleading Finally, we are adopting a catch-all provision, as proposed, that will prohibit any advertisement that is otherwise materially misleading.265 We did not receive any comments on this catch-all provision. We continue to believe this prohibition will help ensure 263 An advertisement that includes only favorable performance results or excludes only unfavorable performance results may also be ‘‘misleading’’ to the extent that such an advertisement would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning the investment adviser that would not be implied or inferred were certain additional facts—i.e., any performance results excluded from the advertisement—disclosed. See final rule 206(4)– 1(a)(3). 264 See Amendments to Investment Company Advertising Rules, Release No. IC–26195 (Oct. 3, 2003) [68 FR 57760 (Oct. 6, 2003)]. 265 Final rule 206(4)–1(a)(7). PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 that materially misleading practices not specifically covered by the other prohibitions will be addressed. For example, if an adviser provided accurate disclosures, but presented them in an unreadable font, such an advertisement would be materially misleading and prohibited under this provision. Because we are prohibiting a variety of specific types of advertisement practices within the general prohibitions, most of which include an element of materiality, as discussed above, we are focusing the catch-all provision on only those advertisements that are otherwise materially misleading. We continue to believe that limiting the catch-all to materially misleading advertisements will be more appropriate within the overall structure of the prohibitions while still achieving our goal of prohibiting misleading conduct that may affect an investor’s decision-making process. We also continue to believe that, in light of the rule’s prohibition on making untrue statements and omissions of material fact, including ‘‘false’’ is unnecessary in the catch-all provision as it is already covered by another prohibition.266 C. Conditions Applicable to Testimonials and Endorsements, Including Solicitations 1. Overview Consistent with the proposal, the final rule permits advisers to include testimonials and endorsements in an advertisement, subject to the rule’s general prohibitions and additional conditions.267 These conditions differ depending on whether the testimonial or endorsement is compensated or uncompensated, which is similar to the framework we proposed.268 Numerous commenters supported the proposed expansion from the current advertising rule to permit advisers to include testimonials and endorsements in advertisements.269 Commenters 266 See final rule 206(4)–1(a)(1). made by an adviser that would be prohibited under the final rule’s general prohibitions of certain marketing practices would also be prohibited in an adviser’s advertisement if made by a third party in a covered testimonial or endorsement. For example, as we stated in the Proposing Release, we would generally view an advertisement as unlikely to be presented in a manner that is fair and balanced if it contains a testimonial, endorsement, or third-party rating that references performance information or specific investment advice provided by the adviser that was profitable but is not representative of the experience of the adviser’s investors. 2019 Proposing Release, supra footnote 7, at section II.A.2.e. 268 Final rule 206(4)–1(b). 269 See, e.g., Consumer Federation Comment Letter; IAA Comment Letter; LinkedIn Comment Letter; Fidelity Comment Letter; TINA Comment Letter. 267 Statements E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 explained that consumer preferences have shifted to rely increasingly on third-party resources to inform purchasing decisions.270 Other commenters opposed permitting any testimonials or endorsements, paid or unpaid, in adviser advertisements.271 These commenters were concerned that permitting advisers to advertise paid testimonials and endorsements would increase puffery and cause a ‘‘race to the bottom’’ for advisers seeking paid endorsements.272 As discussed above, we have expanded the definitions of both testimonial and endorsement to include certain solicitation activity.273 This expansion recognizes the overlap between our approach to solicitation under the proposal and compensated testimonials and endorsements.274 It is also designed to capture solicitation activities that previously have been subject to the cash solicitation rule and subject them to the marketing rule. The final rule includes conditions for an adviser’s use of testimonials and endorsements designed to address concerns raised by commenters. These conditions include disclosure requirements to make prospective clients and investors aware of the conflicts of interest associated with testimonials and endorsements and a requirement that an investment adviser have a reasonable basis to believe that the testimonial or endorsement complies with the marketing rule. In addition, because we believe compensated testimonials and endorsements present a heightened risk for conflicts and misleading investors, the final rule will prevent advisers from using certain compensated testimonials and endorsements made by certain ‘‘bad actors’’ and other ineligible persons. The final rule will also require that an investment adviser have a written agreement with certain persons giving a testimonial or endorsement for compensation above the de minimis threshold.275 270 See Consumer Federation Comment Letter; IAA Comment Letter. 271 See Comment Letter of TABR Capital Management, LLC (Jan. 6, 2020); Comment Letter of the Institute for the Fiduciary Standard (Feb. 10, 2020) (‘‘Fiduciary Institute Comment Letter’’). 272 See NAPFA Comment Letter; Mercer Comment Letter (arguing that permitting paid endorsements will lead to largest advisers vying for endorsements from celebrities and popular ‘‘financial gurus’’). 273 See supra section II.A.3. 274 Final rule 206(4)–1(e)(6) and (16). 275 See final rule 206(4)–1(b) (imposing disclosure, adviser oversight, and disqualification conditions). This approach derives from the current solicitation rule. See also final rule 206(4)– 1(b)(4)(i). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 2. Required Disclosures The final rule will require advertisements that include any testimonials or endorsements to provide disclosures of certain information similar to what was proposed under each of the advertising and solicitation rules, subject to certain exceptions, as discussed below. Specifically, the final rule will require that the investment adviser disclose, or reasonably believe that the person giving the testimonial or endorsement discloses, the following at the time the testimonial or endorsement is disseminated: (i) Clearly and prominently: (A) That the testimonial was given by a current client or private fund investor, and the endorsement was given by a person other than a current client or private fund investor, as applicable; (B) That cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and (C) A brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person; (ii) The material terms of any compensation arrangement including a description of the compensation provided or to be provided, directly or indirectly, to the person for the testimonial or endorsement; and (iii) A description of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person and/or any compensation arrangement.276 We are not adopting the proposed requirement under the solicitation rule to disclose the amount of any additional cost to the investor as a result of solicitation for the reasons discussed below.277 We believe that disclosures are needed to inform and protect investors effectively when they are presented with testimonials and 276 Final rule 206(4)–1(b)(1). We proposed the final disclosure requirements separately under the proposed amendments to the advertising rule and solicitation rule. The proposed advertising rule amendments would have required disclosures that: (1) The testimonial was given by a client or investor, and the endorsement was given by a nonclient or non-investor, as applicable; and (2) if applicable, cash or non-cash compensation has been provided by or on behalf of the adviser in connection with obtaining or using the testimonial or endorsement. See proposed rule 206(4)–1(b)(1). The proposed amendments to the solicitation rule would have required disclosure of the terms of the compensation arrangement and description of any material conflicts of interest. See proposed rules 206(4)–3(a)(1)(iii)(D) and (E). 277 See proposed rule 206(4)–3(a)(1)(iii)(F). PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 13047 endorsements. We also share the concerns raised by some commenters that permitting paid testimonials and endorsements would increase the likelihood that personal bias will mislead investors.278 To address these issues in particular, we are adopting two disclosure requirements that we proposed under the solicitation rule— the disclosure of compensation arrangements and material conflicts of interest—under the final rule. We believe that these disclosures will benefit investors by providing them with a fuller context when presented with a testimonial or endorsement, without overly burdening those providing the testimonial or endorsement. Some commenters suggested that we should align our disclosure approach with FINRA’s rule 2210 to ease the compliance burdens of investment advisers that are registered brokerdealers or affiliated with brokerdealers.279 However, instead of aligning our disclosures with FINRA’s, such as FINRA’s specific, standardized disclosures in rule 2210(d)(6),280 we believe the final rule should provide advisers with a broad framework within which to determine how best to present testimonials and endorsements so they are not false or misleading. Accordingly, we are not adopting standardized disclosure requirements under our final rule. As a result, dually registered advisers and broker-dealers, that are not subject to the exemptions discussed below, that provide testimonials and endorsements with the disclosures required by FINRA should consider what additional or different disclosures they would need to make to comply with the final marketing rule.281 a. Clearly and Prominently The final rule will require that particular disclosures with respect to testimonials and endorsements be made clearly and prominently.282 The 278 See NAPFA Comment Letter; Mercer Comment Letter. 279 MMI Comment Letter; Mercer Comment Letter. 280 FINRA’s rule 2210(d)(6) requires, among other things, that a testimonial disclose the following: (i) The fact that it may not be representative of the experience of other customers; (ii) the fact that the testimonial is no guarantee of future performance or success; and (iii) if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial. FINRA rule 2210(d)(6)(B). 281 For example, unlike under FINRA rule 2210, an adviser would be required to disclose the material terms of compensation for a testimonial, even where a person receives de minimis compensation, under the final marketing rule. 282 See final rule 206(4)–1(b)(1)(i). If the promoter provides the disclosures, the investment adviser E:\FR\FM\05MRR2.SGM Continued 05MRR2 13048 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 proposed advertising rule would have required clear and prominent disclosure of: (1) Whether the testimonial or endorsement was given by a client or investor or a non-client or investor; and (2) if applicable, that compensation was provided by or on behalf of the adviser in connection with the testimonial or endorsement.283 The proposed solicitation rule would have required that, under the terms of the written agreement, the solicitor or adviser provide the investor at the time of solicitation activities with a separate disclosure that includes, among other matters, the terms of any compensation arrangement, including a description of the compensation provided or to be provided to the solicitor, and a description of any potential material conflicts of interest on the part of the solicitor resulting from the investment adviser’s relationship with the solicitor and/or the compensation arrangement.284 In merging the two rules under the final rule, we have determined to preserve that testimonials and endorsements must provide for certain concise disclosures to be made clearly and prominently as well as for certain additional disclosures to be made at the time the testimonial or endorsement is disseminated. We continue to believe that certain required disclosures should be made clearly and prominently to help prevent misleading testimonials and endorsements.285 In addition to the two disclosures required under the proposed advertising rule, we also are requiring that a brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement be made clearly and prominently. In order to be clear and prominent, the disclosures must be at least as prominent as the testimonial or endorsement. In other words, we believe that the ‘‘clear and prominent’’ standard requires that the disclosures be included within the testimonial or endorsement, or in the case of an oral testimonial or endorsement, provided at the same time.286 must reasonably believe that the promoter provides such disclosures clearly and prominently. See final rule 206(4)–1(b)(1). 283 See proposed rule 206(4)–1(b)(1). 284 See proposed rule 206(4)–3(a)(1)(iii). 285 We believe this will help reduce the risk of having misleading testimonials or endorsements in addition to the general prohibitions, which prohibit advertisements from being materially false or misleading. See 206(4)–1(a). 286 See infra section II.C.2.f. (discussing oral testimonials and endorsements). The discussion in this section also applies to other parts of the final rule that include a clear and prominent disclosure standard, including the required disclosures related to third-party ratings and predecessor performance. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 As discussed above, many commenters requested more flexibility with respect to hyperlinked disclosures under the clear and prominent standard.287 With respect to the disclosures for testimonials and endorsements that are subject to the clear and prominent standard, we believe such disclosures must be provided clearly and prominently within the testimonial or endorsement.288 Specifically, we believe such disclosures should appear close to the associated statement such that the statement and disclosures are read at the same time, rather than referring the reader somewhere else to obtain the disclosures. In cases in which an oral testimonial or endorsement is provided, it would be consistent with the clear and prominent standard if the disclosures are provided in a written format, so long as they are provided at the time of the testimonial or endorsement.289 The requirement to provide the disclosures with respect to testimonials and endorsements ‘‘clearly and prominently’’ may necessitate formatting and tailoring based on the form of the communication.290 However, after considering comments, we are requiring advisers to provide only certain disclosures regarding testimonials and endorsements clearly and prominently, as discussed in more detail below.291 We believe that the Accordingly, such required disclosures should be included within the advertisement. 287 See section II.B.4. (discussing commenters’ concerns with respect to the clear and prominent standard). See, e.g., MMI Comment Letter; T. Rowe Price Comment Letter; Fidelity Comment Letter; IAA Comment Letter. 288 See final rule 206(4)–1(b)(1)(i)(A) through (C). 289 Accordingly, in the case of a compensated oral testimonial or endorsement, the adviser may, instead of recording and retaining the entire oral testimonial or endorsement, make and keep a record of the disclosures provided to investors. See final rule 204–2(a)(11)(i)(A)(2). See also infra section II.C.2.f and II.I. (discussing oral testimonials and endorsements). If an adviser or promoter provides an investor with written disclosures in connection with an oral testimonial or endorsement, instead of delivering the disclosures orally, the adviser or promoter should alert the investor to the importance of the disclosures, particularly with respect to the disclosures that must be provided clearly and prominently. See final rule 206(4)–1(b)(1)(i). If an adviser did not inform the investor about the importance of such disclosures, it would violate the general prohibition against false or misleading statements. See final rule 206(4)–1(a)(1). 290 An advertisement intended to be viewed on a mobile device, for example, may meet the standard in a different way than one intended to be seen as a print advertisement (e.g., a person viewing a mobile device could be automatically redirected to the required disclosure before viewing the substance of an advertisement). 291 See infra section II.C.2.a.i. through iii. (discussing status as a client or non-client, fact of compensation, and statement of material conflicts of interest). PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 disclosures required to be provided clearly and prominently are integral to the concerns associated with testimonials and endorsements in an advertisement. Our approach is consistent with the Federal Trade Commission’s (‘‘FTC’’) guidance, which also requires disclosures that are integral to the claim to accompany the claim to prevent deception.292 We also believe that these disclosures can be provided succinctly within the testimonial or endorsement such that advisers may advertise their services using modern technology and platforms that limit the size or characters of an advertisement. Moreover, we expect that succinctly providing these disclosures will promote their salience and impact. Other required disclosures, which provide investors with additional useful information but that are not integral to the concerns related to these advertisements, may be provided through hyperlinks, in a separate disclosure document or any other similar methods. i. Status as a Client or Non-Client Similar to what we proposed under the advertising rule, the final rule will require clear and prominent disclosure that a testimonial was given by a current client or investor, and that an endorsement was given by a person other than a current client or investor.293 We believe that this disclosure will provide investors with important context for weighing the relevance of the testimonial or endorsement. For example, an investor might reasonably give more weight to a statement made about an adviser by a current investor rather than someone who was never an investor.294 Additionally, without clearly attributing an endorsement to someone other than an investor, the advertisement could mislead investors who may assume the 292 See, e.g., Fidelity Comment Letter; IAA Comment Letter; SIFMA AMG Comment Letter II (suggesting that we adopt, or adopt an approach consistent with, the FTC approach to hyperlinks). See also Federal Trade Commission, Dot Com Disclosures Guidance Update (Mar. 2013). While the FTC guidance permits the use of hyperlinks, it generally allows the use of hyperlinks to provide disclosures that are ‘‘not integral to the triggering claim’’ and places a number of conditions on the ability to provide hyperlinks. 293 Final rule 206(4)–1(b)(1)(i)(A). See proposed rule 206(4)–1(b)(1)(i). The promoter may be an entity or a natural person. 294 Client status will be assessed at the time that a testimonial or endorsement is disseminated. However, depending on the facts and circumstances, a former client may be considered a client for these purposes. For example, if a person is giving a statement about his or her recent prior experience with the adviser, the communication could be treated as a testimonial. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations endorsement reflects the endorser’s experience as an investor.295 The proposed solicitation rule would have required disclosure of the name of the solicitor.296 However, similar to the proposed advertising rule, the final rule will not require the disclosure of the name of the promoter.297 We did not receive any comments on the requirement under the proposed solicitation rule to disclose the name of the solicitor. We expect that advisers may still choose to disclose the full name of the promoter because disclosing the name of the promoter could help an investor assess the reputation or other qualifications of the person. However, we believe our final approach is appropriate for privacy reasons and takes into account cases where a promoter may not wish to give his or her name.298 We also believe that in cases where a name is not provided, the rule’s general prohibitions will protect investors from fraudulent or misleading testimonials or endorsements. An investor may also give less weight to that particular testimonial or endorsement. jbell on DSKJLSW7X2PROD with RULES2 ii. Fact of Compensation Similar to what we proposed under the advertising rule, the final rule will require clear and prominent disclosure that cash or non-cash compensation was provided for the testimonial or endorsement, if applicable.299 Similar to the disclosure of a promoter’s status as 295 Testimonials and endorsements are subject to the rule’s general prohibitions. Whether a testimonial or endorsement would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser would depend on the facts and circumstances. For instance, it would be misleading for an adviser to provide investors with a testimonial claiming a positive experience with the adviser by a former client, without mentioning that the person has not been a client for 20 years. 296 See proposed rule 206(4)–3(a)(1)(iii)(B). The proposed rule would have also required disclosure of the adviser’s name. Proposed rule 206(4)– 3(a)(1)(iii)(A). 297 Final rule 206(4)–1(b)(1)(i) through (ii). The proposed advertising rule would have only required disclosure of the client or non-client status of the person providing the testimonial or endorsement and whether compensation has been provided for the testimonial or endorsement. See proposed rule 206(4)–1(b)(1). 298 In the case of testimonials and endorsements where compensation paid is above the de minimis threshold, advisers are required to maintain a written agreement with a promoter. See final rule 206(4)–1(b)(2)(ii) and (b)(4)(i). In such cases, the agreement would provide a record of the name of such promoter. See rule 204–2(a)(10), which currently requires that advisers retain ‘‘[a]ll written agreements (or copies thereof) entered into by the investment adviser with any client or otherwise relating to the business of such investment adviser as such.’’ 299 Final rule 206(4)–1(b)(1)(i)(B). See proposed rule 206(4)–1(b)(1)(ii). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 a current investor or person other than a current investor, we continue to believe that this disclosure will provide investors with important context for weighing the relevance of the testimonial or endorsement. Two commenters specifically supported requiring advisers to disclose whether they paid for testimonials or endorsements under the proposed advertising rule.300 One of these commenters stated that without requiring clear and prominent disclosure that a particular testimonial or endorsement is effectively a ‘‘paid-for advertisement,’’ investors would not be able to determine whether they are consuming an authentic, unbiased review of the adviser.301 We agree, and we believe that this simple but clear disclosure is one that is both beneficial for investors and easy to implement for advisers, including on spaceconstrained platforms. For example, when providing a testimonial or endorsement on a social media platform, an adviser must clearly and prominently label the testimonial or endorsement as being a paid testimonial or endorsement. iii. Statement of Material Conflicts of Interest The final rule will require clear and prominent disclosure of a brief statement of any material conflicts of interest on the part of the promoter resulting from its relationship with the investment adviser.302 Similar to the other disclosures subject to the clear and prominent standard, we expect this disclosure to be succinct. For example, it would be sufficient for an adviser to simply state that the testimonial or endorsement was provided by an affiliate of the adviser, or that the promoter is related to the adviser, if this relationship is the source of the conflict.303 We believe the required disclosures result in information that informs and protects investors, yet can be provided succinctly within the testimonial or endorsement. We also believe this form of layered disclosure enhances the salience of this information and may help investors better focus on the presence of conflicts of interest than requiring potentially more lengthy disclosures. We require a fuller 300 Consumer Federation Comment Letter; SBIA Comment Letter. 301 Consumer Federation Comment Letter. 302 Final rule 206(4)–1(b)(1)(i)(C). 303 We expect this brief statement of any material conflicts of interest to be substantially shorter than the description of any material conflicts of interest that is required, as discussed below. See final rule 206(4)–1(b)(1)(ii). PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 13049 description of any material conflicts of interests resulting from the promoter’s relationship with the adviser and/or the promoter’s compensation arrangement with the adviser as part of the disclosures provided with respect to testimonials or endorsements, but this is not subject to the clear and prominent standard.304 b. Material Terms of Compensation Arrangement The final rule will require disclosure of the material terms of any compensation arrangement, including a description of the compensation provided or to be provided, directly or indirectly, to the person for the testimonial or endorsement.305 This provision is based on the disclosure requirement of the proposed solicitation rule. The proposed solicitation rule would have required the disclosure of the terms of any compensation arrangement, including a description of the compensation provided or to be provided to the solicitor.306 Some commenters stated that the disclosure requirement was overbroad and unclear.307 For instance, one commenter stated that it is unclear whether an adviser should disclose reimbursing a solicitor for third-party expenses in the solicitation process under this requirement.308 The final rule requires disclosure of compensation provided, directly or indirectly, for the testimonial or endorsement. If payment of thirdparty expenses is part of the compensation arrangement for the testimonial or endorsement, then such payment should be disclosed under the final rule. If a specific amount of cash compensation is paid, the advertisement should disclose that amount.309 If the compensation takes the form of a percentage of the total advisory fee over a period of time, then the advertisement should disclose such percentage and time period.310 With respect to non-cash 304 See final rule 206(4)–1(b)(1)(iii). rule 206(4)–1(b)(1)(ii). 306 See proposed rule 206(4)–3(a)(1)(iii)(D). 307 See, e.g., Comment Letter of Flexible Plan Investments, Ltd. on proposed solicitation rule (Feb. 10, 2020) (‘‘Flexible Plan Investments Comment Letter I’’); Comment Letter of Proskauer Rose LLP (Feb. 10, 2020) (‘‘Proskauer Comment Letter’’). 308 Flexible Plan Investments Comment Letter I. 309 This is consistent with the Commission’s position regarding the disclosure requirements under the existing cash solicitation rule. See 1979 Adopting Release, supra footnote 3, at text accompanying nn.15 and 16. 310 This is similar to the Commission’s position under the existing cash solicitation rule. See 1979 Adopting Release, supra footnote 3, at text accompanying nn.15 and 16. 305 Final E:\FR\FM\05MRR2.SGM 05MRR2 13050 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 compensation, if the value of the noncash compensation is readily ascertainable, the disclosures should include that amount. Moreover, if all or part of the compensation, cash or noncash, is payable upon dissemination of the testimonial or endorsement or is deferred or contingent on a certain future event, such as an investor’s continuation or renewal of its advisory relationship, agreement, or investment, then the advertisement should disclose those terms.311 In response to this requirement under our proposed solicitation rule, one commenter argued that requiring detailed disclosures about compensation arrangements would result in lengthy disclosures that would be confusing for, and irrelevant to, investors.312 The commenter suggested that the rule require solicitors to disclose only that they are receiving compensation for the solicitation. This commenter stated that this disclosure would adequately alert investors to the inherent conflict of interest associated with such compensation. At the same time, several commenters considered additional compensation information about a compensated solicitor’s referral, including the amount paid to the solicitor for referring the adviser, whether there would be any additional cost to the investor, and the solicitor’s relationship to the adviser, ‘‘very important.’’ 313 Although we believe that a simple disclosure that compensation was provided is sufficient for purposes of the clear and prominent disclosures, we continue to believe that the disclosure related to the terms of the compensation arrangement help convey to the investor the nature and magnitude of the person’s incentive to refer the investor to the adviser.314 The incentive might vary based on the structure of the compensation arrangement. A promoter that receives a flat or fixed fee from an adviser for a set number of referrals might have a different incentive in referring to the adviser than another that receives a fee, such as a percentage of the investor’s assets under management, 311 This is also similar to the Commission’s position under the existing cash solicitation rule. See 1979 Adopting Release, supra footnote 3, at text accompanying nn.15 and 16. 312 See Proskauer Comment Letter. 313 See Investment Adviser Marketing Feedback Form. 314 As stated in our proposal, the materiality of the incentive to solicit investors to an investor’s evaluation of the referral depends on the type and magnitude of the compensation. We believe that the description of a compensation arrangement will be helpful for investors to consider the types and levels of incentives present. 2019 Proposing Release, supra footnote 7, at section II.B.4. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 for each investor that becomes a client of, or a private fund investor with, the adviser. Furthermore, trailing fees (i.e., fees that are continuing) that are contingent on the investor’s relationship with the adviser continuing for a specified period of time present additional considerations in evaluating the promoter’s incentives. It would be relevant to an investor to know that a promoter continues to receive compensation after the investor becomes a client of, or private fund investor with, the adviser, as well as the period of time over which the promoter continues to receive compensation for such solicitation. A longer trailing period can present a greater incentive to solicit the investor. In addition, if, as part of the compensation arrangement between the adviser and promoter, an investor would pay increased advisory fees for becoming a client as a result of the promoter’s testimonial or endorsement, then this information would be relevant so that the investor can make such considerations when choosing an adviser.315 After considering comments, we are requiring that the disclosures only include the material terms of any compensation arrangement. Accordingly, these disclosures need not include immaterial aspects of a compensation arrangement. These disclosures also need not include detailed information about the calculation of the compensation payable to each person giving a testimonial or endorsement; they need not be lengthy to convey the magnitude and nature of the conflict. In addition, these disclosures should not include all compensation arrangements that an adviser has with any and all promoters, as one commenter suggested, but rather should include only information about the relevant compensation arrangement between an adviser and a specific promoter in order for the disclosure to be effective.316 As modified, this provision will require disclosures about any compensation arrangement with a promoter for its testimonial or endorsement. An adviser may arrange to compensate a third-party marketing company to advertise and refer potential clients to the adviser. If the compensation arrangement calls for a percentage of fees collected from the 315 If the amount of increased fees for the investor is known or could reasonably be obtained, then such amount should be disclosed as part of this requirement. 316 Proskauer Comment Letter (stating that this requirement would result in ‘‘very extensive’’ disclosures, particularly if an adviser has multiple arrangements with multiple solicitors). PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 referred clients, then the disclosures should state so and describe what that percentage is. An adviser may also have a directed brokerage arrangement with a third-party brokerage firm, in which the adviser will direct brokerage to the firm as compensation for the firm’s solicitation of clients for, or referral of clients to, the adviser.317 In these cases, the adviser or firm should disclose the material terms of this arrangement, including a brief description of the compensation provided or to be provided to the firm. As part of the disclosure of the material terms of the compensation, the disclosure should state the range of commissions that the firm charges for investors directed to it by the adviser. Furthermore, if the solicitation or referral is contingent upon the firm receiving a particular threshold of directed brokerage (and other services, if applicable) from the adviser, the disclosure should say so. Additional disclosure would be required, for example, if the firm and the adviser agree that as compensation for the firm’s endorsement of the adviser, the adviser’s directed brokerage activities would extend to other clients such as the solicited client’s friends and family. The final rule will require the advertisement to disclose compensation that the adviser provides directly or indirectly to a person for a testimonial or endorsement.318 For example, if an individual solicits an investor and the adviser compensates a related person of that individual for such solicitation (such as an employer or another entity that is associated with the individual), the adviser or individual will need to include this compensation in its disclosures. If a person, such as a broker-dealer, refers clients to advisers that recommend the broker-dealer’s or its affiliate’s proprietary investment products or recommend products that have revenue sharing or other pecuniary arrangements with the broker-dealer or its affiliate, the disclosures must say so.319 Regardless of whether the adviser’s arrangement is with an individual or the individual’s firm, compensation to the firm for any testimonial or endorsement will constitute compensation under the rule, as it would be likely to affect the 317 Such activities will fall under the definition of endorsement. 318 See final rule 206(4)–1(e)(1)(ii). 319 See also Fiduciary Interpretation, supra footnote 88, at 23 (‘‘an adviser must eliminate or at least expose through full and fair disclosure all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.’’). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations individual’s salary, bonus, commission or continued association with the firm. c. Material Conflicts of Interest The proposed solicitation rule would have required a description of any potential material conflicts of interest on the part of the solicitor resulting from the investment adviser’s relationship with the solicitor and/or compensation arrangement.320 We have slightly modified this proposed requirement by removing the word ‘‘potential’’ from ‘‘potential material conflicts of interest,’’ as discussed in detail below. Accordingly, the final rule will require a description of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person and/or any compensation arrangement.321 One commenter to the proposed advertising rule requested that we broaden the disclosure provision and require disclosure of all ‘‘material connections,’’ stating that there are types of connections besides the fact of compensation that could ‘‘materially affect the weight or credibility’’ of a testimonial or endorsement.322 With respect to the proposed solicitation rule requirement, some commenters supported making clear to investors that a conflict of interest may result from an adviser’s relationship with the solicitor and/or their compensation arrangement.323 Others stated that the disclosure of potential material conflicts of interest would likely be redundant with the required disclosure of the terms of any compensation arrangement.324 Commenters also argued that such a requirement would result in disclosure that is too lengthy without much benefit.325 These commenters stated that registered investment advisers and broker-dealers who act as solicitors are already subject to similar disclosure obligations under Form ADV Part 2 and Regulation BI, respectively.326 320 Proposed rule 206(4)–3(a)(1)(iii)(E). rule 206(4)–1(b)(1)(iii). The materiality standard applies to the investor(s) being solicited by the promoter. In other words, if an investor would consider a particular conflict of interest on the part of the promoter to be material to his or her decision to choose an investment adviser, then such conflict of interest should be disclosed. 322 See TINA Comment Letter. 323 See Proskauer Comment Letter; Mercer Comment Letter. 324 See, e.g., MFA/AIMA Comment Letter I. 325 See, e.g., Fidelity Comment Letter. 326 See, e.g., Fidelity Comment Letter, which also stated that Form CRS would be an additional place where investors may find similar information. jbell on DSKJLSW7X2PROD with RULES2 321 Final VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 We believe our modification of removing the word ‘‘potential’’ from the proposed requirement will help reduce the burden on advisers as well as the length of the disclosures without eliminating any material information provided to investors. We do not believe the compensation arrangement disclosure alone is sufficient as it merely implies the conflict. Rather, there should be explicit disclosure that the promoter, due to such compensation, has an incentive to recommend the adviser, resulting in a material conflict of interest. Additionally, we believe a promoter could have other material conflicts of interest based on a relationship with the investment adviser that could affect the credibility of the testimonial or endorsement. Accordingly, to the extent that there is any material conflict of interest, the rule will require a description of such material conflict of interest. We recognize that persons who are also registered as investment advisers or broker-dealers have other disclosure obligations relating to conflicts of interest, such as the requirements of Form ADV.327 We do not believe that disclosures provided in Form ADV would sufficiently satisfy this provision. For example, although Form ADV Part 2 requires disclosure of material conflicts of interest, the disclosure required by the form is limited to conflicts related to relationships with specific personnel such as the adviser’s supervised persons and related persons.328 Moreover, we do not believe that an adviser that is acting as a promoter would be required to deliver its Form ADV Part 2 to a person the 327 Such persons would also have disclosure obligations under the anti-fraud provisions of the Federal securities laws. If a person meets the definition of ‘‘investment adviser,’’ as defined under section 202(a)(11) of the Advisers Act, such person has a fiduciary duty to clients, regardless of whether the adviser is registered or required to be registered, and is thus liable under the anti-fraud provisions of the Advisers Act and other Federal securities laws for failure to disclose conflicts of interest. 328 See, e.g., Item 4.A. of Form ADV, Part 2 (requires disclosure if a relationship between adviser and supervised person’s other financial industry activities creates a material conflict of interest with clients); Item 5.E of Form ADV, Part 2 (requires disclosure of conflict of interest to the extent that the adviser or any of its supervised persons accepts compensation for the sale of securities or other investment products); Item 10.C. of Form ADV, Part 2 (requires description of material conflict of interests with related persons, as defined in Form ADV, and only if the relationship or arrangement with the related person creates a material conflict of interest with clients); Item 10.D. of Form ADV, Part 2 (requires disclosure of material conflict of interest if the adviser receives compensation from or has other business relationships with other advisers). PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 13051 adviser was soliciting to become a client of another investment adviser. On the other hand, in circumstances where Regulation BI applies to a brokerdealer’s activity as a promoter, we believe the Disclosure Obligation under Regulation BI is sufficiently similar to satisfy the disclosure provisions under our final rule.329 Accordingly, as discussed below, we are adopting a partial exemption from the final rule’s required disclosures in certain circumstances.330 We had proposed under the solicitation rule to require disclosure of the amount of any additional cost to the investor as a result of the testimonial or endorsement. We did not receive any comments on this proposed requirement. After further contemplation, we believe that such a requirement under the final rule, which would apply to all testimonials and endorsements, would create burdens that are not commensurate with the benefits of the disclosure and are accordingly eliminating this requirement.331 Such costs could vary by client and over time, making it difficult for advisers to disclose concisely in an advertisement. Moreover, to the extent that an adviser knows or reasonably should know that an investor would pay increased advisory fees as a result of its compensation arrangement or relationship with a promoter, then such disclosures would be made under another provision of the rule as discussed above.332 d. Reasonable Belief Under the final rule, an adviser that does not provide the required 329 The Disclosure Obligation requires that a broker-dealer disclose in writing all material facts about the scope and terms of its relationship with a retail customer, including the material fees and costs the customer will incur as well as all material facts relating to its conflicts of interest associated with the recommendation, including third-party payments and compensation arrangements. See Regulation Best Interest Release, supra footnote 146, at 14. See also infra section II.C.5. (discussing exemptions). 330 See infra section II.C.5. (discussing exemptions). To the extent that a broker-dealer’s testimonial or endorsement under rule 206(4)–1 is a recommendation to a retail customer of a securities transaction or investment strategy involving securities by a broker-dealer, the Disclosure Obligation under Regulation BI would apply to the broker-dealer’s testimonial or endorsement. 331 This will be a change from the current solicitation rule’s requirement that the solicitor state whether the client will pay a specific fee to the adviser in addition to the advisory fee, and whether the client will pay higher advisory fees than other clients (and the difference in such fees) because the client was referred by the solicitor. See current rule 206(4)–3(b)(6). 332 See section II.C.2.b. (discussing material terms of compensation arrangement disclosure). E:\FR\FM\05MRR2.SGM 05MRR2 13052 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations disclosures must reasonably believe that the promoter discloses the required information. We proposed a reasonable belief standard under the advertising rule and continue to believe that the standard is appropriate in ensuring that the required disclosures are provided.333 To have a reasonable belief, an adviser may provide the required disclosures to a promoter and seek to confirm that the promoter provides those disclosures to investors. For example, if a blogger or social media influencer is endorsing and referring clients to the adviser through his or her website or platform, the adviser may provide such blogger or influencer with the required disclosures and confirm that they are provided appropriately on his or her respective pages. The adviser may choose to include provisions in its written agreement with the promoter, requiring the promoter to provide the required disclosures to investors.334 The aforementioned ways are only examples of how an adviser may demonstrate that it has a reasonable belief. e. Timing of Disclosures jbell on DSKJLSW7X2PROD with RULES2 Under the final rule, the required disclosures with respect to testimonials and endorsements must be delivered at the time the testimonial or endorsement is disseminated.335 The proposed solicitation rule would have required delivery of a separate solicitor disclosure at the time of any solicitation activities (or in the case of a mass communication, as soon as reasonably practicable thereafter).336 Given that the final rule requires certain disclosures to be included within the testimonial or endorsement per the clear and prominent standard, rather than delivered separately, as discussed below, we are not adopting the proposed alternative to provide the disclosures as soon as reasonably practicable thereafter in the case of mass communications. 333 See proposed rule 206(4)–1(b)(1) and (2) (each requiring a reasonable belief standard for investment advisers). See also proposed rule 206(4)–3(a)(2) (requiring a reasonable basis for believing that solicitor has complied with the written agreement requirement). 334 See final rule 206(4)–1(b)(2)(ii). To the extent that the promoter’s testimonial or endorsement falls under the de minimis exemption, advisers would not be required to, but may choose to, enter into a written agreement and include such provisions. Final rule 206(4)–1(b)(2)(ii) and (b)(4)(i). 335 Final rule 206(4)–1(b)(1). This is similar to the existing cash solicitation rule, which requires that the solicitor disclosure be delivered at the time of any solicitation activities. See current rule 206(4)– 3(a)(2)(iii)(A). 336 Proposed rule 206(4)–3(a)(1)(iii). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 We continue to believe the timing of disclosures is important.337 If the disclosures are not provided at the time the testimonial or endorsement is disseminated, many of the disclosures may not have the same impact on investors.338 Some commenters to the proposed solicitation rule suggested that the rule require delivery of solicitor disclosure after a prospective client expresses interest in the adviser’s services or becomes a client of the adviser, rather than at the time of solicitation.339 We decline to make this change as we continue to believe these disclosures should be provided at the time of dissemination of the testimonial or endorsement to protect against investor confusion.340 f. No Separate Disclosure Requirement We are not adopting the proposed requirement for a separate solicitor’s disclosure.341 In light of the merger of the advertising and solicitation rules, we believe that requiring certain disclosures be provided clearly and prominently within the testimonial or endorsement, and other disclosures be otherwise provided, is a more practical and effective approach to informing investors and clients.342 For example, if 337 The timing for several aspects of the proposed solicitation rule was ‘‘at the time’’ of solicitation. See 2019 Proposing Release, supra footnote 7, at section II.B.4 (discussing solicitor disclosure), section II.B.5. (discussing written agreement), section II.B.6. (discussing adviser oversight and compliance) and section II.B.7 (discussing disqualification). 338 The current solicitation rule requires that the solicitor deliver the solicitor disclosure ‘‘at the time of any solicitation activities.’’ Rule 206(4)– 3(a)(2)(ii). 339 See IAA Comment Letter; Flexible Plan Investments Comment Letter I (‘‘. . . delivery should simply be required before the recipient of the solicitation or referral becomes a client of the adviser.’’); Nesler Comment Letter. 340 The exemption for broker-dealers subject to Regulation BI would allow for the related disclosures to be provided prior to or at the time of a recommendation, which may, in some cases, precede a particular testimonial or endorsement for private fund investors. However, unless the brokerdealer had made previous recommendations subject to Regulation BI to the investor, the testimonial or endorsement would likely be the first time the investor is receiving the disclosure. See Regulation Best Interest Release, supra footnote 146 (‘‘Brokerdealers could meet the Disclosure Obligation by making certain required disclosures of information regarding conflicts of interest to their customers at the beginning of a relationship, and this form of disclosure may be standardized. However, if standardized disclosure, provided at such time, does not sufficiently identify the material facts relating to conflicts of interest associated with any particular recommendation, the disclosure would need to be supplemented so that such disclosure is tailored to the particular recommendation.’’). 341 See proposed rule 206(4)–3(a)(1)(iii). The current solicitation rule also requires delivery of a separate disclosure. 342 See final rule 206(4)–1(b)(1)(i). See also section II.C.2.a. (discussing clear and prominent standard). PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 an adviser compensates a podcast host for endorsing the adviser in its podcast or as an advertisement during the podcast, including certain of the required disclosures in the podcast itself would give greater prominence to these disclosures and have a greater impact on the potential investor than a separate disclosure document with all of the required disclosures. Commenters raised concerns about separate solicitor disclosure, noting that the extra documentation would burden investment advisers and overwhelm clients.343 These commenters also suggested providing flexibility to include the disclosures within other solicitation materials or incorporating the solicitor disclosure into other required disclosures, such as the Form ADV Part 2A. We believe that it would reduce the effectiveness of the disclosures for testimonials and endorsements to allow them all to be included within other solicitation materials given our view that particular disclosures should be provided clearly and prominently. In a change from the proposal, the final rule will not permit the delivery of the solicitor disclosure as soon as reasonably practicable after the time of any solicitation activities in the case of a mass communication. We believe that the changes under the final rule, such as the elimination of a separate disclosure requirement, eliminate the need to provide a different delivery requirement for the required disclosures. In fact, as noted above, we believe that the required disclosures should be provided at the time that such testimonial or endorsement is disseminated in all cases in order to have a meaningful impact on investors. Under the proposed solicitation rule, either the adviser or the solicitor would have been able to give the disclosures. Commenters generally supported this flexibility.344 Accordingly, under the final rule, either the adviser or the promoter may provide the required disclosures, subject to the other conditions of the rule.345 We do not believe the impact of the disclosures will be undermined by permitting either 343 See, e.g., MFA/AIMA Comment Letter I; SIFMA AMG Comment Letter I (responding to our request for comment in the Proposing Release as to whether the disclosure should be separate, as proposed). 344 See, e.g., SIFMA AMG Comment Letter I; IAA Comment Letter. 345 See final rule 206(4)–1(b)(1). This is also similar to the proposed advertising rule, which required that the investment adviser clearly and prominently disclose or reasonably believe that the testimonial or endorsement clearly and prominently disclosed certain information. See proposed rule 206(4)–1(b)(1). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 the adviser or the promoter to provide the disclosures. Our final rule does not require an adviser or promoter to present the required disclosures in paper.346 One commenter stated that an investor would not grasp the importance of the disclosure if it is not in a paper document.347 We disagree that electronic or oral communication cannot be effective. We believe that providing flexibility regarding disclosure format is necessary to allow the disclosures to be provided at the time of dissemination of a testimonial or endorsement. We also believe that our adopted disclosure requirements will be adaptable to different types of testimonial and endorsement arrangements. Because disclosures must be clear and prominent, the final rule mitigates concerns that investors will not read or hear electronic disclosures. Regardless of the format, the adviser will be required, under the Act’s books and records rule, to make and keep true, accurate, and current copies of the advertisement.348 In some circumstances, a copy of the advertisement (i.e., the testimonial or endorsement) may include all of the required disclosures with respect to the testimonial or endorsement.349 In the 346 If the disclosures are made in writing, we have stated that an ‘‘in writing’’ requirement could be satisfied either through paper or electronic means consistent with existing Commission guidance on electronic delivery of documents. See Regulation Best Interest Release, supra footnote 146, at text accompanying nn.499–500. If delivery of the required disclosure is made electronically, it should be done in accordance with the Commission’s guidance regarding electronic delivery. See Use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of Information; Additional Examples Under the Securities Act of 1933, Securities Exchange Act of 1934, and Investment Company Act of 1940, Release No. 34–37182 (May 9, 1996) [61 FR 24644 (May 15, 1996)]; see also 2000 Release, supra footnote 43; and see also 1995 Release, supra footnote 43. 347 See NASAA Comment Letter (‘‘Emails, text messages, instant messages, electronic presentations, videos, podcasts, and other modern methods of communications . . . do not adequately ensure that the investor will read, hear, or understand the importance of the disclosures. Furthermore, these and similar electronic communications are ill-suited to allowing the client to retain a copy of the disclosure in a form and location that can easily be recalled when necessary.’’). 348 To the extent that a testimonial or endorsement is disseminated by an adviser indirectly through a third party, an adviser should retain such records as well. See final rule 204– 2(a)(11)(i)(A), which requires that advisers retain a copy of each advertisement. 349 In addition to the disclosures that are required to be provided clearly and prominently within the testimonial or endorsement, an adviser may choose to provide the other disclosures that are not subject to the clear and prominent standard within the testimonial or endorsement. See supra section II.C.2.a. (discussing clear and prominent standard). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 case of a compensated oral testimonial or endorsement, the adviser may, instead of recording and retaining the entire oral testimonial or endorsement, make and keep a record of the disclosures provided to investors.350 Additionally, in response to one commenter,351 we are clarifying that if an adviser disseminates the required disclosures orally in connection with an oral testimonial or endorsement, the adviser may choose, consistent with applicable law, to record the oral disclosures either prior to or at the time of the dissemination of the testimonial or endorsement.352 3. Adviser Oversight and Compliance All testimonials and endorsements, including those that are compensated and those that are uncompensated and meet prong one of the definition of advertisement, will be subject to an adviser oversight and compliance provision under the final rule.353 The final rule will require the investment adviser to have: (i) A reasonable basis for believing that any testimonial or endorsement complies with the requirements of the rule, and (ii) a written agreement with any person giving a compensated testimonial or endorsement that describes the scope of the agreed upon activities and the terms of the compensation for those activities when the adviser is providing compensation for testimonials and endorsements that is above the de minimis threshold.354 The oversight requirement we are adopting is similar to the proposed oversight requirement and the current solicitation rule’s oversight requirement, but differs in several respects to address commenters’ concerns and to reflect the merger of the two rules.355 In circumstances in which an adviser does not provide the other disclosures within the advertisement, an adviser would be required to maintain such disclosures under the recordkeeping rule. See final rule 204–2(a)(15)(i). 350 See final rule 204–2(a)(11)(i)(A)(2). If the required disclosures are provided in a written format, then only the written disclosures would need to be maintained. If the required disclosures are provided orally, however, this record need not necessarily be an actual recording of the oral disclosures provided, but must contain the fact that the oral disclosures were provided, the substance of what was provided, and when. 351 See Nesler Comment Letter (asking the Commission to clarify that if disclosures are provided orally, such disclosure in oral form needs to be recorded prior to being provided to a client, and not at the time it is provided to the client). 352 In order to avoid duplicative records, advisers may maintain records of a script or reading of a script of disclosures provided orally. 353 Final rule 206(4)–1(b)(2) and (4). 354 Final rule 206(4)–1(b)(2). 355 See current rule 206(4)–3(a)(2)(iii)(C) (requiring that the investment adviser make a bona PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 13053 First, the adviser oversight condition will require that the adviser have a reasonable basis for believing that the testimonial or endorsement complies with the requirements of the final rule, rather than the terms of a written agreement as proposed. The proposal would have replaced the solicitation rule’s current requirement that the written agreement contain an undertaking by the solicitor to perform its duties under the agreement in a manner consistent with the provisions of the Act and the rules thereunder with the requirement that the solicitor agree to perform its solicitation activities in accordance with sections 206(1), (2), and (4) of the Act.356 We believe that explicitly requiring advisers to oversee third-party advertisements for compliance with the specific restrictions and requirements in the marketing rule, rather than the broader anti-fraud provisions, more appropriately and precisely addresses the risks posed by such advertisements. The question of what would constitute a reasonable basis for believing that the testimonial or endorsement complies with the requirements of the final rule would depend upon the facts and circumstances. For instance, in the context of solicitation or referral activity, we believe that, as under the solicitation rule, a reasonable basis could involve periodically making inquiries of a sample of investors solicited or referred by the promoter in order to assess whether that promoter’s statements comply with the rule.357 An adviser could implement policies and procedures to form a reasonable basis for believing the testimonial or endorsement complies with the rule. An adviser also could include terms in its written agreement with the promoter to help form such a reasonable belief. Such agreements could provide mechanisms, for example, to enable advisers to prereview testimonials or endorsements, or otherwise impose limitations on the content of those statements.358 Second, the final rule will require that an adviser pay any compensation over fide effort to ascertain whether the solicitor has complied with the agreement, and have a reasonable basis for believing that the solicitor has so complied.). 356 See rule 206(4)–3(a)(2)(iii)(C). 357 1979 Adopting Release, supra footnote 3, accompanying nn.14 and 15. 358 However, the oversight requirement contains two prongs with separate obligations. Although certain mechanisms in the written agreement, if implemented, could lead the adviser to have a reasonable basis for believing that any testimonial or endorsement complies with the requirements of the rule, having a written agreement by itself would not satisfy the first prong of the oversight requirement. E:\FR\FM\05MRR2.SGM 05MRR2 13054 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 the de minimis threshold for a testimonial or endorsement pursuant to a written agreement with the person (aside from certain affiliates) giving the testimonial or endorsement. As proposed, the final rule will require that the written agreement describe the scope of the agreed upon activities and the terms of the compensation for those activities. Also as proposed, the final rule will not require that the written agreement require the promoter to deliver the adviser’s brochure. We continue to believe that this requirement is duplicative of an adviser’s delivery obligation under rule 204–3, the Act’s brochure rule. The final rule, however, will not require that the written agreement require the promoter to deliver a separate written disclosure document as proposed (and as required under the current solicitation rule).359 Instead we are requiring advertisements that include testimonials or endorsements to provide certain disclosures at the time they are disseminated. Thus, we do not believe the rule should also prescribe in the written agreement that these disclosures are delivered in a separate document.360 In many cases, we believe the adviser itself will be providing the disclosures. Therefore, this approach will provide the adviser with flexibility in determining whether and how to address these disclosures in its written agreement with a promoter. Consistent with the final rule’s principles-based approach, this streamlined requirement provides more flexibility for an adviser to determine how to tailor its written agreement with its promoters.361 We believe that advisers are better situated to tailor their oversight approach based on the types of testimonials and endorsements used and the risks in their particular arrangements. For the same reasons, as proposed, the final rule will not incorporate the current solicitation rule’s requirement for the adviser to obtain a signed and dated acknowledgment from the client that the client has received the required disclosure.362 This principles-based approach is consistent with the Act’s compliance rule, which requires advisers to adopt and implement compliance policies and procedures, but 359 See rule 206(4)–3(a)(2)(iii); see proposed rule 206(4)–3(a)(1). 360 See supra section II.C.2.f. 361 For example, the written agreement requirement could be met through a written private placement agreement that describes the scope of the agreed upon activities and the terms of the compensation for those activities. 362 See rule 206(4)–3(a)(2)(iii)(B). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 does not mandate specific elements of such policies and procedures.363 One commenter supported a flexible and principles-based approach to adviser oversight.364 Several commenters supported our proposed approach to streamline the required provisions of the written agreement, such as by removing the provision requiring the solicitor to deliver the adviser’s brochure.365 Another commenter opposed the proposed requirement that the written agreement require the adviser to oversee the solicitor for compliance with the Act’s anti-fraud provisions, arguing that this is a regulatory function, not an advisory function.366 Some commenters also specifically supported removing the current rule’s requirement that an adviser obtain a signed and dated acknowledgment.367 Two commenters, however, opposed the proposed oversight requirement, arguing that it would be burdensome and overbroad to require the adviser to oversee compliance with a written agreement.368 One commenter argued that it would impose a new monitoring cost on advisers, which they will ultimately pass along to investors.369 Another commenter claimed that requiring advisers to contact a sample of clients to ascertain whether solicitors were complying with the written solicitation agreement would be awkward and burdensome.370 We believe the modifications to the adviser oversight condition discussed above address commenters’ concerns. These changes are consistent with our overall approach to shift to a principlesbased rule and leverage the Act’s existing compliance rule.371 We disagree with commenters’ assertion that this oversight requirement imposes 363 Under the compliance rule, each adviser that is registered or required to be registered under the Act is required to adopt and implement written policies and procedures reasonably designed to prevent the adviser and its supervised persons from violating the Advisers Act and the rules thereunder. Rule 206(4)–7. See 2019 Proposing Release, supra footnote 7, at section II.B.6. Advisers should address their marketing practices in their policies and procedures under the compliance rule. 364 MFA/AIMA Comment Letter I. 365 Mercer Comment Letter; SIFMA AMG Comment Letter II; Nesler Comment Letter; IAA Comment Letter. 366 Mercer Comment Letter. 367 MFA/AIMA Commenter Letter I; SIFMA AMG Comment Letter II. 368 Mercer Comment Letter; SIFMA AMG Comment Letter II. 369 SIFMA AMG Comment Letter II. 370 Mercer Comment Letter. 371 Rule 206(4)–7. See Compliance Programs of Investment Companies and Investment Advisers, Release No. IA–2204 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)] (‘‘Compliance Program Adopting Release’’). PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 a novel burden on advisers or is not an advisory function, considering the current solicitation rule’s oversight provision and the Advisers Act compliance rule. We continue to believe that the oversight provision will protect investors’ interests by requiring advisers to monitor third-party statements that constitute adviser advertisements (whether compensated or uncompensated) for compliance with the rule’s requirements, especially when the adviser does not disseminate the testimonials or endorsements directly.372 4. Disqualification for Persons Who Have Engaged in Misconduct The final marketing rule prohibits an adviser from compensating a person, directly or indirectly, for a testimonial or endorsement if the adviser knows, or in the exercise of reasonable care should know, that the person giving the testimonial or endorsement is an ineligible person at the time the testimonial or endorsement is disseminated.373 Under the final rule, an ‘‘ineligible person’’ is a person who is subject either to a ‘‘disqualifying Commission action’’ or to any ‘‘disqualifying event,’’ 374 and, as discussed below, certain of that person’s employees and other persons associated with an ineligible person. The final marketing rule’s disqualification provisions follow a structure similar to the proposed solicitation rule’s disqualification provisions, with the following changes. First, to reflect the incorporation of solicitation and referral activities into the final marketing rule’s definitions of endorsements and testimonials, the final rule applies the disqualification provisions to persons providing compensated testimonials and endorsements (i.e., compensated promoters). Second, under the final rule, certain Commission cease and desist orders will be disqualifying events (rather than disqualifying Commission actions, as proposed), and compensated promoters subject thereto may be eligible for the final rule’s conditional carve-out applicable to disqualifying events. Third, the final rule conforms the proposed ten-year lookback period across all disqualifying events, aligning to advisers’ disciplinary 372 In addition, any endorsements and testimonials by third parties that are advertisements, or are part of an advertisement, will be subject to the recordkeeping obligations of rule 204–2, as discussed below. See infra section II.I. 373 Final rule 206(4)–1(b)(3). 374 Final rule 206(4)–1(e)(9). See final rule 206(4)– 1(e)(3) and (4) for the defined terms ‘‘disqualifying Commission action’’ and ‘‘disqualifying event.’’ E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 disclosure reporting on Form ADV Part 1A.375 Fourth, the final rule’s definition of ineligible person will not apply to certain control affiliates of the ineligible person. Fifth, the final rule will exempt from the disqualification provisions compensated promoters that are brokerdealers registered with the Commission in accordance with section 15(b) of the Exchange Act, provided that they are not subject to statutory disqualification as defined in the Exchange Act. It will also exempt any person covered by rule 506(d) of Regulation D with respect to a rule 506 securities offering, provided the person’s involvement would not disqualify the offering under that rule.376 Commenters generally supported the disqualification of compensated promoters that are ‘‘bad actors,’’ noting the importance of protecting investors from their influence in soliciting clients or investors for investment advisers.377 We believe compensated testimonials and endorsements raise the same concerns about misleading investors as compensated solicitations, and the final rule treats solicitations within the scope of the terms testimonial and endorsement. We are therefore adopting a final rule that prohibits advisers from compensating bad actors for testimonials and endorsements, including solicitations. We did not propose, and we are not adopting, disqualification provisions for providers of uncompensated testimonials and endorsements. It has been, and continues to be, our view that the disqualification provisions are needed most where there are financial incentives for a promoter to engage in fraudulent conduct to persuade an investor to hire an investment adviser or invest in an investment adviser’s private fund.378 For testimonials and endorsements that lack financial 375 Commenters’ requests for not applying the proposed rule to certain existing solicitation arrangements are addressed in a separate section, below. 376 See rule 506(d) of Regulation D under the Securities Act (‘‘rule 506(d) of Regulation D’’). Consistent with the approach discussed below, the final rule’s disqualification provision, paragraph (b)(3), will not disqualify any broker-dealer or any covered person for purposes of the final rule for any matter(s) that occurred prior to the effective date of the rule, if such matter(s) would not have disqualified such person under rule 206(4)– 3(a)(1)(ii), as in effect prior to the effective date of the rule. See infra section II.C.4.f. 377 See NAPFA Comment Letter; NRS Comment Letter; MFA/AIMA Comment Letter I; IAA Comment Letter; SIFMA AMG Comment Letter I; MMI Comment Letter; Consumer Federation Comment Letter. Some commenters, however, disagreed with particular aspects of the proposed disqualification provisions, discussed below. 378 See 2019 Proposing Release, supra footnote 7, at text accompanying nn.26–27. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 incentives, we believe the burden of assessing whether a promoter is disqualified would likely not be justified by the risk that the promoter would engage in fraudulent conduct. We believe that the final rule’s other provisions applicable to testimonials and endorsements (i.e., required disclosures and adviser oversight and compliance), in combination with the final marketing rule’s general prohibitions, are sufficient to address the risks that uncompensated testimonials and endorsements may present in misleading investors. Some commenters recommended that the proposed solicitation rule exempt registered broker-dealers altogether, stating that applying the rule to brokerdealers would result in duplicative regulation.379 Some also recommended that the Commission conform the final rule to the disqualifying events set forth in rule 506(d) of Regulation D under the Securities Act 380 for solicitors of investors in private funds who would be newly subject to the solicitation rule, or that we provide an exemption from the final rule’s disqualification provisions for persons that are subject to rule 506 of Regulation D.381 They stated that having one set of disqualifying events for solicitors that are subject to both the final solicitation rule and rule 506 of Regulation D would streamline compliance processes for such solicitors. As discussed below, we agree that registered broker-dealers acting as compensated promoters need not be subject to the disqualification provisions of both the Advisers Act marketing rule and the Exchange Act.382 Accordingly, the final rule contains an 379 See e.g., MFA/AIMA Comment Letter I; Sidley Austin Comment Letter; SIFMA AMG Comment Letter I. See also infra section II.C.5, which discusses commenters’ concerns about overlapping requirements for broker-dealers, particularly with respect to disclosures. One commenter stated that most solicitors who place private fund interests are broker-dealers already subject to the statutory disqualifications in section 3(a)(39) of the Exchange Act, but did not comment on the comparability of the statutory disqualification provisions. See IAA Comment Letter. 380 See rule 506(d) of Regulation D. 381 See MMI Comment Letter; SIFMA AMG Comment Letter I & III; FSI Comment Letter; Credit Suisse Comment Letter. Another alternative that commenters suggested was codification of existing no-action letters for broker-dealers and other solicitors. See infra section II.C.4.e (discussing the final rule’s conditional exception from the definition of disqualifying event). 382 See infra section II.C.5.c. (discussing that broker-dealers are subject to disqualification for a variety of misconduct under the Exchange Act section 3(a)(39), that the Exchange Act is particularized to broker-dealer activity, and that we believe such disqualification provisions will serve the same policy goal as the disqualification provisions under this rule). PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 13055 exemption from the disqualification provisions for registered broker-dealers, provided they are not subject to a statutory disqualification under the Exchange Act’s disqualification provisions. We similarly agree that persons covered by rule 506(d) of Regulation D with respect to a rule 506 securities offering need not be subject to both the disqualification provisions of the Advisers Act marketing rule and the bad actor disqualification provisions of rule 506 of Regulation D with respect to their participation in the offering.383 Accordingly, the final rule also contains an exemption from the disqualification provisions for any person that is covered by rule 506(d) of Regulation D with respect to a rule 506 securities offering, provided the person’s involvement would not disqualify the offering under that rule.384 This exemption applies to persons covered by rule 506(d) of Regulation D only to the extent they are acting thereunder in a rule 506 securities offering. For example, a broker-dealer acting as a placement agent for a private fund in a rule 506 securities offering that is covered by this exemption will only be covered with respect to the brokerdealer’s testimonials and endorsements made in its capacity under rule 506(d) of Regulation D as part of the offering. While we believe these exemptions will avoid regulatory overlap that would yield little benefit, we recognize that each disqualification regime is unique and will apply differently to compensated promoters regulated thereunder.385 Because each 383 See id. (discussing that these covered persons are subject to disqualification for a variety of misconduct under rule 506(d) of Regulation D, that rule 506(d) of Regulation D is particularized to activities in connection with certain securities offerings, and that we believe such disqualification provisions will serve the same policy goal as the disqualification provisions under this rule). 384 Final rule 206(4)–1(b)(4)(iv). See rule 506(d)(1) of Regulation D. See also infra section II.C.5. 385 For example, the final rule’s disqualification provisions and rule 506 of Regulation D apply to certain Commission orders that restrict a person’s activities (e.g., supervisory or compliance bars or suspensions), whereas the Exchange Act’s disqualification provisions do not. See, e.g., final rule 206(4)–1(e)(3); rule 506(d)(1)(ii); section 3(a)(39) of the Exchange Act. In addition, the Exchange Act disqualification provisions are triggered by activities of employees and other associated persons, similar to the final rule’s application to ‘‘ineligible persons,’’ but rule 506 of Regulation D is triggered by events involving partners, directors, and certain officers, but not other employees or associated persons. See final rule 206(4)–1(e)(9)(i)(A); rule 506(d)(1); section 3(a)(39)(E) of the Exchange Act. As another example, while the look-back periods under the final rule and the Exchange Act’s statutory disqualification extend for ten years, some of the look-back periods under rule 506 of Regulation D extend for ten years, and others extend only for five E:\FR\FM\05MRR2.SGM Continued 05MRR2 13056 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations disqualification regime is particularized to the activity thereunder, our final rule’s exemptions defer to these other disqualification provisions where applicable. jbell on DSKJLSW7X2PROD with RULES2 a. Knowledge or Reasonable Care Standard No commenters objected to the proposed solicitation rule’s introduction of a knowledge or reasonable care standard for the disqualification provisions, which we proposed to replace the current solicitation rule’s strict liability standard.386 One commenter specifically supported the proposed standard.387 Others commented on the proposal’s requirement that an adviser make the assessment about a solicitor’s eligibility status ‘‘at the time of solicitation.’’ 388 One commenter supported this timing,389 while another commenter stated that this timing would present an undue burden on advisers that may interpret the provision as requiring continuous monitoring of their solicitors.390 Another commenter agreed with the Commission’s approach in the proposal to not prescribe the level, method, or frequency of required due diligence.391 We continue to believe that including a reasonable care standard preserves the benefits of a disqualification provision, while reducing the likelihood that advisers will inadvertently violate the provision (i.e., due to disqualifying events that they would not, even in the exercise of reasonable care, have known existed). Our final marketing rule generally maintains the proposed solicitation rule’s knowledge or reasonable care standard with one modification to reflect its application to compensated testimonials and years. See, e.g., final rule 206(4)–1(e)(4); rule 506(d)(1)(i) and (ii); section 3(a)(39)(F) of the Exchange Act. 386 See 2019 Proposing Release, supra footnote 7, at text accompanying n.456. Under the proposed solicitation rule, an adviser could not compensate a solicitor, directly or indirectly, for any solicitation activity if the adviser knows, or, in the exercise of reasonable care, should have known, that the solicitor is an ineligible solicitor. See proposed rule 206(4)–3(a)(3). 387 See NRS Comment Letter. 388 See NAPFA Comment Letter; FSI Comment Letter; MFA/AIMA Comment Letter I. Under the proposed solicitation rule, the definition of ‘‘ineligible solicitor’’ meant, in part, ‘‘[a] person who at the time of the solicitation is subject to a disqualifying Commission action or is subject to any disqualifying event.’’ Proposed rule 206(4)– 3(a)(3)(ii)(A). 389 See NAPFA Comment Letter. 390 See MFA/AIMA Comment Letter I (stating that a requirement to make an assessment at the time of solicitation would exceed the ‘‘reasonable care’’ standard). 391 See FSI Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 endorsements.392 Instead of tying the standard to the ‘‘time of solicitation,’’ the final marketing rule ties it to the time the compensated endorsement or testimonial is disseminated.393 We believe this timing is appropriate because it mirrors the timing of the final marketing rule’s required disclosures for testimonials and endorsements.394 Furthermore, we believe that the time of dissemination is often when a compensated testimonial or endorsement by a bad actor could mislead a client or investor. For example, if a person provides a compensated testimonial or endorsement of an adviser in a face-toface meeting with a potential advisory client, the time of dissemination (i.e., the meeting) is the point at which the client could be misled. In some instances, an adviser may be obligated to compensate the promoter for a period after the dissemination of a testimonial or endorsement. For example, a promoter may continue to receive trailing compensation as a percentage of a client’s assets under management with the adviser for the duration of time that client continues to use the adviser. If a compensated promoter was subject to a disqualifying event or disqualifying Commission action at the time of dissemination, but the adviser did not know, or have reason to know, of such event, then the adviser may make trailing payments resulting from such dissemination.395 The final marketing rule will not require an adviser to monitor the eligibility of compensated promoters on a continuous basis, as one commenter suggested. The frequency with which an adviser must monitor eligibility and the steps an adviser must take in making this assessment will vary depending on 392 The proposed solicitation rule defined ‘‘ineligible solicitor’’, in part, as a person who ‘‘at the time of the solicitation’’ is subject to a disqualifying Commission action or is subject to any disqualifying event. See proposed rule 206(4)– 3(a)(3)(ii)(A). 393 See final rule 206(4)–1(b)(3). The final marketing rule also moves the timing of the reasonable care requirement to the operative disqualification provision, instead of including it within the definition of ‘‘ineligible person.’’ See id. 394 Final rule 206(4)–1(b)(1). See supra section II.C.2. 395 Under the final marketing rule, an adviser may pay trailing compensation for solicitations that were made prior to the marketing rule’s effective date, provided the adviser complied with rule 206(4)–3 as in effect at the time. For example, if a solicitor was not disqualified under rule 206(4)–3 at the time of a solicitation, but the solicitor would have been an ineligible person at the time of solicitation under the final marketing rule solely because of a change in the scope of events that trigger disqualification, the adviser may provide trailing compensation. Commenters advocated for this approach. See IAA Comment Letter; MMI Comment Letter. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 what constitutes the exercise of reasonable care in a particular set of facts and circumstances. Advisers could likely take a similar approach to monitoring promoters as they take in monitoring their own supervised persons, though advisers may assess the eligibility of their supervised persons more frequently in light of their obligations to report promptly certain disciplinary events on Form ADV.396 The frequency of inquiry could vary depending upon, for example, the risk that a person could become an ineligible person and the impact of other screening and compliance mechanisms already in place.397 In some cases where an endorsement or testimonial is posted on a public website and disseminated over a long period, it may not be practical for an adviser to update its inquiry continuously. In this case, we would expect an adviser to update its inquiry into the compensated promoter’s eligibility at least annually while the endorsement or testimonial is available to clients and investors in order to demonstrate that it did not know, or have reason to know, that the promoter was ineligible at the time of dissemination.398 If the adviser has reason to believe that the compensated promoter is an ineligible person, then the exercise of reasonable care would require the adviser to inquire promptly 396 Registered investment advisers ascertain their supervised persons’ disciplinary history in order to report disciplinary events on Form ADV, which advisers must update by filing additional amendments promptly if the disciplinary information becomes inaccurate in any way. See Form ADV: General Instructions. Instruction 4. Certain registered investment advisers are also required to deliver to retail investors a relationship summary disclosing information about the firm. See rule 204–5. Form ADV, Part 3 requires that an adviser state ‘‘Yes’’ if it or any of its financial professionals currently disclose, or are required to disclose, disciplinary information in its Form ADV, and that the adviser take certain steps to update its relationship summary and inform the Commission and its retail investors whenever any information in the relationship summary becomes materially inaccurate. See Form ADV, Part 3: Instructions to Form CRS, General Instruction 8 and Item 4. In addition, if a person is subject to certain disciplinary events and the Commission has issued an order that, for example, censures or places limitations on the activities of that person, it is unlawful for any investment adviser to permit such a person to become, or remain, a person associated with the investment adviser without the consent of the Commission, if such investment adviser knew, or in the exercise of reasonable care, should have known, of such order. See section 203(f) of the Act. 397 Advisers should address such methods in their policies and procedures under the Act’s compliance rule. See rule 206(4)–7. 398 However, this adviser would have to conduct its inquiry more often than annually if there is information or other indicators suggesting changes in circumstance that would be disqualifying under the rule. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations into the promoter’s eligibility under the rule.399 Like the proposed solicitation rule, the final marketing rule will require that an adviser inquire into the relevant facts; however, it does not specify what method or level of due diligence or other inquiry is sufficient to exercise reasonable care. For example, advisers generally have an in-depth knowledge of their own personnel gained through the hiring process and in the course of the employment relationship. In such circumstances, further steps generally would not be required in connection with a compensated endorsement or testimonial by such personnel. Factual inquiry by means of questionnaires or certifications, perhaps accompanied by contractual representations, covenants and undertakings, may be sufficient in other circumstances, particularly if there is no information or other indicators suggesting bad actor involvement. jbell on DSKJLSW7X2PROD with RULES2 b. Ineligible Person Like the proposed solicitation rule, the final marketing rule applies the definition of ineligible person not only to the person subject to the disqualifying event or disqualifying Commission action, as both terms are discussed below, but also to certain persons associated with an ineligible person.400 An ineligible person includes a person who is subject to a disqualifying Commission action or is subject to any disqualifying event. It also includes any employee, officer, or director of an ineligible person and any other individuals with similar status or functions within the scope of association with an ineligible person. If the ineligible person is a partnership, the definition includes all general partners. If the ineligible person is a limited liability company managed by elected managers, the definition includes all elected managers. Unlike the proposed rule, the definition does not include persons that directly or indirectly control, or are controlled by, an ineligible person. One commenter supported the proposed definition of ineligible solicitor.401 Some commenters, however, expressed concern that the proposed solicitation rule would disqualify solicitors solely because their 399 If a promoter notifies an adviser that it is subject to a disqualifying event or disqualifying Commission action, the adviser would have knowledge of the promoter’s status as an ineligible person and the final rule would prohibit the adviser from compensating the promoter. 400 See final rule 206(4)–1(e)(9). See also proposed rule 206(4)–3(a)(3)(ii). 401 See NAPFA Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 affiliates are ineligible solicitors, when their affiliates are not involved with or connected to the solicitation.402 These commenters stated that such potential disqualification would disadvantage larger, more established solicitors that have multiple affiliated entities, and that smaller standalone solicitors would therefore have a competitive advantage. They also stated that disqualification by affiliation, as proposed, would disadvantage investors through lack of choice. After considering comments, we agree that the final rule should not apply to a disqualified person’s control affiliates. These affiliates may operate independently from the person providing the compensated testimonial or endorsement, and may be uninvolved with an adviser’s arrangement to compensate that person for the testimonial or endorsement. However, any compensation arrangement structured to avoid the final rule’s restrictions, depending on the facts and circumstances, would violate section 208(d) of the Act’s general prohibitions against doing anything indirectly which would be prohibited if done directly.403 Under the final rule’s definition of ineligible person, an entity that is not an ineligible person will not become an ineligible person solely because its employee, officer, or director (or an individual with a similar status or functions) is an ineligible person. However, any employee, officer, director, or person with similar status or functions that is an ineligible person may not directly or indirectly receive compensation for a testimonial or endorsement (e.g., by receipt of a share of profits the entity receives from the testimonial or endorsement, or as a bonus tied to the entity’s overall profits without setting aside revenue from testimonials and endorsements).404 In addition, we are clarifying that, in the case of an entity that is an ineligible person, the final rule’s definition of ineligible person will apply to that entity’s employees, officers, and directors (and persons with similar status or functions) associated with the ineligible person, but only within the scope of that association.405 In some 402 See Credit Suisse Comment Letter; MFA/ AIMA Comment Letter I; IAA Comment Letter. 403 Section 208(d) of the Act. 404 See final rule 206(4)–1(b)(3). This principle also applies if the entity is a partnership, to all general partners; and if the entity is a limited liability company managed by elected managers, to all elected managers. 405 Final rule 206(4)–1(e)(9) (defining ineligible person, in part, as ‘‘[a] person who is subject to a disqualifying Commission action or is subject to any disqualifying event,’’ and ‘‘[a]ny employee, officer, or director of the ineligible person and any PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 13057 cases, for example, an employee may be associated with two different firms, one of which is an ineligible person and the other is not. Under the final rule, if the employee is not herself an ineligible person, she may conduct compensated testimonial and endorsement activity on behalf of the firm that is not an ineligible person, because she would not be conducting that activity within the scope of her association with the ineligible person. The final marketing rule adopts, without change from the proposal, the provisions of the definition applying to general partners and elected managers of a partnership and limited liability company, respectively.406 Commenters did not respond to these aspects of the definition. c. Disqualifying Commission Action Under the final rule, like the proposed rule, a disqualifying Commission action is any Commission opinion or order barring, suspending, or prohibiting a person from acting in any capacity under the Federal securities laws.407 Commenters stated that advisers have historically engaged solicitors that are subject to Commission actions or orders that address disqualifying events under the cash solicitation rule, but that do not bar, suspend, or prohibit the solicitor from acting in any capacity under the Federal securities laws.408 These commenters requested that we continue to permit advisers to engage solicitors subject to these types of Commission actions to avoid disturbing the existing other individuals with similar status or functions within the scope of association with the ineligible person.’’) 406 Final rule 206(4)–1(e)(9). See also proposed rule 206(4)–3(a)(3)(ii). 407 Final rule 206(4)–1(e)(3). The imposition of a bar, suspension, or prohibition may appear in an opinion of the Commission or in an administrative law judge initial decision that has become final pursuant to a Commission order. In both cases, such a bar, suspension, or prohibition is a disqualifying Commission action under the final rule. In addition to associational bars or suspensions, these include, for example, officer and director bars imposed in Commission cease and desist orders, limitations on activities imposed under section 203(e) or 203(f) of the Advisers Act that prevent persons from acting in certain capacities, penny stock bars imposed under section 15(b) of the Exchange Act, and investment company prohibitions imposed under section 9(b) of the Investment Company Act. In addition, under the final rule, if the Commission prohibits or suspends an individual from acting in a specific capacity under the Federal securities laws (e.g., as a supervisor or compliance officer), such prohibition will be a disqualifying Commission action, even if the Commission has not barred or suspended the individual from association with an investment adviser, broker-dealer or other registrant. 408 See Mercer Comment Letter; Credit Suisse Comment Letter. See infra section II.C.4.e (discussing the final marketing rule’s conditional carve-out). E:\FR\FM\05MRR2.SGM 05MRR2 13058 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations balance between protecting investors and aiding market efficiency. We agree with commenters that the final rule should permit advisers to engage compensated solicitors and other compensated promoters that are subject to certain Commission orders, provided that the Commission has not barred, suspended, or prohibited the compensated promoter from acting in any capacity under the Federal securities laws, and subject to conditions under the final rule. We are therefore relocating within the rule— from the definition of disqualifying Commission action, as proposed, to the definition of disqualifying event— Commission cease and desist orders from committing or causing a violation or future violation of any scienter-based anti-fraud provision of the Federal securities laws, and Section 5 of the Securities Act.409 This change will subject these orders to the final rule’s conditional carve-out, if available, which aligns the rule’s treatment of these orders with the final rule’s other disqualifying events. We believe that these cease and desist orders could call into question a person’s trustworthiness or ability to act as a compensated promoter,410 and that the final rule’s conditional carve-out, discussed below, will address the risks of compensating a promoter subject to such an order. No one commented specifically on the proposed inclusion of this provision.411 jbell on DSKJLSW7X2PROD with RULES2 d. Disqualifying Event The final rule’s disqualifying events are substantially similar to what we proposed, except for conforming the look-back period across all disqualifying events to ten years prior to the time the person disseminates the testimonial or endorsement. In addition, as noted above, we are including Commission cease and desist orders from committing or causing a violation or future violation of any scienter-based anti-fraud provision of the Federal securities laws, and Section 5 of the Securities Act as disqualifying events (rather than disqualifying Commission actions). Under the final marketing rule, therefore, a disqualifying event generally includes a finding, order, or conviction by a United States court or 409 See final rule 206(4)–1(e)(4)(v). See also proposed rule 206(4)–3(a)(3)(iii)(A)(1). 410 See 2019 Proposing Release, supra footnote 7, at text accompanying n.467. 411 But see supra footnote 381 (discussing that some commenters advocated for conforming the rule’s disciplinary provision with rule 506 of Regulation D under the Securities Act, which includes similar cease and desist orders, in connection with the proposed rule’s new application to broker-dealers soliciting investors in private funds). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 certain regulatory agencies that a person has engaged in any act or omission referenced in one or more of the provision’s five prongs. A disqualifying event is any of five categories of events that occurred within ten years prior to the person disseminating an endorsement or testimonial.412 The first is a conviction by court of competent jurisdiction within the United States of any felony or misdemeanor involving conduct described in paragraph (2)(A) through (D) of section 203(e) of the Act.413 The second is a conviction by a court of competent jurisdiction within the United States of engaging in, any of the conduct specified in paragraphs (1), (5), or (6) of section 203(e) of the Act.414 The third is the entry of any final order by any entity described in paragraph (9) section 203(e) of the Act,415 or by the U.S. Commodity Futures Trading Commission or a self-regulatory organization (as defined in the Form ADV Glossary of Terms), of the type described in paragraph (9) of section 203(e) of the Act. The fourth is the entry of an order, judgment or decree that is described in paragraph (4) of section 203(e) of the Act, and that is in effect at the time of such dissemination by any court of competent jurisdiction within the United States.416 The fifth is a Commission order that a person cease and desist from committing or causing a violation or future violation of (i) any scienter-based anti-fraud provision of the Federal securities laws, including without limitation section 17(a)(1) of the Securities Act, section 10(b) of the Exchange Act, section 15(c)(1) of the Exchange Act, and section 206(1) of the Act, or any other rule or regulation thereunder, or (ii) Section 5 of the Securities Act.417 A disqualifying event does not include any of these events with respect to a person that is also subject to: An order pursuant to section 9(c) of the Investment Company Act with respect to such event; or a Commission opinion or order with respect to such event that is not a disqualifying Commission action, provided in each case that certain conditions are met.418 The disqualifying events in the final rule incorporate a familiar framework 412 Final rule 206(4)–1(e)(4). rule 206(4)–1(e)(4)(i). 414 Final rule 206(4)–1(e)(4)(ii). 415 Final rule 206(4)–1(e)(4)(iii). We made a nonsubstantive change from the proposal to cross reference the Advisers Act statutory provision rather than repeat the wording of the statutory provision in the final rule. 416 Final rule 206(4)–1(e)(4)(iv). 417 Rule 206(4)–1(e)(4)(v). 418 Rule 206(4)–1(e)(4)(vi). 413 Final PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 for advisers evaluating promoters. As proposed, the rule’s disqualifying events are drawn from section 203(e) of the Act, which is a basis for Commission action to censure, place limitations on the activities, or revoke the registration of any investment adviser or its associated persons.419 The final rule also includes actions of two types of regulatory entities not referenced in section 203(e) of the Act—specifically, the Commodity Futures Trading Commission (CFTC) and self-regulatory organizations—as we had proposed. Certain disciplinary actions by these organizations are included in Form ADV Part 1A’s disciplinary history disclosures,420 which all registered investment advisers must complete for themselves and for their advisory affiliates.421 Only one commenter commented specifically on the addition of disciplinary actions by the CFTC, and supported it.422 No one commented specifically on the inclusion of disciplinary events by self-regulatory organizations. However, the final rule refers to self-regulatory organization as defined in the Form ADV Glossary of Terms, rather than the term defined in the Exchange Act, as proposed.423 We believe that compensated promoters that are advisers must be familiar with the Form ADV definition,424 which is the same as the Exchange Act definition except that the Form ADV definition includes commodities exchanges and excludes the Municipal Securities Rulemaking Board.425 The inclusion of commodities exchanges also aligns with the final rule’s inclusion of the CFTC in the disciplinary events provisions. As discussed above, we are including in this definition a Commission cease and desist order from committing or 419 See section 203(e) and (f) of the Act. Form ADV Part 1A, Item 11 (requiring disclosure of certain actions related to the Commodity Futures Trading Commission (CFTC) and self-regulatory organizations). 421 The term advisory affiliates is defined in the Form ADV Glossary of Terms, in part, as (1) all of your officers, partners, or directors (or any person performing similar functions); (2) all persons directly or indirectly controlling or controlled by you; and (3) all of your current employees (other than employees performing only clerical, administrative, support or similar functions). Form ADV Part 2 also requires information about the disciplinary history of the adviser and its personnel. See e.g., Form ADV Part 2A, Item 9. 422 See Consumer Federation Comment Letter. 423 See proposed rule 206(4)–3(a)(3)(iii)(B)(3). 424 See the Form ADV Glossary of Terms (defining Self-Regulatory Organization as ‘‘[a]ny national securities or commodities exchange, registered securities association, or registered clearing agency.’’). 425 See Exchange Act section 3(26). The Form ADV definition also aligns with the definition of self-regulatory organization used in Form BD for broker-dealers. See Form BD, Explanation of Terms. 420 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 causing a violation or future violation of scienter-based anti-fraud provision of the Federal securities laws or of Section 5 of the Securities Act, which we had proposed to be disqualifying Commission actions. We continue to believe that including violations or future violations of these provisions protects investors from compensated promoters’ bad acts that are likely to have the most effect on investors’ review of a promoter’s compensated testimonial or endorsement. Like those in the proposed rule, the final marketing rule’s ‘‘disqualifying events’’ are limited to actions of courts of competent jurisdiction within the United States, and of certain regulatory and self-regulatory organizations within the United States. Only one commenter commented on this aspect of the proposed rule, and supported it.426 In a change from the proposed rule, the final rule’s look-back period will apply to all of the rule’s ‘‘disqualifying events,’’ rather than only to some. We received no comments on the proposed look-back period, but we are conforming the period across the definition to ease advisers’ compliance with the rule by providing a consistent framework for compliance. A ten-year look-back period is included in section 203(e) of the Advisers Act.427 Advisers also apply this look-back period when reporting to the Commission their disciplinary history and the disciplinary history of all of their advisory affiliates.428 In addition, we are making a change to the fourth prong of the definition of disqualifying event to specify that this prong applies only to any order, judgment, or decree described therein that is in effect at the time the testimonial or endorsement is disseminated. This change aligns this prong of the definition of disciplinary event with the provision of the Advisers Act that it references.429 In addition, we are making a change from the proposed solicitation rule’s look-back period to tie it to the time the testimonial or endorsement is disseminated, rather than to the time of solicitation. As discussed above, this change in timing will not result in a 426 See NRS Comment Letter. A person subject to a regulatory action by a foreign court or regulatory or self-regulatory organization may become be an ineligible person under the final rule, to the extent that the Commission uses its authority to bar, suspend, or prohibit that person from acting in any capacity under the Federal securities laws. See the final rule’s definition of disqualifying Commission action. 427 Sections 203(e)(2) and (3) of the Act (containing a ten-year look-back period for convictions for certain felonies and misdemeanors). 428 Form ADV Part 1A, Item 11. 429 See section 203(e)(4) of the Act. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 substantive change in timing for solicitations delivered orally, for which the time of solicitation and the time of dissemination are generally the same. This change conforms the look-back period to other aspects of the final marketing rule.430 Specifically, we believe that the same rationale for tying the final rule’s reasonable care knowledge requirement to the dissemination of a compensated testimonial or endorsement applies here. Therefore, a disqualifying event is any of the final rule’s enumerated disciplinary events that occurred within ten years prior to dissemination of an endorsement or testimonial. e. Conditional Exception From Definition of ‘‘Disqualifying Event’’ The final rule provides a conditional carve-out from the definition of disqualifying event, adapted from the proposed solicitation rule. The carveout permits an adviser to compensate a promoter that is subject to certain disqualifying actions, when the Commission has issued an opinion or order with respect to the promoter’s disqualifying action, but not barred or suspended the promoter or prohibited the promoter from acting in any capacity under the Federal securities laws, subject to conditions. Specifically, the carve-out applies to a person that is subject to (A) an order pursuant to section 9(c) of the Investment Company Act with respect to a disciplinary action that would otherwise be a disciplinary event; or (B) a Commission opinion or order with respect to such action that is not a disqualifying Commission action, provided that, for each type of order or opinion described therein, certain conditions are met.431 The conditions are that: (1) The person is in compliance with the terms of the order or opinion including, but not limited to, the payment of disgorgement, prejudgment interest, civil or administrative penalties, and fines; and (2) for a period of ten years following the date of each order or opinion, the advertisement containing the testimonial or endorsement must include a statement that the person providing the testimonial or endorsement is subject to a Commission order or opinion regarding one or more disciplinary action(s), and include the order or 430 See supra sections II.C.2 (discussing the disclosure requirements for testimonials and endorsements) and II.C.4.a (discussing the reasonable care knowledge standard). 431 Final rule 206(4)–1(e)(4)(vi). The conditions apply to each applicable type of order, and opinion or order, described in paragraphs (A) and (B) therein. See final rule 206(4)–1(e)(4)(vi). PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 13059 opinion or a link to the order or opinion on the Commission’s website.432 This conditional carve-out is substantively similar to the proposed solicitation rule’s carve-out from the definition of ineligible solicitor, with two changes The first change is that the final rule requires that the promoter be ‘‘in compliance with,’’ rather than, as proposed, that a solicitor ‘‘has complied with,’’ the terms of the order or opinion. The final rule will therefore permit a compensated promoter to apply the conditional carve-out if the promoter has complied with all of the terms of the applicable opinion or order that are required to be completed at the time the testimonial or endorsement is disseminated, even if there are additional terms of the applicable order or opinion that are, at that time, not yet required to be completed. We believe that the carve-out should not benefit promoters that are not in good standing under the terms of their Commission opinion or order. Second, we revised the disclosure requirement of the conditional carveout. The final rule’s disclosure condition is designed to provide investors with notice that the promoter has disciplinary action(s) and direct the investor to additional information. We revised the disclosure condition to reflect that the final rule does not require a separate solicitor disclosure, as proposed for compensated solicitations. It also reflects that the final rule’s disqualification provisions apply to a broader population of promoters than solicitors and that advisers may advertise compensated testimonials and endorsements through spaceconstrained media. Accordingly, because there is no longer a separate solicitor disclosure requirement, the final rule requires the disclosure about disciplinary action(s) as part of the advertisement, rather than included in a separate solicitor disclosure. Further, because a testimonial or endorsement may appear in space-constrained media, the required disclosure is more concise than proposed. Instead of requiring a separate description of the acts or omissions that are the subject of, and the terms of, the opinion or order, the advertisement containing the testimonial or endorsement under the final rule must include a statement that the promoter is subject to a Commission opinion or order regarding one or more disciplinary action(s), and include the order or opinion or a link to the order or opinion on the Commission’s 432 Id. E:\FR\FM\05MRR2.SGM 05MRR2 13060 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 website.433 We believe the final rule’s disclosure will make salient the fact that the promoter is subject to disciplinary action(s), while directing the investor to the facts and circumstance in the Commission opinion or order. An advertisement containing testimonial or endorsement disseminated electronically should include the opinion or order or an electronic link directly to the opinion or order on the Commission’s website. Some commenters requested we adopt a carve-out that aligns with advisers’ long-established practice of engaging solicitors subject to Commission actions where the Commission order or opinion does not bar, suspend, or prohibit a person from acting in any capacity under the Federal securities laws.434 One commenter did not oppose the proposed carve-out, but urged the Commission to use its authority to issue non-disqualifying Commission actions only in the most exceptional of circumstances.435 We believe that when the Commission has issued an opinion or order with respect to a person’s disqualifying conduct but not barred or suspended the person or prohibited the person from acting in any capacity under the Federal securities laws, it is appropriate to likewise permit such person to engage in activities related to compensated testimonials and endorsements. This approach obviates the need for the Commission to consider how to treat 433 Id. See also proposed rule 206(4)– 3(a)(3)(iii)(C)(2)(ii). 434 See Credit Suisse Comment Letter; Mercer Comment Letter. See also Dougherty & Co., LLC, SEC Staff No-Action Letter (Mar. 21, 2003), revised by Dougherty & Co., LLC, SEC Staff No-Action Letter (July 3, 2003) (collectively, the ‘‘Dougherty Letter’’). In the Dougherty Letter, Commission staff stated that it would not recommend enforcement action under section 206(4) and rule 206(4)–3 if an investment adviser pays cash solicitation fees to a solicitor who is subject to an order issued by the Commission under section 203(f) of the Advisers Act, or who is subject to a ‘‘Rule 206(4)–3 Disqualifying Order,’’ based on certain representations. The staff described a Rule 206(4)– 3 Disqualifying Order as an order issued by the Commission in which the Commission has found that the solicitor: (a) Has been convicted of any felony or misdemeanor involving conduct described in section 203(e)(2)(A) through (D) of the Advisers Act; (b) has engaged, or has been convicted of engaging, in any of the conduct specified in paragraphs (1), (5), or (6) of section 203(e) of the Advisers Act; or (c) was subject to an order, judgment, or decree described in section 203(e)(4) of the Advisers Act. Representations included that no Rule 206(4)–3 Disqualifying Order bars or suspends the solicitor from acting in any capacity under the Federal securities laws, and that, for a period of ten years following the date of each Rule 206(4)–3 Disqualifying Order, the solicitor or the investment adviser with which it has a solicitation arrangement subject to the cash solicitation rule discloses the order to each person whom the solicitor solicits. 435 See Consumer Federation Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 under the final rule a person with these disciplinary events. However, in the event that the Commission has not previously evaluated the disqualifying event and neither the promoter nor any person on its behalf has previously sought a waiver under the Investment Company Act with respect to the disqualifying event, such person may contact the Commission to seek relief. Commenters that addressed this provision generally supported it, noting the appropriateness of disclosure as a remedy for solicitors subject to nondisqualifying Commission actions.436 One commenter, however, stated that the ten-year disclosure period is overly punitive, and requested that we reduce the disclosure period to five years.437 We are adopting a ten-year look-back, however, because that period is consistent with the look-back period for the rule’s disqualifying events, which is based on the look-back in the certain of the Act’s statutory disqualification provisions and the rules for reporting to the Commission disciplinary history of advisers and their advisory affiliates.438 We believe that this period provides for a sufficient period after the disqualifying event that the past actions of the ineligible person may no longer pose as significant a risk. f. Application to Existing Events The final rule will not apply to preeffective date conduct that would otherwise trigger the disqualification provisions, as we proposed.439 The final rule’s disqualification provision, paragraph (b)(3), will not disqualify any person for purposes of the final rule for any matter(s), that occurred prior to the effective date of the rule, if such matter(s) would not have disqualified such person under rule 206(4)– 3(a)(1)(ii), as in effect prior to the effective date of the rule.440 As discussed above, the final rule’s disqualifying events are slightly broader than those under the current solicitation 436 See Credit Suisse Comment Letter; SIFMA AMG Comment Letter; Mercer Comment Letter. 437 See SIFMA AMG Comment Letter I (‘‘The ten year time period is significant, and may have the effect of forcing such persons out of business rather than making them come into compliance.’’). 438 See supra footnotes 427 and 428 (discussing the ten-year lookback). 439 As discussed below, the staff is also stating its view that it will not object if certain third parties that have been operating in a manner consistent with certain staff no-action letters under the existing cash solicitation rule, which will be nullified due to the rescission of the solicitation rule, provide compensated testimonials and endorsements under the new rule notwithstanding otherwise disqualifying events. See infra section II.J. 440 Final rule 206(4)–1(b)(3). Such a person will not be an ‘‘ineligible person’’ due to that conduct. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 rule. For example, the solicitation rule’s disqualification provisions do not include the entry of a final order of the CFTC or a self-regulatory organization, whereas the final rule includes such conduct.441 We agree with commenters that it would be inappropriate to apply the final rule’s broader disqualification provisions retroactively to prior conduct—such as a pre-effective date CFTC order—when such conduct had not disqualified that solicitor under the solicitation rule.442 In this case, the rule will not disqualify a person for prior conduct that did not cause disqualification at that time under the solicitation rule. However, we disagree with some commenters who requested that we grandfather all ongoing solicitation arrangements entered into prior to the final rule’s effective date. Commenters argued that without a broad grandfathering provision, the final rule would require firms to renegotiate agreements with solicitors that had not been subject to the current rule when executed.443 Commenters’ approach would effectively provide a blanket exemption that permits solicitation activities to continue indefinitely without complying with the final rule, if a solicitor performs such activity pursuant to a pre-effective date solicitation arrangement.444 Unlike the scenario discussed above, we believe this would exempt post-effective date solicitation activity that we explicitly intend to capture in the final rule. 5. Exemptions Under the final rule, we are adopting exemptions from certain conditions for compensated testimonials and endorsements by an adviser’s affiliated personnel and for de minimis compensation.445 We are also adopting a partial exemption from certain conditions for testimonials and endorsements by a registered brokerdealer. The final rule will not exempt testimonials and endorsements related to the provision of impersonal investment advice or nonprofit 441 Compare current rule 206(4)–3(a)(1)(ii), with final rule 206(4)–1(e)(5)(iii). 442 See IAA Comment Letter; Credit Suisse Comment Letter. 443 See, e.g., FSI Comment Letter; IAA Comment Letter. 444 However, see supra footnote 395 and accompanying text for a discussion of trailing compensation. 445 The proposed rule would have provided four exemptions under the solicitation rule for: (1) Impersonal investment advice; (2) advisers’ inhouse solicitors and other affiliated solicitors; (3) de minimis compensation; and (4) nonprofit programs. Proposed rule 206(4)–3(b). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations programs.446 Although some commenters suggested that we adopt additional exemptions for participants in refer-a-friend programs,447 publishers (e.g., bloggers),448 and those who refer clients from networking relationships,449 we do not believe general exemptions for these categories are appropriate. We believe that the final exemptions appropriately balance the risks of the use of compensated testimonials and endorsements with the benefits and protections of the final rule. a. Affiliated Personnel Similar to the proposed solicitation rule, the final rule will partially exempt a testimonial or endorsement by an adviser’s partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person.450 For this exemption to apply, the affiliation between the investment adviser and such person must be readily apparent to or disclosed to the client or investor at the time the testimonial or endorsement is disseminated and the investment adviser must document such person’s status at the time the testimonial or endorsement is disseminated.451 This is a partial exemption because the testimonial or endorsement will be exempt from the final rule’s disclosure requirements, but it still will be necessary to comply with the adviser oversight and disqualification provisions.452 Commenters were generally supportive of retaining this current partial exemption under the solicitation rule.453 As proposed under the solicitation rule, we are modifying the current rule to permit an adviser to rely on the exemption not only when the affiliated status is disclosed to the investor, but 446 See final rule 206(4)–1(b). IAA Comment Letter. 448 See IAA Comment Letter. 449 MMI Comment Letter. 450 For ease of reference, we refer to these persons in the release as ‘‘affiliated persons’’ or ‘‘affiliated personnel.’’ 451 Final rule 206(4)–1(b). The proposed solicitation rule would have provided a partial exemption for an adviser’s in-house solicitors and other affiliated solicitors. See proposed rule 206(4)– 3(b)(2). 452 However, an adviser’s affiliated persons will not be required to comply with the written agreement requirement under the adviser oversight and compliance provision. See final rule 206(4)– 1(b)(4)(ii). See also proposed rule 206(4)–3(b)(2). The proposed rule would have created an exemption from the disclosure requirements by virtue of the exemption from the written agreement requirement. 453 See, e.g., SIFMA AMG Comment Letter I; Proskauer Comment Letter. jbell on DSKJLSW7X2PROD with RULES2 447 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 also when such relationship is readily apparent to the investor.454 We continue to believe that, in such cases, a requirement to disclose a person’s status as an affiliated person would not result in a benefit to the investor, and would create compliance burdens for the adviser and person giving the testimonial or endorsement. Commenters generally agreed with our approach, noting that disclosures regarding status are unnecessary because of the obvious and close relationship of some affiliates.455 However, commenters also suggested more guidance on the meaning of ‘‘readily apparent.’’ 456 What constitutes ‘‘readily apparent’’ will depend on the facts and circumstances. The relationship between an affiliated person and the adviser may be readily apparent to an investor, such as when an in-house solicitor shares the same name as the advisory firm or a person operates under the same name brand as the adviser. An affiliated relationship also may be readily apparent when a person is clearly identified as related to the adviser in its communications with the investor at the time the testimonial or endorsement is disseminated. For example, the person’s affiliation would be readily apparent if a business card distributed to investors at the time the testimonial or endorsement is disseminated clearly and prominently states that the person is a representative of the adviser. There may be other situations where the relationship between the adviser and its affiliated personnel is well known. One commenter suggested that there be a presumption that an adviser and its affiliated person’s relationship is readily apparent to an investor if the adviser has disclosed the affiliation in its Form ADV brochure.457 However, we are not adopting such a presumption because the client may not have read the Form ADV brochure at the time the testimonial or endorsement is disseminated. In certain situations, the adviser’s relationship with an affiliated person is not readily apparent, such as when the person is a representative of the adviser but operates its marketing activities through its own DBA name or brand, and the name of the adviser is omitted or less prominent.458 If an adviser’s and 454 Final rule 206(4)–1(b)(4)(ii). e.g., SIFMA AMG Comment Letter I; Proskauer Comment Letter; Mercer Comment Letter. 456 SIFMA AMG Comment Letter I; Fidelity Comment Letter. 457 Fidelity Comment Letter. 458 Such persons could be employees or independent contractors. 455 See, PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 13061 its affiliated person’s relationship is not readily apparent, the adviser or affiliated person must disclose the affiliation in order to avail itself of the rule’s partial exemption. As proposed under the solicitation rule, we are expanding the current partial exemption for affiliated persons to cover any person that controls, is controlled by, or is under common control with, the investment adviser that is compensating the person pursuant to the final rule.459 One commenter explicitly supported this expansion.460 We continue to believe that the rule should treat a person that controls, is controlled by, or is under common control with, the investment adviser, similarly to any partners, officers, directors or employees of such affiliated person. One commenter suggested that we include an adviser’s independent contractors under this partial exemption.461 However, another suggested that we limit the exemption to an adviser’s supervised persons.462 We believe that the supervision and control an adviser exercises over an endorsing independent contractor may vary among different advisers and independent contractors. If the adviser exercises substantially the same level of supervision and control over an independent contractor as the adviser exercises over its own employees with respect to its marketing activities, the partial exemption would be available. We continue to believe, and commenters generally agreed, that when an investor is aware that a person endorsing the adviser is affiliated with the adviser, disclosures are not necessary to inform the investor of the person’s bias in recommending such adviser. 463 An investor is on notice that an in-house solicitor has a stake in soliciting the investor for its own firm. In these instances, the policy goals underlying the disclosure element of the final rule would already be satisfied. As proposed under the solicitation rule, the final rule’s disqualification provisions will apply to affiliated personnel.464 One commenter expressed 459 Final rule 206(4)–1(b)(4)(ii). Fidelity Comment Letter. 461 SIFMA AMG Comment Letter I. We requested comment on whether we should define ‘‘employee’’ to include an adviser’s independent contractors or provide that this partial exemption for in-house personnel applies to an adviser’s independent contractors. 2019 Proposing Release, supra footnote 7, at section II.B.7. 462 See Mercer Comment Letter. 463 See SIFMA AMG Comment Letter I; Proskauer Comment Letter; Mercer Comment Letter. 464 See final rule 206(4)–1(b)(3). See also proposed rule 206(4)–3(b)(2). 460 See E:\FR\FM\05MRR2.SGM 05MRR2 13062 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations concern that this approach would be overly restrictive and suggested that the rule also should exempt certain affiliated personnel from the disqualification provisions.465 This commenter stated that there is greater control and opportunity to train and rehabilitate affiliated personnel. We do not believe that the availability of training justifies exempting affiliated personnel from the disqualification provisions, and in other circumstances under the Federal securities laws the availability of such training does not affect affiliated personnel’s disqualification. Some affiliated persons with disciplinary events under the final rule will be disqualified from association with an investment adviser independent of the final rule, if the Commission has barred or suspended those persons from association with an investment adviser under section 203(f) of the Act. However, other affiliated persons with such disciplinary events may not be subject to such Commission action and, absent the application of the rule’s disqualification provisions, would be permitted to endorse an adviser as an affiliated person, notwithstanding their disqualifying event. After considering comments, including those from our Investor Feedback Flyers, we believe that the disqualification provisions should apply to compensated testimonials and endorsements, regardless of whether the marketing activity is conducted by a person affiliated or unaffiliated with the adviser.466 Unlike the proposed solicitation rule, however, the final rule will subject affiliated persons to a part of the adviser oversight and compliance provision, which will require that the investment adviser have a reasonable basis for believing that the testimonial or endorsement complies with the requirements of the rule.467 We believe that this part of the oversight and compliance provision will help reduce the risk that any testimonials or endorsements do not comply with the final rule, particularly with respect to certain affiliates that may not be subject 465 SIFMA AMG Comment Letter I. Investment Adviser Marketing Feedback Form. Question 15 asks ‘‘How important is it to know the following information about a paid salesperson’s referral?’’ and lists among other things, ‘‘Whether the solicitor has been disciplined for financial-related misconduct.’’ Commenters were given the option to answer on a scale of 1– 5, with 1 meaning ‘‘Very Important’’ and 5 meaning ‘‘Not Important.’’ There was also an option to answer ‘‘Don’t Know.’’ More than two-thirds of the respondents indicated that this disciplinary information was ‘‘Very Important.’’ 467 See final rule 206(4)–1(b)(2)(i)). jbell on DSKJLSW7X2PROD with RULES2 466 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 to the adviser’s compliance policies and procedures. However, similar to the proposed solicitation rule, the final rule will not subject affiliated personnel to the written agreement requirement under the adviser oversight and compliance provision.468 Although we did not receive any comments on this particular modification under the proposed in-house and other affiliated personnel exemption, we continue to believe that advisers should not be required to enter into written agreements with their own affiliated persons in order to avail themselves of this partial exemption. We also continue to believe that such a requirement under the current rule creates additional compliance obligations for the adviser and its affiliated persons that are not justified by any corresponding benefit. Finally, we are adopting a new requirement, largely as proposed under the solicitation rule, that in order to avail itself of this partial exemption, an adviser must document an affiliated person’s status contemporaneously with disseminating the testimonial or endorsement.469 One commenter criticized this requirement as unnecessary and unduly burdensome, stating that the Commission should either remove it or clarify the form and type of documentation expected.470 We are not requiring a specific form of documentation to record an affiliated person’s status. We continue to believe that this approach affords advisers the flexibility to develop their own policies and procedures or use existing records to document such status. Advisers may wish to document this status through various means. For example, an adviser’s policies and procedures regarding affiliated personnel may require that the adviser document a person’s status on an internal form at the time that the adviser or affiliated person disseminates the testimonial or endorsement. However, an adviser does not need to create a new form of separate documentation to satisfy this requirement. For example, to the extent that an affiliated person’s status is notated through corporate records, employee payroll records, Central Registration Depository (‘‘CRD’’), or any other similar records and licensing for investment adviser representatives, then such records 468 See final rule 206(4)–1(b)(4)(ii). rule 206(4)–1(e)(2). The proposed solicitation rule would have required that ‘‘the adviser documents such solicitor’s status at the time the adviser enters into the solicitation arrangement.’’ Proposed rule 206(4)–3(b)(2)(ii) (emphasis added). 470 MMI Comment Letter. 469 Final PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 would suffice so long as such records are kept current. Similar to our approach under the disqualification provisions applicable to testimonials and endorsements, we believe that the time of dissemination is the most appropriate time for an adviser to know about, or exercise reasonable care to determine, whether personnel is affiliated. The rule does not require an adviser to monitor the affiliated status of a person on a continuous basis. Instead, an adviser could conduct periodic inquiries to confirm that any testimonials or endorsements provided in reliance on this exemption are by affiliated personnel. b. De Minimis Compensation The final rule will have a partial exemption for the use of testimonials or endorsements that are for zero or de minimis compensation.471 Specifically, a testimonial or endorsement that is disseminated for no compensation or de minimis compensation will not be subject to the disqualification provisions or the written agreement requirement, but must comply with the disclosure and oversight provisions.472 The proposed solicitation rule would have provided a full exemption for solicitation activities performed for de minimis compensation, which we proposed as $100 or less.473 Commenters generally supported the proposed de minimis exemption. However, commenters also suggested modifications to increase the utility of the exemption.474 For example, some commenters suggested raising the proposed de minimis threshold amount, arguing that $100 would be too low.475 One commenter, while generally supporting the idea of a de minimis exemption, stated that tracking the exemption would be difficult in certain situations where advisers may make donations on behalf of clients who refer new prospective clients.476 Another commenter stated that the exemption would only offer a superficial benefit 471 Final rule 206(4)–1(b)(4)(i). supra footnote 123 (stating that a testimonial or endorsement for which an adviser provides de minimis compensation will be an advertisement under the second prong of the definition of advertisement). 473 Proposed rule 206(4)–3(b)(3). Under the proposed de minimis compensation exemption, the solicitation rule would not have applied if the solicitor complied with certain conditions. 474 See, e.g., Comment Letter of Wealthfront Corp. (Mar. 3, 2020); SIFMA AMG Comment Letter I; MMI Comment Letter; and Flexible Plan Investments Comment Letter I. 475 See, e.g., Comment Letter of MarketCounsel (Feb. 10, 2020) (‘‘MarketCounsel Comment Letter’’); SIFMA AMG Comment Letter I; IAA Comment Letter. 476 NAPFA Comment Letter. 472 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations because compensation paid to a solicitor would trigger required disclosure under the advertising rule since solicitor referrals often involve testimonials or endorsements.477 One commenter suggested eliminating the exemption altogether, arguing that small dollar values still create conflicts between a solicitor and the solicited investor.478 After considering comments, we believe a partial exemption is necessary because it could be overly burdensome for advisers and persons providing testimonials or endorsements for de minimis compensation to comply with the rule’s disqualification provisions. We do not believe the same level of incentive or risk to defraud investors exists when a de minimis fee is involved.479 In supporting our proposed de minimis exemption, commenters agreed that a solicitor’s incentives are reduced significantly when receiving de minimis compensation and that the need for heightened safeguards is likewise reduced.480 We also believe that many solicitation and referral programs would benefit from this exemption. Commenters confirmed our observation that there is a recent trend towards the use of programs that involve de minimis compensation, such as refer-a-friend programs.481 However, we agree with commenters to both the proposed advertising rule and solicitation rule who expressed concern that minimal compensation may still create conflicts.482 We believe disclosure of any conflicts is paramount to mitigate the risks that an investor would mistakenly view the promoter as unbiased and rely on a testimonial or endorsement more than the investor otherwise would have if the investor knew of any incentive or conflict. Even when there is no compensation involved, we believe these conflicts of interest create an incentive or bias on the part of the promoter. For instance, if the adviser and the promoter are participants in a referral network, it is 477 SBIA Comment Letter. Comment Letter. 479 We stated in our proposal that we recognize that the solicitor disqualification may pose major challenges, especially for smaller advisers. See 2019 Proposing Release, supra footnote 7, at section II.B.7. 480 See, e.g., IAA Comment Letter (‘‘This will help alleviate the compliance burden on investment advisers where incentives are inherently limited, and thus risks to prospective clients are low.’’); Mercer Comment Letter. 481 See, e.g., MarketCounsel Comment Letter; SIFMA AMG Comment Letter I. 482 See NASAA Comment Letter (arguing against the proposed de minimis exemption under the solicitation rule); Prof. Jacobson Comment Letter (supporting no de minimis exemption for testimonials and endorsements from the proposed advertising rule’s disclosure requirements). jbell on DSKJLSW7X2PROD with RULES2 478 NASAA VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 important that these investors fully understand that the provider expects to benefit from its endorsement of or testimonial about the adviser. Although this will create some burden for promoters who are not already subject to the existing cash solicitation rule, we believe that the benefits of fully informing and protecting investors justify any such burden. Moreover, with respect to advisers, providing such disclosures is consistent with an adviser’s duty to disclose all conflicts of interest and thus will not be unduly burdensome for advisers. In addition, we believe that subjecting testimonials and endorsements that are for no or de minimis compensation to the adviser oversight requirement is a reasonable benefit that justifies any burdens. Accordingly, unlike the proposed de minimis exemption under the solicitation rule, the final marketing rule will subject testimonials and endorsements for zero or de minimis compensation to the required disclosure and adviser oversight provisions and exempt such testimonials and endorsements only from the disqualification provisions.483 We also believe the exemption from the disqualification provisions will help ease the burden of compliance in many situations where the testimonials or endorsements are limited in scope, such as in refer-a-friend programs. To illustrate, if the disqualification provisions were to apply, one commenter stated that firms with ‘‘thousands of retail clients,’’ not knowing who will participate in the refer-a-friend programs, would have to inquire into each client’s disciplinary history.484 We agree that such an undertaking would be a major compliance challenge that is disproportionate to the limited scope and magnitude of such non-professional refer-a-friend programs. We accordingly believe that our approach appropriately balances the need for protections of the final rule with the burdens placed on the advisers complying with the rule. After considering comments and various thresholds, however, we are increasing the proposed de minimis threshold amount to $1,000.485 Accordingly, the disqualification provisions will not apply if an 483 See final rule 206(4)–1(b)(4)(i). However, testimonials and endorsements for zero or de minimis compensation will not be required to have a written agreement under the adviser oversight provision. See id. See also section II.C.3. (discussing the written agreement requirement under the adviser oversight and compliance provision). 484 IAA Comment Letter. 485 Final rule 206(4)–1(e)(2). PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 13063 investment adviser provides compensation to a promoter of a total of $1,000 or less (or the equivalent value in non-cash compensation) during the preceding twelve months. We consider $1,000 to more appropriately capture referrals from both professional and non-professional types of testimonials and endorsements than the $100 amount we proposed. We also continue to believe that adopting an aggregate limit over a trailing 12-month period is consistent with our goal of providing an exception for small or nominal payments.486 One commenter supported our approach in requiring a trailing period, agreeing that it would not overly burden advisers because adviser should be keeping records of such payments.487 c. Registered Broker-Dealers Under the final rule, we are providing an exemption from the rule’s disqualification provisions for promoters that are brokers or dealers registered with the Commission in accordance with section 15(b) of the Exchange Act, provided they are not subject to statutory disqualification under the Exchange Act.488 In addition, we are providing an exemption from the rule’s disclosure provisions when a broker-dealer is providing a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation BI.489 Finally, we are providing an exemption from certain disclosure requirements when a brokerdealer provides a testimonial or endorsement to an investor who is not a retail customer as defined in Regulation BI.490 While the proposed amendments to the solicitation rule would have applied the rule to all broker-dealer solicitations, we had contemplated whether to exempt certain advertisements or solicitation activities in some fashion from each of the proposed rules because we recognized some overlap in requirements applicable to broker-dealers.491 We received several comments suggesting that we eliminate the application of the 486 We would measure the initial date of the 12month period to begin at the time that a promoter’s testimonial or endorsement is initially disseminated. 487 MarketCounsel Comment Letter. 488 Final rule 206(4)–1(b)(4)(iii)(C). 489 Final rule 206(4)–1(b)(4)(iii)(A). 490 Final rule 206(4)–1(b)(4)(iii)(B). 491 2019 Proposing Release, supra footnote 7, at 38 and 211. We also considered the recently proposed exemption for certain ‘‘finders’’ involved in exempt offerings. See Notice of Proposed Exemptive Order Granting Conditional Exemption from the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, Release No. 34– 90112 (Oct. 7, 2020) [85 FR 64542 (Oct. 13, 2020)]. E:\FR\FM\05MRR2.SGM 05MRR2 13064 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 proposed advertising rule to advertisements related to potential investors in pooled investment vehicles, and that we exempt registered brokerdealers that solicit private fund investors from the proposed solicitation rule.492 These commenters expressed concern that the proposed amendments would result in unnecessary and overlapping layers of regulation, including with respect to disclosures provided to investors, when a registered broker-dealer is involved in the sale of interests in a pooled investment vehicle.493 One commenter also stated that broker-dealers already are subject to the statutory disqualifications in section 3(a)(39) of the Exchange Act.494 We continue to believe that certain provisions of the final rule, such as the general prohibitions and performance provisions, should apply to all advertisements, regardless of whether the advertisement is provided to potential clients of an investment adviser or potential investors in a private fund.495 However, we recognize that regulatory overlap would yield little benefit. Specifically, we agree with commenters that certain statutory or regulatory requirements applicable to registered broker-dealers will satisfy the policy goals of some of the conditions.496 Broker-dealers are subject to disqualification for a variety of misconduct under the Exchange Act, many of which we believe are sufficiently similar to the misconduct that would trigger a disqualification under the marketing rule, but the Exchange Act is particularized to broker-dealer activity.497 We are 492 See, e.g., Wellington Comment Letter; Fidelity Comment Letter; MFA/AIMA Comment Letter I; IAA Comment Letter; Credit Suisse Comment Letter: SIFMA AMG Comment Letter I. 493 Id. 494 IAA Comment Letter. 495 As stated in the proposal, we recognize that there may be some overlap between the prohibition in rule 206(4)–8 and the final rule. However, the final rule provides more specificity regarding what we believe to be false or misleading statements that advisers to private funds must avoid in their advertisements. We also continue to believe that any additional costs to advisers to private funds as a result of potential overlap between the final rule and rule 206(4)–8 with respect to advertisements will be minimal, as an advertisement that would raise issues under rule 206(4)–8 might also raise issues under a specific provision of the final rule as well as other anti-fraud provisions of the Federal securities laws. See 2019 Proposing Release, supra footnote 7, at 35–36. 496 See, e.g., MFA/AIMA Comment Letter I; Sidley Austin Comment Letter; SIFMA Comment Letter I. 497 See section 3(a)(39) of the Exchange Act. Among other things, a person is subject to ‘‘statutory disqualification’’ under the Exchange Act if such person (i) is subject to an order of the Commission denying, suspending for a period not exceeding 12 months, or revoking the person’s VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 confident these disqualification provisions will serve the same policy goal as the disqualification provisions under this rule.498 As a result, the final rule will exempt from the disqualification provisions any testimonial or endorsement by a brokerdealer registered with the Commission under section 15(b) of the Exchange Act, if the broker-dealer is not subject to statutory disqualification under section 3(a)(39) of the Exchange Act.499 Likewise, we recognize that the requirements under Regulation BI include conflicts of interest and compensation disclosures.500 For instance, under the Regulation BI Disclosure Obligation, when making a recommendation to a retail customer, a broker-dealer must disclose all material facts about the scope and terms of its relationship with the retail customer, such as the material fees and costs the customer will incur, as well as all material facts relating to its conflicts of interest associated with the recommendation, including third-party payments and compensation arrangements.501 In addition, all of the other Regulation BI obligations would apply when the broker-dealer is making a recommendation to a retail customer. Accordingly, we believe that the robust, protective framework of Regulation BI registration as a broker or dealer or barring or suspending for a period not exceeding 12 months the person’s being associated with a broker or dealer; (ii) is subject to an order of the CFTC denying, suspending, or revoking his registration under the Commodity Exchange Act; and (iii) has been convicted of any specified offense or other felony within 10 years of the date of filing of an application for membership of a self-regulatory organization. See also final rule 206(4)–1(e)(4). 498 In this case, we agree with commenters that certain statutory or regulatory requirements applicable to registered broker-dealers will satisfy the policy goals of some of the conditions. See, e.g., MFA/AIMA Comment Letter I; Sidley Austin Comment Letter; SIFMA AMG Comment Letter I. 499 Final rule 206(4)–1(b)(4)(iii)(C). See also supra section II.C.4.f. (discussing grandfathering for broker-dealers and covered persons with respect to the disqualification provisions). Advisers must have a reasonable basis for believing that the brokerdealer is not subject to such statutory disqualification, consistent with the adviser oversight and compliance provision applicable to testimonials and endorsements. Final rule 206(4)– 1(b)(2)(i). 500 Although Regulation BI does not explicitly require disclosure related to whether or not the broker-dealer is a current client or investor of the adviser, the Disclosure Obligation under Regulation BI requires the broker-dealer firm or representative to disclose that it is acting in a broker-dealer capacity, which we believe investors will generally understand to imply that the broker-dealer is not a client or investor of the adviser. Given this, we do not believe we need to separately require such a broker-dealer to disclose its status as a client or non-client. 501 See Regulation Best Interest Release, supra footnote 146, at 14. Regulation BI applies when a broker-dealer makes a recommendation to a ‘‘retail customer.’’ See id. PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 renders the disclosure requirements of the final marketing rule unnecessary when a broker-dealer provides a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation BI.502 In addition, we are providing a partial exemption in cases where a registered broker-dealer provides a testimonial or endorsement to an investor who is not a retail customer as defined in Regulation BI.503 Specifically, under the final rule, a broker-dealer that provides a testimonial or endorsement to such an investor will not be required to disclose the material terms of any compensation arrangement or a description of any material conflicts of interest.504 We believe that the clear and prominent disclosures such a broker-dealer will be required to provide under our final rule are sufficient to alert an investor that is not a retail customer that a testimonial or endorsement is a paid solicitation.505 We also believe that these investors will be able to request from the broker-dealer other information about the solicitation. Aside from this partial exemption from the disclosure provisions, the disclosure obligations of the final marketing rule will apply when a broker-dealer provides a testimonial or endorsement that is not a recommendation subject to Regulation BI. While registered broker-dealers may be subject to other disclosure obligations in these circumstances, these obligations generally do not align with the disclosure obligations for testimonials and endorsements under our final rule.506 In addition, although broker-dealers must comply with FINRA rule 2210, we do not believe that FINRA rule 2210 requires the same substantive disclosures that we require under the final rule.507 Moreover, communications for purposes of FINRA rule 2210 are ‘‘written’’ communications, whereas our final rule would apply to written and oral advertisements.508 Accordingly, 502 Final rule 206(4)–1(b)(4)(iii)(A). rule 206(4)–1(b)(4)(iii)(B). 504 Id. However, the broker-dealer must clearly and prominently disclose: (A) That the testimonial was given by a current client or investor, or the endorsement was given by a person other than a current client or investor; (B) that cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and (C) a brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person. See final rule 206(4)–1(b)(1)(i). 505 See final rule 206(4)–1(b)(1)(i). 506 See, e.g., Exchange Act section 10(b) and rules 10b–5, 10b–10(a)(2), 12b–20, 15c1–5, and 15c1–6 as well as FINRA rules 2010, 2020, 2262, 2269, and 5123. 507 See, e.g., FINRA rule 2210(d)(6). 508 See FINRA rule 2210(a)(1). Although FINRA rule 2210(f) separately covers public appearances, 503 Final E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations absent any exemption under the final rule, the rule will require the disclosures of compensation arrangements and material conflicts of interest associated with a testimonial or endorsement.509 The final rule does not provide an exemption for registered broker-dealers from the adviser oversight and compliance condition applicable to testimonials and endorsements, including the written agreement requirement. We continue to believe that advisers should reasonably ensure that a registered broker-dealer providing a testimonial or endorsement for the adviser is complying with the rule’s applicable conditions. We believe that many advisers would already have an incentive to oversee any broker-dealers operating as their promoters and accordingly believe that this provision will provide an additional benefit to investors without being unduly burdensome. As noted above, in the context of private placements of private fund shares, we believe that a written private placement agreement would meet the final rule’s written agreement requirement, further reducing the compliance burdens associated with this aspect of the rule.510 jbell on DSKJLSW7X2PROD with RULES2 d. ‘‘Covered Persons’’ Under the final rule, similar to the partial exemption for registered brokerdealers, we are providing an exemption from the rule’s disqualification provisions for ‘‘covered persons’’ under rule 506(d) of Regulation D with respect to a rule 506 securities offering, provided the person’s involvement would not disqualify the offering under that rule.511 With respect to rule 506 of Regulation D, ‘‘covered persons’’ include the issuer, its predecessors and affiliated issuers; directors, general partners, and managing members of the issuer; executive officers of the issuer, and other officers of the issuer that participate in the offering; beneficial owners of 20 percent or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power; promoters connected to the issuer in any capacity at the time of sale; for pooled investment fund issuers, the fund’s investment manager and any general partner, managing member, director, executive officer or other ‘‘communications’’ consist of ‘‘correspondence, retail communications, and institutional communications,’’ all of which are defined as written communications. See FINRA rule 2210(a)(2), (3), and (5). 509 See final rule 206(4)–1(b)(1). 510 See supra footnote 361 and accompanying text. 511 See final rule 206(4)–1(b)(4)(iv). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 officer participating in the offering of any such investment manager; and persons compensated for soliciting investors, including any general partner, managing member, director, executive officer or other officer participating in the offering of any such solicitor.512 Commenters expressed concern that issuers and solicitors conducting private fund offerings in reliance on Regulation D would face increased compliance burdens in observing two sets of overlapping disqualification regulations.513 Stating that a majority of private placements are carried out under rule 506, these commenters suggested we conform the rule’s disqualification provisions to the provisions under rule 506 of Regulation D for solicitors of investors in private funds who would be newly subject to the solicitation rule, or that we provide an exemption from the final rule’s disqualification provisions for persons that are subject to rule 506 of Regulation D.514 We agree with commenters that having one set of disqualifying events for promoters with respect to offerings conducted in reliance on rule 506 of Regulation D would streamline compliance processes and reduce the burden for such promoters. Additionally, similar to the statutory disqualification provisions under the Exchange Act, we believe that the disqualification provisions, or ‘‘bad actor’’ provisions, under Regulation D will serve the same policy goal as our final rule’s disqualification provisions.515 While we recognize that the two sets of disqualification provisions are not identical and that there are certain categories of disqualifying events that do not overlap, we do not believe that the differences justify having more than one set of disqualification provisions for compliance. Moreover, this exemption is narrowly limited to testimonials and endorsements that are in connection with a sale of securities under rule 506 of the Securities Act. Accordingly, in 512 See rule 506(d)(1) under the Securities Act. e.g., Credit Suisse Comment Letter; SIFMA AMG Comment Letter I; MMI Comment Letter. 514 Id. 515 We believe that the two sets of provisions are sufficiently similar to help realize our policy goal of reducing the risk that certain ineligible persons should not be acting as promoters. For example, an offering is disqualified under rule 506(d) if a covered person is subject to any order of the Commission entered within five years before such sale that, at the time of such sale, orders the person to cease and desist from committing or causing a violation or future violation of: (i) Any scienterbased anti-fraud provision of the Federal securities laws; or (ii) section 5 of the Securities Act. See section 506(d)(1)(v) of the Securities Act. See also final rule 206(4)–1(e)(4)(v). 513 See, PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 13065 cases where a covered person’s activity with respect to a rule 506 securities offering would be considered a testimonial or endorsement under our final rule, such covered person will not be subject to the disqualification provisions under our final rule so long as his or her involvement would not disqualify the offering under rule 506(d) under the Securities Act.516 Given that Regulation D does not have any similar provisions that are sufficient to replace our final rule’s disclosure or adviser oversight and compliance provisions, covered persons under rule 506(d) of Regulation D will not be exempt from our rule’s disclosure and adviser oversight and compliance obligations for testimonials and endorsements. Accordingly, similar to the exemption for registered brokerdealers, persons covered by rule 506(d) of Regulation D with respect to a rule 506 offering will still be subject to all other provisions of the final rule, to the extent that their activity falls within the scope of the rule, including the general prohibitions, performance provisions, and conditions applicable to testimonials and endorsements except the disqualification provisions. e. No Exemptions for Impersonal Investment Advice and Nonprofit Programs i. Impersonal Investment Advice The proposed solicitation rule would have provided a partial exemption for solicitation activities for investment advisory services that do not purport to meet the objectives or needs of specific individuals or accounts.517 The proposed advertising rule did not provide any similar exemption. As a result of the merger of the two rules, the final rule will not have an exemption for promoters that refer investors for the provision of impersonal investment advice.518 One commenter supported our proposal to retain and modify the current exemption under the solicitation rule for solicitation activities related to the provision of impersonal investment advice.519 This commenter stated that the exemption is a ‘‘long-standing feature of the regime covering solicitation,’’ and that our proposed 516 Final rule 206(4)–1(b)(4)(iv). rule 206(4)–3(b)(1). Specifically, such solicitors would not have had to enter into a written agreement and provide the solicitor disclosure and would not have been subject to the adviser oversight and compliance provision. However, such solicitors would have been subject to the disqualification provisions under the proposed rule. 518 Final rule 206(4)–1(b). 519 SIFMA AMG Comment Letter I. 517 Proposed E:\FR\FM\05MRR2.SGM 05MRR2 13066 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations modifications such as removing the requirement to enter into a written agreement would improve aspects of the exemption. However, in the context of advertising, and testimonials and endorsements in particular, we do not believe that there should be any distinction made between personal and impersonal investment advice.520 Many testimonials and endorsements, by their nature, will be used to promote and advertise an adviser’s services, without taking into account a particular investor’s objectives or needs. Accordingly, in such cases, we believe that investors should be afforded all protections of the final rule. A testimonial or endorsement serving as an advertisement for an adviser should not be exempt from providing disclosures when there is a material conflict of interest simply because the advertisement is related to the provision of impersonal investment advice instead of personal investment advice. We stated in the proposal that the current and proposed solicitation rule provided a partial exemption for impersonal advisory services because we understood that ‘‘prospective clients normally would be aware that a person selling such services was a salesman who was paid to do so.’’ However, with respect to the proposed advertising rule, one commenter argued against regulations built on any underlying assumption that consumers are skilled at evaluating testimonials.521 Other commenters argued against permitting testimonials and endorsements, raising concerns about investor confusion and inadvertent investor harm.522 Although we continue to recognize that a potential investor may be aware of a promoter’s incentive to sell, after considering comments, we believe that any use of testimonials or endorsements, subject to the final exemptions, needs certain protections. Accordingly, notwithstanding the fact that an adviser may offer impersonalized services, if an adviser’s advertisement includes a testimonial or endorsement, then such advertisement will be subject to the final rule’s provisions. jbell on DSKJLSW7X2PROD with RULES2 ii. Nonprofit Programs Exemption The proposed solicitation rule would have exempted certain types of nonprofit programs from the substantive requirements of the rule, codifying the 520 See current rule 206(4)–1. The current advertising rule does not have any exemptions for advertisements related to impersonal investment advice. 521 See TINA Comment Letter. 522 See Mercer Comment Letter; NAPFA Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 positions taken in previous staff noaction letters.523 The proposed advertising rule provided no such exemption for testimonials or endorsements. The final marketing rule will not have an exemption for nonprofit programs.524 We proposed this exemption because we believed that the potential for the solicitor to demonstrate bias towards one adviser or another when there is no profit motive made the protections of the solicitation rule unnecessary.525 One commenter supported the proposed exemption and suggested that the same type of approach could be helpful for for-profit entities that provide matching of investors and advisers based on objective criteria.526 However, given the merger of the advertising and solicitation rules and our final rule’s requirements, we no longer believe that an exemption for nonprofit programs would be appropriate or necessary. Instead, we believe the requirements of the final rule are important for investors even when the advertisement take the form of a testimonial or endorsement by a nonprofit program. Among other things, our proposed solicitation rule would have required a separate solicitor disclosure that provided investors with certain information including the terms of compensation, and a written agreement between the adviser and solicitor describing the solicitation activities and requiring solicitor compliance with section 206 of the Act.527 The proposed nonprofit programs exemption would have exempted advisers and solicitors from the requirements of the proposed solicitation rule including the written agreement and disclosure requirements, 523 Some solicitors have, from time to time, requested that the staff not recommend enforcement action under the cash solicitation rule for referral programs with some, or all, of these features. See National Football League Players Association, SEC Staff No-Action Letter (Jan. 25, 2002) (‘‘NFLPA Letter’’); Excellence in Advertising, Limited, SEC Staff No-Action Letter (Nov. 13, 1986) (‘‘EIA Letter’’); International Association for Financial Planning, SEC Staff No-Action Letter (June 1, 1998) (‘‘IAFP Letter’’). These staff no-action letters will be nullified following the rescission of the solicitation rule. 524 See final rule 206(4)–1(b). The proposed solicitation rule would not have applied to an adviser’s participation in a program when the adviser had a reasonable basis for believing that the solicitor is a nonprofit program, participating advisers compensated the solicitor only for the costs reasonably incurred in operating the program, and the solicitor provided clients a list, based on non-qualitative criteria, of at least two advisers. See proposed rule 206(4)–3(b)(4). There is no special exception made for nonprofit programs under the current advertising rule. 525 2019 Proposing Release, supra footnote 7, at section II.B.7. 526 SIFMA AMG Comment Letter I. 527 See proposed rule 206(4)–3(a)(1). PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 provided that the adviser and solicitor still met a number of conditions including some advisory oversight and different disclosures.528 Under the final rule, though we are not providing an exemption for nonprofit programs per se, we took into account that, if there is no or minimal compensation involved, the nonprofit program would fall under the de minimis exemption. As a result, many nonprofit programs may effectively be subject to the required disclosures and a part of the adviser oversight provision under the final rule, similar to the proposed exemption under the solicitation rule.529 Under the final rule, the nonprofit program would need to disclose that it is not a current client of the adviser, the material terms of compensation, which, if any, would be similar to the disclosure under the proposed exemption,530 and any material conflicts of interest. With respect to the adviser oversight provision, if the nonprofit program falls under the de minimis exemption,531 advisers would only need to have a reasonable basis for believing that the nonprofit program complies with the final rule, rather than a number of specific items as proposed under the solicitation rule.532 We believe that the disclosure and advisory oversight requirements under 528 See proposed rule 206(4)–3(b)(4), which would have required that: (i) The adviser have a ‘‘reasonable basis for believing’’ that among other things, the solicitor is a nonprofit program and that the solicitor (or adviser) ‘‘prominently discloses to the client, at the time of any solicitation activities,’’ certain information; and (ii) solicitor or adviser disclose: (1) The criteria for inclusion on the list of investment advisers; and (2) that investment advisers reimburse the solicitor for the costs reasonably incurred in operating the program. 529 See final rule 206(4)–1(b)(4)(i). The proposed nonprofit program exemption would have required that the client receive certain disclosures. See proposed rule 206(4)–3(b)(4)(ii). The exemption would have also had a ‘‘reasonable basis’’ standard for the adviser’s reliance on the exemption. See proposed rule 206(4)–3(b)(4)(i). As with the de minimis exemption, nonprofit programs would not have been subject to the disqualification provisions under the proposed rule. See proposed rule 206(4)– 3(b)(4). Since a person or program would be unlikely to demonstrate bias in referring one adviser over another when neither adviser provides compensation based on the number of referrals made or any other indicator of the potential to earn the adviser profit, we believed, and continue to believe, that an exemption from the disqualification provisions in such cases is appropriate. 530 The proposed exemption would have required that the solicitor or adviser disclose to the client that investment advisers reimburse the solicitor for the costs reasonably incurred in operating the client. Proposed rule 206(4)–3(b)(4)(ii)(B). 531 Such a program within the de minimis exemption will not be subject to the written agreement requirement under the adviser oversight and compliance provision. Final rule 206(4)– 1(b)(2)(ii) and (b)(4)(i). 532 See proposed rule 206(4)–3(b)(4)(i). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations the final rule are more appropriate than, and preferable to, the more tailored disclosures and conditions that were proposed under the nonprofit program exemption. Accordingly, we believe eliminating the proposed nonprofit program exemption is appropriate, and the final rule will subject advisers participating in any referral program, whether nonprofit or for profit, to the rule in order to provide investors with sufficient and necessary information when presented with a testimonial or endorsement of an adviser by such a program. Absent the de minimis or other exemption, the rule will subject all referral programs that provide testimonials or endorsements to the required disclosures, adviser oversight and disqualification provisions. jbell on DSKJLSW7X2PROD with RULES2 D. Third-Party Ratings As proposed, the final rule will prohibit including third-party ratings in an advertisement, unless they comply with the rule’s general prohibitions and additional conditions. An investment adviser may not include a third-party rating in its advertisement unless the adviser has a reasonable basis for believing that any questionnaire or survey used in the preparation of the third-party rating meets certain criteria and provides certain disclosures. Several commenters supported the proposed rule’s approach of expressly permitting the inclusion of third-party ratings in advertisements.533 However, one commenter requested that we prohibit third-party ratings in retail advertisements, arguing that advisers will be incentivized to purchase only positive third-party ratings and aggressively market them to mislead investors.534 We believe that the final rule’s conditions for including thirdparty ratings in an advertisement, discussed in more detail below, in conjunction with the rule’s general prohibitions, mitigate any such incentives and safeguard investors from misleading third-party ratings. The final rule will, as proposed, define ‘‘third-party rating’’ as a ‘‘rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms), and such person provides such ratings or rankings in the ordinary course of its business.’’ 535 This definition is 533 See, e.g., Blackrock Comment Letter; IAA Comment Letter. 534 See NASAA Comment Letter. 535 Rule 206(4)–1(e)(17). An adviser’s ‘‘related person’’ is defined in Form ADV’s Glossary of Terms as ‘‘[a]ny advisory affiliate and any person that is under common control with your firm.’’ Italicized terms are defined in the Form ADV VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 intended to permit advisers to use thirdparty ratings, subject to conditions, when the ratings are conducted in the ordinary course of business. We continue to believe that the ordinary course of business requirement would largely correspond to persons with the experience to develop and promote ratings based on relevant criteria. It would also distinguish third-party ratings from testimonials and endorsements that resemble third-party ratings, but that are not made by persons who are in the business of providing ratings or rankings. The requirement that the provider not be an adviser’s related person will avoid the risk that certain affiliations could result in a biased rating. The final rule also will subject advertisements that include third-party ratings to additional tailored conditions, as proposed. For such advertisements, the final rule will require that the investment adviser have a reasonable basis to believe that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result (the ‘‘due diligence requirement’’).536 The final rule also will require that an investment adviser clearly and prominently disclose, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses: (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 thirdparty that created and tabulated the rating; and (iii) if applicable, that compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating (the ‘‘disclosure requirement’’).537 In order to be clear and prominent, the disclosure must be at least as prominent as the third-party rating.538 While we are adopting the Glossary. We believe that a rating by a person under common control with the adviser could present the same bias towards the adviser as a rating by an adviser’s other advisory affiliates. 536 See final rule 206(4)–1(c). 537 See id. 538 Commenters claimed that a ‘‘clearly and prominently’’ disclosure standard would pose challenges for certain advertisements, including advertisements on certain social media or internet platforms, if hyperlinking is not permitted. See, e.g., Fidelity Comment Letter; LinkedIn Comment Letter; MMI Comment Letter. As discussed above, we continue to believe that it would not be consistent with the clear and prominent standard to use a hyperlink to include the disclosures required under the final rule. See supra section II.C.2.a. Instead, such required disclosures should be included within the advertisement. PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 13067 conditions required for including any third-party rating in an advertisement largely as proposed, we are providing additional clarification on how advisers can comply with such conditions. Several commenters requested guidance on how an adviser can satisfy the due diligence requirement.539 We continue to believe that an adviser could satisfy the requirement by accessing the questionnaire or survey that was used in the preparation of the rating. We are persuaded by commenters’ concerns, however, that third-party rating agencies may be reluctant to share proprietary survey or questionnaire information to advisers, such as their calculation methodology.540 Accordingly, we are clarifying that obtaining the questionnaire or survey used in the preparation of the rating is not the only means to satisfy this requirement. We also do not believe that this condition requires an adviser to obtain complete information about how the third-party rating agency collects underlying data or calculates a rating, as one commenter suggested.541 Nevertheless, we continue to believe that an adviser relying solely on the results of a survey or questionnaire—i.e., the rating itself— without conducting some due diligence into the underlying methodology and structure, could give rise to advertisements that include misleading ratings. To satisfy the due diligence requirement, an adviser could seek representations from the third-party rating agency regarding general aspects of how the survey or questionnaire is designed, structured, and administered. Alternatively, a third-party rating provider may publicly disclose similar information about its survey or questionnaire methodology. In either case, the adviser could obtain sufficient information to formulate a reasonable belief as required by the due diligence requirement without obtaining proprietary data of third-party rating agencies. The first provision of the disclosure requirement—the date on which the rating was given and the period of time upon which the rating was based—will assist investors in evaluating the relevance of the rating. Ratings from an earlier date, or that are based on information from an earlier period, may not reflect the current state of an 539 See, e.g., Blackrock Comment Letter (suggesting that firms might not be willing to provide proprietary survey methodology information to advisers); MFA/AIMA Comment Letter I; IAA Comment Letter; AIC Comment Letter. 540 See, e.g., Blackrock Comment Letter; AIC Comment Letter. 541 See IAA Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 13068 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 investment adviser’s business. An advertisement that includes an older rating would be misleading without clear and prominent disclosure of the rating’s date.542 The second provision of the disclosure requirement—the identity of the third party that created the rating— is important because it will provide investors with the opportunity to assess the qualifications and credibility of the rating provider. Investors can look up a third party by name and find relevant information, if available, about the third party’s qualifications and can form their own opinions about credibility. The final provision of the disclosure requirement—that compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating—provides consumers with important context for weighing the relevance of the statement in light of the compensation incentive.543 Although the final rule uses the term ‘‘compensation,’’ this term continues to refer to cash and non-cash compensation, as proposed. Similarly, the final rule replaces the phrase ‘‘by or on behalf’’ with ‘‘directly or indirectly.’’ As discussed above, this reflects a nonsubstantive change to use a phrase that we believe is commonly understood in the industry.544 While the final rule explicitly requires these three disclosures, they would not cure a rating that could otherwise be false or misleading under the final rule’s general prohibitions or under the general anti-fraud provisions of the Federal securities laws. For example, where an adviser’s advertisement references a recent rating and discloses the date, but the rating is based upon on an aspect of the adviser’s business that has since materially changed, the advertisement would be misleading. Likewise, an adviser’s advertisement would be misleading if it indicates that the adviser is rated highly without disclosing that the rating is based solely on a criterion, such as assets under management, that may not relate to the quality of the investment advice. 542 In addition, an adviser would be required to provide contextual disclosures of subsequent, lessfavorable performance in the rating, if applicable. See final rule 206(4)–1(a). 543 In many cases, third-party ratings are developed by relying significantly on questionnaires or client surveys and involve different compensation models. For example, some investment advisers compensate the third-party ratings firm for the right to include the ratings or rankings that are calculated as a result of the survey in their advertisements. Other investment advisers compensate the third-party ratings firm to be included in the initial pool of advisers from which the rating or ranking is determined. 544 See supra section II.A. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 E. Performance Advertising The final rule’s general prohibitions apply to advertisements that include performance results (‘‘performance advertising’’), as proposed. We are adopting specific requirements and restrictions for performance advertising, with some changes from the proposal as described below. We continue to believe that performance advertising raises special concerns that warrant additional requirements and restrictions under the final marketing rule.545 In particular, the presentation of performance could lead reasonable investors to unwarranted assumptions and thus would result in a misleading advertisement.546 Some commenters objected to the proposed rule’s specific performance advertising provisions, favoring relying only on the rule’s general prohibitions for non-retail investors.547 However, commenters generally did not advocate for the removal of the performance advertising provisions as a whole. After considering comments, we remain convinced that additional protections should apply to advertisements that include performance results. We proposed several requirements for all advertisements that include performance advertising. Specifically, under our proposal, an advertisement could not: (i) Include gross performance, unless the advertisement provided or offered to provide a schedule of fees and expenses deducted to calculate net performance (the ‘‘proposed schedule of fees requirement’’); (ii) contain any statement that the performance results have been approved or reviewed by the Commission (the ‘‘Commission approval requirement’’); and (iii) provide related, extracted, or hypothetical performance without meeting specific conditions.548 For Retail Advertisements,549 our 545 See 2019 Proposing Release, supra footnote 7, at text accompanying n. 181. 546 For example, investors may rely particularly heavily on advertised performance results in choosing whether to hire or retain an investment adviser or invest in a private fund managed by the adviser. This reliance may be misplaced to the extent that an investor considers past performance achieved by an investment adviser to be predictive of the results that the investment adviser will achieve for the investor. 547 See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter I. 548 Proposed rule 206(4)–1(c)(1). 549 We proposed to define clients and investors that are ‘‘qualified purchasers’’ or ‘‘knowledgeable employees’’ as ‘‘Non-Retail Persons’’ and to define all other clients and investors as ‘‘Retail Persons.’’ See proposed rule 206(4)–1(e)(8) and (14). Similarly, the proposed rule distinguished between advertisements for which an adviser has adopted and implemented policies and procedures reasonably designed to ensure that the advertisements are disseminated solely to NonRetail Persons as ‘‘Non-Retail Advertisements’’ and all other advertisements as ‘‘Retail PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 proposal also would have required that: (i) Any presentation of gross performance also include net performance, subject to conditions (the ‘‘net performance requirement’’); and (ii) any performance results of a portfolio or composite aggregation of related portfolios include performance results for one-, five-, and ten-year periods, subject to conditions (the ‘‘time period requirement’’).550 As discussed in more detail below, the final rule substantially adopts the proposed rule’s requirements, and applies them to all advertisements that include performance advertising. Unlike the proposed rule, the final rule does not provide separate requirements for performance advertising in Retail Advertisements and Non-Retail Advertisements and will not include the proposed schedule of fees requirement. 1. Net Performance Requirement; Elimination of Proposed Schedule of Fees Requirement The final rule will prohibit any presentation of gross performance in an advertisement unless the advertisement also presents net performance (i) with at least equal prominence to, and in a format designed to facilitate comparison with, the gross performance; and (ii) calculated over the same time period, and using the same type of return and methodology as, the gross performance.551 The final rule applies the net performance requirement to all advertisements, not only to Retail Advertisements and, in turn, eliminates the proposed schedule of fees requirement.552 We discuss below the benefits of expanding the net performance requirement to all performance advertisements in light of the removal of the proposed schedule of fees requirement, and the anticipated effects on advisers. Some commenters supported our proposal to require advisers that present gross performance in Retail Advertisements to present net performance.553 They agreed that presentations of net performance help demonstrate the effect that fees and expenses will have on future performance. One commenter also stated that providing net performance information to Non-Retail Persons alerts Advertisements.’’ See proposed rule 206(4)–1(e)(7) and (13). 550 Proposed rule 206(4)–1(c)(2). 551 Final rule 206(4)–1(d)(1). 552 Id. 553 See Consumer Federation Comment Letter; CFA Institute Comment Letter; Proskauer Comment Letter. The majority of commenters who responded via the Investor Feedback Flyer marked net performance results as ‘‘Very Important.’’ E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 them to the fact that fees and expenses may significantly reduce performance.554 Some commenters also supported our proposal to allow advisers to exclude net performance in Non-Retail Advertisements, stating that Non-Retail Persons are often not at risk of being misled by gross performance.555 However, another commenter stated that many Non-Retail Persons investing in private funds prefer to receive both net and gross performance results in advertisements because it provides an opportunity to cross check the investors’ net performance calculations against advisers’ calculations.556 In addition, while some commenters supported permitting different performance presentations in Retail and Non-Retail Advertisements,557 other commenters stated that it could create operational, administrative, and compliance burdens for advisers, and significant potential for errors.558 Some commenters stated that advisers would face difficulties in controlling the distribution of Non-Retail Advertisements pursuant to policies and procedures that would be required under the proposal.559 A few commenters also raised concerns that in some cases Retail and Non-Retail Persons may invest in the same fund, but may receive different types or levels of information because of the proposed rule’s bifurcated approach.560 After considering comments, we believe that the net performance 554 See NYC Bar Comment Letter (expressing this idea in the context of its overall argument that the rule should not require an adviser to provide (or offer to provide) a schedule of fees and expenses to Non-Retail Persons when also presenting net performance). 555 See, e.g., IAA Comment Letter; Proskauer Comment Letter (stating that for Non-Retail Persons, disclosure that gross performance is gross and not net is sufficient); CFA Institute Comment Letter; MFA/AIMA Comment Letter I; Blackrock Comment Letter. 556 See ILPA Comment Letter. 557 See, e.g., CFA Institute Comment Letter; Consumer Federation Comment Letter. 558 See, e.g., NYC Bar Comment Letter; NSCP Comment Letter; AIC Comment Letter I; NAPFA Comment Letter; ACG Comment Letter. 559 See, e.g., NSCP Comment Letter; IAA Comment Letter (stating that prospective investors typically do not provide information about their retail or non-retail status at the marketing stage, and stating that in the case of non-U.S. investors, this information is generally not gathered at any stage). 560 See Ropes & Gray Comment Letter; Association for Corporate Growth Comment Letter. For example, a private fund that relies on section 3(c)(1) of the Investment Company Act may have investors that qualify as Retail and Non-Retail Persons under the proposed amendments to the advertising rule. Retail Persons would receive different disclosures under the proposal, raising the possibility of unequal treatment and potential questions about fair disclosure. See proposed rule 206(4)–1(c)(1) and (2). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 requirement is reasonably designed to prevent all types of prospective clients and private fund investors from being misled by the presentation of gross performance in an advertisement. Presenting gross performance alone in this context may imply that investors received the full amount of the presented returns, when the fees and expenses paid in connection with the investment adviser’s investment advisory services would reduce the returns to investors. Presenting gross performance alone also may be misleading to the extent that amounts paid in fees and expenses are not deducted and thus not compounded in calculating the returns. In addition, we believe that presenting net performance in all advertisements will help illustrate for investors the effect of fees and expenses on the advertised performance results and allow all investors to compare the adviser’s performance presentation with their own calculations, if applicable. We do not believe the burden will be considerable given that many advisers already present net performance.561 Given the operational complexity and challenges that commenters noted, as well as changes we are making to the final rule to streamline the performance presentation requirements for all advisers, we are persuaded that the rule should no longer provide different flexibility for advertisements to NonRetail Persons. Accordingly, the final rule implements changes from the proposed rule that we believe, when viewed as a whole, simplify the rule’s compliance for all advisers, while preserving and promoting protection for all investors. In particular, we are eliminating the proposed schedule of fees requirement. Commenters stated that this requirement could be overly burdensome for advisers and may not provide relevant information to investors.562 Some commenters also stated that Non-Retail Persons are in a position to negotiate for appropriately tailored disclosures based on their particular needs.563 While one commenter disagreed, arguing that investors in private funds (including Non-Retail Persons) sometimes have difficulty obtaining information regarding fees and expenses for complex 561 See CFA Institute Comment Letter. e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; CFA Institute Comment Letter (stating that they do not believe it is feasible for an adviser that presents gross returns to provide the proposed fee schedule, but that advisers should disclose certain information about fees a client will pay). 563 See MFA/AIMA Comment Letter I; NYC Bar Comment Letter. 562 See, PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 13069 products,564 we believe requiring net performance for all advertisements with appropriate disclosures will alert investors to the effect of fees on an adviser’s performance results. As proposed, the final rule will not prescribe disclosure requirements for net and gross performance presentations. Instead, an adviser would need to comply with the final rule’s general prohibitions. Comments were mixed on this aspect of the proposal.565 We continue to believe, however, that advisers should evaluate the particular facts and circumstances that may be relevant to investors, including the assumptions, factors, and conditions that contributed to the performance, and include appropriate disclosures or other information such that the advertisement does not violate the prohibitions in paragraph (a) of the final rule or other applicable law. Depending on the facts and circumstances, disclosures may include: (1) The material conditions, objectives, and investment strategies used to obtain the results portrayed; (2) whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings; (3) the effect of material market or economic conditions on the results portrayed; (4) the possibility of loss; and (5) the material facts relevant to any comparison made to the results of an index or other benchmark.566 a. Definition of Gross Performance Similar to the proposal, both ‘‘gross performance’’ and ‘‘net performance’’ will be defined by reference to a ‘‘portfolio,’’ which is defined as ‘‘a group of investments managed by the investment adviser’’ and can include ‘‘an account or private fund.’’ 567 Under the final rule, ‘‘gross performance’’ is defined to mean the performance results of a portfolio (or portions of a portfolio that are included in extracted performance, if applicable) before the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant 564 See ILPA Comment Letter. e.g., NAPFA Comment Letter (opposing additional disclosure requirements); NRS Comment Letter (supporting additional disclosure requirements). See also ILPA Comment Letter (requesting that the Commission incorporate specific disclosures for non-retail investors reviewing private equity fund performance advertising). 566 See 2019 Proposing Release, supra footnote 7, at nn.191–195. 567 Final rule 206(4)–1(e)(11). See also proposed rule 206(4)–1(e)(10). 565 See, E:\FR\FM\05MRR2.SGM 05MRR2 13070 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations portfolio.568 We are adopting the definition of gross performance as proposed, with one change to require, as a commenter requested, that advisers that show extracted performance in accordance with the final marketing rule must show net and gross performance for the applicable subset of investments extracted from a portfolio.569 This change clarifies that gross performance applies not only to an entire portfolio but also to a portion of a portfolio that is included in extracted performance. Gross performance does not show the impact of all fees and expenses that the adviser’s existing investors have borne or that prospective investors would bear, which can be relevant to an evaluation of the investment experience of the adviser’s advisory clients and/or investors in private funds advised by the investment adviser.570 While commenters generally supported the proposed definition of gross performance, some requested that we clarify the types of fees and expenses advisers must deduct in calculating gross performance.571 For example, some commenters requested we specify that gross returns should reflect the deduction of transaction costs, if any exist.572 One of these commenters also requested that we add a definition for ‘‘pure gross returns’’ (i.e., returns that do not reflect the deduction of any transaction costs), and require advisers to make additional disclosures when presenting pure gross returns in advertisements.573 The same commenter requested that we clarify that advisory fees paid to underlying investment vehicles must be deducted from gross performance. Like the proposed rule, the final rule does not prescribe any particular calculation of gross performance. For example, many private funds use money-weighted returns instead of timeweighted returns.574 Under the final 568 Final rule 206(4)–1(e)(7). CFA Institute Comment Letter. See infra section II.E.5 (discussing extracted performance). 570 See 2019 Proposing Release, supra footnote 7, at text accompanying nn.235–236. 571 See, e.g., IAA Comment Letter; CFA Institute Comment Letter. 572 See IAA Comment Letter (recommending for all cases where an investment adviser has discretion and is responsible for the execution of client transactions); CFA Institute Comment Letter (recommending for all presentations of gross returns other than those the adviser describes as ‘‘pure gross returns’’). 573 CFA Institute Comment Letter (‘‘Pure gross returns are commonly used when transaction costs are bundled with investment management fees, such as in a wrap fee arrangement.’’). This commenter also requested that we clarify whether returns of accounts that pay zero commissions are gross returns or pure gross returns. 574 See, e.g., CFA Institute Comment Letter. jbell on DSKJLSW7X2PROD with RULES2 569 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 rule, advisers may use the type of returns appropriate for their strategies provided that the usage does not violate the rule’s general prohibitions, and, if applicable, subject to the requirements discussed below.575 We continue to believe that, because of the variation among types of advisers and investments, prescribing the calculation could unduly limit the ability of advisers to present performance information that they believe would be most relevant and useful to an advertisement’s audience. However, if an investment adviser calculates the performance of a portfolio in part by deducting transaction fees and expenses, but deducts no other fees or expenses, then such performance would be ‘‘gross performance.’’ If an investment adviser’s calculation of performance reflects the deduction of advisory fees paid to an underlying investment vehicle before the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio, then such performance would be ‘‘gross performance.’’ It would be misleading to present gross performance information without providing appropriate disclosure about gross performance, taking into account the particular facts and circumstances of the advertised performance. Advisers generally should describe the type of performance return presented in the advertisement. For example, an advertisement may or may not present the performance of a portfolio using a return that accounts for the cash flows into and out of the portfolio. In either case, under the final rule, an adviser generally should disclose what elements are included in the return presented so that the audience can understand, for example, how it reflects cash flow and other relevant factors. Similarly, if an adviser’s presentation of gross performance does not reflect the deduction of transaction fees and expenses, an adviser should disclose that fact to avoid being misleading, if it would not be clear to the investor from the context of the advertisement.576 575 See, e.g., supra section II.B; infra section II.E. though we are not adopting a definition of ‘‘pure gross performance,’’ as one commenter suggested, we believe that any adviser that presents such performance results in addition to gross performance and net performance should identify pure gross returns and disclose that pure gross returns do not reflect the deduction of transaction costs, to avoid misleading recipients of the advertisement. 576 Even PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 b. Definition of Net Performance We are adopting the definition of net performance as proposed, with some modifications. First, as with gross performance and for the same reasons, the final rule provides that net performance applies not only to an entire portfolio but also to a portion of a portfolio that is included in extracted performance. Second, we are specifying when advisers may exclude certain custodian fees paid to third parties. Third, we are prescribing some aspects of the calculation of net performance using model fees. The final rule defines ‘‘net performance’’ to mean, in part, the performance results of a portfolio (or portions of a portfolio that are included in extracted performance, if applicable) after the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio.577 Once an adviser establishes the ‘‘portfolio’’ for which performance results are presented, the adviser must determine the fees and expenses borne by the owner of the portfolio and then deduct those to establish the ‘‘net performance.’’ The final rule includes a nonexhaustive list of the types of fees and expenses to be considered in preparing net performance that is identical to the proposal.578 This list includes, if applicable, advisory fees, advisory fees paid to underlying investment vehicles, and payments by the investment adviser for which the client or investor reimburses the investment adviser. It illustrates fees and expenses that clients or investors bear in connection with the services they receive. In addition, ‘‘net performance’’ may exclude custodian fees paid to a bank or other third-party organization for safekeeping funds and securities. Finally, the final rule permits the use of a model fee in calculating net performance in an advertisement, subject to conditions. A few commenters supported the proposed definition of net performance.579 Some commenters, however, requested we prescribe additional requirements for net performance calculations, including specific requirements for certain private funds.580 For example, one commenter 577 Final rule 206(4)–1(e)(10). proposed rule 206(4)–1(e)(6). 579 See IAA Comment Letter; MFA/AIMA Comment Letter I; NRS Comment Letter. 580 See Consumer Federation Comment Letter (stating that the Commission should require advisers to comply with a uniform set of principles when calculating performance). See also CFA 578 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 recommended that, when clients cannot ‘‘opt out’’ of custody or other administrative costs, the rule should expressly require the adviser to deduct these fees and costs when presenting net returns of a specific pooled investment vehicle.581 This commenter requested that we clarify that when presenting net performance of a specific pooled fund, advisers must deduct administrative fees, as required when complying with the CFA Institute’s Global Investment Performance Standards (‘‘GIPS standards’’). Some commenters supported our proposal not to prescribe specific calculations, stating that there is no single correct way to calculate returns.582 Some of these commenters also requested we clarify that net performance calculations in advertisements must reflect the deduction of any transaction costs and investment advisory fees (including any performance-based fees or carried interest). One commenter requested clarification that net performance fees exclude taxes on gains generated in a portfolio.583 As proposed, the final rule does not prescribe any particular calculation of net performance. We believe that prescribing the calculation of net performance could unduly limit the ability of advisers to present performance information that they believe would be most relevant and useful to an advertisement’s audience. Therefore, the final rule’s definition continues to include a non-exhaustive list of the types of fees and expenses to be considered in preparing net performance. We decline, however, to enumerate all potential private fund fees and expenses, as one commenter suggested.584 Instead, the final rule’s definition of net performance requires the deduction of private fund fees and expenses that the investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant fund. However, we are clarifying in response to some commenters that any adviser that deducts applicable transaction fees and expenses, or advisory fees paid to an underlying investment vehicle, when calculating gross performance should also do so for net performance. We are also clarifying that, under the final rule’s definition of net performance, advisory fees include Institute Comment Letter; ILPA Comment Letter (both letters discussing particular concerns regarding private equity funds). 581 See CFA Institute Comment Letter. 582 See, e.g., IAA Comment Letter; NRS Comment Letter. 583 See Resolute Comment Letter. 584 See ILPA Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 performance-based fees and performance allocations that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio. With respect to administrative fees and expenses that a commenter raised, whether a client or investor pays them in connection with the investment adviser’s advisory services (and therefore they must be deducted) depends on the facts and circumstances. For example, if an adviser agrees to bear certain administrative fees as a result of negotiations with investors in the private fund, or if an investor agrees to directly bear them, we do not believe that those fees should be included in the calculation of net performance. In response to a commenter discussed above, we believe that capital gains taxes paid outside of the portfolio are not fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services (and are therefore not required to be deducted in the calculation of net performance).585 In addition, as proposed, the definition of net performance refers to the deduction of all fees that an investor ‘‘has paid or would have paid’’ in connection with the services provided. That is, where hypothetical performance is permissibly advertised under the final rule, net performance should reflect the fees and expenses that ‘‘would have’’ been paid if the hypothetical performance had been achieved by an actual portfolio.586 c. Deduction of Custodian Fees Paid to a Bank or Other Third-Party Organization Under the final rule, presentation of ‘‘net performance’’ in an advertisement may exclude custodian fees paid to a bank or other third-party organization for safekeeping funds and securities, as proposed.587 We understand that advisory clients commonly select and directly pay custodians, and in such cases, advisers may not have knowledge of the amount of such custodian fees to deduct for purposes of establishing net performance. One commenter supported this treatment for non-pooled investment vehicles, stating that the rule should not require an adviser to reflect the deduction of custodian fees when 585 See Resolute Comment Letter. rule 206(4)–1(e)(10). 587 Final rule 206(4)–1(e)(10)(i). See proposed rule 206(4)–1(e)(6)(iii). 586 Final PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 13071 clients select their custodians.588 However, this commenter also recommended that the rule expressly require custody fee deduction if a client cannot ‘‘opt-out’’ of paying those fees. After considering comments, we continue to believe that the final rule should allow an adviser to exclude custodian fees paid to third parties given a client may control custodian selection (and accompanying fees). We believe that this approach is appropriate even where advisers know the amount of custodian fees—e.g., where the adviser recommended the custodian. However, to the extent a client or investor pays an adviser, rather than a third party, for custodial services, then the adviser must deduct the custodial fee in calculating net performance for purposes of the advertisement. This will be the case, for example, when an adviser provides custodial services with respect to funds or securities for which the performance is presented and charges a separate fee for those services, or when custodial fees are included in a single fee paid to the adviser, such as if they are included in wrap fee programs. This would also be the case when a client or investor reimburses the investment adviser for third-party custodian fees. d. Deduction of Model Fees Under the final rule, presentation of ‘‘net performance’’ in advertisements may reflect the deduction of a model fee when doing so would result in performance figures that are no higher than if the actual fee had been deducted, as proposed.589 This will result in performance that is no higher than if the adviser deducted actual fees. For example, in a private fund with multiple series or classes where each series or class has different fees, an adviser may display the performance of the highest fee class. We did not receive any comments on this aspect of the proposal. Advisers may choose this modification to ease calculating net performance. When an adviser advertises net performance that is no higher than if deducting actual fees, there appears to be little chance of misleading the audience into believing that investors received better returns than they actually did.590 588 See CFA Institute Comment Letter. See also IAA Comment Letter (supporting permitting the exclusion of custodian fees, generally). 589 Final rule 206(4)–1(e)(10)(ii)(A). 590 If the fee to be charged to the intended audience is anticipated to be higher than the actual fees charged, the adviser must use a model fee that reflects the anticipated fee to be charged in order not to violate the rule’s general prohibitions. See id. See also final rule 206(4)–1(a). E:\FR\FM\05MRR2.SGM 05MRR2 13072 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 The rule also will allow net performance to reflect the deduction of a model fee that is equal to the highest fee charged to the intended audience to whom the advertisement is disseminated, similar to as proposed.591 We continue to believe that allowing advisers to present net performance that reflects the deduction of this type of model fee may be useful for advisers who manage a particular strategy for different types of investors. For example, under the final rule, an adviser managing several accounts, each using the same investment strategy, could present in an advertisement the gross and net performance of all such accounts. For net performance, the adviser may deduct a model fee equal to the highest fee charged to retail investors (assuming an intended retail audience). This provision of the definition of net performance does not permit net performance that reflects a model fee that is not available to the intended audience. One commenter requested that we permit advisers to deduct model fees that reflect either the highest fee that was charged historically or the highest potential fee that it will charge the investors or clients receiving the particular advertisement, provided the performance is accompanied by appropriate disclosure.592 Under the final rule, an adviser does not have discretion to choose the model fee to use in calculating net performance—it must use the higher of these two model fees.593 Another commenter supported this provision, but stated that where an adviser has not yet managed an actual account for clients or investors similar to the relevant audience, the rule should permit the adviser to deduct a model fee that is equal to the highest fee to be charged to relevant audience.594 We agree, and the final rule requires the use of such a model fee.595 591 Final rule 206(4)–1(e)(10)(ii)(B). The final rule reflects one change from the proposal, in response to a commenter that requested that we conform the phrase ‘‘relevant audience’’ in the proposed rule’s model fee provision, to other parts of the rule. See CFA Institute Comment Letter. We agree, and have revised the provision to refer to the ‘‘intended audience to whom the advertisement is disseminated.’’ 592 See MMI Comment Letter. 593 See supra footnote 590 (discussing the final rule’s first model fee provision and the general prohibitions). As discussed above, net performance that reflects a model fee that is not available to the intended audience is not permitted under the final rule’s second model fee provision. 594 See CFA Institute Comment Letter. 595 See final rule 206(4)–1(e)(10) (referring, in the definition of net performance, to the deduction of all fees and expenses that a client or investor ‘‘would have paid’’). An adviser could use such a model fee pursuant to the second model fee provision. Final rule 206(4)–1(e)(10)(ii)(B). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 Another commenter expressed concern that the proposed rule would require an adviser to overstate its normal fee, when deducting a model fee, because the adviser had previously charged a client a higher fee for unique relationship servicing requirements.596 If an adviser charged a higher fee for unique services that it does not intend to provide in the future to the intended audience for the advertisement, the portfolio may be outside of the scope of the adviser’s performance calculation. For example, it may not meet the criteria for a related portfolio and, in that case, should not be included in the calculation of related performance. Similarly, one commenter stated that the rule should not require an adviser to deduct a model fee when presenting performance of a portfolio of a non-fee paying client.597 This commenter requested that we instead permit such adviser to calculate net performance returns using actual investment management fees (i.e., zero fees) and disclose the percentage of assets under management represented by non-fee paying portfolios. Further, this commenter stated that the GIPS standards do not require the application of a model fee to non-fee-paying portfolios to calculate net returns, and that requiring it in the final rule may result in many advisers being required to restate historical performance. We believe this presentation could mislead investors to believe that they could receive returns as high as non-fee paying clients, even with the commenter’s proposed disclosure. In the 2019 Proposing Release, we expressed similar concerns with presenting related performance of accounts with fee waivers or reduced rates unavailable to unaffiliated clients of the adviser.598 Accordingly, to satisfy the final rule’s general prohibitions, an adviser generally should apply a model fee that reflects either the highest fee that was charged historically or the highest potential fee that it will charge the investors or clients receiving the particular advertisement. One commenter requested clarification that model fees also may exclude custodian fees that would be paid to a bank or other third-party organization.599 We agree that an adviser that uses a model fee in accordance with the final rule may also exclude custodian fees if otherwise permitted under the final rule. e. Conditions for Presentation As proposed, the final rule will require that net performance be presented in the advertisement with at least equal prominence to, and in a format designed to facilitate comparison with, the gross performance, and calculated over the same time period, and using the same type of return and methodology as, the gross performance.600 These conditions are designed to help ensure that net performance effectively conveys to the audience information about the effect of fees and expenses on the relevant performance. A calculation of net performance over a different time period or using a different type of return or methodology would not necessarily provide information about the effect of fees and expenses. Only one commenter discussed this condition and recommended that the Commission encourage advisers to be certain that the layout of the information presented is not misleading.601 As described above, advertisements containing any performance presentation will be subject to the rule’s general prohibitions. 2. Prescribed Time Periods Our final rule also adopts the proposed one-, five-, and ten-year time period requirement for the presentation of performance results in an advertisement, with some modifications from the proposed rule. First, the final rule applies the time period requirement to all advertisements (with a new exception for private funds), rather than only to Retail Advertisements, as proposed.602 Second, prescribed time periods must end on a date that is no less recent than the most recent calendar year-end, rather than the most recent practicable date, as proposed.603 As proposed, this time period requirement will apply to all performance results, including gross and net performance, and including any composite aggregation of related portfolios. Also, as proposed, if the relevant portfolio did not exist for a particular prescribed period, then an adviser must present performance information for the life of the portfolio.604 For example, if a portfolio has been in existence for seven years, then the adviser must show 600 Final 596 See Wellington Comment Letter. 597 See CFA Institute Comment Letter. 598 See 2019 Proposing Release, supra footnote 7, at text following footnote 288. 599 See IAA Comment Letter. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 rule 206(4)–1(d)(1)(i) and (ii). CFA Institute Comment Letter. 602 Final rule 206(4)–1(d)(2). See proposed rule 206(4)–1(c)(2)(ii). 603 See id. 604 See id. 601 See E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 performance results for one- and fiveyear periods, as well as for the sevenyear period. An investment adviser is free to include performance results for other periods as long as the advertisement also presents results for the prescribed time periods, and otherwise complies with the requirements of the final rule.605 The final rule also adopts the proposed requirement that the prescribed time periods be presented with equal prominence in the advertisement, so that an investor can observe the history of the adviser’s performance on a short-term and longterm basis.606 An adviser may not highlight the single one-, five-, or tenyear period that shows the best performance, instead of showing them in relation to each other. We believe this standardized presentation provides the audience with insight into the experience of the investment adviser over set periods that are likely to reflect how the advertised portfolio(s) performed during different market or economic conditions. For portfolios in existence for at least ten years, performance for that period could provide investors with more complete information than only performance over the most recent year. That performance may prompt investors to seek additional information from advisers regarding the causes of significant changes in performance over longer periods. Some commenters supported this aspect of the proposal for this reason.607 These commenters also stated that this information would aid investors in comparing different performance advertisements and reduce the risk that advisers would present performance based on cherry-picked periods. Several commenters stated that the proposed time period requirement for closed-end private funds, however, would be inappropriate and confusing for investors, in part, because such performance (especially five- and tenyear periods) may not exist for the fund advertised, since private funds are often advertised to investors at early stages.608 605 For example, an adviser may present performance results for three-year periods, which is a requirement for advisers that claim compliance with the GIPS standards. See, e.g., CFA Institute Comment Letter. We are not requiring a three-year period, however, because we believe the time periods required under the final rule already provide investors with sufficient information regarding performance over varying time periods. 606 Final rule 206(4)–1(d)(2). 607 See Consumer Federation Comment Letter; CFA Institute Comment Letter; Fried Frank Comment Letter. 608 See AIC Comment Letter I; Fried Frank Comment Letter; MFA/AIMA Comment Letter I; IAA Comment Letter; Ropes & Gray Comment Letter; NYC Bar Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 In addition, commenters stated that the performance of private equity funds can vary substantially over the term of the fund (with early years often negatively affected by organizational expenses of the ‘‘J-curve’’), and that the presentation of performance over prescribed time periods is therefore not useful to investors.609 Similarly, commenters noted that the presentation of performance using an internal rate of return, as is typical with private equity funds, is often not meaningful in the early years of the fund because the fund is not fully invested, no investments have been harvested, and the new investments likely have not changed in value.610 In light of our decision not to distinguish the treatment of Retail and Non-Retail Advertisements, and after considering comments, we agree that requiring advisers to provide performance results of private funds over one-, five-, and ten-year periods in advertisements will not provide investors with useful insight into how the advertised portfolio(s) performed during different market or economic conditions. Our final rule therefore applies the time period requirement to all performance advertisements, except for performance of a private fund.611 An adviser may rely on this exception when displaying performance advertising of any type of private fund, rather than only when displaying performance advertising of private equity funds or other closed-end private funds. We believe that it is appropriate to except any private fund because there may be additional types of private funds than those identified by commenters for which displaying this information could be misleading. We decline to allow only certain defined types of private funds to rely on this exception, given the varied limitations that private funds may place on redemptions now and in the future. We also do not believe the benefit of having advisers parse the rule’s requirements based on specific fund types would justify the complexity. Further, although we are not mandating presentation of performance for any specific time periods for these funds, presentations of private fund performance are subject to the general anti-fraud provisions of the Federal securities laws and the general prohibitions in the final rule, including the prohibition of including or 609 See, e.g., AIC Comment Letter; Fried Frank Comment Letter; Ropes & Gray Comment Letter; IAA Comment Letter. 610 See Fried Frank Comment Letter; MFA/AIMA Comment Letter I. 611 Final rule 206(4)–1(d)(2). See also final rule 206(4)–1(e)(13) (defining private fund). PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 13073 excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.612 Other commenters stated that our proposal would create operational difficulties for advisers that present annual returns as of the most recent calendar year-end.613 A commenter stated that, for these advisers, the proposal’s requirement to present one-, five-, and ten-year returns as of the ‘‘most recent practicable date’’ would require that they continuously update their performance presentations throughout the year.614 This commenter requested we permit annual returns presented through the most recent calendar year-end. This commenter also requested that the final rule align with the GIPS standards by allowing advisers to present annual returns for the past ten years (or since inception if the track record exists for less than ten years) as of the most recent calendar year end, instead of one-, five-, and ten-year annualized returns. We understand that, for some advisers, the most recent calendar yearend may be the most recent practicable date. Our final rule therefore requires that the prescribed time period end on a date that is no less recent than the most recent calendar year-end. In selecting time periods for purposes of an advertisement, an adviser may not select the periods that show only the most favorable performance—e.g., presenting a five-year period ending on a particular date because that five-year period showed growth while presenting a tenyear period ending on a different date because that ten-year period showed growth. Depending on the facts and circumstances, an adviser may be required to present performance results as of a more recent date than the most recent calendar year-end to comply with the rule’s general prohibitions.615 For example, it could be misleading for an adviser to present performance returns as of the most recent calendar year-end if more timely quarter-end performance is available and events have occurred 612 See Fried Frank Comment Letter; Ropes & Gray Comment Letter (discussing that when not using time-based performance, there is a potential for investment advisers to cherry-pick only recent performance results or strong performance years, or otherwise mislead investors by using ‘‘not meaningful’’ to show performance information). 613 See CFA Institute Comment Letter; IAA Comment Letter. 614 CFA Institute Comment Letter. Cf. MMI Comment Letter (requesting that our final rule permit advisers to present quarterly performance results). 615 See, e.g., final rule 206(4)–1(a)(6) (an advertisement may not include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced). E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13074 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations since that time that would have a significant negative effect on the adviser’s performance. If more recent quarter-end performance data is not available, the adviser should include appropriate disclosure about the performance presented in the advertisement. We are also clarifying that, for an adviser that provides performance results in advertisements for periods other than one, five, and ten years, the adviser is free to include such results as long as the advertisement presents results for the final rule’s required time periods. Thus, an adviser that complies with the GIPS standards may present annual returns for the past ten years (or since inception if the track record exists for less than ten years) as of the most recent calendar year end, in addition to performance results for the final rule’s required periods. advertisement’s audience. An express or implied statement that the Commission has reviewed or approved the performance results could advance such unrealistic expectations. For example, while potentially true, a statement that ‘‘performance results are prepared in compliance with the Commission’s requirements on performance presentations in advertisements’’ may mislead an investor into thinking that the Commission has approved the results portrayed.619 Such a statement could also be misleading to the extent it suggests that the Commission has reviewed or approved more generally the investment adviser, its services, its personnel, its competence or experience, or its investment strategies and methods. Therefore, under the final rule, advisers may not represent that the Commission has approved or reviewed the performance results.620 3. Statements About Commission Approval As proposed, the final rule prohibits any statement, express or implied, that the calculation or presentation of performance results in the advertisement has been approved or reviewed by the Commission in any advertisement containing performance results.616 This approval prohibition is intended to prevent advisers from representing that the Commission has approved or reviewed the performance results, even when the adviser is presenting performance results in accordance with the rule. Furthermore, the final rule’s general prohibitions have the effect of prohibiting an adviser from stating or implying that any part of an advertisement, and the advertisement as a whole, has been approved or reviewed by the Commission.617 Our final rule prescribes this condition specifically for advertisements containing performance results because of the particular weight an investor would likely give to performance results that it believes the Commission has reviewed or vetted. We received few comments on this aspect of the proposed rule, with one commenter supporting it and the other requesting clarification as to whether this provision would prohibit advertisements that combine performance results with summary information about an adviser’s recent SEC examination.618 We continue to believe that performance results may lead to a heightened risk of creating unrealistic expectations in an 4. Related Performance The final rule will condition the use of ‘‘related performance’’ in adviser advertisements, on the inclusion of all ‘‘related portfolios.’’ 621 Under the final rule, however, an adviser may exclude related portfolios if the advertised performance results are not materially higher than if all related portfolios had been included, and the exclusion does not alter the presentation of any applicable prescribed time period. The final rule defines ‘‘related performance’’ as ‘‘the performance results of one or more related portfolios, either on a portfolio-by-portfolio basis or as a composite aggregation of all portfolios falling within stated criteria.’’ 622 It defines ‘‘portfolio’’ as ‘‘a group of investments managed by the investment adviser,’’ and includes in the definition that ‘‘[a] portfolio may be an account or a private fund.’’ 623 It defines ‘‘related portfolio’’ as ‘‘a portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered in the advertisement.’’ 624 The final rule’s treatment of related performance, 616 Final rule 206(4)–1(d)(3). rule 206(4)–1(a)(3). 618 See, e.g., Mercer Comment Letter (supporting this aspect of the proposed rule). 617 Final VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 619 Similarly, section 208(a) of the Act, states that it is unlawful for a registered investment adviser to represent or imply in any manner whatsoever that it has been sponsored, recommended, or approved, or that his abilities or qualifications have in any respect been passed upon by the United States or any agency or any officer thereof. 620 See also section 208(a) of the Act. 621 Final rule 206(4)–1(d)(4). The presentation must also comply with the rule’s general prohibitions. See final rule 206(4)–1(a). 622 Final rule 206(4)–1(e)(14). 623 Final rule 206(4)–1(e)(11). A portfolio also includes, but is not limited to, a portfolio for the account of the investment adviser or its advisory affiliate (as defined in the Form ADV Glossary of Terms). See id. 624 Final rule 206(4)–1(e)(15). PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 including the conditions and definitions, is largely the same as the proposal. We discuss the few differences from the proposal below. Commenters broadly supported allowing advisers to present related performance in adviser advertisements.625 They generally agreed that related performance can be a valuable tool to assist an investor in evaluating a particular investment adviser or investment strategy, and that its use is consistent with industry practice. A few commenters also generally supported the proposed rule’s conditions for the presentation of related performance.626 Others, however, described the proposed conditions as overly prescriptive and stated that we should address cherrypicking related portfolios solely through the rule’s general prohibitions, such as the ‘‘fair and balanced’’ provision.627 Another commenter stated that we should remove the conditions and permit advisers to identify (and document) objective criteria that they can apply on a consistent basis to exclude certain types of accounts.628 Conversely, one commenter said we should require composite performance without any exclusions of related portfolios because allowing exclusions from composites would be different from the GIPS standards that require composites to include all portfolios that are managed in the composite’s strategy.629 We continue to believe that conditioning the presentation of related performance in advertisements on the presentation of all related portfolios (with limited exceptions) is necessary to prevent investment advisers from including only related portfolios that have favorable performance results or otherwise ‘‘cherry-picking.’’ We believe our approach will provide advisers some flexibility in presenting related portfolios, without permitting exclusion because of poor performance. We believe this approach strikes the right balance between commenters that advocated for relying solely on the rule’s general prohibition (and/or an adviser’s own objective criteria), on the 625 See, e.g., MFA/AIMA Comment Letter I; Proskauer Comment Letter; Comment Letter of Loan Syndications and Trading Association (Feb. 10, 2020) (‘‘LSTA Comment Letter’’); MMI Comment Letter. 626 See MFA/AIMA Comment Letter I (supporting the conditions generally, but requesting that we also permit advisers to present representative accounts that would not meet the proposed rule’s conditions); LSTA Comment Letter. 627 See IAA Comment Letter; SIFMA AMG Comment Letter II; Ropes & Gray Comment Letter. 628 See SIFMA AMG Comment Letter II. 629 See CFA Institute Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 one hand, and requiring advisers to present all related performance, on the other hand. Under the final rule, although we are permitting an adviser to exclude related portfolios subject to conditions in the final rule, an adviser may nonetheless present performance without the exclusion of any related portfolios to comply with both the GIPS standards and the final marketing rule. In a change from the proposed rule, the final rule will allow an investment adviser to exclude from the presentation of related performance in the advertisement one or more related portfolios so long as the advertised performance results are ‘‘not materially higher than’’—rather than ‘‘no higher than’’—if all related portfolios had been included. One commenter recommended this change, stating that it will not necessarily be clear whether performance is ‘‘no higher’’ because performance results may vary based on the time period presented.630 Another commenter cautioned that, even with such conditions, an adviser would have difficulty demonstrating compliance for each period in its track record.631 Furthermore, this commenter stated that an adviser would incur the burden of calculating performance including all related portfolios in order to show that the performance presented was ‘‘no higher than’’ or ‘‘not materially higher than’’ if all related portfolios had been included. We understand that an adviser will likely be required to calculate the performance of all related portfolios to ensure that the exclusion of certain portfolios from the advertisement meets the rule’s conditions. Because of the special concerns that performance advertising raises, however, we believe that this burden is warranted to prevent related performance advertising from misleading investors. We believe that the modified condition we are adopting will achieve the same policy goal as our proposed rule, but give advisers additional flexibility to present related performance when there may be immaterial differences in performance results depending on the methods of 630 See IAA Comment Letter (‘‘A firm may seek to exclude an account that has a superior five-year return, but a poor one-year return, or present the performance of a representative account that has a superior one-year return, but a poor five-year return. In this scenario, the advertised performance over five and ten years would be lower, but the 1year return would be higher. This practice may be prohibited by the proposed rule because the 1-year return does not satisfy the rule’s requirements, even though the longer term returns do satisfy the rule’s requirements.’’). See also CFA Institute Comment Letter (noting the same issue but making a different recommendation). 631 See CFA Institute Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 calculation of returns or as between the different prescribed time periods.632 Under the final rule, an adviser may meet this condition if the results for one prescribed time period are no higher than if all related portfolios had been included for that time period, and the results for another prescribed time period are higher, but not materially higher, than if all related portfolios had been included for that time period. It may also meet this condition if the results for any and all prescribed time periods are not materially higher than if all related portfolios had been included for each time period. As proposed, the exclusion for related portfolios is also subject to the final rule’s time period requirement for the presentation of performance in advertisements.633 We did not receive any comments on this condition. Related performance therefore cannot exclude any related portfolio if doing so would alter the presentation of the proposed rule’s prescribed time periods. Some commenters recommended that we permit advisers to advertise one ‘‘representative account,’’ such as a flagship fund, without any prescribed conditions or in addition to providing the performance results of all related portfolios.634 Commenters generally describe representative accounts as those that most closely resemble, or are most representative of, the advertised portfolio’s specific strategy.635 A few commenters stated that permitting representative accounts would provide flexibility to advisers that manage separate accounts and may not maintain composites that cover all portfolios managed to a specific strategy, and to smaller advisers that do not have the resources to calculate the performance of a composite that includes all those portfolios.636 One such commenter stated that smaller advisers would therefore face challenges under the proposed rule in demonstrating that the performance of a representative account 632 We are not prescribing a specific numerical or percentage threshold for materiality or immateriality as part of this requirement. Instead, based on the facts and circumstances, if the results of excluding the related portfolio would be material to a reasonable client or investor, the portfolio should not be excluded. 633 See final rule 206(4)–1(d)(4)(ii). 634 See, e.g., IAA Comment Letter; Wellington Comment Letter; MFA/AIMA Comment Letter I; CFA Institute Comment Letter. 635 See Wellington Comment Letter; CFA Institute Comment Letter. See also MFA/AIMA Comment Letter I (discussing their view that ‘‘investment advisers need some flexibility to recognize a ‘flagship’ fund for a given strategy and to treat that ‘flagship’ fund as the sole related portfolio in many instances.’’). 636 See IAA Comment Letter; CFA Institute Comment Letter. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 13075 is no higher than if all related portfolios had been included.637 Others stated that permitting representative accounts would provide investors with more pertinent information than under our proposed rule, because they believe that prospective fund investors are generally less interested in the results of the ancillary funds around that flagship fund, and could find the additional information to be confusing.638 We are not convinced that the benefits of an adviser presenting in an advertisement a single representative account that is not subject to prescribed conditions would justify the risks of cherry-picking related portfolios with higher-than-usual returns.639 We also believe the materiality standard we are adopting helps to alleviate the burden on advisers to present all related performance (subject to a conditional exception). We therefore decline to make this suggested change to the rule. An adviser, however, may present the results of a single representative account (such as a flagship fund) or a subset of related portfolios alongside the required related performance so long as the advertisement would otherwise comply with the general prohibitions.640 In these circumstances, where the required related performance is also presented in the advertisement, we believe the concerns regarding cherry-picking a particular portfolio are mitigated. In addition, as proposed, advisers may present related performance on a portfolio-by-portfolio basis under the final rule. Advisers that manage a small number of related portfolios may find a portfolio-by-portfolio presentation to be the clearest way of demonstrating related performance in their advertisements. Presenting related performance on a portfolio-by-portfolio basis may illustrate for the audience the differences in performance achieved by the investment adviser in managing portfolios having substantially similar investment policies, objectives, and strategies. A portfolio-by-portfolio presentation also may best illustrate the differences in performance between a flagship fund and other related portfolios in some cases. As in the proposal, presenting related performance on a portfolio-by-portfolio 637 See IAA Comment Letter. MFA/AIMA Comment Letter I; Wellington Comment Letter; SIFMA AMG Comment Letter II. 639 Under our final rule, advisers may include performance returns of a single portfolio (without also providing the performance of other related portfolios) if the performance is not materially higher than if all related portfolios had been included, and the performance does not violate the rule’s general prohibitions. 640 See Wellington Comment Letter. 638 See E:\FR\FM\05MRR2.SGM 05MRR2 13076 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations basis will be subject to the general prohibitions, including the prohibition on omitting material facts necessary to make the presentation, in light of the circumstances under which it was made, not misleading. For example, an advertisement presenting related performance on a portfolio-by-portfolio basis could be potentially misleading if it does not disclose the size of the portfolios and the basis on which the adviser selected the portfolios. The alternative for presenting related performance, also as proposed, is as a composite aggregation of all portfolios falling within stated criteria, which we discuss below. jbell on DSKJLSW7X2PROD with RULES2 a. Related Portfolio Regarding presentations of related portfolios in advertisements, the final rule is similar to the proposal in that it does not identify or prescribe particular requirements for determining whether portfolios are ‘‘related’’ beyond whether there are ‘‘substantially similar’’ investment policies, objectives, and strategies as those of the services being offered in the advertisement. Some commenters also requested clarification that ‘‘related portfolio’’ does not include the performance results of the separately managed account or pooled investment vehicle being offered.641 We agree that the offered portfolio is not included in the definition of ‘‘related portfolio.’’ 642 One commenter requested that we permit advisers to present performance results of a private fund both with and without the effect of any side pockets.643 Whether a side pocket should be considered part of a portfolio or a separate portfolio and/or a related portfolio subject to the final rule’s conditions for presenting related performance will be subject to the final rule’s conditions for the presentation of performance and the rule’s general prohibitions.644 A commenter also requested that we permit an adviser to exclude a separately managed account that has similar investment policies, objectives, and strategies to a private fund that the investment adviser is offering, but is customized to reflect a client’s investment objectives and desired 641 See SIFMA AMG Comment Letter II; AIC Comment Letter; CFA Institute Comment Letter. 642 A portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered in the advertisement is a related portfolio. See final rule 206(4)–1(e)(15). Any performance presented in the advertisement, whether or not related, must not violate the final rule’s general prohibitions, and the applicable requirements for the presentation of performance. See final rule 206(4)–1(a) and (d). 643 See CFA Institute Comment Letter. 644 See final rule 206(4)–1(a). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 restrictions, and has fees and expenses that may not be comparable to the private fund.645 Another commenter, however, noted that each adviser should determine for itself whether portfolios having client-specific constraints are ‘‘substantially similar.’’ 646 Whether a portfolio is a ‘‘related portfolio’’ under the rule requires a facts and circumstances analysis. An adviser may determine that a portfolio with material client constraints or other material differences, for example, does not have substantially similar investment policies, objectives, and strategies and should not be included as a related portfolio. On the other hand, different fees and expenses alone would not allow an adviser to exclude a portfolio that has a substantially similar investment policy, objective, and strategy as those of the services offered. Two commenters also requested that the rule permit an adviser that has advised multiple private funds over time to exclude earlier private funds that the adviser determines are no longer relevant to investors, even if these funds have substantially similar investment policies, objectives, and strategies (and are therefore related portfolios).647 They stated that the performance of prior funds may not be relevant because the successor fund is larger than previous funds and capable of different types of investments, and that there may have been changed market conditions and/or investment professional turnover. Under the final rule, if the relevant financial markets or investment advisory personnel have changed over time such that the investment policies, objectives, and strategies of an adviser’s earlier private funds are no longer substantially similar to those of the fund being marketed, the adviser would not be required to include the earlier private funds in its related performance. In a change from the proposal, the final rule refers to presentation of related performance as ‘‘a composite aggregation’’—rather than ‘‘one or more composite aggregations’’—‘‘of all portfolios within stated criteria.’’ 648 An adviser may use the same criteria to construct any composites to meet the GIPS standards in order to satisfy the 645 See AIC Comment Letter I. Consumer Federation Comment Letter. 647 See AIC Comment Letter I; Ropes & Gray Comment Letter. 648 One commenter requested that we add a definition of ‘‘composite’’ that matches a commonly accepted industry term. See CFA Institute Comment Letter. The final rule does not include a definition for composite, because we understand that many investment advisers already have criteria governing their creation and presentation of composites. 646 See PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 ‘‘substantially similar’’ requirement of the final rule’s definition of ‘‘related portfolio.’’ 649 However, in response to a comment from the organization that developed and administers the GIPS standards, our final rule clarifies that an adviser may only have one composite aggregation for each stated set of criteria. We agree with this commenter that the rule should not permit advisers to create more than one composite aggregation of all portfolios falling within a stated set of criteria.650 In addition, similar to the proposal, the final rule does not prescribe specific criteria to define the relevant portfolios but requires that once the criteria are established, all related portfolios meeting the criteria are included in the composite. As with the presentation of related performance on a portfolio-by-portfolio basis in an advertisement, any presentation as a composite is subject to the general prohibitions, including the prohibition on omitting material facts necessary to make the presentation, in light of the circumstances under which it was made, not misleading. For example, an advertisement presenting related performance in a composite would be false or misleading where the composite is represented as including all portfolios in the strategy being advertised but excludes some portfolios falling within the stated criteria or is otherwise manipulated by the adviser. We also believe that omitting the criteria the adviser used in defining the related portfolios and crafting the composite could result in an advertisement presenting related performance that is misleading. Finally, the final rule’s definition of ‘‘portfolio’’ includes a portfolio for the account of the investment adviser or its advisory affiliate. This is substantially the same as the proposed definition.651 The only commenter that addressed this aspect of ‘‘related performance’’ generally agreed with our proposed approach.652 5. Extracted Performance The final rule prohibits an adviser from presenting extracted performance in an advertisement unless the advertisement provides, or offers to provide promptly, the performance 649 See 2019 Proposing Release, supra footnote 7, at n.280 (discussing that, for GIPS purposes, a composite is an aggregation of portfolios managed according to a similar investment mandate, objective, or strategy). 650 See CFA Institute Comment Letter. 651 To simplify the definitions, the final rule includes this wording within the definition of ‘‘portfolio,’’ rather than within the definition of ‘‘related portfolio,’’ as proposed. 652 See CFA Institute Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations results of the total portfolio from which the performance was extracted.653 ‘‘Extracted performance’’ means ‘‘the performance results of a subset of investments extracted from a portfolio.’’ 654 We are adopting this provision substantially as proposed, though we are requiring the adviser provide, or offer to provide, the results of the ‘‘total portfolio,’’ instead of the results of ‘‘all investments in the portfolio,’’ at the request of a commenter that recommended we clarify an adviser does not have to highlight individual positions.655 Commenters supported permitting extracted performance in advertisements, although they differed on what constitutes extracted performance.656 Some commenters agreed that an adviser’s extracted performance can provide useful information to investors, who often request such information to assist them in evaluating a particular investment adviser or investment strategy.657 They noted that this is especially true for new or modified investment strategies, or new investment vehicles using a new or modified investment strategy. However, two commenters requested clarification about the definition of extracted performance and objected to the proposed conditions.658 One questioned whether the proposed definition includes composites of performance extracted from multiple portfolios, stating that the proposed conditions would be onerous in this case.659 This commenter recommended eliminating the conditions and instead relying on the general prohibitions to ensure advertisements with extracted performance are fair and balanced and not misleading. The other stated that the final rule should distinguish between performance that is extracted from a single portfolio (e.g., such as segment returns), and a standalone strategy presented as a composite of extracts from multiple portfolios.660 This 653 Final rule 206(4)–1(d)(5). rule 206(4)–1(e)(6). 655 See MFA/AIMA Comment Letter II. Final rule 206(4)–1(d)(5). 656 See MFA/AIMA Comment Letter I; LSTA Comment Letter; Proskauer Comment Letter; IAA Comment Letter; CFA Institute Comment Letter. 657 See MFA/AIMA Comment Letter I; LSTA Comment Letter. These commenters did not object to the proposed rule’s conditions for presenting extracted performance. 658 See IAA Comment Letter; CFA Institute Comment Letter. 659 See IAA Comment Letter (stating that advisers that present composite performance that includes extracted performance would need to present the performance of each of the total portfolios from which the carve-out segments were extracted under the proposed rule). 660 See CFA Institute Comment Letter. jbell on DSKJLSW7X2PROD with RULES2 654 Final VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 commenter stated that advisers typically present standalone composites and the final rule should permit them, subject to similar conditions as under the GIPS standards.661 This commenter further agreed with the proposed requirement to provide, or offer to provide promptly, the performance results of the entire portfolio along with the extract when extracted performance is not advertised as a standalone strategy. Like the proposed rule, our final rule’s provision for extracted performance addresses the performance results of a subset of investments extracted from a single portfolio. For example, an investment adviser seeking to manage a new portfolio of only fixedincome investments may wish to advertise its performance results from managing fixed-income investments within a multi-strategy portfolio. If a prospective investor already has investments in fixed-income assets, it may want to use the extracted performance to consider the effect of an additional fixed-income investment on the prospective investor’s overall portfolio. The prospective investor may also use the presentation of extracted performance from several investment advisers as a means of comparing investment advisers’ management capabilities in that specific strategy. We continue to believe that extracted performance can provide important information to investors about performance actually achieved within a portfolio. It can also provide investors with information about performance attribution within a portfolio.662 Moreover, we expect that conditioning the presentation of extracted performance on presenting (or offering to provide promptly) the performance results of the entire portfolio from which the performance was extracted will prevent investment advisers from cherry-picking certain performance results and provide investors necessary context for evaluating the extract.663 661 See CFA Institute Comment Letter. CFA Institute agreed that for advisers presenting segment returns, or attribution, of a total portfolio, the condition to present performance of the total portfolio would be relevant. 662 See CFA Institute Comment Letter (requesting guidance on whether the proposed rule’s ‘‘extracted performance’’ covers attribution). 663 This context should include any particular differences in performance results between the entire portfolio and the extract. It may include assumptions underlying the extracted performance if necessary to prevent the performance results from being misleading. We received no comments on the ‘‘or offer to provide’’ aspect of the proposal’s provision to permit an adviser to provide, or offer to promptly provide the performance results of the entire portfolio from which the extract was extracted (italics added). Therefore, we adopted this aspect of the proposed rule. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 13077 Requiring advisers to provide (or offer to provide promptly) this information mitigates the risk of extracted performance misleading investors. Furthermore, any differences between the performance of the entire portfolio and the extracted performance might be a basis for additional discussions between the investor and the adviser, which would assist the investor in deciding whether to hire or retain the adviser. On the other hand, performance that is extracted from a composite from multiple portfolios is not extracted performance as defined in the final rule because it is not a subset of investments extracted from a portfolio. We believe that such a performance presentation carries a greater risk of misleading investors than an extract from a single portfolio because an adviser could cherry-pick holdings from across the composite and deem those holdings part of a particular strategy. In addition, similar to hypothetical performance, this type of composite performance presentation may not reflect the holdings of any actual investor. As a result, the final rule does not prohibit an adviser from presenting a composite of extracts in an advertisement, including composite performance that complies with the GIPS standards, but this performance information is subject to the additional protections that apply to advertisements containing hypothetical performance, as discussed below. While these additional protections may result in additional burdens for advisers that typically present extracted performance from multiple portfolios as a composite, we believe that the investor protection gained from applying the hypothetical performance restrictions to the presentation of this type of performance, which reflects a hypothetical portfolio, justifies such burden.664 One commenter recommended that we provide advisers with the option to either disclose assumptions underlying extracted performance, or provide them upon request, stating that detailed information about the selection criteria and assumptions used by the adviser could be overwhelming for a retail 664 The general prohibitions also will apply to any presentation of extracted performance. For example, we view it as misleading for an adviser to present extracted performance without disclosing that it represents a subset of a portfolio’s investments (an omission of a material fact). Similarly, we would view it as misleading to include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced, and able to be substantiated in accordance with the general prohibitions. In addition, an extract would likely be false or misleading where it excludes investments that fall within the represented selection criteria. E:\FR\FM\05MRR2.SGM 05MRR2 13078 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations audience.665 The final rule does not require an adviser to provide detailed information regarding the selection criteria and assumptions underlying extracted performance unless the absence of such disclosures, based on the facts and circumstances, would result in performance information that is misleading or otherwise violates one of the general prohibitions. As discussed above, an adviser should take into account the audience for the extracted performance in crafting disclosures. Finally, as proposed, the final rule does not prescribe any particular treatment for a cash allocation with respect to extracted performance. One commenter recommended that we require such an allocation when presenting extracted performance advertised as a standalone strategy.666 This commenter also stated that including an allocation of cash is not necessary when showing a segment of a strategy that is not used to advertise a standalone strategy. We believe that, depending on the facts and circumstances, presenting extracted performance without accounting for the allocation of cash could imply that the allocation of cash had no effect on the extracted performance and would be misleading.667 In other cases, however, allocating cash to extracted performance may not be appropriate, such as when cash allocation decisions were made separately from the management of the extracted investments and the extracted performance is not presented as a standalone strategy. We, therefore, believe that it is appropriate to provide advisers with flexibility here since the appropriateness of allocating cash will be based on the facts and circumstances. Regardless, we would view it as misleading under the final rule to present extracted performance in an advertisement without disclosing whether it reflects an allocation of the cash held by the entire portfolio and the effect of such cash allocation, or of the absence of such an allocation, on the results portrayed. jbell on DSKJLSW7X2PROD with RULES2 6. Hypothetical Performance The final rule will prohibit an adviser from providing hypothetical performance in an advertisement, unless 665 See CFA Institute Comment Letter (discussing presentations of performance for standalone strategies). 666 See CFA Institute Comment Letter. 667 For example, it would be misleading to present extracted performance without allocating cash when the allocation of cash was part of the portfolio management for the subset of investments extracted from a portfolio, and such allocation would have materially reduced the extracted performance returns. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 the adviser takes certain steps to address its potentially misleading nature. Largely as proposed, the final rule will condition the presentation of hypothetical performance in advertisements on the adviser adopting policies and procedures reasonably designed to ensure that the hypothetical performance information is relevant to the likely financial situation and investment objectives of the advertisement’s intended audience. We intend for advertisements including hypothetical performance information to only be distributed to investors who have access to the resources to independently analyze this information and who have the financial expertise to understand the risks and limitations of these types of presentations (referred to herein collectively as ‘‘investors who have the resources and financial expertise’’).668 An adviser also must provide additional information about the hypothetical performance that is tailored to the audience receiving the advertisement, such that the intended audience has sufficient information to understand the criteria, assumptions, risks, and limitations. While commenters requested additional flexibility with regard to some of the conditions, they generally supported our proposed treatment of hypothetical performance.669 However, one commenter stated that we should not allow the presentation of hypothetical performance in advertisements.670 We are adopting the hypothetical performance provisions of the rule largely as proposed because we believe that such presentations in advertisements pose a high risk of misleading investors since, in many cases, they may be readily optimized through hindsight. Moreover, the absence of an actual investor or, in some cases, actual money underlying hypothetical performance raises the risk of a misleading advertisement, because such performance does not reflect actual losses or other real-world consequences if an adviser makes a bad investment or takes on excessive risk. However, we 668 We would not view the mere fact that an investor would be interested in high returns as satisfying the requirement that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience. 669 See, e.g., Wellington Comment Letter; Comment Letter of Withers Bergman LLP (Feb. 10, 2020) (‘‘Withers Bergman Comment Letter’’); MMI Comment Letter; NAPFA Comment Letter. 670 See Mercer Comment Letter (stating that the restrictions imposed on hypothetical performance by the proposed general prohibitions would not be sufficient to prevent advisers from displaying hypothetical performance in a materially misleading manner). PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 understand that other information that may demonstrate the adviser’s investment process as well as hypothetical performance may be useful to prospective investors who have the resources and financial expertise. When subjected to this analysis, the information may allow an investor to evaluate an adviser’s investment process over a wide range of periods and market environments or form reasonable expectations about how the investment process might perform under different conditions. We believe the three conditions discussed below, as well as our changes to the definition of ‘‘hypothetical performance,’’ will make it more likely that the dissemination of advertisements containing hypothetical performance information will be limited to investors who have the resources and financial expertise to appropriately consider such information. Certain commenters suggested that we only allow advisers to present hypothetical performance to Non-Retail Persons,671 while others advocated for a more nuanced approach (rather than categorical exclusions) that would allow the dissemination of hypothetical performance based on facts and circumstances.672 As noted above, the final rule will not include different provisions for Retail and Non-Retail Persons and we believe that the rule is sufficiently flexible to facilitate the application of the hypothetical performance conditions based on facts and circumstances. Like the proposed rule, the final rule applies to communications containing hypothetical performance that otherwise fall within the definition of ‘‘advertisement’’ because we believe that there is a significant risk that such performance could mislead investors.673 Some commenters stated that we should not impose the hypothetical performance conditions to one-on-one communications as such an approach would inhibit communications between an adviser and prospective or current investors.674 As discussed above, communications are excluded from the 671 See, e.g., NASAA Comment Letter; Prof. Jacobson Comment Letter; Mercer Comment Letter. 672 See, e.g., MFA/AIMA Comment Letter I. 673 See proposed rule 206(4)–1(e)(1). The proposed rule included one-on-one communications in the definition of advertisement. While the proposed rule excluded responses to unsolicited requests from the definition of advertisement, the exclusion did not cover hypothetical performance even if such performance was included in a one-on-one communication. As a result, under our proposed rule, hypothetical performance would have been subject to the specific conditions of the proposed rule (subsection (c)). 674 See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 scope of the final rule as long as they are provided in response to unsolicited investor requests; provided to a private fund investor in a one-on-one communication; or occur extemporaneously, live, and orally.675 While the final rule allows advisers to provide certain performance presentations in advertisements that would otherwise be considered hypothetical performance (i.e., interactive tools and educational materials), we believe there are adequate protections to address this risk in part because the anti-fraud provisions of the Advisers Act would apply.676 We also made the following changes to the treatment of hypothetical performance advertising under the rule in response to commenters’ concerns: (1) Added more flexibility to the policies and procedures requirement of the final rule to allow advisers to consider the likely financial situation and investment objectives of the intended audience; (2) added more flexibility to allow advisers to consider each of the three hypothetical performance conditions with respect to the intended audience of the advertisement (as opposed to the specific person receiving the advertisement containing hypothetical performance information); (3) broadened the requirement for advisers to provide sufficient information to all investors (and not only Retail Persons) to enable them to understand the risks and limitations of using hypothetical performance advertising, except for private fund investors; and (4) revised the definition of hypothetical performance by: (a) Broadening the types of model portfolios whose performance is considered hypothetical performance; (b) excluding the performance of proprietary portfolios and seed capital portfolios; (c) including data from prior periods (and not just ‘‘market data’’ as proposed) for certain backtested performance; and (d) excluding interactive analysis tools and predecessor performance. The final rule also makes clear that an adviser need not comply with certain conditions on the presentation of performance in advertisements, namely the requirements to present specific time periods, and the particular conditions applicable to presenting related or extracted performance.677 675 See final rule 206(4)–1(e)(1)(i)(A) and (C). The conditions also will not apply if hypothetical performance is included in a regulatory notice. Final rule 206(4)–1(e)(1)(i)(B). 676 In connection with the marketing of private funds, the anti-fraud provisions of the Securities Act and Exchange Act would also apply. 677 See final rule 206(4)–1(d)(6)(iii). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 a. Types of Hypothetical Performance The final rule defines ‘‘hypothetical performance’’ as ‘‘performance results that were not actually achieved by any portfolio of the investment adviser’’ and explicitly includes, but is not limited to, model performance, backtested performance, and targeted or projected performance returns.678 The proposed definition of hypothetical performance would have included ‘‘performance results that were not actually achieved by any portfolio of any client of the investment adviser’’ (emphasis added).679 In response to one commenter’s concerns,680 we removed the ‘‘of any client’’ qualifier in order to clarify that the actual performance of the adviser’s proprietary portfolios and seed capital portfolios is not hypothetical performance. However, advisers should not invest a nominal amount of assets in a portfolio in an effort to avoid the ‘‘hypothetical performance’’ designation. Instead, to show that the results are those of an actual portfolio, an adviser must invest an amount of seed capital that is sufficient to demonstrate that the adviser is not attempting to do indirectly what it is prohibited from doing directly,681 or otherwise be able to demonstrate that the strategy is reasonably intended to be offered to investors. In a change from the proposal, we also narrowed the definition of hypothetical performance under the rule to exclude interactive analysis tools and predecessor performance. While we proposed to exclude certain financial tools from the hypothetical performance provisions, below we clarify the treatment of such tools in response to commenters’ concerns. We excluded predecessor performance because we are adopting specific rule text on the presentation of predecessor performance. We discuss each type of hypothetical performance in the following sections. Model Performance. The proposal referred to, but did not define, ‘‘representative performance’’ and discussed model performance as a type of representative performance.682 In response to commenters’ concerns,683 678 Final rule 206(4)–1(e)(8). proposed rule 206(4)–1(e)(5). 680 See, e.g., CFA Institute Comment Letter. 681 See section 208(d) of the Act. 682 See 2019 Proposing Release, supra footnote 7, at section II.A.5 (describing representative performance as including performance generated by models that adhered to the same investment strategy as that used by the adviser for actual clients). 683 See, e.g., CFA Institute Comment Letter; IAA Comment Letter. 679 See PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 13079 we are no longer using the term ‘‘representative performance’’ and are treating all ‘‘model performance’’ as hypothetical performance.684 We did not intend to limit the definition of hypothetical performance to only performance generated by the models described in the Clover no-action letter. Rather, we proposed this definition to make clear that the rule would apply in the context of a common industry practice that has evolved around prior staff letters.685 But, as one commenter noted, the discussion of model portfolios in staff letters reflects only the specific circumstances of the adviser seeking a staff letter, and advisers currently employ model portfolios in a variety of circumstances.686 Instead of limiting the discussion of model portfolios to those managed alongside portfolios managed for actual investors,687 the final rule will broaden the definition. Model performance will include, but not be limited to, performance generated by the following types of models: (i) Those described in the Clover no-action letter where the adviser applies the same investment strategy to actual investor accounts, but where the adviser makes slight adjustments to the model (e.g., allocation and weighting) to accommodate different investor investment objectives; (ii) computer generated models; and (iii) those the adviser creates or purchases from model providers that are not used for actual investors. After considering comments, we believe it is appropriate for the final rule to accommodate the use of these variations while ensuring that advisers consider whether this information is relevant to the intended audience.688 684 See final rule 206(4)–1(e)(8)(i). Model performance would include, among other things, the type of ‘‘model performance’’ described in the Clover Letter: Performance results generated by a ‘‘model’’ portfolio managed with the same investment philosophy used by the adviser for actual client accounts and ‘‘consist[ing] of the same securities’’ recommended by the adviser to its clients during the same time period, ‘‘with variances in specific client objectives being addressed via the asset allocation process (i.e., the relative weighting of stocks, bonds, and cash equivalents in each account).’’ See Clover Letter. The rule will treat this as hypothetical performance because, although the ‘‘model’’ consists of the same securities held by several portfolios, the asset allocation process would result in performance results that were not actually achieved by any portfolio. 685 See Clover Letter. 686 See SIFMA AMG Comment Letter II; IAA Comment Letter (discussing ‘‘other types of ‘model’ performance that do not reflect investment advice actually provided to clients’’). 687 See proposed rule 206(4)–1(e)(5). 688 See, e.g., SIFMA AMG Comment Letter II (suggesting that the Commission recognize that model portfolios are not limited to the type E:\FR\FM\05MRR2.SGM Continued 05MRR2 13080 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 One commenter supported treating model performance as hypothetical performance,689 while some commenters objected because model performance could reflect the actual performance of a strategy that is managed in real time.690 We understand that model portfolios can be (but are not always) managed alongside portfolios with investor or adviser assets and that many investors find model performance helpful. For instance, model performance may present a nuanced view of how an adviser would construct a portfolio without the impact of certain factors, such as the timing of cash flows or investor-specific restrictions, which may not be relevant to the particular investor. Model performance also can help an investor assess the adviser’s investment style for new strategies that have not yet been widely adopted (or adopted at all) by the adviser’s investors. However, we believe that model performance is appropriately treated as hypothetical performance because such performance was not achieved by the actual performance of a portfolio and could mislead investors. For example, advances in computer technologies have enabled an adviser to generate hundreds or thousands of potential model portfolios in addition to the ones it actually offers or manages. An adviser that generates a large number of model portfolios has an incentive to advertise only the results of the highest performing models and ignore others. The adviser could run numerous variations of its investment strategy, select the most attractive results, and then present those results as evidence of how well the strategy would have performed under prior market conditions. Even in cases where an adviser generates only a single model portfolio, neither investor nor sufficient adviser assets are at risk, so the adviser can manage that portfolio in a significantly different manner than if such risk existed. For these reasons, we believe it is more likely for an investor to be misled where the investor does not have the resources to scrutinize such performance and the underlying assumptions used to generate model portfolio performance. We believe treating model performance as hypothetical performance under the rule guards against the investor protection concerns addressed above. discussed in the Clover Letter); IAA Comment Letter. 689 See CFA Institute Comment Letter (stating that ‘‘paper portfolios’’ should be treated as hypothetical performance). 690 See, e.g., SIFMA AMG Comment Letter II; MMI Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 Some commenters suggested that we consider more flexible treatment of model performance given that performance generated by certain types of model portfolios would be less likely to mislead investors.691 We believe that the conditions described below are sufficiently flexible to allow advisers to tailor their approach based on the intended audience of the advertisement and the type of hypothetical performance, including performance generated for different types of model portfolios. For example, if an adviser believes that model performance is less likely to mislead the intended audience, the adviser may decide that lessstringent policies and procedures are required under the first condition, and that the required disclosures may differ and be more limited than those required for backtested performance. In contrast, if an adviser believes that model performance is highly likely to mislead a particular audience (e.g., it is difficult to provide disclosure that is sufficiently specific but also understandable), the adviser could adopt policies and procedures that eliminate the presentation of that type of model performance to this investor type in its advertisements or modify the presentation to satisfy the requirements of the final rule. An adviser would need to consider the intended audience of the advertisement and the type of hypothetical performance in order to satisfy the conditions. Commenters suggested that we consider the impact of this characterization of hypothetical performance on model providers to wrap fee accounts and advisers that provide models to other, end-user advisers for implementation.692 We understand that model providers may not have access to the actual performance data generated after the end-user adviser implements the model and that the performance data they have access to may reflect another adviser’s fees or adjustments. Even if model 691 See, e.g., NYC Bar Comment Letter; NRS Comment Letter; MFA/AIMA Comment Letter I (stating that ‘‘the Commission should modify the Proposed Advertising Rule to allow investment advisers to scale the scope of disclosures to the risk profile of the type of ‘hypothetical performance’ information.’’). 692 See, e.g., SIFMA AMG Comment Letter II; MMI Comment Letter (stating that model performance is not hypothetical because it ‘‘reflects actual performance of an investment strategy in real-time’’); IAA Comment Letter (stating that ‘‘[m]any advisers serve as model providers to wrap accounts and other advisers. Such model providers would not necessarily have the data on the actual performance of the accounts managed to their models, as they are not acting directly as advisers to the underlying accounts.’’); NYC Bar Comment Letter. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 providers had access to such actual performance data, we believe they would still be subject to the hypothetical performance provisions because the performance generated would be the performance of a portfolio managed by the end-user adviser, not the model provider. However, we believe that model providers would not have difficulty satisfying the three hypothetical performance provisions. For example, we anticipate the intended audience for model provider advertisements often will be end-user advisers or wrap fee program sponsors. Model providers therefore could adopt simple policies and procedures because the model provider reasonably believes that the intended audience is sophisticated and should have the analytical resources and tools necessary to interpret this type of hypothetical performance. The model provider could similarly satisfy the rule’s disclosure requirements for hypothetical performance based on the end-user’s profile since the model providers would know that the end-user adviser is a wellinformed investor with analytical tools at his/her disposal. Backtested Performance. As proposed, the final rule will treat backtested performance as a type of hypothetical performance. We proposed to include ‘‘[p]erformance that is backtested by the application of a strategy to market data from prior periods when the strategy was not actually used during those periods.’’ 693 One commenter supported broadening the types of backtested performance that would be subject to the hypothetical performance provisions.694 Other commenters said that we should not treat backtested performance as a type of hypothetical performance.695 We acknowledge that backtested performance may help investors understand how an investment strategy may have performed in the past if the strategy had existed or had been applied at that time. In addition, this type of 693 See 2019 Proposing Release, supra footnote 7, at section II.A.5.c.iv. 694 See CFA Institute Comment Letter (stating that proposed definition of backtested performance would not include ‘‘strategies that take data from other portfolios managed by the Adviser or someone else and backtest an asset allocation strategy.’’). 695 See, e.g., NYC Bar Comment Letter (stating ‘‘backtested returns are a conditional analysis of prior data’’ and advisers use this information to stress test investment methodologies that the advisers intend to use in the future); MMI Comment Letter (stating ‘‘backtested performance figures are not purely hypothetical, but rather reflect an analysis of actual investment performance based on certain assumptions’’ and that such illustrations ‘‘analyze historical data’’). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 performance information may demonstrate how the adviser adjusted its model to reflect new or changed data sources. While we understand the potential value of such data to investors, backtested performance information also has the potential to mislead investors. Because this performance is calculated after the end of the relevant period, it allows an adviser to claim credit for investment decisions that may have been optimized through hindsight, rather than on a forward-looking application of stated investment methods or criteria and with investment decisions made in real time and with actual financial risk. For example, an investment adviser is able to modify its investment strategy or choice of parameters and assumptions until it can generate attractive results and then present those as evidence of how its strategy would have performed in the past.696 We believe that backtested performance included in an advertisement is more likely to be misleading to the extent that the intended audience does not have the resources and financial expertise to assess the hypothetical performance presentation. The conditions that the final rule will impose on displays of hypothetical performance in advertisements are designed to ensure that advisers present backtested performance in a manner that is appropriate for the advertisement’s intended audience. In response to a commenter’s suggestion,697 the final rule will apply to advertisements including presentations of performance that is backtested by the application of a strategy to data from prior time periods when the strategy was not actually used during those time periods, instead of applying only to application of the strategy to ‘‘market’’ data from a prior time period. Accordingly, the hypothetical performance provisions will apply to presentations of both market and non-market data in advertisements. This change will account for scenarios where an adviser could backtest performance based on 696 See, e.g., David H. Bailey, Jonathan M. Borwein, Marcos Lo´pez de Prado, and Qiji Jim Zhu, Pseudo-Mathematics and Financial Charlatanism: The Effects of Backtest Overfitting on Out-ofSample Performance, 61(5) Notices of the Am. Mathematical Society, 458, 466 (May 2014), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2308659 (describing the potential to overfit an investment strategy so that it performs well in-sample (the simulation over the sample used in the design of the strategy) but performs poorly out-of-sample (the simulation over a sample not used in the design of the strategy)). 697 See CFA Institute Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 non-market data (e.g., data from other portfolios managed by the adviser). We are otherwise adopting this provision as proposed. Another commenter asked that we address which disclosures must accompany specific displays of backtested performance.698 In the spirit of our principles-based approach, we decline to prescribe the exact disclosure language that should accompany displays of backtested performance in advertisements. Targets and Projections. As proposed, the final rule will treat presentations of targeted and projected returns in advertisements as presentations of hypothetical performance. Targeted returns reflect an investment adviser’s aspirational performance goals. Projected returns reflect an investment adviser’s performance estimate, which is often based on historical data and assumptions. Projected returns are commonly established through mathematical modeling.699 Most commenters that addressed this topic opposed the characterization of targeted returns as hypothetical performance on the grounds that targeted returns indicate expectations about how a product or strategy is intended to perform (e.g., how aggressively a strategy will be managed) as opposed to predictions of performance.700 Several of these commenters agreed that the Commission should continue to treat projected returns as hypothetical performance.701 Targets and projections could potentially be presented in such a manner to raise unrealistic expectations of an advertisement’s audience and thus be misleading, particularly if they use assumptions that are not reasonably achievable. For example, an advertisement may present unwarranted 698 See NRS Comment Letter. final rule does not define ‘‘targeted return’’ or ‘‘projected return.’’ We believe that these terms have commonly understood meanings, and we do not intend to narrow or expand inadvertently the wide variety of returns that may be considered targets or projections. We generally would consider a target or projection to be any type of performance that an advertisement presents as results that could be achieved, are likely to be achieved, or may be achieved in the future by the investment adviser with respect to an investor. 700 See, e.g., Wellington Comment Letter (agreeing that projected returns have a heightened ability to mislead investors, but stating that targeted returns can provide useful information about the risk profile of an investment strategy); Fidelity Comment Letter; MMI Comment Letter (stating that targeted returns ‘‘are performance goals that an adviser seeks to achieve with a particular strategy or product’’ while hypothetical returns ‘‘represent a projection of what returns will or could be based on a series of assumptions’’). 701 See, e.g., CFA Institute Comment Letter; AIC Comment Letter. 699 The PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 13081 claims based on assumptions that are virtually impossible to occur, such as an assumption that three or four specific industries will experience decades of uninterrupted growth. We recognize, however, that there are some differences between targeted and projected returns. Targeted returns are aspirational and may be used as a benchmark or to describe an investment strategy or objective to measure the success of the strategy.702 Projected returns, on the other hand, use historical data and assumptions to predict a likely return.703 Therefore, targeted returns may not involve all (or any) of the assumptions and criteria applied to generate a projection. Still, we do not believe that the difference between targeted and projected returns is always readily apparent to recipients of an advertisement. We believe that the presentation of targeted returns in such context could result in unrealistic expectations. We continue to believe, therefore, that the presentation of targets and projections in advertisements should be subject to the rule’s hypothetical performance conditions. The conditions we are adopting with respect to the use of hypothetical performance are principles-based, allowing the adviser to tailor the disclosure to the type of performance used in the advertisement. For example, in the case of an advertisement that presents targeted returns, which are generally aspirational in nature and not necessarily based on ‘‘criteria and assumptions,’’ to meet this disclosure requirement an adviser’s disclosure could state that criteria and assumptions were not used. We believe that providing hypothetical performance in advertisements only to those investors with the resources and financial expertise to assess targets or projections will help avoid scenarios where an investor might be misled into thinking that such performance is guaranteed. We recognize that some investors want to consider targeted returns and projected returns (along with these underlying assumptions) when evaluating investment products, strategies, and services. For example, based on our staff’s outreach and experience, we understand that financially sophisticated investors in particular may have specific return targets that they seek to achieve, and their planning processes may necessarily include reviewing and analyzing the targets advertised by investment advisers and the information 702 See, e.g., CFA Institute Comment Letter. 703 Id. E:\FR\FM\05MRR2.SGM 05MRR2 13082 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations underlying those targets. Specifically, an analysis of these targets or projections can inform an investor about an adviser’s risk tolerance when managing a particular strategy. We understand that information about an adviser’s targets or projections also can be useful to an investor when assessing how the adviser’s strategy fits within the investor’s overall portfolio, but advisers must consider the intended audience when making such presentations in advertisements. The rule will apply only to targeted or projected performance returns ‘‘with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement.’’ 704 This means that projections of general market performance or economic conditions in an advertisement are not targeted or projected performance returns subject to the provision on presentation of hypothetical performance. We did not propose to exclude from the definition of ‘‘hypothetical performance’’ the performance generated by interactive analysis tools. However, in the proposal, we noted that FINRA permits investment analysis tools as a limited exception from FINRA’s general prohibition of projections of performance, subject to certain conditions and disclosures, and we requested comment on whether we should consider FINRA’s approach.705 Commenters generally supported an exclusion for such tools and for adopting FINRA’s approach.706 As a result, the final rule will exclude the performance generated by investment analysis tools from the definition of hypothetical performance and will import a definition of ‘‘investment analysis tool’’ from FINRA Rule 2214 with slight modifications.707 FINRA Rule 2214 defines an ‘‘investment analysis tool’’ as ‘‘an interactive technological tool that 704 Final rule 206(4)–1(e)(8)(iii). 2019 Proposing Release, supra footnote 7, at section II.A.5.c.iv. 706 See, e.g., SIFMA AMG Comment Letter II (stating that ‘‘[i]n the retail setting it is common to use projections that are based on statistically valid methodologies (e.g., Monte Carlo simulations) to assist clients and investors in understanding whether the investment of their current assets will allow them to meet future goals’’); BlackRock Comment Letter (stating that the rule should provide a safe harbor from the hypothetical performance provisions for investment analysis tools that comply with FINRA rule 2214); IAA Comment Letter; T. Rowe Price Comment Letter. 707 FINRA rule 2214 provides a limited exception from FINRA rule 2210’s prohibition on communications that predict or project performance. While FINRA rule 2210 applies differently to communications directed to retail versus institutional investors, our final rule does not have such a bifurcated approach. jbell on DSKJLSW7X2PROD with RULES2 705 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 produces simulations and statistical analyses that present the likelihood of various investment outcomes if certain investments are made or certain investment strategies or styles are undertaken, thereby serving as an additional resource to investors in the evaluation of the potential risks and returns of investment choices.’’ We will adopt this definition, but will require that a current or prospective investor must use the tool (i.e., input information into the tool or provide information to the adviser to input into the tool). Despite the fact that an investment analysis tool is often a computergenerated model that does not reflect the results of an actual account, the rule will allow an adviser to present these tools in advertisements without complying with the conditions applicable to hypothetical performance.708 We do not view these tools as presenting the same investor risks that model portfolios do because they typically present information about various investment outcomes based on the investor’s situation and require the investor to interface directly with the tool. In providing an interactive analysis tool, an adviser should consider which disclosures are necessary in order to comply with the general prohibitions of the final marketing rule. For example, to comply with the first general prohibition, the adviser should neither imply nor state that the interactive tool, alone, can determine which securities to buy or sell. The final rule will allow advisers to use interactive analysis tools, provided that the investment adviser: (1) Provides a description of the criteria and methodology used, including the investment analysis tool’s limitations and key assumptions; (2) explains that the results may vary with each use and over time; (3) if applicable, describes the 708 Under the final rule, general educational communications that rely on public information and do not reference specific advisory products or services offered by the adviser would not qualify as advertisements. See supra section II.A.2.a.v. Educational presentations of performance that reflect an allocation of assets by type or class, which we understand investment advisers may use to inform investors and to educate them about historical trends regarding asset classes would not be treated as advertisements and would not be subject to the rule’s conditions on the use of hypothetical performance. For example, the following would not be considered hypothetical performance under the final rule: A presentation of performance that illustrates how a portfolio allocated 60% to equities and 40% to bonds would have performed over the past 50 years as compared to a portfolio composed of 40% equities and 60% bonds. Our approach regarding educational presentations of performance would apply even if the investment adviser used one of the allocations in managing a strategy being advertised or illustrated such allocations by reference to relevant indices or other benchmarks. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 universe of investments considered in the analysis, explains how the tool determines which investments to select, discloses if the tool favors certain investments and, if so, explains the reason for the selectivity, and states that other investments not considered may have characteristics similar or superior to those being analyzed; and (4) discloses that the tool generates outcomes that are hypothetical in nature.709 The fact that an interactive tool uses the same underlying assumptions does not mean that outputs the tool generates are advertisements (because the adviser or investor inputs investor-specific information). We believe that there are adequate investor protection guardrails in place to allow advisers to provide interactive analysis tools.710 Commenters suggested that we clarify the treatment of broad market or indexbased performance data.711 We agree that the use of index-based data can be informative to investors as a benchmarking tool.712 For example, in a scenario where an actual portfolio tracks an index, information regarding the index’s performance can provide useful information regarding tracking error, sector allocation, and performance attribution. Accordingly, we believe that an index used as a performance benchmark in an advertisement would not be hypothetical performance, unless it is presented as performance that could be achieved by a portfolio.713 709 See final rule 206(4)–1(e)(8)(iv)(A)(4). Such disclosure could state, for example: ‘‘IMPORTANT: The projections or other information generated by [name of investment analysis tool] regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.’’ 710 See section 206 of the Advisers Act. See also section 17(a) of the Securities Act, section 10(b) of the Exchange Act (and rule 10b–5 thereunder), and rule 206(4)–8 under the Advisers Act. 711 See IAA Comment Letter; CFA Institute Comment Letter (stating that ‘‘indexes created by the Adviser should be considered hypothetical performance when the Adviser backtests the index to see how it would have performed. Other than this case, we do not believe that benchmarks should be considered hypothetical performance.’’). 712 See e.g., IAA Comment Letter; CFA Institute Comment Letter. 713 See final rule 206(4)–1(e)(8) (defining ‘‘hypothetical performance’’ as ‘‘performance results that were not actually achieved by any portfolio of the investment adviser’’). Although we would not expect an adviser to comply with the conditions applicable to hypothetical performance, we would expect the adviser to comply with the general prohibitions, for instance, by disclosing that the volatility of the index is materially different from that of the model or actual performance results with which the index is compared. Most of the other provisions of the rule would be irrelevant. For instance, although the conditions on the presentation of performance would apply, the requirement to show net performance would be E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 b. Conditions on Presentation of Hypothetical Performance Largely as proposed, the final rule will prohibit the presentation of hypothetical performance in advertisements except under certain conditions designed to address the potential for hypothetical performance to mislead investors. First, the adviser must adopt and implement policies and procedures reasonably designed to ensure that the hypothetical performance information is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement. Second, the adviser must provide sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance (the ‘‘criteria and assumptions’’). Third, the adviser must provide (or, if the intended audience is a private fund investor, provide, or offer to provide promptly) sufficient information to enable the intended audience to understand the risks and limitations of using hypothetical performance in making investment decisions (the ‘‘risk information’’).714 For purposes of this discussion, we refer to the criteria and assumptions and the risk information collectively as the ‘‘underlying information.’’ Finally, the final rule does not require an investment adviser to comply with several conditions applicable to the presentation of performance information in advertisements, specifically the requirement to present specific time periods, and the requirements related to the presentation of related performance, and extracted performance.715 Policies and Procedures. In a modification from the proposal, under the first condition for displaying hypothetical performance information in advertisements, advisers must adopt and implement policies and procedures ‘‘reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives’’ of the intended audience.716 The proposed condition would have required a higher degree of certainty of the financial situation and investment objectives of the person to whom the advertisement is disseminated. Under the final rule, inapplicable because there are no fees or expenses to deduct from an index. Index information that is provided for general educational purposes and not, for instance, as a comparison to the adviser’s performance presentation, would not be considered an advertisement. See supra section II.A.2.a.v. 714 See final rule 206(4)–1(d)(6)(iii). 715 See id. 716 Final rule 206(4)–1(d)(6)(i). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 reasonably designed policies and procedures need not address each recipient’s particular circumstances; rather, the adviser must make a reasonable judgement about the likely investment objectives and financial situation of the advertisement’s intended audience. The final rule will not prescribe the ways in which an adviser may seek to satisfy the policies and procedures requirement, including how the adviser will establish that the policies and procedures are reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience. We have previously used policies and procedures to establish a defined audience.717 We believe that this approach will provide investment advisers with the flexibility to develop policies and procedures that best suit their investor base and operations. While one commenter supported the proposed condition,718 several commenters suggested that we eliminate it because it is too subjective and difficult to implement.719 One commenter suggested that the condition not apply to institutional investors,720 while another commenter stated that the condition imposes a standard so high that an adviser could not satisfy the standard for retail investors.721 Another commenter suggested that we clarify that the proposed condition would not require an adviser to have knowledge of the specific individual circumstances or financial condition of each investor receiving hypothetical performance from the adviser.722 We continue to believe that this condition, as modified, will ensure that advisers provide advertisements containing relevant hypothetical 717 We have defined ‘‘retail money market fund’’ to mean ‘‘a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons.’’ See 17 CFR 270.2a–7(a)(21); see also Money Market Fund Reform; Amendments to Form PF, Release No. IA–3879 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)], at nn.715–716 and accompanying text. 718 See Consumer Federation Comment Letter. 719 See, e.g., MMI Comment Letter (stating this condition would be difficult, if not impossible, to satisfy for an advertisement that would be disseminated to a large number of people); SIFMA AMG Comment Letter II; Wellington Comment Letter. 720 See Credit Suisse Comment Letter. 721 See CFA Institute Comment Letter. 722 See Comment Letter of Flexible Plan Investments, Ltd. on proposed advertising rule (Feb. 10, 2020) (‘‘Flexible Plan Investments Comment Letter II’’) (noting that the relevancy requirement would be difficult to administer because ‘‘[i]t will be dependent on knowing in many cases the exact person to whom the use of (sic) hypothetical performance is being delivered.’’). PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 13083 performance to the appropriate audience without creating unnecessary compliance burdens. In response to commenters’ concerns, however, the final rule will specify that the policies and procedures must be reasonably designed to ensure that hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience. We added the qualifier ‘‘likely’’ to clarify that an adviser is not required to know the actual financial situation or investment objectives of each investor that receives hypothetical performance. We also replaced the word ‘‘person’’ with ‘‘intended audience’’ to clarify that advisers can comply with this condition, as well as the other conditions related to hypothetical performance, by grouping investors into categories or types, and to emphasize that an investor might not be a natural person. We believe that these changes will ease the compliance burdens commenters identified. This condition is designed to help ensure that an adviser provides advertisements containing hypothetical performance information only to those investors with the resources and financial expertise. Hypothetical performance may not be relevant to the likely financial situation and investment objectives of and may be misleading for investors that do not have the resources and financial expertise. For example, analysis of hypothetical performance may require tools and/or other data to assess the impact of assumptions driving hypothetical performance, such as factor or other performance attribution, fee compounding, or the probability of various outcomes. Without being able to subject hypothetical performance to additional analysis, this information could tell an investor little about an investment adviser’s process or other information relevant to a decision to hire the adviser. Instead, providing hypothetical performance to an investor that does not have access to the resources and financial expertise needed to assess the hypothetical performance and underlying information could mislead the investor to believe something about the adviser’s experience or ability that is unwarranted. We believe that advisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation. In that case, because the advertisement would be available to mass audiences, an adviser generally could not form any expectations about E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13084 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations their financial situation or investment objectives. The adviser’s past experiences with particular types of investors should lead the adviser to design reasonable policies and procedures that distinguish among investor types and whether hypothetical performance is relevant to the likely financial situation and investment objectives of an audience composed of that type. Such policies and procedures could distinguish investor types on the basis of criteria, such as previous investments with the adviser, net worth or investing experience if that information is available to the adviser, certain regulatory defined categories (e.g., qualified purchasers or qualified clients), or whether the intended audience includes only natural persons or only institutions. An adviser could determine that certain hypothetical performance presentations are relevant to the likely financial situation and investment objectives of certain types of investors based on routine requests from those types of investors in the past. For example, an adviser, based on its past experience, might be able to reasonably conclude that hypothetical performance would be relevant to investors who meet certain financial sophistication standards such as qualified client 723 or qualified purchaser.724 The adviser could explain in its policies and procedures why it believes that hypothetical performance is relevant for this intended audience. In addition, an adviser’s policies and procedures should address how the adviser’s dissemination of the advertisement would seek to be limited to that audience. As discussed above, hypothetical performance directed to mass audiences generally will not be able to meet this standard. One commenter expressed concerns that this condition would pose a compliance challenge for advisers to private funds because they do not have insight into potential investors, especially prior to the time when subscription documents are disseminated.725 Because an adviser’s policies and procedures should be informed by its prior experience with certain investor types, an adviser that plans to advise a private fund can develop policies and procedures that take into account its experience advising a prior private fund for which it raised money from investors. That experience might indicate that investors 723 See rule 205–3(d)(1) under the Act. section 2(a)(51) of the Investment Company Act. 725 See Ropes & Gray Comment Letter. 724 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 in the vehicle valued a particular type of hypothetical performance because, for example, the investors used it to assess the adviser’s strategy and investment process. Similarly, an adviser could determine, based on its experience, that hypothetical performance is not relevant to the likely financial situation and investment objectives of certain investors and reflect such determination in its policies and procedures. New advisers that do not have prior client experiences to inform their determination of the intended audience can rely on other resources, including information they have gathered from potential investors (e.g., questionnaires, surveys, or conversations) and academic research, to help identify the intended audience in connection with the three hypothetical performance conditions.726 One commenter expressed concern that this condition would effectively restrict hypothetical performance only to a sub-set of investors with the financial and analytical resources to analyze such performance even if an investor outside of this sub-set specifically requested the information.727 As noted above, we believe that it is appropriate to apply the hypothetical performance conditions to communications that otherwise meet the definition of advertisement, even if they take place in one-on-one settings due to the potential for such information to mislead investors. However, advisers would still be able to provide investors with interactive financial analysis tools without subjecting those tools to the hypothetical performance conditions. Criteria and Assumptions. The second condition for the presentation of hypothetical performance will require the adviser to provide sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating 726 Advisers may already be required to comply with similar provisions under other regulatory regimes that also require advisers to consider the recipient when disseminating communications. See, e.g., FINRA rule 2210(d)(1)(E) (‘‘Members must consider the nature of the audience to which the communication will be directed and must provide details and explanations appropriate to the audience.’’); Global Investment Performance Standards (GIPS) for Firms (2020), Provision 1.A.11; GIPS Standards Handbook for Firms (Nov. 2020), Discussion of Provision 1.A.11. 727 See CFA Institute Comment Letter (suggesting that ‘‘an [a]dviser could consider hypothetical performance to be relevant to the financial situation and investment objectives of the person if the person has expressed interest in the strategy or the [a]dviser has determined it is an appropriate strategy for the investor based on their (sic) investment needs’’). PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 the hypothetical performance.728 The rule does not prescribe any particular methodology or calculation for the different categories of hypothetical performance, just as it does not prescribe methodologies or calculations for actual performance. Instead, advisers must provide the information about criteria and assumptions so that the intended audience can understand how the hypothetical performance was calculated. We are adopting the second condition largely as proposed, except that we are replacing the phrase ‘‘such person’’ with ‘‘the intended audience’’ for consistency with the first condition, as discussed above. In addition, and in response to one commenter’s concerns,729 we are clarifying that the adviser is responsible for providing sufficient information as we agree that it would not be workable to require advisers to have a precise understanding of exactly what each investor needs in order to allow that investor to understand the calculations and assumptions underlying the hypothetical performance.730 Several commenters expressed concern that this condition would require advisers to disclose proprietary or confidential information 731 due to the statement in the proposal that this condition may require advisers to provide the ‘‘methodology used in calculating and generating the hypothetical performance.’’ 732 To clarify, we do not expect advisers to disclose proprietary or confidential information to satisfy this condition. We expect that a general description of the methodology used would be sufficient information for an investor to understand how it was generated. Under the final rule, the condition will not require an adviser to provide information that would be necessary to allow the intended audience to replicate the performance (e.g., information that is confidential or proprietary). With 728 See final rule 206(4)–1(d)(6)(ii). We would consider any calculation information provided alongside the hypothetical performance to be a part of the advertisement and therefore subject to the books and records rule. See infra section II.I. 729 See Flexible Plan Investments Comment Letter II. 730 This obligation would be similar to an adviser’s obligation to provide full and fair disclosure to its clients of all material facts relating to the advisory relationship and of conflicts of interest. See Fiduciary Interpretation, supra footnote 8888, at n.70 (stating that institutional clients, as compared to retail clients, generally have a greater capacity and more resources to analyze and understand complex conflicts and their ramifications). 731 See, e.g., Withers Bergman Comment Letter; MFA/AIMA Comment Letter I; Resolute Comment Letter. 732 See 2019 Proposing Release, supra footnote 7, at section II.A.5.c.iv. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 respect to assumptions, investment advisers should provide information that includes any assumptions on which the hypothetical performance rests— e.g., in the case of targeted or projected returns, the adviser’s view of the likelihood of a given event occurring. Commenters suggested that we not require advisers to disclose the extent to which hypothetical performance is based on the likelihood of an event occurring because this would require advisers to make speculative statements.733 Yet, commenters agreed that an adviser should disclose the assumptions it has made.734 It is our view that assumptions underlying hypothetical performance should be interpreted to include assumptions that future events will occur. We believe that hypothetical performance, by its nature, contains a speculative element; therefore, requiring advisers to disclose the assumptions that informed a model aligns with the types of restrictions we seek to place on performance presentation that have a high potential to mislead investors. We believe advisers should provide this information so that the intended audience is able to determine, in part, how much value to attribute to the hypothetical performance. Without information regarding criteria and assumptions, we believe that such performance would be misleading even to an investor with the resources and financial expertise to evaluate it. Risk Information. The final rule will require the adviser to provide—or, if the intended audience is a private fund investor, to provide, or offer to provide promptly—sufficient information to enable the intended audience to understand the risks and limitations of using the hypothetical performance in the advertisement in making investment decisions.735 Commenters generally supported this condition.736 However, one commenter suggested that we add a reasonableness component in order to provide more flexibility, requiring advisers to provide reasonably sufficient information.737 We do not believe this change is necessary as we believe that advisers’ consideration of the intended audience 733 See, e.g., NYC Bar Comment Letter; AIC Comment Letter. 734 See, e.g., NYC Bar Comment Letter; AIC Comment Letter (stating that the requirements of the second condition are ‘‘consistent with market practice’’ but that advisers should not be required to state the likelihood that a given event would occur). 735 See final rule 206(4)–1(d)(6)(iii). 736 See CFA Institute Comment Letter; Withers Bergman Comment Letter. 737 See Flexible Plan Investments Comment Letter II. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 will provide advisers with flexibility and alleviate some of the burdens imposed by these conditions. In a change from the proposal, we replaced ‘‘Non-Retail Person’’ with ‘‘an investor in a private fund’’ in order to align with broader changes to the rule (i.e., to dispense with the distinction between Retail and Non-Retail Persons).738 As explained above, we also replaced references to ‘‘such person’’ with ‘‘the intended audience.’’ After considering comments,739 the final rule will not require advisers to provide private fund investors with information on the risks and limitations of using the advertised hypothetical performance. Instead, advisers can merely offer to promptly provide such information. With respect to risks and limitations, investment advisers should provide information that would apply to both hypothetical performance generally and to the specific hypothetical performance presented—e.g., if applicable, that hypothetical performance reflects certain assumptions but that the adviser generated dozens of other, varying performance results applying different assumptions. Risk information should also include any known reasons why the hypothetical performance might differ from actual performance of a portfolio—e.g., that the hypothetical performance does not reflect cash flows into or out of the portfolio. This risk information will, in part, enable the intended audience to understand how much value to attribute to the hypothetical performance in deciding whether to hire or retain the investment adviser or invest in a private fund managed by the adviser. An adviser should tailor its risk information to its intended audience. In addition, any communication that is an advertisement under the first prong of the definition of advertisement, and that includes hypothetical performance, will be required to comply with the general prohibitions.740 As a result, the rule will prohibit advisers from presenting hypothetical performance in such advertisements in a materially misleading way. For example, we would view an advertisement as including an untrue statement of material fact if the advertised hypothetical performance 738 See proposed rule 206(4)–1(c)(1)(v)(C) (requiring an adviser to ‘‘[p]rovide[ ] (or, if such person is a non-retail person, provide[ ] or offer[ ] to provide promptly) sufficient information to enable such person to understand the risks and limitations of using such hypothetical performance in making investment decisions.’’). 739 See, e.g., Ropes & Gray Comment Letter; IAA Comment Letter; AIC Comment Letter. 740 See supra section II.B. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 13085 reflected the application of rules, criteria, assumptions, or general methodologies that were materially different from those stated or applied in the underlying information of such hypothetical performance. Also, we would view it as materially misleading for an advertisement to present hypothetical performance that discusses any potential benefits resulting from the adviser’s methods of operation without providing fair and balanced discussion of any associated material risks or material limitations associated with the potential benefits.741 Similarly, an adviser can meets its obligation with respect to an advertisement presenting hypothetical performance that includes an offer to promptly provide risk information to a private fund investor if the adviser makes reasonable efforts to promptly provide such information upon the investor’s request. F. Portability of Performance, Testimonials, Endorsements, ThirdParty Ratings, and Specific Investment Advice Among the performance results that an investment adviser may seek to advertise are those of groups of investments or accounts for which the adviser, its personnel, or its predecessor investment adviser firms have provided investment advice in the past as or at a different entity. In some cases, an investment adviser may seek to advertise the performance results of portfolios managed by the investment adviser before it was spun out from another adviser. Alternatively, an adviser may seek to advertise performance achieved by its investment personnel when they were employed by another investment adviser. This may occur, for example, when a portfolio management team leaves one advisory firm and joins another advisory firm or begins its own firm. Predecessor performance results may be directly relevant to an audience when the advertisement offers services to be provided by the personnel responsible for the predecessor performance, even when the personnel did not work for the adviser disseminating the advertisement (the ‘‘advertising adviser’’) during the period for which performance is being advertised.742 We believe that the presentation of predecessor performance can mislead 741 See final rule 206(4)–1(a)(4). term ‘‘predecessor performance’’ is defined in final rule 206(4)–1(e) and refers to all situations where an investment adviser presents investment performance achieved by a group of investments consisting of an account or a private fund that was not advised by the investment adviser at all times during the period shown. 742 The E:\FR\FM\05MRR2.SGM 05MRR2 13086 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 investors, especially, for example, when: (i) The team that was primarily responsible for the predecessor performance is different from the team whose advisory services are being offered in the advertisement, (ii) an individual who played a significant part in achieving the predecessor performance is not a member of the advertising adviser’s investment team,743 (iii) the adviser that generated the performance underwent a restructuring, reorganization, or sale,744 or (iv) an advertising adviser does not clearly disclose that the performance was achieved at a different entity. We have previously identified characteristics of a restructuring, sale, or reorganization (collectively, ‘‘reorganization’’) that likely support a finding that an adviser’s business continued to exist where: There was a substantial and direct business nexus between the successor and predecessor advisers; the reorganization was not designed to eliminate substantial liabilities and/or spin off personnel; and, if applicable, the successor adviser assumed substantially all of the assets and liabilities of the predecessor adviser.745 Under the final rule, we would consider similar factors when analyzing the extent to which an advertising adviser must treat a predecessor adviser’s performance as predecessor performance. For example, we do not believe that a change of brand name, without additional differences between the advisory entity before and after the restructuring, would render its past performance as ‘‘predecessor performance.’’ Likewise, a mere change in the form of legal organization (e.g., from a corporation to limited liability company) or a change in ownership of the adviser would likely not raise the concerns described in this section. In the proposal, we considered whether applying the rule’s general prohibitions and the more specific performance advertising restrictions would sufficiently alleviate our concerns,746 or whether specific rule provisions would more appropriately 743 See, e.g., Fiduciary Management Associates, Inc., SEC Staff No-Action Letter (Feb. 2, 1984) (‘‘Fiduciary Management Letter’’). 744 See, e.g., South State Bank, SEC Staff NoAction Letter (May 8, 2018) (‘‘South State Bank Letter’’) (the staff stated that it would not recommend enforcement action based on representations designed to ensure advisory clients would not be misled if clients attributed the predecessor adviser’s performance to the advertising adviser, including, for example, that it would operate in the same manner and under the same brand name as the predecessor adviser). 745 See Registration of Successors to BrokerDealers and Investment Advisers, Release No. IA– 1357 (Dec. 28, 1992) [58 FR 7–01 (Jan. 4, 1993)]. 746 See proposed rule 206(4)–1(a) and (c). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 address those concerns.747 For example, we questioned whether the untrue or misleading implication general prohibition would prevent the display of predecessor performance containing an untrue or misleading implication about a material fact relating to the advertising adviser. As another example, we stated that, depending on the circumstances, predecessor performance results that exclude accounts managed in a substantially similar manner at the predecessor firm may be misleading and implicate the proposed general prohibitions in the rule. We stated that such presentations could result in the inclusion or exclusion of performance results in a manner that is neither accurate nor fair and balanced. Accordingly, we requested comment on whether the advertising rule should include additional provisions on the presentation of predecessor performance results, and we specifically asked about the approach our staff has taken in providing guidance on this issue under the current rule.748 Some commenters supported the addition of a provision on this topic, urging us to address predecessor performance in the final rule.749 Two commenters supported the approach our staff took in its no-action letters and suggested we adopt a rule that would draw from those requirements, with minor modifications.750 In light of these comments, we believe that placing explicit guardrails on displays of predecessor performance will increase investor protection, in addition to the general prohibitions. Moreover, we expect that clarifying our views on positions taken by our staff over the years will promote consistency of 747 For the discussion that follows, see generally 2019 Proposing Release, supra footnote 7, at section II.A.6. 748 See Horizon Asset Management, LLC, SEC Staff No-Action Letter (Sept. 13, 1996) (‘‘Horizon Letter’’); Great Lakes Advisers, Inc., SEC Staff NoAction Letter (Apr. 3, 1992) (‘‘Great Lakes Letter’’); Fiduciary Management Letter; South State Bank Letter. We requested comment on a number of the issues raised by predecessor performance. See 2019 Proposing Release, supra footnote 7, at section II.A.6. 749 See IAA Comment Letter; CFA Institute Comment Letter (supporting specific provisions on predecessor performance, but suggesting compliance with GIPS standards); Fried Frank Comment Letter (stating that the final rule should explicitly address predecessor performance and supporting a ‘‘principles-based, disclosure-driven approach’’ that has a similar framework as the proposed approach to hypothetical performance); Comment Letter of SIFMA (Supplemental) (June 5, 2020) (‘‘SIFMA Supplemental Comment Letter’’). 750 See IAA Comment Letter; SIFMA Supplemental Comment Letter. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 practices among advisory firms and thereby level the playing field. Investments advisers will be prohibited from displaying predecessor performance in an advertisement, unless the following requirements are satisfied: (A) The person or persons who were primarily responsible for achieving the prior performance results manage accounts at the advertising adviser; (B) the accounts managed at the predecessor investment adviser are sufficiently similar to the accounts managed at the advertising adviser that the performance results would provide relevant information to investors; (C) all accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance and the exclusion of any account does not alter the presentation of any prescribed time periods; and (D) the advertisement clearly and prominently includes all relevant disclosures, including that the performance results were from accounts managed at another entity.751 In addition to applying these specific provisions, advisers should consider the extent to which other provisions of the advertising rule, such as the general prohibitions (including those pertaining to the fair and balanced presentation of information), apply to any display of predecessor performance. Primarily Responsible. In order to present predecessor performance in an advertisement, the person or persons who were primarily responsible for achieving the prior performance results while employed at the predecessor firm must manage accounts at the advertising adviser.752 We believe that the ‘‘primarily responsible’’ requirement will help place critical guardrails on the use of predecessor performance and will require advisers to focus on the role that the individual played in producing the performance (e.g., the extent of the person’s decision-making authority or influence). Advisers should consider the substantive responsibilities of those who are responsible for generating the performance at issue and, where more than one individual is primarily 751 See final rule 206(4)–1(d)(7)(iv); see also 2019 Proposing Release, supra footnote 7, at sections II.A.5.c.ii and II.A.6. 752 See final rule 206(4)–1(d)(7)(i). Our staff has applied a similar principle when considering the presentation of predecessor performance. See Horizon Letter (stating that the staff would not find a display of predecessor performance to be in and of itself misleading based on several representations, including that ‘‘the person or persons who manage accounts at the adviser were also those primarily responsible for achieving the prior performance results’’). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 responsible for making investment decisions, whether a substantial identity of the group responsible for achieving the prior performance have moved over to the advertising adviser. We anticipate that this principles-based approach will address scenarios where a committee makes the investment decisions and where a single person is responsible for investment decisions. Where a committee managed the group of investments at the predecessor firm, a committee comprising a substantial identity of the membership must manage the portfolios at the advertising adviser.753 A person or group of persons is ‘‘primarily responsible’’ for achieving prior performance results if the person makes or the group makes investment decisions.754 Where more than one person is involved in making investment decisions, advisers should consider the authority and influence that each person has in making investment decisions.755 Sufficiently similar accounts. Under the final rule, an advertising adviser may not present predecessor performance in an advertisement unless the accounts managed at the predecessor and advertising advisers are 753 Our staff applied a similar principle when considering investment teams or committees. See Great Lakes Letter, at n.4 (staff declined to take a no-action position where only one person from a three-person committee transferred from the predecessor adviser to the advertising adviser and where the other two individuals played a significant role stating that, ‘‘at a minimum, there would have to be a substantial identity of personnel among the predecessor’s and successor’s committees.’’); Horizon Letter (staff stated that it would not recommend enforcement action under rule 206(4)–1 where one individual was primarily responsible for achieving performance results at the predecessor firm and, upon joining the advertising adviser, would be a member of a three-person committee. The individual would still have final decision-making authority and the other committee members would only advise the sole decisionmaker.). 754 Commenters generally supported applying guardrails to displays of predecessor performance based on existing staff no-action letters and industry best practices. See IAA Comment Letter (citing Horizon Letter, South State Bank Letter, Great Lakes Letter, Fiduciary Management Letter, and Conway Asset Management, Inc., SEC Staff NoAction Letter (Jan. 27, 1989)); Fried Frank Comment Letter; SIFMA Supplemental Comment Letter. 755 See 2019 Proposing Release, supra footnote 7, at section II.A.6. (stating that it may be difficult to attach relative significance to the role played by each group member where an adviser selects portfolio securities by consensus or committee decision-making). See also Great Lakes Letter; Horizon Letter. Commenters generally supported the positon our staff has taken in no-action letters on predecessor performance where a committee makes investment decisions. See, e.g., IAA Comment Letter (suggesting that the final rule require that ‘‘substantially all of the investment decision-makers who manage accounts at the adviser are those primarily responsible for achieving the prior performance results’’). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 ‘‘sufficiently similar’’ in order to ensure the investor receives relevant information.756 Prior staff letters took no-action positions with accounts that were ‘‘so similar’’ to the advertised accounts.757 We believe that the language in the final rule provides advisers appropriate flexibility in displaying predecessor performance and would not result in investor confusion. Managed in a substantially similar manner. Under the final rule, an investment adviser using predecessor performance in an advertisement will be required to display all accounts that were managed in a ‘‘substantially similar manner’’ at the predecessor adviser, unless excluding any account would not result in materially higher performance and the exclusion of any account does not alter the presentation of any applicable time periods required by the rule.758 This condition mirrors the related performance provisions of the final rule, which requires investment advisers to include all related portfolios and only permits an adviser to exclude a related portfolio if performance would not be materially higher and if the exclusion of any related portfolio does not alter the presentation of any applicable time periods required by the rule.759 Accounts that are managed in a substantially similar manner are those with substantially similar investment policies, objectives, and strategies.760 As 756 See final rule 206(4)–1(d)(7)(ii). Our staff applied a similar principle when considering whether displays of predecessor performance would be relevant to investors. See Horizon Letter (stating that the staff would not find a display of predecessor performance to be in and of itself misleading based on several representations, including that ‘‘the accounts managed at the predecessor entity are so similar to the accounts currently under management that the performance results would provide relevant information to prospective clients’’). 757 See IAA Comment Letter (suggesting that the Commission require the accounts to be ‘‘sufficiently similar’’ instead of ‘‘so similar’’). 758 See final rule 206(4)–1(d)(7)(iii). Our staff applied a similar principle when considering whether displays of predecessor performance would be relevant to investors. See Horizon Letter (stating that the staff would not find a display of predecessor performance to be in and of itself misleading based on several representations, including that ‘‘all accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance’’); IAA Comment Letter (supporting this provision). 759 See final rule 206(4)–1(d)(4); 2019 Proposing Release, supra footnote 7, at section II.A.5.c.ii, n.279. 760 See final rule 206(4)–1(e)(15). Our staff has stated that it would not recommend enforcement action if advisers present predecessor performance where the adviser presents the composite performance of all of the predecessor firm’s accounts that had the same investment objectives and were managed using the same investment PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 13087 a result, advisers can use the same approach for determining the scope of the accounts that are managed in a substantially similar manner as they use to determine which accounts are related portfolios for purposes of displaying related performance. An adviser that chooses to display predecessor performance information in an advertisement must consider the related performance requirements of the final rule. For example, if an adviser includes predecessor performance and the advertising adviser manages accounts that are related portfolios to those groups of investments depicted in the predecessor performance, then the advertising adviser must include these related portfolios in its performance display.761 Relevant disclosures. The final rule will require an adviser to clearly and prominently include all relevant disclosures and indicate that the performance results were from accounts managed at another entity.762 While what disclosures are ‘‘relevant’’ will depend on the facts and circumstances, we agree with a commenter’s suggestion that the fact that the performance was generated from accounts managed at another entity will always be relevant. Accordingly, the final rule will explicitly require this disclosure.763 Additionally, advisers should consider what disclosures would be appropriate to comply with the other provisions of the final rule, such as the general prohibitions. Our amendments to the books and records rule will require an adviser to retain records to support the performance presented.764 We believe that, in order to avoid misleading presentations of predecessor strategies that the adviser will manage at the new firm. See Horizon Letter. 761 In presenting such performance, advisers should also consider the general prohibitions and other performance advertising provisions of the final rule. 762 See final rule 206(4)–1(d)(7)(iv). Our staff applied a similar principle when considering whether displays of predecessor performance would be relevant to investors. See Horizon Letter (stating that the staff would not find a display of predecessor performance to be in and of itself misleading based on several representations, including that ‘‘the advertisement includes all relevant disclosures, including that the performance results were from accounts managed at another entity.’’). Disclosures that are subject to a clear and prominent standard under final rule 206(4)–1 should be included within the advertisement. See supra footnote 286. 763 See IAA Comment Letter (suggesting the addition of ‘‘including that the performance results were from accounts managed at another entity’’ to the rule text). 764 See final rule 204–2(a)(16). See also Great Lakes Letter (stating that rule 204–2(a)(16) applies to a successor’s use of a predecessor’s performance data). E:\FR\FM\05MRR2.SGM 05MRR2 13088 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 performance, an adviser must have access to the books and records underlying the performance.765 We have applied this concept more generally under the final rule, which will also require that an adviser have a reasonable basis for believing that it will be able to substantiate (upon demand by the Commission) all material statements of fact contained in an advertisement.766 Certain commenters that addressed this aspect of the proposal requested that we preserve flexibility for the types of records that support predecessor performance,767 while another commenter disagreed that flexibility was appropriate and suggested permitting predecessor performance only where the records required under rule 204–2 were available.768 Without supporting information, we are concerned about the accuracy of such performance displays and that such information could be misleading. We do not believe that an advertising adviser could recreate performance based on a sampling of investor statements and/or display performance from a prior firm because we are concerned that such an approach has a heightened risk of cherry picking performance. Allowing a sampling of information to support performance displays is inconsistent with our general approach to require advisers to display all applicable 765 Our staff took this approach in stating that it would not recommend enforcement action under section 206 of the Advisers Act or the current advertising rule if an advertising adviser presents performance results achieved at another firm based on several representations, including that the advertising adviser would keep the books and records of the predecessor firm that are necessary to substantiate the performance results in accordance with rule 204–2(a)(16). See Horizon Letter; see also Great Lakes Letter, at n.3 (stating that rule 204–2(a)(16) ‘‘applies also to a successor’s use of a predecessor’s performance data’’). We understand that investment advisers who consider this staff no-action letter currently keep copies of all advertisements containing performance data and all documents necessary to form the basis of those calculations. 766 See final rule 206(4)–1(a)(2). 767 See SIFMA AMG Comment Letter II; IAA Comment Letter (stating that an adviser should be permitted to substantiate performance using publicly available information and audit or verification statements); MarketCounsel Comment Letter (noting that the books and records of the predecessor firm are often unavailable due to contractual or privacy restrictions and suggesting that the Commission permit advertising advisers to recreate performance based on a sampling of client statements and/or display performance from a prior firm in a scenario where the advertising adviser has a copy of the advertisement and where the prior firm was subject to the books and records rule). 768 See CFA Institute Comment Letter (stating that alternative books and records requirements should not be an option for predecessor performance because verification reports will not satisfy the books and records requirements in most cases, nor would performance information that has been subject to a financial statement audit). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 performance (e.g., related performance) to mitigate these cherry-picking concerns. Because the final rule addresses the portability of adviser performance, our staff will withdraw several no-action letters our staff has issued on this topic.769 However, other related letters will not be withdrawn in connection with this rulemaking since they address different activity than the activity covered by our final rule text on predecessor performance. Those letters address topics including an adviser’s use of performance generated by predecessor accounts (e.g., separate accounts or private funds) in RIC advertisements and filings 770 and the establishment of pools in order to generate performance track records.771 These letters generally address the use of performance from predecessor accounts (i.e., where the same adviser uses performance generated by one investment vehicle in an advertisement for another product) rather than performance of a predecessor advisory firm.772 Although we requested comment on the portability of testimonials, endorsements, third-party ratings, and specific investment advice,773 commenters did not address these topics. To the extent that testimonials, endorsements, third-party ratings, and specific investment advice contain performance from a predecessor firm, the general prohibitions apply to such testimonials, endorsements, and thirdparty ratings. We do not believe we need to address their portability specifically as the general prohibitions, depending on the facts and circumstances, will have the effect of prohibiting advisers from presenting misleading information to investors by using outdated testimonials, endorsements, and third-party ratings. G. Review and Approval of Advertisements The final rule will not require investment advisers to review and approve their advertisements prior to dissemination, unlike the proposal. The proposed advertising rule would have 769 See infra section II.J. e.g., MassMutual Institutional Funds, SEC Staff No-Action Letter (Sept. 28, 1995); NicholasApplegate, SEC Staff No-Action Letter (Aug. 6, 1996); Growth Stock Outlook Trust Inc., SEC Staff No-Action Letter (Apr. 15, 1986). 771 See Dr. William Greene, SEC Staff No-Action Letter (Feb. 3, 1997). 772 See, e.g., Salomon Brothers Asset Management Inc., SEC Staff No-Action Letter (July 23, 1999). See also, Jennison Associates LLC, SEC Staff No-Action Letter (July 6, 2000). 773 See 2019 Proposing Release, supra footnote 7, at section II.A.6. 770 See, PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 required an adviser to have an advertisement reviewed and approved for consistency with the requirements of the proposed rule by a designated employee before disseminating the advertisement, except in certain circumstances.774 We proposed this requirement because we believed it might reduce the likelihood of advisers violating the proposed rule. We believed it was important that investment advisers implement a process designed to promote compliance with the proposed rule’s requirements. We also proposed to require that advisers create and maintain a written record of the review and approval of the advertisement, which would have allowed our examination staff to better review adviser compliance with the rule. Many commenters opposed this requirement or suggested modifications to it. Commenters expressed concern that it would impose a significant compliance burden on advisers, especially smaller firms.775 Many commenters also argued that such a requirement would be duplicative of the compliance rule, pointing out that most advisers already have implemented policies and procedures to review advertisements for accuracy prior to dissemination.776 Other commenters stated that an inflexible review and approval requirement covering nearly all advertisements would impair an adviser’s ability to communicate timely with clients, resulting in poor client service or slow responses during periods of market volatility.777 Commenters claimed that the proposal, which did not exclude one-on-one communications from the definition of advertisement, would effectively require advisers to screen all communications to assess whether a communication would constitute an advertisement subject to the review and approval requirement, or met one of the requirement’s exceptions.778 Consequently, some of these commenters suggested that if we adopt this requirement, the final rule should expand the exceptions to include, for example, responses to questions that contain pre-approved template language, advertisements to Non-Retail 774 See proposed rule 206(4)–1(d). e.g., FPA Comment Letter; MFA/AIMA Comment Letter I. 776 See, e.g., SBIA Commenter Letter; SIFMA AMG Comment Letter I. 777 See, e.g., Commonwealth Comment Letter. 778 See, e.g., NSCP Comment Letter; SIFMA AMG Comment Letter I. 775 See, E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 Persons, and interactive social media content.779 After considering these comments, we are not adopting the proposed internal review and approval requirement. Instead, we believe an adviser’s existing obligations under the compliance rule will allow an adviser to tailor its compliance program to its own advertising practices to prevent violations from occurring, detect violations that have occurred, and correct promptly any violations that have occurred.780 In adopting the compliance rule, the Commission stated that investment advisers should adopt policies and procedures that address ‘‘. . . the accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements.’’ 781 We believe for these compliance policies and procedures to be effective, they should include objective and testable means reasonably designed to prevent violations of the final rule in the advertisements the adviser disseminates. Advisers can establish such an objective and testable compliance policies and procedures through a variety of tools. For example, internal pre-review and approval of advertisements could serve as an effective component of an adviser’s compliance program. Other effective methods to prevent issues could include reviewing a sample of advertisements based on risk or pre-approving templates. Effective methods to detect and correct promptly violations and adjust practices to prevent future violations might include spot-checking advertisements and periodic reviews.782 Commenters confirmed our understanding that the internal policies 779 See, e.g., MFA/AIMA Comment Letter I; MMI Comment Letter; ICE Comment Letter. 780 See Compliance Program Adopting Release, supra footnote 371, at 74716. Rule 206(4)–7 makes it unlawful for an investment adviser to provide investment advice unless the adviser has adopted and implemented written policies and procedures reasonably designed to prevent violations of the Advisers Act and rules that the Commission has adopted under the Act, which will include final rule 206(4)–1 and its specific requirements. See rule 206(4)–7(a). Rule 206(4)–7 also requires investment advisers to review, no less than annually, the adequacy of the policies and procedures and the effectiveness of their implementation, and to designate who is responsible for administering the policies and procedures adopted under the rule. See id. at (b)–(c). 781 See Compliance Program Adopting Release, supra footnote 371, at 74716. 782 See Compliance Program Adopting Release, supra footnote 371, at 74716. If advisers indirectly market or solicit through third parties, they should consider how to tailor policies and procedures according to the risks posed by those third parties making statements that constitute advertisements under the rule. See supra section II.C.3. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 and procedures of many advisers currently require some level of review for advertisements, although not prereview of every advertisement.783 Advisers should also consider the extent to which reasonably designed policies and procedures should involve training on the requirements and prohibitions of the advertising rule for any employee(s) involved in the creation, review, or dissemination of adviser advertisements. In addition, consistent with the Commission’s examination authority, upon request, advisers must promptly provide information about their compliance policies and procedures and any records that document implementation of those policies and procedures to us and our staff.784 The Commission’s ability to collect information in a timely fashion through its examination authority, and evaluate such information for compliance with the Federal securities laws, is essential to our mission of protecting investors and our securities markets.785 Indeed, the prompt production of records to the Commission is central to our mission of protecting investors, and is imperative to an effective and efficient examination program.786 In connection with the proposed review and approval requirement, we also proposed to require investment advisers to maintain a copy of all written approvals of advertisements by designated employees.787 As we are not adopting the proposed pre-use approval requirement, we are also not adopting 783 See, e.g., SBIA Comment Letter; SIFMA AMG Comment Letter I (stating that advisers’ compliances programs currently include upfront reviews of templates, spot-checking or sampling advertisements after dissemination, or a risk-based approach depending on the type of advertisement). 784 See 15 U.S.C. 80b–4 (section 204 of the Investment Advisers Act) (providing the Commission with examination authority over ‘‘all records’’ of an investment adviser); see rule 204– 2(g)(2) (requiring prompt production of records); see rule 204–2(a)(17) (requiring investment advisers to make and keep records of their policies and procedures formulated pursuant to rule 206(4)–7). 785 See, e.g., 15 U.S.C. 80b–4 (section 204 of the Investment Advisers Act) (providing the Commission with examination authority); see also 17 CFR 275.204–2 (rule 204–2 under the Investment Advisers Act) (Commission books and records rules). 786 See, e.g., Electronic Recordkeeping by Investment Companies and Investment Advisers, Release No. IA–1945 (May 24, 2001) [66 FR 29224 (May 30, 2001)] (explaining that the ‘‘continuing accessibility and integrity of fund and adviser records are critical to the fulfillment of our oversight responsibilities,’’ and noting the Commission’s expectation that a fund or adviser would be permitted to delay furnishing electronically stored records for more than 24 hours only in ‘‘unusual circumstances.’’). 787 See proposed rule 204–2(a)(11)(iii). PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 13089 this associated recordkeeping requirement. H. Amendments to Form ADV We are adopting, largely as proposed, amendments to Item 5 of Form ADV Part 1A to improve information available to the Commission and the public about advisers’ marketing practices. Item 5 currently requires an adviser to provide information about its advisory business.788 We proposed to add a subsection L (‘‘Marketing Activities’’) to require information about an adviser’s use in its advertisements of performance results, testimonials, endorsements, third-party ratings, and references to its specific investment advice. Several commenters supported the proposed additions to Form ADV,789 while others questioned their usefulness.790 Some commenters suggested removing the question regarding whether an adviser’s performance results were verified, arguing that it could disadvantage smaller advisers or could provide investors with a false assurance of accuracy.791 Other commenters suggested that we include questions about an adviser’s use of other types of performance, such as predecessor performance,792 or specific types of hypothetical performance.793 One commenter opposed including questions regarding the amount or range of compensation paid for testimonials, endorsements, or third-party ratings, arguing that this could be commercially sensitive information.794 Others suggested technical improvements to the proposed section. For example, one commenter requested that we clarify how frequently advisers must update responses to Item 5.L.795 Another commenter requested that we define advertisement and other relevant terms 788 Exempt reporting advisers (that are not also registering with any state securities authority) are not required to complete Item 5 of Part 1A. Accordingly, subsection L of Item 5 of Part 1A will not be required for such advisers. See, e.g., Instruction 3 to Form ADV: General Instructions (‘‘How is Form ADV organized’’). Exempt reporting advisers will not be subject to the final rule. See supra footnote 21. 789 See CFA Institute Comment Letter; NRS Comment Letter; NAPFA Comment Letter. 790 See, e.g., SIFMA AMG Comment Letter I. 791 See, e.g., JG Advisory Comment Letter; Pickard Djinis Comment Letter. 792 See CFA Institute Comment Letter. 793 See NRS Comment Letter (suggesting that Form ADV specifically request that an adviser disclose whether its advertisements include backtested performance or projected or targeted returns). 794 See SIFMA AMG Comment Letter I. 795 See NRS Comment Letter. E:\FR\FM\05MRR2.SGM 05MRR2 13090 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations of Item 5.L in the Form ADV Glossary.796 After considering the comments, we are adopting new subsection L to Item 5 of Form ADV with slight modifications to the ordering and content of the subsection versus the proposal. We are also amending the Form ADV Glossary to incorporate the final rule’s definitions for ‘‘advertisement,’’ ‘‘endorsement,’’ ‘‘hypothetical performance,’’ ‘‘testimonial,’’ ‘‘third-party rating,’’ and ‘‘predecessor performance.’’ Because new subsection L is included under Item 5 of Form ADV, advisers will be required to update responses to these questions in their annual updating amendment only.797 We continue to believe that this new information will be useful for staff in reviewing an adviser’s compliance with the final rule, including the restrictions and conditions on advisers’ use in advertisements of performance presentations and third-party statements. First, we are combining several proposed questions into Item 5.L(1), which will require an adviser to state whether any of its advertisements include performance results, a reference to specific investment advice, testimonials, endorsements, or thirdparty ratings.798 Unlike under the proposal, this item will require an adviser to address separately whether its advertisements include testimonials, endorsements, and third-party ratings. We believe that requiring advisers to address each separately will provide more specific and useful information to our staff regarding whether an adviser engages in these marketing practices. We are not including the proposed related question that would have asked whether the performance results in Item 5.L(1) were reviewed or verified, as proposed. We agree with commenters that ‘‘verification’’ may inappropriately suggest an assurance of accuracy to investors, and disadvantage smaller advisers that may not obtain third-party reviews of their performance results.799 As proposed, we are requiring an adviser to state whether the adviser pays or otherwise provides cash or non-cash compensation, directly or indirectly, in connection with the use of testimonials, jbell on DSKJLSW7X2PROD with RULES2 796 See Pickard Djinis Comment Letter. 797 See Instruction 4 to Form ADV: General Instructions (‘‘When am I required to update my Form ADV?’’). 798 The question will exclude testimonials and endorsements given by certain affiliated persons of the adviser that satisfy rule 206(4)–1(b)(4)(ii). 799 See JG Advisory Comment Letter; CFA Institute Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 endorsements, or third-party ratings.800 This question will only require ‘yes’ or ‘no’ responses, and will not require additional information about the amount or range of compensation provided to avoid the disclosure of potentially sensitive information as suggested by one commenter.801 Third, unlike under our proposal, we are adding items requiring an adviser to state whether any of its advertisements include hypothetical performance and predecessor performance, respectively. We agree with commenters’ suggestions that this information could be useful for our staff preparing for examinations, especially considering that hypothetical performance can pose a heightened risk of misleading investors.802 Additionally, as explained above, the final rule specifically addresses when advisers can include predecessor performance in advertisements.803 Responses regarding predecessor performance will enable our examination staff to better assess compliance with this new provision of the rule. I. Recordkeeping We are adopting amendments to the books and records rule, largely as proposed, to reflect the final rule and to help further the Commission’s inspection and enforcement capabilities. Investment advisers must make and keep records of all advertisements they disseminate, and certain alternative methods for complying with this provision are available for oral advertisements, including oral testimonials and oral endorsements.804 If an adviser provides an advertisement orally, the adviser may, instead of recording and retaining the advertisement, retain a copy of any written or recorded materials used by the adviser in connection with the oral advertisement.805 If an adviser’s advertisement includes a compensated oral testimonial or endorsement, the adviser may, instead of recording and retaining the advertisement, make and keep a record of the disclosures provided to investors.806 Further, if an adviser’s disclosures with respect to a testimonial or endorsement are not included in the advertisement, then the adviser must retain copies of such disclosures provided to investors.807 800 This question will appear in Item 5.L(2), but had been proposed as Item 5.L(4). 801 See SIFMA AMG Comment Letter I. 802 See, e.g., CFA Institute Comment Letter; NRS Comment Letter. 803 See supra section II.F. 804 See final rule 204–2(a)(11)(i)(A). 805 See final rule 204–2(a)(11)(i)(A)(1). 806 See final rule 204–2(a)(11)(i)(A)(2). 807 See final rule 204–2(a)(11)(i)(A) and (15)(i). PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 Commenters generally disagreed with this expansion of the books and records rule, which currently only requires advisers to retain advertisements sent to ten or more persons. According to commenters, advisory firms of all sizes would face compliance challenges, especially smaller advisers, if required to maintain all advertisements.808 We believe, however, that this change is necessary to conform the books and records rule to the definition of advertisement and is designed to ensure advisers comply with the requirements in the final rule.809 Our decision to narrow the proposed definition of advertisement by excluding one-on-one communications from the first prong of the definition (other than most communications that include hypothetical performance) will lessen any burden imposed by the associated recordkeeping obligations. One commenter asked us to clarify that electronic mail (‘‘email’’) archives are an acceptable method of maintaining records of advertisements that are disseminated to investors, and we agree.810 The final rule does not prescribe or prohibit any particular method of maintaining records. Rather, it requires the adviser to maintain and preserve these records ‘‘in an easily accessible place for a period of not less than five years, the first two years in an appropriate office of the investment adviser, from the end of the fiscal year during which the investment adviser last published or otherwise disseminated, directly or indirectly, the . . . advertisement.’’ 811 We believe it would be permissible for an adviser to store records using email archives (including in cloud storage or with a third-party vendor), provided that the adviser can promptly produce records in accordance with the recordkeeping rule 812 and statements of the Commission.813 808 See JG Advisory Comment Letter; NAPFA Comment Letter; FPA Comment Letter. 809 See also NRS Comment Letter (stating that ‘‘most advisers have developed procedures requiring the retention of all written communications, so that individuals within the firm do not have the discretion to determine whether or not a particular communication is required under rule 204–2(a)(7).’’). As proposed, we are not changing the requirement that advisers keep a record of communications other than advertisements (e.g., notices, circulars, newspaper articles, investment letters, and bulletins) that the investment adviser disseminates, directly or indirectly, to ten or more persons. 810 See JG Advisory Comment Letter. 811 Final rule 204–2(e)(3)(i). This provision has not been amended from the current rule. 812 See final rule 204–2(g)(2)(ii). This provision has not been amended from the current rule. 813 See Amendments to the Timing Requirements for Filing Reports on Form N–PORT, Release No. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 The current recordkeeping rule requires advisers to retain originals of all written communications received and copies sent by the adviser relating to the performance or rate of return of any or all managed accounts or securities recommendations.814 As proposed, the final rule will amend the current rule to also require advisers to maintain written communications relating to the performance or rate of return of any portfolios (as defined in the final marketing rule).815 The current recordkeeping rule requires advisers to retain all accounts, books, internal working papers, and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any advertisement.816 As proposed, the final rule will amend the current rule to also require advisers to maintain accounts, books, internal working papers, and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any portfolios (as defined in the final marketing rule).817 In addition, the supporting records of investment advisers that display hypothetical performance must include copies of all information provided or offered pursuant to the hypothetical performance provisions of the final rule.818 These changes are designed to help to facilitate the Commission’s inspection and enforcement capabilities. In a change from the proposal, the final rule will require advisers to maintain documentation of communications relating to predecessor IC–33384 (Feb. 27, 2019) [84 FR 7980 (Mar. 6, 2019)] (interim final rule), at n.44. See also JG Advisory Comment Letter (suggesting that the Commission clarify that email archives are an acceptable method of recordkeeping in certain contexts). 814 See current rule 204–2(a)(7)(iv). 815 See final rule 204–2(a)(7)(iv). 816 See current rule 204–2(a)(16). 817 See final rule 204–2(a)(16). See also Recordkeeping by Investment Advisers, Release No. IA–1135 (Aug. 17, 1988) [53 FR 32033 (Aug. 23, 1988)] (describing as ‘‘supporting records’’ the documents necessary to form the basis for performance information in advertisements that are required under rule 204–2(a)(16)). 818 See final rule 206(4)–1(d)(6), which will prohibit hypothetical performance in an advertisement except under certain conditions, including a requirement that the investment adviser provides (or offers to provide promptly to a recipient that is a private fund investor) sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions. Any such supplemental information that is required by final rule 206(4)–1 to be a part of the advertisement is subject to the books and records rule. See final rule 204–2(a)(16). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 performance.819 This change complements the predecessor performance provisions of the final rule and will help ensure that advertising advisers retain appropriate documentation to substantiate displays of predecessor performance. One commenter noted that advisers often have difficulty complying with the books and records requirements in connection with predecessor performance.820 For the reasons discussed above, we decline to provide additional flexibility.821 In a change from the proposal, we will require advisers to make and keep a record of who the ‘‘intended audience’’ is pursuant to the hypothetical performance and model fee provisions of the final marketing rule.822 Our examination staff may choose to review the adviser’s policies and procedures (for displaying hypothetical performance) against the records retained in connection with this new recordkeeping provision when determining whether the adviser satisfied the hypothetical performance policies and procedures condition. Also, we believe this additional requirement will assist our examination staff in confirming that advisers are appropriately considering the target audience when preparing and disseminating net performance and hypothetical performance. We proposed to require investment advisers to maintain a copy of all written approvals of advertisements by designated employees in order to track a corresponding proposed provision of the advertising rule relating to a review and approval process.823 Since we are not adopting the provision of the proposed advertising rule relating to review and approval, we are not adopting the corresponding proposed recordkeeping requirement. As discussed above, we are persuaded by commenters who asserted that an adviser’s own policies and procedures would provide an effective compliance mechanism.824 The combination of the current solicitation rule and current advertising 819 See proposed rule 204–2(a)(7)(iv). See also 2019 Proposing Release, supra footnote 7, at sections II.A.6. and II.C. (requesting comment about whether to amend the books and records rule to address the substantiation of performance results from a predecessor firm and whether the Commission should amend the rule to address specifically other provisions of the proposed advertising rule). 820 See SIFMA AMG Comment Letter II. 821 See supra section I.F. 822 See final rule 204–2(a)(19). See also final rule 206(4)–1(d)(6) and (e)(10)(ii)(B). 823 See proposed rule 204–2(a)(11)(iii). 824 See, e.g., NRS Comment Letter. PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 13091 rule into a single marketing rule resulted in additional changes to the books and records rule. We are adopting, as proposed, changes to the books and records rule in order to correspond to the marketing rule’s provisions that address testimonials and endorsements. The rule will require investment advisers to make and keep any communication or other document related to the investment adviser’s determination that it has a reasonable basis for believing that a testimonial or endorsement complies with rule 206(4)– 1 and that a third-party rating complies with rule 206(4)–1(c)(1).825 We are not adopting amendments to the books and records rule that would specifically reference the adviser’s obligation to retain the written agreements with promoters 826 because such a provision would be duplicative of the current books and records rule.827 We did not receive any comments on the proposed amendments to the recordkeeping rule provisions that corresponded to the proposed amendments to the solicitation rule. For the reasons discussed in the proposal regarding amendments to the solicitation rule, we are retaining the current recordkeeping rule’s requirement for investment advisers to keep a record of the disclosures delivered to investors, which now apply to testimonials, endorsements, and third-party ratings. However, we are adjusting the wording to correspond to changes to the final marketing rule that permit either the investment adviser or the promoter to provide the disclosure. Further, in a change from the current solicitation rule, the final marketing rule will not require a promoter to provide an investor with the adviser’s brochure. Accordingly, as proposed, we will remove the corresponding books and records requirement as no longer relevant or necessary. As discussed above, in a change from the proposed amendments to the solicitation rule, the final rule contains a partial exemption (from the disclosure requirements associated with testimonials and endorsements in the final rule) for an adviser’s affiliated personnel. The amended recordkeeping rule will now contain a corresponding requirement for advisers that rely on the exemption to keep a record of the names of all affiliated personnel and document their affiliates’ status at the time the 825 See final rule 204–2(a)(15)(ii). final rule 206(4)–1(b)(2)(ii). 827 Advisers are already required to retain the written agreement pursuant to current rule 204– 2(a)(10). 826 See E:\FR\FM\05MRR2.SGM 05MRR2 13092 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations investment adviser disseminates the testimonial or endorsement.828 Finally, we are adopting, as proposed, the requirement that an adviser retain a copy of any questionnaire or survey used in the preparation of a third-party rating included or appearing in any advertisement.829 Commenters expressed concerns about not being able to obtain a copy of the questionnaire or survey.830 As discussed above, we recognize this concern and the rule will require an adviser to retain a copy of this material only in the event the adviser obtains a copy of the questionnaire or survey (i.e., an adviser would not be required to obtain a copy of the questionnaire or survey in order to comply with rule 206(4)–1 or rule 204–2). J. Existing Staff No-Action Letters Staff in the Division of Investment Management reviewed certain of our staff’s no-action letters that addresses the application of the advertising and solicitation rules to determine whether any such letters should be withdrawn in connection with the adoption of the marketing rule. Because we are rescinding the solicitation rule, the staff no-action letters that address that rule will be nullified.831 Additionally, pursuant to the staff’s review, the staff will be withdrawing the staff’s remaining no-action letters and other staff guidance, or portions thereof, as of the compliance date of the final rules.832 A few commenters supported this approach, suggesting that the final rule should either supersede or incorporate every letter.833 Other commenters requested that certain no-action letters not be withdrawn that were issued to solicitors who would otherwise be subject to the rule’s disqualification provisions.834 These commenters alternatively requested that the Commission grandfather such solicitation arrangements if these letters are withdrawn. Based on the staff’s review, we understand that some solicitors may 828 See final rule 204–2(a)(15)(iii). final rule 204–2(a)(11)(ii). 830 See, e.g., Blackrock Comment Letter; AIC Comment Letter. 831 The order granting exemptive relief under rule 206(4)–3 is also terminated. See In the Matter of Blackrock, Investment Advisers Release Nos. 2971 (Jan. 4, 2010) [75 FR 1421 (Jan. 11, 2010)] (application) and 2988 (Feb. 26, 2010) (order) (stating that ‘‘the Applicant will rely on the Order only for so long as the Cash Solicitation Rule in effect as of the date of the Order is operative.’’). 832 A list of the letters to be withdrawn will be available on the Commission’s website. 833 IAA Comment Letter; Mercer Comment Letter. 834 See, e.g., SIFMA AMG Comment Letter II; Mercer Comment Letter; Stansberry Comment Letter. jbell on DSKJLSW7X2PROD with RULES2 829 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 continue to conduct solicitation activity consistent with the conditions stated in certain of the solicitor disqualification letters identified below.835 The majority of these letters, however, pertain to events that occurred more than ten years prior to the effective date of the marketing rule and thus would not be disqualifying events under the marketing rule.836 The nullification of these solicitation disqualification letters will not have an impact on the relevant solicitor’s eligibility under the rule. For the minority of the solicitor disqualification letters that involve events that occurred within the rule’s ten-year lookback period, however, nullification of these letters could trigger disqualification under the marketing rule for that underlying event. To avoid this result, we understand that the staff will take a noaction position with respect to the events in those letters to prevent those solicitors from being deemed disqualified under the marketing rule. This position is designed primarily to assist the phase-out of these letters as of the compliance date of the final rule.837 K. Transition Period and Compliance Date The final rule will provide an eighteen-month transition period between the effective date of the rule and the compliance date. While we had proposed a one-year transition period, two commenters requested a longer transition period to prepare for the new rule’s requirements.838 One of these commenters argued that a two-year transition period would be more appropriate given the compliance burden of implementing the proposed review and approval requirement.839 We did not adopt the proposed pre-review and approval requirement; nevertheless, we appreciate commenters’ concerns. Accordingly, the compliance date will be eighteen months following the effective date of the rules. Any advertisements disseminated on or after the compliance date by advisers registered or required to be registered with the Commission would be subject to the new marketing rule. The compliance date for the amended recordkeeping rule will also provide an eighteen-month transition date from the 835 See also, Stansberry Comment Letter. final rule 206(4)–1(e)(4). 837 We believe that the need for this position will likely be temporary since the events covered by these letters, over time, will fall outside the ten-year lookback period for purposes of disqualification under the rule. 838 See FPA Comment Letter; MFA/AIMA Comment Letter I. 839 See MFA/AIMA Comment Letter I. 836 See PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 effective date of the rule. Advisers filing Form ADV after a similar eighteenmonth transition period from the effective date of the rule will be required to complete the amended form. Importantly, Form ADV does not require an adviser to update responses to Item 5 promptly by filing an other-thanannual amendment, and if an adviser submits an other-than-annual amendment, the adviser is not required to update its response to Item 5 even if the response has become inaccurate.840 Therefore, each adviser is only responsible for filing an amended form that includes responses to the amended questions in Item 5 in its next annual updating amendment that is filed after the eighteen-month transition period. L. Other Matters Pursuant to the Congressional Review Act,841 the Office of Information and Regulatory Affairs has designated this rule a ‘‘major rule’’ as defined by 5 U.S.C. 804(2). If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. III. Economic Analysis A. Introduction We are mindful of the costs imposed by, and the benefits obtained from, our rules. Whenever we engage in rulemaking and are required to consider or determine whether an action is necessary or appropriate in the public interest, section 202(c) of the Advisers Act requires the Commission to consider, in addition to the protection of investors, whether the action would promote efficiency, competition, and capital formation. The following analysis considers, in detail, the potential economic effects that may result from the final rule, including the benefits and costs to market participants as well as the broader implications of the final rule for efficiency, competition, and capital formation. Where possible, the Commission quantifies the likely economic effects of the final rule; however, the Commission is unable to quantify certain economic effects because it lacks the information necessary to provide estimates or ranges. In some cases, quantification is particularly challenging due to the number of assumptions that would be 840 See 841 5 E:\FR\FM\05MRR2.SGM Form ADV General Instruction 4. U.S.C. 801 et seq. 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations required to forecast how investment advisers would respond to the new conditions of the final rule, and how those responses would in turn affect the broader market for investment advice and the investors’ participation in this market. Nevertheless, as described more fully below, the Commission is providing both a qualitative assessment and, where feasible, a quantified estimate of the economic effects. In large part, the scope of these costs and benefits is determined by the scope of the rule’s definition of advertisement. The final rule’s definition includes many of the types of communications subject to the current advertising rule. The final rule, however, will expressly apply the protections of the rule to investors in private funds, and advisers will now incur costs related to these communications, to the extent that their current practices differ from the final rule. In addition, the definition’s scope has been expanded to include communications made by promoters, including cash-compensated promoters, who were previously subject to the cash solicitation rule, and non-cashcompensated promoters who were not. Some of these affected promoters whose communications will be newly defined as advertisements may also be registered broker-dealers whose communications may be subject to other regulatory requirements governing communications and advertisements, including those under the Exchange Act, the rules promulgated thereunder (including Regulation BI), and FINRA rules (including FINRA rule 2210). The final rule’s application to promoters that are registered broker-dealers relating to endorsements to private fund investors may create some overlap in regulation to the extent regulatory requirements under the Exchange Act and FINRA rules apply to their promotional activities. This may create burdens on these promoters to the extent their compliance with these other regulatory requirements does not fully satisfy the final rule. However, both the costs and benefits of the testimonial and endorsement requirements will be mitigated by the exclusions from the endorsement requirements that will apply to these registered broker-dealers. Other aspects of the final rule will also yield costs and benefits, such as the final rule’s general prohibitions on certain marketing practices. The impact of these changes are generally limited to the extent that communications are subject to similar restrictions under the current advertising rule, the current solicitation rule, and the general antifraud provisions of the securities laws, and the extent to which the final rule’s VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 prohibitions conform to current market practices. The impact is more pronounced with respect to communications newly subject to the definition of an advertisement and not previously subject to the solicitation rule—particularly to communications by solicitors who are not cashcompensated. In addition, the rules and rescission of existing no-action letters may increase certainty because advisers who choose to advertise will be able to follow the requirements of the final rules rather than various no-action letters, which could ultimately reduce compliance costs. Conversely, to the extent that the specificity of the rules prompts some advisers to devote greater resources to ensure compliance obligations under the final rules, the requirements of the rules may impose greater costs on such funds and advisers. Changes in costs of compliance for advisers ultimately could affect investors to the extent that any changes in costs would be passed down to them in the form of changed fund operating expenses or higher advisory fees. In addition, the rule will (i) permit investment advisers to use certain features in an advertisement, such as testimonials and endorsements, subject to certain conditions, such as disclosing information that would help investors evaluate the advertisement, and (ii) prohibit third-party ratings and investment adviser performance in advertisements unless they comply with certain conditions. The ability to use testimonials and endorsements will likely have a less pronounced impact on advisers that are currently complying with the solicitation rule because this aspect of the marketing rule is drawn from the current solicitation rule. The impact of restrictions in the marketing rule related to the use of performance advertising is likely similar on advisers currently subject to the advertising or solicitation rule because this aspect of the final rule permits certain activity that is not permissible under either current rule. If an adviser that is subject to the current advertising rule is implementing practices similar to those of the recipients of staff letters with respect to performance advertising, the impact of this new aspect of the final rule may be less pronounced for these advisers as compared to the impact on other advisers to the extent that there are some similarities between the final rule and the staff letters. The Commission is also adopting amendments to Form ADV that are designed to provide additional information regarding advisers’ marketing practices, and amendments to PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 13093 the Advisers Act books and records rule to correspond to the features of the marketing rule. The final rule reflects market developments since 1961 and 1979, when rules 206(4)–1 and 206(4)– 3, respectively, were adopted, as well as practices addressed in staff no-action letters. These market developments include advances in communication technology and marketing practices that did not exist at the time the rules were adopted and may fall outside of the scope of the current rules. B. Broad Economic Considerations While we discuss investment advisers’ many diverse marketing methods and practices in detail later, here we discuss the broad economic considerations that frame our economic analysis of the final rule and describe the relevant structural features of the market for investment advice and its relationship to marketing of advisory services and private funds. Key to this framework is the problem that investors face when searching for an investment adviser; specifically the lack of information that investors may have about the ability and potential fit of an investment adviser for the investor’s preferences. By setting up this economic framework, we can see how the characteristics of the market for investment advice and its participants can influence the costs and benefits of the final rule and its impact on efficiency, competition, and capital formation. Information Usefulness The usefulness of the information in investment adviser advertisements is an important factor in determining how investors decide with which investment advisers to engage. For the purposes of the final rule, we use the term ‘‘ability’’ to refer to the usefulness of advice an investment adviser provides. The ‘‘potential fit’’ of an investment adviser refers to attributes that investors may have specific preferences for, such as communication style, investment style, or risk preference. For example, some investors would prefer an investment adviser that does not proactively provide advice or suggest investments, while others might prefer a more active communication and management style. While the effectiveness and usefulness of an investment adviser’s advertisements can have direct effects on the quality of the matches that investors make with investment advisers—in terms of both fit and better returns from the investment—there may be important indirect effects as well. If the final rule provides additional methods for investment advisers to E:\FR\FM\05MRR2.SGM 05MRR2 13094 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 credibly and truthfully advertise their ability and potential fit with investors, investment advisers may have a greater marginal incentive to invest more in the quality of their services, because advisers would have additional methods to communicate their ability and potential fit through advertisements. Additionally, because investors might be able to better observe the relative qualities of competing investment advisers, the final rule may also enhance competition among investment advisers. In summary, to the extent that the final rule improves the effectiveness and usefulness of investment adviser advertisements, the final rule could also have a secondary effect of increasing competition among investment advisers, and encourage investment in the quality of services. Information Access Investors generally have access to a variety of sources of information on the ability and potential fit of an investment adviser. Advertisements, word of mouth referrals, and independent research are all ways in which investors acquire information about investment advisers as they search for them. During this search, investors trade off the benefits of finding a better investment adviser (in terms of ability and potential fit) against the costs of searching for and obtaining information about one. If the cost of searching is too high, investors may contract with lower quality investment advisers on average, because they cannot spend the resources to conduct a search that would yield an investment adviser with higher ability or better fit, or they might not be able to evaluate the quality of the investment adviser they have found. Thus, higher search costs can result in inefficiencies because the same expected quality of match requires an investor to incur higher search costs. Similarly, for a fixed amount of spending on a search, an investor is less able to find information about investment advisers, and finds a lower expected quality of match. Marketing can potentially mitigate inefficiencies associated with the costs of searching for good products or suitable services. To the extent that marketing provides accurate and useful information to investors about investment advisers at little or no cost to investors, marketing can reduce the search costs that investors bear to acquire information and improve the ability of investors to identify high quality investment advisers. Investors have a variety of preferences regarding investment adviser characteristics such as investment strategies or communication styles. Marketing can VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 help communicate information about an investment adviser’s ability, and that may aid an investor in selecting an investment adviser who is a good ‘‘fit’’ for the investor’s preferences. While marketing by or on behalf of investment advisers may reduce search costs for potential investors, investment advisers’ or promoters’ incentives may not necessarily be aligned with those of potential investors. Such a misalignment could undercut the potential gains to efficiency. For example, investment advisers have incentives to structure their advertisements to gain potential investors, regardless of whether their advertisements accurately reflect their ability and indicate whether they offer a potential fit with an investor’s preferences. One commenter suggested, for instance, that advisers may be incentivized to purchase positive testimonials or endorsements, or otherwise curate content.842 In addition, advertisements might make claims that are costly for investors to verify or are inherently unverifiable. For example, evaluating a claim that an investment adviser’s strategy generates ‘‘alpha’’ or returns in excess of priced risk factors generally requires information about the strategy’s returns and permitted holdings, as well as a model that attributes returns to risk factors. While some investors may have ready access to these resources or information, other investors may not. In some cases, an investor may be unable to assess the plausibility of an investment adviser’s claims. An investment adviser might also state facts but omit the contextual details that an investor would need to properly evaluate these facts. Several economic models suggest that the ability to control or influence an investor’s access to information can hamper the investor’s ability to process information in an unbiased manner, even if the specific facts or information communicated to an investor are not false.843 For example, this type of control or influence on information can be as explicit as deletion or removal of unfavorable ratings or reviews,844 or as implicit as a reordering of the ratings or 842 See NASAA Comment Letter. Rayo and Ilya Segal, Optimal Information Disclosure, 118 J. POL. ECON. 949 (2010); Emir Kamenica and Matthew Gentzkow, Bayesian Persuasion, 101 a.m. ECON. REV. 2590 (2011); Pak Hung Au and King King Li, Bayesian Persuasion and Reciprocity: Theory and Experiment, SSRN (June 5, 2018), available at https://ssrn.com/ abstract=3191203; Jacob Glazer and Ariel Rubinstein, On Optimal Rules of Persuasion, 72 ECONOMETRICA 1715 (2004) (‘‘Glazer’’). 844 See id. for Segal and Rayo 2010, Kamenica and Gentzkow 2011, Au Li 2018. 843 Luis PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 a suggestion of which ratings or reviews to read.845 Similarly, promoters may overstate the quality of the investment adviser they are promoting or their familiarity with the advisers’ services, or hide negative details that would have aided an investor when choosing an investment adviser or private fund, given promoters’ financial incentive to recommend the adviser to the investor. Information Evaluation There are considerable differences among investors and potential investors in their ability to process and evaluate information communicated by investment advisers. Many investors and prospective investors may lack the financial literacy needed to evaluate and interpret the types of financial information contained in investment adviser advertisements. In 2010, the Dodd-Frank Act required the Commission to study the financial literacy among retail investors, including methods and efforts that could increase financial literacy among investors.846 The Commission contracted with the Federal Research Division at the Library of Congress to conduct a review of the quantitative studies on the financial literacy of retail investors in the United States.847 According to the Library of Congress Report, studies show consistently that many American retail investors 848 lack important elements of financial literacy. For example, studies have found that many investors do not understand certain financial concepts, such as compound interest and inflation. Studies have also found that many investors do not understand other key 845 See Glazer, supra footnote 843. Securities and Exchange Commission, Study Regarding Financial Literacy Among Investors As Required by Section 917 of the DoddFrank Wall Street Reform and Consumer Protection Act (Aug. 2012), available at https://www.sec.gov/ news/studies/2012/917-financial-literacy-studypart1.pdf. (‘‘Financial Literacy Study’’). 847 See id. Although the report does not link American investors specifically to those who would become clients of SEC-registered investment advisers or investors in private funds, we believe that the study may be indicative of the level of financial literacy for prospective investors. 848 The financial literacy studies in the Library of Congress Report (2011) fall into three categories, depending on the population or special topic under investigation. Most studies survey the general population. For example, the FINRA Investor Education Foundation’s 2009 National Financial Capability study, which was included in the Library of Congress Report, consisted of a national sample of 1488 respondents. Other research included in the report focus on particular subgroups, such as women, or specific age groups or minority groups. A third type of study deals specifically with investment fraud. These studies do not differentiate between qualified purchasers, knowledgeable employees, and other investors. Results from studies conducted on general populations may not apply to private fund investors. 846 U.S. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations financial concepts, such as diversification or the differences between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns.849 A 2016 FINRA survey found that 56 percent of respondents correctly answered less than half of a set of financial literacy questions, and yet 65 percent of respondents assessed their own knowledge about investing as high (between five and seven on a sevenpoint scale).850 Moreover, the general lack of financial literacy among some investors makes it difficult for those investors to evaluate claims about financial services made in advertisements, which increases the risk that such investors are unable to effectively use the information in advertisements to find an investment adviser that has high ability and is a good fit.851 C. Baseline 1. Market for Investment Advisers for the Advertising Rule jbell on DSKJLSW7X2PROD with RULES2 a. Current Regulation The current rule 206(4)–1 imposes four broadly drawn limitations on the content of advertisements that are ‘‘directly or indirectly’’ published, circulated, or distributed by investment advisers. In addition to these specific prohibitions, the current rule prohibits any advertisement that contains any untrue statement of a material fact, or which is otherwise false or misleading. This prohibition operates more generally than the specific prohibitions to address advertisements that do not violate any of the specific prohibition but still may be fraudulent, deceptive, or manipulative and, accordingly, may risk misleading investors. For purposes of the advertising rule, the Commission currently defines ‘‘advertisement’’ to be ‘‘any notice, circular, letter or written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as 849 See Financial Literacy Study, supra footnote 846. 850 FINRA Investor Education Foundation, Investors in the United States (2016). 851 Annamaria Lusardi and Olivia S. Mitchell, The Economic Importance of Financial Literacy: Theory and Evidence, 52 J. ECON. LITERATURE 5 (2014). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.’’ Investment advisers owe a fiduciary duty under the Advisers Act, which is enforceable under the Act’s anti-fraud provisions in section 206.852 Section 206 of the Advisers Act prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business.853 b. Market Practice In addition to section 206 and rule 206(4)–1, investment advisers have considered staff no-action letters in their advertising practices. For example, the staff has issued no-action letters under rule 206(4)–1(b), stating that, in general, the staff would not view a written communication by an adviser to an existing client or investor about the performance of the securities in the investor’s account as an ‘‘offer’’ of investment advisory services but instead would view it as part of the adviser’s advisory services (unless the context in which the performance or past specific recommendations are provided suggests otherwise), and that the staff would not view communications by an adviser in response to an unsolicited request by an investor, prospective client, or consultant for specified information as an advertisement.854 The staff has also stated that it would not recommend enforcement action under section 206(4) and rule 206(4)–1 on issues relating to third-party ratings and testimonials. Specifically, the staff has stated that it would not recommend enforcement action if certain circumstances were present regarding the use of ratings or testimonials, such as: (i) References to independent thirdparty ratings that are developed by relying significantly on client surveys or clients’ experiences more generally; 855 852 See Fiduciary Interpretation, supra footnote 88, at 6–7. 853 See also section 17(a) of the Securities Act, section 10(b) of the Exchange Act and rule 10b–5 thereunder, and rule 206(4)–8 under the Advisers Act. 854 See ICAA letter, supra footnote 95. 855 See Investment Adviser Association, SEC Staff No-Action Letter (Dec. 2, 2005) (not recommending enforcement action if in determining whether a third-party rating is a testimonial, the adviser considers the criteria used by the third party when formulating the rating and the significance to the ratings formulation of criteria related to client evaluations of the adviser); DALBAR, Inc., SEC Staff No-Action Letter (Mar. 24, 1998) (not recommending enforcement action if an adviser used references to third-party ratings that reflect client experiences, based on certain representations and certain disclosures made, both of which PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 13095 (ii) the use of ‘‘social plug-ins’’ such as the ‘‘like’’ feature on an investment adviser’s social media site; 856 and (iii) references regarding, for example, an adviser’s religious affiliation or moral character, trustworthiness, diligence or judgement, in addition to more typical testimonials that reference an adviser’s technical competence or performance track record.857 The Commission has also stated that an investment adviser should consider the application of rule 206(4)–1, including the prohibition on testimonials, before including hyperlinks to third-party websites on its website or in its electronic communications.858 For example, staff has stated that it would not recommend enforcement action, under certain circumstances, when an adviser provided: (i) Full and partial client lists; 859 and (ii) references to unbiased third-party articles concerning the investment adviser’s performance.860 Staff no-action letters have also stated that the staff would not recommend enforcement action under rule 206(4)–1 for references to specific investment advice in an advertisement, notwithstanding the rule’s general prohibition of the use of past specific recommendations. An adviser that acts consistently with a staff no-action letter may include past specific recommendations in an advertisement designed to ensure that the rating is developed in a fair and unbiased manner and that disclosures provide investors with sufficient context to make informed decisions). 856 See, e.g., National Examination Risk Alert, Office of Compliance, Inspections and Examinations (Jan. 4, 2012). 857 See Gallagher and Associates, Ltd., SEC Staff No-Action Letter (July 10, 1995) (where the staff reiterated its view that rule 206(4)–1 prohibits testimonials of any kind concerning the investment adviser); see also IM Guidance Update No. 2014– 04, at n.12 and accompanying text, in which staff partially withdrew its Gallagher position. 858 See Interpretive Guidance on the Use of Company websites, Release No. IC–28351 (Aug. 1, 2008); see also Guidance on the Testimonial Rule and Social Media, IM Guidance Update No. 2014– 04, at n.19 and accompanying text. 859 See, e.g., Cambiar Investors, Inc., SEC Staff No-Action Letter (Aug. 28, 1997) (stating it would not recommend enforcement action when the adviser proposed to use partial client lists that do no more than identify certain clients of the adviser, the Commission staff stated its view that partial client lists would not be testimonials because they do not include statements of a client’s experience with, or endorsement of, an investment adviser); see also Denver Investment Advisors, Inc., SEC Staff No-Action Letter (July 30, 1993) (stating that partial client lists can be, but are not necessarily, considered false and misleading under 206(4)– 1(a)(5)). 860 See New York Investors Group, Inc., SEC Staff No-Action Letter (Sept. 7, 1982) (stating that in the staff’s view an unbiased third-party article concerning an adviser’s performance is not a testimonial unless the content includes a statement of a customer’s experience with or endorsement of the adviser). E:\FR\FM\05MRR2.SGM 05MRR2 13096 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 provided the recommendations were selected using performance-based or objective, non-performance-based criteria, and in either case, the adviser’s practices are consistent with a number of specific representations articulated in the no-action letters.861 For example, the staff stated that it would not recommend enforcement action if an adviser included in an advertisement a partial list of recommendations provided that, in general, the list: (i) Includes an equal number (at least five) of best and worst-performing holdings; (ii) takes into account consistently the weighting of each holding within the portfolio (or representative account) that contributed to the performance during the measurement period; (iii) is presented consistently from measurement period to measurement period; and (iv) discloses how to obtain the calculation methodology and an analysis showing every included holding’s contribution to the portfolio’s (or representative account’s) overall performance.862 The staff has also stated that it would not recommend enforcement action if an adviser includes in an advertisement a partial list of recommendations selected using objective, non-performance-based criteria, provided that, in general: (i) The same selection criteria are used consistently from measurement period to measurement period; (ii) there is no discussion of the profits or losses (realized or unrealized) of any specific securities; and (iii) the adviser maintains certain records, including, for example, records that evidence a complete list of securities recommended by the adviser in the preceding year for the specific investment category covered by the advertisement and the criteria 861 See, e.g., Scientific Market Analysis, SEC Staff No-Action Letter (Mar. 24, 1976) (the staff would not recommend enforcement action when an investment adviser offers a list of past specific recommendations, provided that the adviser offers to provide the list free of charge); and Kurtz Capital Management, SEC Staff No-Action Letter (Jan. 18, 1988) (the staff would not recommend enforcement action relating to an adviser’s distribution of past specific recommendations contained in third-party reports, provided that the adviser sends only bonafide unbiased articles). 862 See The TCW Letter (not recommending enforcement action based on certain representations such as presenting best and worst-performing holdings on the same page with equal prominence; disclosing that the holdings identified do not represent all of the securities purchased, sold or recommended for the adviser’s clients and that past performance does not guarantee future results; and maintaining certain records, including, for example, evidence supporting the selection criteria used and supporting data necessary to demonstrate the calculation of the chart or list’s contribution analysis). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 used to select the specific securities listed in the advertisement.863 Finally, the Commission has brought enforcement actions related to the presentation of performance results in advertisements. For example, we have alleged in settled enforcement actions that the performance information that certain advisers included in their advertisements failed to disclose all material facts, and thus created unwarranted implications or inferences.864 Our staff has also expressed its views as to the types of disclosures that would be necessary in order to make the presentation of certain performance information in advertisements not misleading.865 Our staff has taken the position that the failure to disclose how material market conditions, advisory fee expenses, brokerage commissions, and the reinvestment of dividends affect the performance results would be misleading.866 Our staff has also 863 See Franklin Letter (not recommending enforcement action based on certain representations including that the adviser would disclose in the advertisement that the specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients, and that the investor not assume that investments in the securities identified and discussed were or will be profitable); see also supra footnote 204 (citing Clover Letter, Stalker Letter, and Eberstadt Letter regarding untrue or misleading implications). 864 See, e.g., In the Matter of Van Kampen Investment Advisory Corp., Release No. IA–1819 (Sept. 8, 1999) (settled order); In the Matter of Seaboard Investment Advisers, Inc., Release No. IA–1431 (Aug. 3, 1994) (settled order). 865 See, e.g., Clover Letter (not recommending enforcement action provided that certain disclosures about included performance results are made). Regarding mutual funds, our staff has stated that it would not recommend enforcement action if an advertisement included performance data from private accounts that are substantially similar in size and investment strategy to the fund in the fund’s prospectus or sales literature if the prospectuses or advertisements: (i) Disclose that the performance results are not those of the fund and should be considered a substitute for such performance; (ii) include the fund’s performance results if such results exist and; (iii) disclose all material differences between the institutional accounts and the fund. See Nicholas-Applegate Mutual Funds, SEC Staff No-Action Letter (Aug. 6, 1996); GE Funds, SEC Staff No-Action Letter (Feb. 7, 1997); ITT Hartford Mutual Funds, SEC Staff NoAction Letter (Feb. 7, 1997). 866 See Clover Letter (not recommending enforcement action provided that if an adviser compares performance to that of an index, it would disclose all material factors affecting the comparison) See also Investment Company Institute, SEC Staff No-Action Letter (May 5, 1988); Association for Investment Management and Research, SEC Staff No-Action Letter (Dec. 18, 1996) (not recommending enforcement action provided that gross performance results may be provided to clients so long as this information is presented on a one-on-one basis or alongside net performance with appropriate disclosure.) See Also Securities Industry Association, SEC Staff NoAction Letter (Nov. 27, 1989) (not recommending enforcement action provided that an adviser that PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 considered materially misleading the suggestion of potential profits without disclosure of the possibility of losses.867 Our staff has taken the position that prior performance results of accounts managed by a predecessor entity may be used so long as: (i) The person responsible for such results is still the adviser; (ii) the prior account and the present account are similar enough that the performance results would provide relevant information; (iii) all prior accounts that are being managed in a substantially similar fashion to the present account are being factored into the calculation; and (iv) the advertisement includes all relevant disclosures.868 More recently, our staff has taken the position that, based on certain representations, a surviving investment adviser following an internal restructuring may continue to use the performance track record of a predecessor advisory affiliate to the same extent as if the restructuring had not occurred.869 In addition, the Commission believes that many advisers currently prepare and present GIPS standard-compliant performance information, and also that many advisers currently prepare annual performance information for investors. The GIPS standards require advisers to provide certain reports to prospective clients at a specific time, and the standards provide guidance on how advisers can determine whether a potential investor qualifies as a ‘‘prospective client.’’ 870 advertises historical net performance using a model fee makes certain disclosures). 867 See Clover Letter (stating staff’s view that an adviser’s advertisement that suggests or makes claims about the potential for profit without also disclosing the possibility of loss may be misleading for purposes of rule 206(4)–1(a)(5)). 868 See Horizon Letter; see also Great Lakes Letter (not recommending enforcement action if a successor adviser, composed of less than 100 percent of the predecessor’s committee, used the preceding performance information in their calculation when there was a substantial identification of personnel, and noting that without substantial identification of personnel in such a committee, use of the data would be misleading even with appropriate disclosure). 869 See South State Bank Letter (the staff stated that it would not recommend enforcement action on representations including, for example, that the successor adviser would operate in the same manner and under the same brand name as the predecessor adviser). 870 Global Investment Performance Standards (GIPS) for Firms (2020), Provision 1.A.11. (requiring the firm to ‘‘make every reasonable effort to provide a GIPS Composite Report to all Prospective Clients when they initially become Prospective Clients’’), and GIPS Standards Handbook for Firms (Nov. 2020), Discussion of Provision 1.A.11. (stating that ‘‘[i]t is up to the firm to establish policies and procedures for determining who is considered to be a prospective client. These include policies and procedures for determining when an interested party becomes a prospective client. An interested E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 Regarding the use of model performance results, the staff has taken the position that such results are misleading under rule 206(4)–1(a)(5) if the investment adviser does not make certain disclosures.871 The Commission has also taken the position that the use of backtested performance data may be misleading unless accompanied by disclosure detailing the inherent limitations of data derived from the retroactive application of a model developed with the benefit of hindsight.872 Moreover, staff have taken the position that the rule 204–2(a)(16) requirement to keep records of documents necessary to form the basis for performance data provided in advertisements also applies to a successor’s use of a predecessor’s performance data.873 Certain investment advisers that must comply with the final rule are also party becomes a prospective client when two tests are met. First, the interested party must have expressed interest in a specific composite strategy or strategies. Second, the firm must have determined that the interested party qualifies to invest in the respective composite strategy’’). 871 Id. See also In the Matter of LBS Capital Mgmt. Inc., Release No. IA–1644 (July 18, 1997) (settled order) (The Commission brought an enforcement action and stated its view that the marketing materials were misleading and that the Commission looks at ‘‘investment sophistication or acumen’’ of the recipients of an advertisement will look into the identity of the intended recipient of advertisement when determining if the results were misleading.). 872 See In the Matter of Market Timing Systems, Inc., et al., Release No. IA–2047 (Aug. 28, 2002) (settled order) (The Commission brought an enforcement action against, among others, a registered investment adviser, asserting that its advertising was misleading because it failed to disclose that performance results advertised were hypothetical and generated by the retroactive application of a model, and in other cases failed to disclose the relevant limitations inherent in hypothetical results and the reasons why actual results would differ); see also In the Matter of Leeb Investment Advisers, et al., Release No. IA–1545 (Jan. 16, 1996) (settled order) (The Commission brought an enforcement action against, among others, a registered investment adviser, asserting that advertising mutual fund performance using a market-timing program based on backtested performance was misleading because the program changed during the measurement period and certain trading strategies were not available at the beginning of the measurement period.). See also In the Matter of Schield Mgmt. Co., et al., Release No. IA–1872 (May 31, 2000) (settled order) (The Commission brought an enforcement action against, among others, a registered investment adviser, asserting that advertisements presenting backtested results were misleading in violation of section 206(2) and rule 206(4)–1 because, among other things, they failed to disclose or inadequately disclosed that the performance was backtested, and stating that labeling backtested returns ‘‘hypothetical’’ did not fully convey the limitations of the performance.). 873 Rule 204–2(a)(16); See Great Lakes Letter (not recommending enforcement action and stating the staff’s view that the requirement in rule 204– 2(a)(16) applies to a successor’s use of a predecessor’s performance data.) VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 subject to other regulatory regimes that govern communications and advertisements. For example, investment advisers that are also registered as broker-dealers must comply with FINRA’s rules.874 FINRA rule 2210 governs broker-dealers’ communications with the public, including communications with retail and institutional investors, and provides standards for the content, approval, recordkeeping, and filing of communications with FINRA. In particular, FINRA’s rule 2210(d)(6) requires any retail communication or correspondence providing any testimonial concerning the investment advice or investment performance of a member or its products to prominently disclose: (i) The fact that the testimonial may not be representative of the experiences of other customers; (ii) the fact that the testimonial is no guarantee of future performance or success; and (iii) if more that $100 is paid for the testimonial, the fact that it is a paid testimonial. FINRA rule 2210(d)(6) also requires that if a testimonial in any type of communication concerns a technical aspect of investing, the person making the testimonial must have the knowledge and experience to form a valid opinion. Regulation BI also applies to testimonials or endorsements by promoters that are registered brokerdealers to the extent such testimonials or endorsements are recommendations to retail customers under that regulation. Additionally, communications to investors in private funds are subject to various statutory and regulatory anti-fraud provisions, such as rule 206(4)–8 under the Advisers Act, section 17(a) of the Securities Act, section 10(b) of the Exchange Act and rule 10b–5 thereunder. c. Data on Investment Advisers Based on Form ADV filings, as of August 1, 2020, 13,724 investment advisers were registered with the Commission. Of these registered investment advisers (‘‘RIAs’’), 11,653 reported that they were ‘‘large advisory firms,’’ with regulatory assets under management (‘‘RAUM’’) of at least $90 million. 512 reported that they were ‘‘mid-sized advisory firms,’’ with RAUM of between $25 million and $100 million, and 1,561 did not report as either, which implies that they have 874 Similarly, investment advisers registered with the Commission may also be registered with the National Futures Association and may be subject to additional compliance rules on sales practices and promotional material. See NFA Compliance Rules 2–29 and 2–36. See also Municipal Securities Rulemaking Board rules G–21(a) and G–40. PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 13097 regulatory assets under management of under $25 million.875 Form ADV disclosures show $97.05 trillion in RAUM for all RIAs, with an average of $7.07 billion and a median of $350 million. These values show that the distribution of RAUM is skewed, with more RIAs managing assets below the average, than above. The majority of RIAs report that they provide portfolio management services for individuals and small businesses.876 In aggregate, RIAs have over $97 trillion in RAUM. A substantial percentage of RAUM at investment advisers is held by institutional investors, such as investment companies, pooled investment vehicles, and pension or profit-sharing plans.877 Based on staff analysis of Form ADV data, 8,134 (59 percent) of RIAs have some portion of their business dedicated to individual clients, including both high net worth and non-high net worth individual clients.878 In total, firms that have some portion of their business dedicated to high net worth clients have approximately $44 trillion of RAUM,879 of which $12 trillion is attributable to individual clients, including both non875 From Form ADV: A ‘‘Large advisory firm’’ either: (a) Has regulatory assets under management of $100 million or more or (b) has regulatory assets under management of $90 million or more at the time of filing its most recent annual updating amendment and is registered with the SEC; a ‘‘midsized advisory firm’’ has regulatory assets under management of $25 million or more but less than $100 million and either: (a) Not required to be registered as an adviser with the state securities authority of the state where they maintain their principal office and place of business or (b) not subject to examination by the state securities authority of the state where they maintain their principal office and place of business. 876 Of the 13,724 RIAs, 8,795 (64 percent) report in Item 5.G.(2) of Form ADV that they provide portfolio management services for individuals and/ or small businesses. In addition, there are approximately 17,932 state-registered investment advisers. Approximately 14,851 state-registered investment advisers are retail facing (see Item 5.D. of Form ADV). 877 See Table 1. 878 We use the responses to Items 5(D)(a)(1), 5(D)(a)(3), 5(D)(b)(1), and 5(D)(b)(3) of Part 1A of Form ADV. If at least one of these responses was filled out as greater than 0, the firm is considered as providing business to retail investors. Form ADV Part 1A. Of the 8,134 investment advisers serving individual clients, 356 are also registered as brokerdealers. By high net worth (HNW) individual, we are referring to an individual who is a ‘‘qualified client’’ as defined in rule 205–3 under the Advisers Act. Generally, this means a natural person with at least $1,000,000 in assets under the management of an adviser, or whose net worth exceeds $2,100,000 (excluding the value of his or her primary residence). See rule 205–3(d)(1); Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205–3 under the Investment Advisers Act of 1940, Release No. IA–4421 (June 14, 2016). 879 The aggregate RAUM reported for these investment advisers that have retail investors includes both retail RAUM as well as any institutional RAUM also held at these advisers. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations high net worth and high net worth clients. Approximately 7,115 RIAs (52 percent) serve 35.4 million non-high net worth individual clients and have approximately $5.2 trillion in RAUM attributable to the non-high net worth clients, while nearly 7,694 RIAs (56 percent) serve approximately 4.9 million high net worth individual clients with $7.5 trillion in RAUM attributable to the high-net worth clients. In addition, there are 3,517 broker dealers registered with FINRA, 442 identify themselves as dually registered broker-dealers, and 2,394 investment advisers (17%) report an affiliate that is a broker-dealer. 2. Market for Solicitation Activity a. Current Regulations The current solicitation rule makes paying a cash fee for referrals of advisory clients unlawful unless the solicitor and the adviser enter into a written agreement. A solicitor’s written agreement with an advisor must also contain an undertaking by the solicitor jbell on DSKJLSW7X2PROD with RULES2 c. RIAs to Private Funds Based on Form ADV data from August 1, 2020, 4,925 RIAs report that they are advisers to private funds, and 54 of these RIAs report that they are a small entity.886 Of the RIAs that advise private funds, 1,641 RIAs report that they use the services of solicitors that are not their employees or themselves (‘‘related marketers’’ in Form ADV). Among the rule 206(4)–3(a)(1)(ii). rule 206(4)–3(b). 882 See rule 206(4)–3(a)(2)(iii)(B). to perform its duties under the agreement in a manner consistent with the instructions of the investment adviser and the provisions of the Advisers Act and the rules thereunder. In addition, among other provisions, it requires the solicitor to provide the client with a current copy of the investment adviser’s Form ADV brochure and a separate written solicitor disclosure document at the time of solicitation.880 The solicitor disclosure must contain information highlighting the solicitor’s financial interest in the investor’s choice of an investment adviser.881 Further, advisers are required to have a reasonable belief that solicitors are complying with these contractual requirements. In addition, the solicitation rule prescribes certain methods of compliance, such as requiring an adviser to receive a signed and dated acknowledgment of receipt of the required disclosures.882 The solicitation rule also prohibits advisers who have RIAs that hire solicitors, each RIA uses 3 solicitors on average, while the median number of solicitors reported is 1, and the maximum is 67. There are 343 RIAs that indicate that they have at least one related marketer, and 206 of them indicate that they only rely on related marketers. Among RIAs that report using a related marketer, the average number of related marketers reported is 1.5, while the median 880 See 883 See 881 See 884 Response VerDate Sep<11>2014 21:12 Mar 04, 2021 rule 206(4)–3(a)(1)(ii). to Item 8(h)(1) of Part 1A of Form ADV. Jkt 253001 PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 engaged in certain misconduct from acting as solicitors.883 b. Data on Solicitors Given that there is no current registration requirement for solicitors of investment advisers based on their solicitation activity, our view on solicitation practices is through the disclosures made by RIAs in Form ADV. As of August 1, 2020, 27 percent of RIAs reported compensating any person besides an employee for client referrals.884 As shown in Figure [1], the share of RIAs that reported this type of arrangement has declined since 2009. However, this figure does not capture employees of an investment adviser that are compensated for client referrals, who are solicitors under the solicitation rule. The downward trend in Figure [1] may suggest that the use of solicitors is declining through an overall decline in client referral activity. Alternatively, the data presented in the figure is also consistent with employers shifting their solicitation activities in-house. reported is 1 and the maximum is 24. 1,315 RIAs indicate that they have at least one marketer that is registered with the SEC: The average number of marketers, registered with the SEC as either IAs or BDs, employed by these RIAs is 3.1, while the median number reported is 2 and the maximum is 67. Finally, 570 RIAs indicate that they have at least one non-US marketer: The average number of non-US marketers 885 Based on responses to Item 8(h)(1) of Part 1A of Form ADV. 886 Form ADV Item 5.F.2 and Item 12.A. E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.000</GPH> 13098 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations reported among these RIAs is 3.1, while the median is 1 and the maximum is 60.887 3. RIA Clients RIAs are required to report their specific number of clients in 13 different categories and a catch-all ‘‘Other’’ category.888 Based on Form ADV data collected as of August 1, 2020, RIAs report having a total of approximately 42 million clients, and $97 trillion in RAUM. Individual investors constitute the majority (95 percent) of the RIA client base. Columns 2 and 3 of Table 1 present the breakdown of the RIA client base, and column 4 shows the total RAUM from each investor category as of August 2020. Non-high net worth (HNW) individuals comprise the largest group 13099 of advisory clients by client number—83 percent of total clients. The number of HNW individuals is only 12 percent of advisory clients, but RAUM from HNW individuals makes up almost 8 percent of the industry-wide RAUM ($97 trillion) in 2018, while RAUM from non-HNW individuals accounts makes up about 5.4 percent. TABLE 1—INVESTOR CATEGORIES BY CLIENTS, RAUM, AND ADVISERS 889 Investor categories Non-HNW individuals ........................................................... HNW individuals ................................................................... Other investment advisers ................................................... Corporations or other businesses ........................................ Pension and profit sharing plans ......................................... Other .................................................................................... Pooled Investment Vehicles (PIVs)—Other ......................... State/municipal entities ........................................................ Charities ............................................................................... Banking or thrift institutions ................................................. Insurance companies ........................................................... PIVs—Investment companies .............................................. Sovereign Wealth Funds and Foreign official institutions ... PIVs—Business development companies ........................... jbell on DSKJLSW7X2PROD with RULES2 Clients (%) Clients 35,433,736 4,916,781 863,785 321,471 386,897 279,025 83,942 24,761 99,968 9,833 12,070 26,520 1,643 159 83.451 11.580 2.034 0.757 0.911 0.657 0.198 0.058 0.235 0.023 0.028 0.062 0.004 0.0004 RAUM (billions) $5,228.92 7,465.29 1,250.71 2,674.23 6,504.54 970.50 25,883.53 3,565.01 1,189.66 992.93 6,257.69 33,362.03 1,544.11 132.15 RAUM (%) 5.39 7.69 1.29 2.76 6.70 1.00 26.68 3.67 1.23 1.02 6.45 34.39 1.59 0.14 Advisers 7,115 7,694 548 3,320 3,933 951 5,354 970 3,302 281 711 1,583 213 87 A number of surveys show that individuals 890 predominantly find their current financial firm or financial professional from personal referrals by family, friends, or colleagues, rather than through advertisements.891 For instance, a 2008 study conducted by RAND reported that 46 percent of survey respondents indicated that they located a financial professional from personal referral, although this percentage varied depending on the type of service provided (e.g., only 35 percent of survey participants used personal referrals for brokerage services). After personal referrals, RAND 2008 survey participants ranked professional referrals (31 percent), print advertisements (4 percent), direct mailings (3 percent), online advertisements (2 percent), and television advertisements (1 percent), as their source of locating individual professionals. The RAND 2008 study separately inquired about locating a financial firm,892 in which a smaller group of respondents reported selecting a financial firm (of any type) based on: Referral from family or friends (29 percent), professional referral (18 percent), print advertisement (11 percent), online advertisements (8 percent), television advertisements (6 percent), direct mailings (2 percent), with a general ‘‘other’’ category (36 percent). The Commission’s 2012 Financial Literacy Study provides similar responses, although it allowed survey respondents to identify multiple sources from which they obtained information that facilitated the selection of the current financial firm or financial professional.893 In the 2012 Financial Literacy Study,894 51 percent of survey participants received a referral from family, friends, or colleagues. Other sources of information or referrals came from: Referral from another financial professional (23 percent), online search (14 percent), attendance at a financial professional-hosted investment seminar (13 percent), advertisement (e.g., television or newspaper) (11.5 percent), other (8 percent), while approximately 4 percent did not know or could not remember how they selected their financial firm or financial professional. Twenty-five percent of survey respondents indicated that the ‘‘name or reputation of the financial firm or financial professional’’ affected the selection decision. 887 Data on solicitors (marketers) hired by RIAs to private funds are collected from Form ADV Section 7.B(1) (28). 888 Form ADV Item 5.D. of Part 1A. 889 Data taken from Form ADV data. 890 The surveys generally use ‘‘retail investors’’ to refer to individuals that invest for their own personal accounts. 891 See Angela A. Hung, et al., Investor and Industry Perspectives on Investment Advisers and Broker-Dealers, RAND Institute for Civil Justice Technical Report (2008), available at https:// www.rand.org/content/dam/rand/pubs/technical_ reports/2008/RAND_TR556.pdf (‘‘RAND 2008’’), which discusses a shift from transaction-based to fee-based brokerage accounts prior to certain regulatory changes at the time; see also Financial Literacy Study, supra footnote 846. 892 Only one-third of the survey respondents that responded to ‘‘method to locate individual professionals’’ also provided information regarding locating the financial firm. 893 See Financial Literacy Study, supra footnote 846. 894 The data used in the 917 Financial Literacy Study comes from the Siegel & Gale, Investor Research Report (July 26, 2012), available at https:// www.sec.gov/news/studies/2012/917-financialliteracy-study-part3.pdf. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 D. Costs and Benefits of the Final Rule and Form Amendments The Commission is adopting a final combined marketing rule by amending rule 206(4)–1, which is related to advertisements, and eliminating rule 206(4)–3, which deals with solicitation. The final rule changes the definition of advertisement and generally expands the set of permitted advertisements. It includes general prohibitions of certain advertising practices, and will (i) impose requirements of or restrictions on investment adviser performance in advertisements, and (ii) permit investment advisers to use certain features in an advertisement, such as testimonials, endorsements, and thirdparty ratings, subject to certain conditions, such as disclosing E:\FR\FM\05MRR2.SGM 05MRR2 13100 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 information that would help investors evaluate the advertisement. The marketing rule, among other things, also applies disclosure, oversight, and disqualification requirements to compensated testimonials or endorsements, including those directed at prospective investors in private funds. The Commission is also adopting amendments to Form ADV that are designed to provide additional information regarding advisers’ marketing practices and amendments to the Advisers Act books and records rule to correspond to the features of the marketing rule. The final rule reflects market developments since 1961 and 1979, when rules 206(4)–1 and 206(4)–3, respectively, were adopted, as well as practices addressed in staff noaction letters. These market developments include advances in communication technology and marketing practices that did not exist at the time the rules were adopted and may fall outside of the scope of the current rules. As a result, the current rule is less effective at mitigating some information and search problems investors face when searching for investment advisers than when it was initially written.895 Advertisements falling in the two categories of communications defined as advertisements in the final rule are currently subject to different regulatory baselines and market practices. We discuss the costs and benefits of specific provisions of the final rule, taking care to note whether a cost or benefit applies to the first or the second prong of advertisement, or both. 1. Quantitative Estimates of Costs and Benefits The economic effects of the final rule are generally difficult to quantify for several reasons. First, there is little to no direct data suggesting how investment advisers and promoters might alter their marketing practices as a result of the final rule or mitigate the compliance burdens related to the final rule, and commenters did not provide any. It is difficult to quantify the impact that specific provisions of the final rule will have on adviser behavior because the final rule may influence adviser behavior in opposing directions. For example, it might motivate advisers to provide more information to potential investors that helps such investors more accurately evaluate those advisers’ abilities and potential fit with such investors’ preferences. Alternatively, the rule may introduce compliance burdens that disincentivize the creation of 895 See infra section III.B. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 communications that fall within the definition of advertisement. This could reduce the amount of information that advisers provide to potential investors through advertisements. Second, it is difficult to quantify the impact that the specific provisions of the final rule will have on investor behavior because the final rule may influence investor behavior in opposing directions. Disclosures might provide additional context for investors to make better decisions when choosing investment advisers; alternatively, they might not be used by investors, or might make them overconfident when making decisions.896 Without knowing the magnitude of these opposing effects, it is not possible to quantify the effects of specific provisions of the final rule. Finally, it is difficult to quantify the extent to which certain changes in adviser, promoter, and investor behavior enhance or diminish the welfare of specific market participants. For example, if investors increased the amount of advisers’ RAUM as a result of the final rule, it is not clear to what extent investor welfare would have improved, without knowing the extent to which the final rule also affected the quality of investment advisers with whom investors chose to invest. Further, if RAUM increased as advisers increased their marketing and incurred higher marketing expenditures, a portion of these expenditures could be transferred to investors through fees offsetting, in part, any increase in investor welfare. Some commenters directly addressed the cost estimates in the proposal.897 Two of these commenters stated that the proposal underestimated the number of advertisements that investment advisers use under the current rule.898 One commenter stated that heavy advertisers would be expected to create new advertisements 50 times per year, and update their advertisements 250 times per year.899 One commenter broadly criticized the cost estimates as too low, and also specifically criticized the proposal’s estimates of the number of advertisements that advisers would distribute.900 In response to commenters, we have adjusted our estimates of the annual number of advertisements that investment advisers will create.901 896 See 897 See infra section III.B. Fidelity, IAA, MFA/AIMA Comment Letters. 898 See Fidelity, IAA Comment Letters. 899 See Fidelity Comment Letter 900 See IAA Letter Comment Letter. 901 See infra section IV.B. PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 One commenter made several critiques of the cost estimates.902 The commenter separated its expected costs into three categories—implementation costs, ongoing costs, and management resource drain, arguing that the proposal failed to recognize whole types of costs. The commenter broadly criticized many of the quantitative estimates in the proposal as significantly underestimating the cost burden on investment advisers. The commenter specifically criticized the cost estimates for third-party rankings, hypothetical performance, and Form ADV changes, but did not provide additional estimates or data to use. Many of the quantitative estimates in the proposal were for the Paperwork Reduction Act (‘‘PRA’’), which are a subset of the total economic costs of the rule. Many of these total costs are difficult to quantify, for reasons mentioned above. However, given the commenter’s feedback on the categories and types of costs that the rules will impose on investment advisers, we have updated our analysis of the costs of the rule, as well as our PRA-related quantitative cost estimates. In the following sections, we have quantified some elements of the overall cost of the general anti-fraud prohibitions as part of the Commission’s Paperwork Reduction Act obligations. These are costs associated with the collection of information that are generated by the final rule, but do not represent the entire cost of each provision. 2. Definition of Advertisement The final rule’s definition of advertisement contains two prongs. The first prong generally captures traditional advertising, and changes the scope of communications that fall within the scope of the final rule. The first prong includes, among other communications, communications made to investors and potential investors in private funds advised by the adviser. The second prong generally includes the cashcompensated solicitation activity that occurs currently under rule 206(4)–3. In addition, the second prong will include non-cash compensated communications made by promoters and compensated solicitation activity for private fund investors. This definition of ‘‘advertisement’’ determines the scope of communications affected by the final rule, which determines, in part, the costs and benefits of the regulatory program set forth by the other components of the final rule (the ‘‘programmatic effects’’). For example, if 902 See E:\FR\FM\05MRR2.SGM MFA/AIMA Comment Letter. 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 the definition of ‘‘advertisement’’ is not sufficiently broad and excludes communications that could serve as a substitute for advertisements and that raise similar investor protection concerns, investment advisers might use these alternative communications to avoid the costs associated with complying with the final rule. This would reduce the effect of changes to the substantive provisions to the advertising rule that would regulate advertisements. Conversely, if the scope of communications captured by the final rule is too broad and captures communications that do not aim to attract clients, the amendments may impose costs on investment advisers while yielding insubstantial benefits. In response to the final rule’s definition of advertisement, investment advisers and promoters might modify their communication strategies in an effort to reduce the amount of communication that could be deemed to fall within the definition of ‘‘advertisement.’’ These strategic responses could, in turn, impose costs on some clients or investors, to the extent that they currently rely on communications by investment advisers or promoters that are advertisements to inform their decisions.903 If investment advisers or promoters respond by reducing the amount of such communications, both prospective and existing investors may need to search more intensively for information about investment advisers than they currently do or, alternatively, base their choice of financial professional on less information. This could result, for example, in inefficiencies to the extent that an existing client of an investment adviser is unaware of the breadth of services the investment adviser provided and incurs costs to open a new account with another investment adviser to obtain certain services. Similarly, a prospective client that receives less information from investment advisers and promoters might ultimately choose an investment adviser that is a poorer match for them or might be discouraged from seeking investment advice. These potential costs to investors depend on the extent to which the final rules cause investment 903 To the extent that broker-dealers and other third parties disseminate communications that are defined as advertisements under the final rule, including with respect to private funds, they may incur compliance costs associated with the final rule. These compliance obligations generally will be separate from any compliance obligations incurred under the requirements of the Exchange Act, the rules promulgated thereunder, and FINRA rules. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 advisers and promoters to reduce their advertisements. As discussed above, some of the affected parties whose communications will be newly defined as advertisements under the final rule may also be registered broker-dealers whose communications are subject to other regulatory regimes that govern communications and advertisements, including those under FINRA rules and, in some cases, Regulation BI. As a result, these parties will incur new compliance obligations with respect to communications subject to the final rule, and may incur incremental costs similar to other parties whose communications are also newly-subject to the rule. In general, however, to the extent that these parties may leverage existing compliance methods similar to those that they currently use, the programmatic effects of including these communications within the final rule’s definition of advertisement may be mitigated. Below, we address the costs and benefits associated with determining the scope of communications affected by the final rule through specific elements of the final rule’s definition of an advertisement.904 We address the costs and benefits of the two prongs of the definition separately. a. Communications Other Than Compensated Testimonials or Endorsements The first prong includes within the definition of an advertisement any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance information, and that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser. It also excludes (a) extemporaneous, live, oral communications, regardless of whether they are broadcast; (b) any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication; and (c) a 904 The specific costs and benefits of the rule’s changes to the substantive prohibitions and conditions applicable to advertisements are discussed in later sections. See infra section II.D.3– 8. PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 13101 communication that includes hypothetical performance that is provided: (i) In response to an unsolicited investor request or (ii) to a private fund investor in a one-on-one communication. i. Any Direct or Indirect Communication an Investment Adviser Makes The first prong includes communications directly or indirectly made by the adviser, regardless of whether they are prepared and disseminated by the adviser or by a third party. Prong one includes communications disseminated by an adviser that incorporate statements or content prepared by a third party, such as positive reviews from clients selectively picked by an adviser to be posted or attributed, materials an adviser helps draft to be distributed by third-party promoters, and endorsements organized by an adviser on social media. This provision (the phrase ‘‘directly or indirectly’’) does not differ from the current rule, and we therefore do not anticipate any significant costs or benefits to be generated directly by this provision. The first prong defines advertisements as communications made to more than one person, or to any number of persons if the communication includes hypothetical performance information that is not provided in response to an unsolicited investor request or to a private fund investor in a one-on-one communication. Because the definition’s limitation to communications to more than one person does not differ from the current rule, we generally do not anticipate any significant costs or benefits to be generated directly by this part of the rule.905 However, the inclusion of oneon-one communications with hypothetical performance information (except for hypothetical performance information that is provided in response to an unsolicited investor request or to a private fund investor) in the definition of advertisement represents a change from the current rule.906 We expect that 905 The final rule does contain a related compliance and recordkeeping requirement that requires investment advisers to retain records of communications addressed to more than one person, which we discuss in further detail later. See infra section III.D.8. 906 The rule excludes from the first prong of the advertisement definition a communication that includes hypothetical performance that is provided in response to an unsolicited investor request for such information or to a private fund investor in a one-on-one communication. See rule 206(4)– 1(e)(1)(i)(C). Because the current advertising rule excludes one-on-one communications from the definition of advertisement, we do not anticipate E:\FR\FM\05MRR2.SGM Continued 05MRR2 13102 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations this change could produce costs and benefits with respect to these one-onone communications that are similar to those described below that are associated with prong one’s inclusion of communications that offer investment advisory services to prospective investors, including for review and monitoring of communications. While the current definition of advertisement includes communications directly or indirectly made by the adviser, it only explicitly covers written, radio, or television advertisements. As a result, the first prong of the definition could cover additional communications with prospective clients as compared to the current definition. This change will further extend the investor protection and benefits of the final rule.907 Investment advisers will also incur costs directly as a result of this change, which may include dedicating personnel time, or conducting training for personnel to determine the extent to which the substantive content of one of these newly-covered types of communication subjects it to the final rule.908 These costs may be mitigated to the extent that investment advisers may be able to leverage existing oversight methods similar to those that they currently use, including those used by dual-registrant advisers or promoters who are also broker-dealers in connection with compliance with FINRA’s rules,909 for example, in communicating with prospective clients through intermediaries. Additionally, investment advisers might reduce certain types of communications to avoid having to bear these costs of complying with the final rule, which may mitigate the benefits of additional information in advertisements available to investors.910 ii. Offers the Investment Adviser’s Investment Advisory Services With Regard to Securities to Prospective Clients or Investors in a Private Fund Advised by the Investment Adviser jbell on DSKJLSW7X2PROD with RULES2 Prong one also includes communications that offer the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by that this exclusion will result in significant costs or cost savings for advisers. 907 See, e.g., infra sections III.D.3; III.D.4; III.D.5. 908 See supra section III.D.1 and footnote 902. 909 See supra section II.A.2.b.i. 910 The final rule contains a related compliance and recordkeeping requirement that requires investment advisers to retain records of communications addressed to more than one person, which we discuss in further detail later. See infra section III.D.8. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 the investment adviser. This prong will expressly apply to communications to prospective investors in private funds. By including communications that offer the adviser’s investment advisory services with regard to securities to private fund investors, the final rule will provide more specificity (and certainty) regarding what we believe to be untrue or misleading statements that advisers must avoid in their advertisements, which may reduce compliance costs for some investment advisers. On the other hand, to the extent that an adviser’s current practices differ from the final rule, an investment adviser may incur some increased costs to review and monitor its communications with potential investors for general compliance purposes. An investment adviser may respond by reducing the number of these advertisements or the amount of information it distributes to potential investors. This could, in turn, reduce the amount of information available to potential investors in these private funds. An investment adviser to a private fund also may respond by not seeking potential investors likely to have less money to invest in the private fund, reducing investment opportunities for these investors. iii. Offers New Investment Advisory Services With Regard to Securities to Current Clients or Investors in a Private Fund Advised by the Investment Adviser The final definition of advertisement under the first prong also includes communications that offer new investment advisory services with regard to securities to existing clients or investors in a private fund advised by the investment adviser. Investment advisers will incur costs similar to those described above that are associated with prong one’s inclusion of communications that offer investment advisory services to prospective investors, including for review and monitoring of communications. However, to the extent that an adviser uses a single set of communications aimed at both new and existing clients, these costs may be mitigated because the adviser may incur only a single set of costs for both prospective and existing investors. b. Compensated Testimonials and Endorsements The second prong of the final definition of advertisement includes testimonials or endorsements for which compensation is provided, excluding any information contained in a statutory or regulatory notice, filing, or other PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication. The baseline for these advertisements is generally shaped by the current solicitation rule, which obligates advisers to enter into written agreements with solicitors to require them to act in a manner consistent with the Advisers Act and rules, including the current advertising rule.911 Under the current solicitation rule, investment advisers must have a reasonable belief that solicitors are complying with this written agreement. Furthermore, solicitations of private fund investors are not subject to the current solicitation rule. Prong two will scope in non-cash compensated testimonials and endorsements and compensated testimonials and endorsements to private fund investors, including communications from solicitors for impersonal advisory services, and, as a result, will extend the investor protection benefits of the final rule to the investors who receive these communications. Similarly, it will impose certain costs on advisers and persons who are solicitors under the current rule, including costs associated with oversight of these communications not currently subject to the rule, including endorsements to private fund investors.912 Advisers may respond by reducing the number of these advertisements or the amount of information they distribute to potential investors. Similarly, advisers to private funds also may respond by not seeking potential investors likely to have less money to invest in the private fund, reducing investment opportunities for these investors. Prong two does not contain the same exclusion for one-on-one communications as prong one. Oversight of one-on-one communications will likely involve greater costs for investment advisers compared to those addressed to more than one person because one-on-one communications have the potential for more variety and volume in their content. However, one-on-one solicitations are subject to the current solicitation rule. Therefore, there will likely be incrementally greater costs for advisers overseeing promoters under the final rule. Of these incremental costs, 911 Under the cash solicitation rule, certain affiliated advisers are not required to satisfy all of the elements of the written agreement. See rule 206(4)–3(a)(2)(ii) and (iii). 912 See infra sections III.D.3–8 for discussion of the direct costs and benefits of the requirements of the rule. E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations the increase in costs is attributable less to the inclusion of one-on-one communications and more to the expansion in compensation type (from cash to non-cash) and the expanded types of persons who would be promoters under the final rule as compared to solicitors under the current solicitation rule. Extending the scope of the rule to communications made by solicitors who receive non-cash compensation may have further benefits for investors. Because solicitations provided in connection with non-cash compensation that solicitors might receive generate nearly identical conflicts of interest to solicitations provided in connection with cash compensation, prong two may reduce the risk that investors might be unaware of such conflicts for a larger set of communications. For example, many advisers use brokerage—a form of noncash compensation—to reward brokers that refer them to investors. This practice presents advisers with conflicts of interest as the brokers’ interests may not be aligned with investors’ interests. Including non-cash compensated testimonials and endorsements in the definition of advertisement would also give cash and non-cash compensation more equal regulatory treatment for these purposes, which will enhance competition between promoters that accept non-cash compensation and those that accept cash compensation. Additionally, to the extent that investment advisers currently direct order flow to broker-dealers with lower execution quality, the final rule’s inclusion of non-cash compensation into the definition of advertisement could potentially affect quality of execution. If the final rule’s requirements for non-cash compensation impose regulatory burdens that reduce the usage of directed brokerage towards brokers with lower quality of execution, these investment advisers might instead choose brokers with higher execution quality, which could result in a benefit for their investors. The extent of additional benefits and costs attributed to prong two of the definition will be mitigated to the extent that solicitors previously entered into written agreements obliging them to act in a manner consistent with the Advisers Act and its rules, including the current advertising rule. As a result of such agreements, the additional costs and benefits of the final rule’s substantive provisions for these solicitors will generally be limited to changes in the programmatic effects of the final rule as compared to the current advertising rule. Any solicitors making VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 communications subject to the final rule who did not previously enter into such a contract will, however, incur these costs fully and also incur costs associated with the creation of written agreements. The benefits and costs attributed to prong two may also be mitigated to the extent that advisers and promoters were previously complying with the current solicitation rule with respect to endorsements to private fund investors and to the extent that some aspects of the final rule overlap with the scope of rule 206(4)–8 under the Advisers Act, section 17(a) of the Securities Act, or section 10(b) and rule 10b–5 under the Exchange Act. c. Exclusions From the Definition of Advertisement The first prong of the definition of an advertisement excludes extemporaneous, live, oral communications. The current rule does not, however, include these communications unless they are broadcast by radio or television. As a result, to the extent that some extemporaneous, live, oral communications were previously transmitted by radio or television or otherwise subject to the current advertising rule, the first prong of the definition could cover fewer of these communications with investors than the current definition. While this change could reduce investor protection and benefits of the final rule to investors with respect to these communications, it may also reduce the costs associated with the fact that advisers might avoid making any extemporaneous communications because of the difficulties in ensuring that they comply with the requirements of the rule. Both prongs of the definition of advertisement contain an exception for any statutorily or regulatory required notice, filing, or communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication. These exceptions are designed to reduce the likelihood that the final rule imposes costs or burdens on communications unrelated to advertising, or adds costs or burdens for communications already regulated by the Commission. The current advertising rule does not exclude statutory or regulatory notices, so the final rule will entail a reduction in costs for investment advisers to the extent they currently bear costs to comply with the advertising rule for their statutory or regulatory notices. Advisers will, however, continue to incur potential liability for these PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 13103 statements under applicable anti-fraud provisions. 3. General Prohibitions The final rule generally prohibits certain marketing practices as a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts. In general, we anticipate that the introduction of these general prohibitions will generate new interpretive questions regarding whether a particular communication is prohibited, which will impose compliance costs on investment advisers, including costs of legal advice and managerial resources, on an initial and ongoing basis. In addition, promoters for investment advisers will bear similar compliance costs, such as for legal advice and managerial resources.913 Below, we analyze the costs and benefits of these general prohibitions.914 The baseline for analyzing different types of advertisements may, however, be different. While advertisements as defined under the final rule will be subject to a single set of prohibitions and requirements, under the baseline, the same advertisements as defined by the final rule may be subject to different regulatory requirements. For example, solicitors that receive cash compensation are currently subject to the solicitation rule and, because they have entered into written agreements that oblige them to act in a manner consistent with the Advisers Act and its rules, the advertising rule. However, some communications that meet the definition of an advertisement do not currently fall under the solicitation rule or the advertising rule. For example, non-cash compensated promoters, and promoters for an adviser’s impersonal advisory services currently are not subject to the requirements of rule 206(4)–3, while under the final rule certain of their communications would be defined as advertisements and subject to the general prohibitions. Further, communications to prospective and current investors in private funds are currently subject to rule 206(4)–8, section 17(a) of the Securities Act, 913 See supra section III.D.1 and footnote 902. addition to the general prohibitions discussed below, the final rule specifically prohibits (i) any untrue statement of a material fact, or omission to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it was made, not misleading and (ii) otherwise materially misleading statements. These provisions prohibit statements that would be prohibited by the current advertising rule and rule 206(4)–8, for example, and as a result, we do not believe that these provisions will generate significant costs or benefits. 914 In E:\FR\FM\05MRR2.SGM 05MRR2 13104 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 section 10(b) of the Exchange Act, and rule 10b–5 thereunder. We have quantified a subset of the costs associated with the general antifraud prohibition, specifically, the burden of information collection costs estimated for the purposes of the Paperwork Reduction Act. The general anti-fraud prohibitions do not create any collection of information burdens, with one exception. The prohibition on unsubstantiated statements of material fact might cause investment advisers to create records to substantiate statements either contemporaneously or after the fact, and we estimate the costs of this collection. We estimate these costs to be $657 for each investment adviser per year, for a total cost of $9,016,668 per year.915 a. Unsubstantiated Material Statements of Fact The final rule contains a prohibition on material statements of fact that an investment adviser does not have a reasonable basis for believing that it will be able to provide substantiation on demand by the Commission. Investment advisers would need to gather materials needed to substantiate the material statements of fact made in advertisements only if requested by the Commission. Currently, there is no express prohibition of making statements in advertisements that the adviser does not have a reasonable basis for believing it will be able to substantiate on demand, in the current rule or the general anti-fraud provisions. This prohibition will benefit current and prospective investors by reducing the likelihood that advisers will make material statements of fact in advertisements that are not able to be substantiated, a practice which could potentially mislead investors. Additionally, the prohibition could incentivize investment advisers to invest additional resources to substantiate material statements of fact. Some commenters noted that a substantiation requirement would be burdensome,916 and we recognize that there will be costs associated with this requirement for advisers. We note, however, that commenters raised these concerns about the proposed requirement, which was not limited to material statements of fact. Nonetheless, there may, for example, be costs to determine whether a statement is a material statement of fact, whether the adviser has a reasonable basis to believe 915 See infra section IV.B.1. e.g., MFA/AIMA Comment Letter I; FPA Comment Letter; NVCA Comment Letter; Fried Frank Comment Letter. 916 See, VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 that it will be able to substantiate the statement upon demand, or how statements or facts would be substantiated on demand. These costs could include, among other things, personnel time for review and documentation, as well as direct costs when demanded by the Commission, which might entail personnel time to prepare materials for the Commission. Further, while an adviser may choose to substantiate the material fact after it has received the demand from the Commission, we recognize that some advisers may choose to create such records contemporaneously with the advertisement for sake of efficiency or to manage their compliance risk, which will cause them to incur compliance costs. Compliance costs may, however, be mitigated to the extent that advisers currently retain records that effectively substantiate performance advertising 917 and, upon inquiry by the staff or the Commission, demonstrate that the adviser’s statements are not untrue statements of material fact, consistent with the Advisers Act and its rules. These costs may be further mitigated to the extent that advisers believe there are external sources that support the material statements of fact they make in advertisements, which they also believe will be available at the time of any subsequent demand by Commission staff. We expect that this may be the case for some of the material facts, and costs may be further mitigated to the extent that advisers do not prepare this support in advance of such demand. We recognize that the costs associated with substantiation might induce some investment advisers to avoid making material statements of fact that are too costly to substantiate. This could yield benefits for clients or investors, to the extent that any such advertisement not made has an increased risk of being misleading. These decisions could, however, have costs to clients or investors to the extent that they would receive less information about an adviser, and costs to advisers to the extent that they forgo some communications to clients or investors. b. Untrue or Misleading Implications or Inferences The final rule contains a prohibition on information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser. There is no provision in the current advertising rule that expressly prohibits 917 See PO 00000 supra footnote 221. Frm 00082 Fmt 4701 Sfmt 4700 this type of information, though in staff no-action letters, the staff has stated its view that in some circumstances an advertisement may be false or misleading if it implies, or a reader would infer from it, something false.918 Further, the current advertising rule and rule 206(4)–8 each generally prohibit misleading statements. To the extent that advisers or promoters do not already omit information that would reasonably be likely to cause an untrue or misleading implication or inference, this prohibition to be drawn concerning a material fact relating to the investment adviser will benefit current and prospective investors by removing this type of information from advertisements, which has the potential to mislead investors and impair their ability to find an investment adviser. In addition, because this prohibition will generally require the adviser to consider the context and totality of information presented such that it would not reasonably be likely to cause any misleading implication or inference to be drawn concerning a material fact relating to the investment adviser, the prohibition will entail compliance costs to investment advisers and promoters, including those related to interpretation of the application of the new rule. We expect, however, that the costs and benefits of the prohibition will likely be mitigated, to the extent that advisers and promoters currently exclude from their communications this type of information. c. Failure To Provide Fair and Balanced Treatment of Material Risks or Other Limitations The final rule contains a prohibition on advertisements which discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any associated material risks or other limitations associated with the potential benefits. Currently, while Form ADV requires disclosure of certain material risks, there is no provision in the current advertising rule, rule 206(4)–8, the other rules under the Advisers Act, or in the Advisers Act itself that explicitly requires such treatment. This prohibition will benefit current and prospective investors by requiring material risks and other limitations to be presented in a fair and balanced manner included in advertisements. This could provide such investors with additional, higher quality, information about 918 See E:\FR\FM\05MRR2.SGM supra section II.B.2; III.C.1.b. 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 investment advisers and additional context for the claims they make in their advertisements. This information would allow investors to find better matches with investment advisers, and would reduce the costs associated with the search for investment advisers. This prohibition, however, may cause advisers and promoters to incur costs associated with changes to compliance processes, and investment advisers might incur costs to adjust their advertising materials to discuss material risks and limitations in a fair and balanced manner, including changes in formatting and tailoring disclosures based on the form of the communication. To the extent that investment advisers already prepare similar disclosure in existing communications with investors or in connection with the preparation of Form ADV Part 2, we expect the costs of compliance to be mitigated. One commenter expressed concern that this prohibition would expand the amount of required disclosures and overwhelmingly lengthen advertisements.919 We recognize that this prohibition will have costs associated with changes to the formatting of advertisements associated with the additional information, including with respect to communications made to prospective and current investors in private funds advised by the investment adviser. Further, we recognize that the associated costs might induce some investment advisers and promoters to avoid making some types of claims to the extent that they will require extensive discussion of the associated material risks or other limitations. This could have costs to investors to the extent that they would receive less information about an adviser, and costs to advisers to the extent that they forgo some communications to investors. This could, however, yield benefits for investors, to the extent that any such advertisement not made has an increased risk of being misleading. d. Anti-Cherry Picking Provisions: References to Specific Investment Advice and Presentation of Performance Results The final rule contains two other provisions designed to address concerns about investment advisers presenting potentially cherry-picked information to investors in advertisements. The first prohibits reference to specific investment advice where such advice is not presented in a manner that is fair and balanced. Currently, there is a per se prohibition against past specific recommendations in the advertising rule, though the current rule allows reference to past specific recommendations in an advertisement where the advertisement offers to furnish a list of all recommendations made by such investment adviser in the last year. Further, the staff has indicated that it would not recommend enforcement action under rule 206(4)–1 under certain circumstances.920 The first provision replaces the current advertising rule’s per se prohibition of past specific recommendations with a principlesbased prohibition on presentations of specific investment advice that is not presented in a manner that is ‘‘fair and balanced.’’ We believe that this change will provide benefits to advisers and promoters by providing additional clarity on which market practices are prohibited. Further, it will provide benefits to current and prospective investors related to potentially expanding the circumstances under which advisers may provide information regarding past specific advice to investors. In addition, investors may be able to better evaluate presentations of past or current specific advice because of the rule’s requirement for fair and balanced presentation. This shift in approach might impose costs on investment advisers and promoters related to compliance, who will need to devote personnel time to evaluate whether a potential presentation of specific investment advice is fair and balanced.921 These compliance costs may be mitigated to the extent that advisers currently present past or current specific recommendations in a ‘‘fair and balanced’’ manner. Further, these costs may also be mitigated to the extent that an adviser currently complies with FINRA’s rule 2210, which requires that broker communications be ‘‘fair and balanced.’’ 922 The second anti-cherry-picking provision prohibits presentations of performance results, or performance time periods that are not presented in a fair and balanced manner. Currently, there is no express provision in the advertising rule requiring presentation of performance results in this manner, though the staff has stated views regarding certain circumstances in which the staff may view a presentation of performance results as misleading, including, for example, where an adviser failed to disclose how material 920 See infra section II.C.1.b. supra section III.D.1 and note 902. 922 See supra section II.B.5.a. 921 See 919 See MFA/AIMA Comment Letter I. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 13105 market conditions, advisory fee expenses, brokerage commissions, and reinvestment of dividends affect the performance results.923 This provision may yield benefits to current and prospective investors by reducing the likelihood that they are misled by advertisements, and requiring the provision of information to evaluate an investment adviser that is presented in a fair and balanced manner. We recognize, however, that the standard in this rule will impose costs on advisers and promoters. Two commenters, for example, indicated that the ‘‘fair and balanced’’ standard may be difficult in application.924 We recognize that this ‘‘fair and balanced’’ component for the second provision also represents a shift towards a principles-based approach, which could impose compliance costs on investment advisers, who might need to devote personnel time to update compliance processes.925 These costs and benefits may be mitigated, however, to the extent that advisers already ensure that their advertisements are fair and balanced in presentation of performance results in order to ensure that they are not misleading under the current advertising rule or other applicable antifraud provisions. These costs might, however, induce some investment advisers to avoid presenting performance results altogether. This could have costs to investors to the extent that they would receive less information about an adviser’s performance, and may make finding an investment adviser more difficult or costly for some investors. Additionally, this could impose costs on advisers to the extent that they forgo some communications to investors. This reduction in performance advertising, however, could yield benefits for investors, to the extent that any such advertisement not made has an increased risk of misleading investors. 4. Conditions Applicable to Testimonials and Endorsements, Including Solicitations The final rule prohibits the use of testimonials and endorsements unless they comply with certain disclosure, oversight, and disqualification requirements, substantially as originally proposed for solicitors. The costs and benefits of this provision of the final rule differ depending on whether the testimonial or endorsement is compensated or uncompensated. 923 See supra section III.C.1.b. Federation Comment Letter; NASAA Comment Letter. 925 See supra section III.D.1 and infra section IV.A. 924 Consumer E:\FR\FM\05MRR2.SGM 05MRR2 13106 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations To clarify the change from the baseline for each type of advertisement, we analyze the costs and benefits of imposing these conditions on testimonials and endorsements that are not compensated. We then separately analyze the costs and benefits of these conditions for testimonials and endorsements that are compensated. As described above, the baseline for each type of advertisement is different, making the extent of the effects of the changes effected by the rule different for advisers, depending on whether they are complying with the current advertising rule and the current solicitation rule.926 We have quantified a subset of the costs associated with requirements for testimonials and endorsements, specifically, the burden of information collection costs estimated for the purposes of the Paperwork Reduction Act.927 The disclosure and oversight provisions of the requirements for testimonials and endorsements will entail information collection costs, and investment advisers will incur initial implementation costs. We estimate that investment advisers will incur an initial implementation cost of $1,060 for each adviser, or $7,273,720 in total.928 We estimate that investment advisers will incur an ongoing internal cost of $5,729 per year per adviser, $500 external cost for those advisers that deliver disclosures by postal service, and $39,998,598 in total.929 We therefore estimate a total industry cost in the first year of $47,272,318.930 a. Communications Other Than Compensated Testimonials or Endorsements The current advertising rule prohibits, but does not define, testimonials and does not address endorsements. In contrast to the current advertising rule, the final rule prohibits advisers from using, or compensating promoters for testimonials and endorsements, unless certain requirements are met, and distinguishes statements made by investors from those made by noninvestors. In general, we believe that the ability of advisers to advertise testimonials and endorsements will give investors additional information about the views 926 See supra section III.D.3. infra section IV.B.2. 928 Initial cost burden estimate of $1,060 from section IV.B.2. 13,724 × 1⁄2 = 6,862 affected investment advisers. $1,060 × 6,862 = $7,273,720. 929 Ongoing cost estimate includes disclosure, oversight, and annual costs from section IV.B.2. $5,679 × 6,862 + $500 external cost × 6,862 advisers × 20% mail use = $39,998,598. 930 This number is based on the following calculation: $7,273,720 + $39,998,598 = $47,272,318. jbell on DSKJLSW7X2PROD with RULES2 927 See VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 of clients and non-clients with an investment adviser, which could improve the matches between investors and investment advisers. Additionally, the ability to use testimonials and endorsements in advertisements might incentivize investment advisers to further improve the quality of the services they provide, because investment advisers will be better able to advertise any improvements in their services. We discuss the costs and benefits of the requirements that must be met in order to include a testimonial or endorsement in an advertisement below. i. Disclosures The final rules impose disclosure requirements on investment advisers that make use of testimonials and endorsements and on persons giving testimonials and endorsements, unless subject to an exemption.931 Under the final rule, an investment adviser must disclose, or reasonably believe that the person giving the testimonial or endorsement discloses, (i) clearly and prominently, (A) whether the person giving the testimonial or endorsement is a client or a non-client, as applicable, (B) that cash or non-cash compensation was provided for the testimonial or endorsement, if applicable, and (C) a brief statement of any material conflicts of interests; (ii) the material terms of the person’s compensation arrangement, if any, including a description of the compensation provided or to be provided to the person for the testimonial or endorsement; and (iii) a description of any material conflicts of interest the person may have that result from the investment adviser’s relationship with such person and/or any compensation arrangement. These disclosures must be delivered at the time the testimonial or endorsement is disseminated. These disclosures can aid investors by providing information and context with which to evaluate a promoter’s claims. Investors may benefit from receiving information about the experiences of other investors or other people. In addition, the requirement that the advertisement clearly and prominently disclose the client status of the promoter, the fact of compensation, and a brief statement of material conflicts of interests will increase the salience of these disclosures, and increase the likelihood that they are incorporated into an investor’s decisions. Testimonials and endorsements may benefit investment advisers by allowing 931 See supra section II.C.5 (discussing partial exemptions from disclosure requirements). PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 them to show satisfied clients or other persons willing to support the investment adviser. However, the positivity of a testimonial or endorsement may not always reflect the investment adviser’s ability or the adviser’s potential ‘‘fit’’ for investors. The final rule may, therefore, lead investment advisers, regardless of ability, to inefficiently increase spending on testimonials or endorsements in advertisements to attract clients. In this case, the fees that result from higher advertising spending could mitigate the benefits that the additional information in testimonials and endorsements might provide to investors. Additionally, to the extent that market practices have developed in such a way that, under circumstances described in staff no-action letters, market participants already include information in advertisements that would be a testimonial under the final rule, the costs and benefits of the final rule’s testimonials and endorsements provision will be decreased in magnitude relative to the baseline. The final rule’s requirement for disclosure of client or non-client status of the promoter, material terms of compensation, and material conflicts of interest, will provide useful information to prospective clients about the potential credibility and incentives of the provider of the testimonial or endorsement. This provision might also yield benefits for investors if investment advisers or their promoters are incentivized to mitigate their conflicts of interest or otherwise improve the quality of their services as a result of the disclosures. This might improve the efficiency of the investment adviser search process by improving the quality of the matches between investors and investment advisers, both because of the additional information about promoters’ incentives and because it may lead investment advisers to alter their arrangements to mitigate conflicts of interest. However, conflict of interest disclosures may not necessarily lead to optimal decisions by investors. For example, the Commission’s Financial Literacy Study surveyed investors about their understanding of fees as disclosed in a typical brochure, finding that many respondents had difficulty interpreting certain disclosures that are relevant to evaluating conflicts of interest.932 These 932 ‘‘For instance, they had difficulty calculating hourly fees and fees based on the value of their assets under management. They also had difficulty answering comprehension questions about investment adviser compensation involving the purchase of a mutual fund and identifying and computing different layers of fees based on the E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations findings are consistent with academic literature that describes investors’ difficulty in understanding financial disclosure. For example, one study shows that, in an experimental setting, even when subjects were told of the bias of persons who were giving them advice, participants did not fully adjust their behavior to reflect the disclosed bias.933 In addition, these papers and others 934 find that mandating disclosure from biased persons may have the unintended consequence of making these persons appear honest and increase trust in them. While the context of these studies is not specific to investment advisers, promoters, or in certain cases, of financial advice generally, they provide evidence that suggests that disclosures might not fully mitigate the incentive problems generated by conflicts of interest. Additionally, advisers or their promoters may incur legal and compliance costs in connection with reviewing existing disclosures and drafting new disclosures to comply with the final rule. jbell on DSKJLSW7X2PROD with RULES2 ii. Oversight and Compliance The final rule has an oversight and compliance provision that requires the investment adviser to have a reasonable basis for believing that a testimonial or endorsement complies with the rule.935 This provision is designed to help ensure that communications made by promoters comply with the provisions of the final rule. This requirement will amount of assets under management. Moreover, many of the online survey respondents on the point-of-sale panel had similar difficulties identifying and understanding fee and compensation information described in a hypothetical point-of-sale disclosure and account statement that would be provided to them by broker-dealers.’’ See Financial Literacy Study, supra footnote 846. 933 See Daylian M. Cain, et al., The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest, 34 J. L. Stud. 1 (2005); George Loewenstein, et al., The Limits of Transparency: Pitfalls and Potential of Disclosing Conflicts of Interest, 101 Am. Econ. Rev. 423 (2011). 934 See e.g., Steven Pearson, et al., A Trial of Disclosing Physicians’ Financial Incentives to Patients, 166 Archives of Internal Medicine 623 (2006); Sunita Sah, George Loewenstein & Daylian M. Cain, The Burden of Disclosure: Increased Compliance With Distrusted Advice, 104 J. Personality & Soc. Psychol. 289 (2013). 935 In addition, the final rule requires that an investment adviser have ‘‘a written agreement with any person giving a compensated testimonial or endorsement that describes the scope of the agreedupon activities and the terms of the compensation for those activities.’’ However, the rule does not contain this requirement in the case of uncompensated testimonials and endorsements or where de minimis compensation is provided to the promoter. For example, promoters providing testimonials or endorsements in refer-a-friend programs might not be subject to these requirements depending on the amount of compensation provided in such programs. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 entail costs for both advisers and their promoters to devote staff and managerial resources, enter into new written agreements or amend existing written agreements, and update their processes to the extent necessary for oversight and compliance of testimonials and endorsements under the final rule. b. Compensated Testimonials or Endorsements The current solicitation rule prohibits advisers from providing solicitors with cash compensation, unless certain requirements are satisfied. Among these requirements is a requirement that the adviser enter into a written agreement requiring the solicitor to act in a manner consistent with the Advisers Act and its rules. Non cash-compensated solicitations are not subject to the solicitation rule, however. To the extent that non-cash compensated testimonials and endorsements are viewed as advertisements made directly or indirectly by an adviser, they may be subject to the current advertising rule, including its general prohibition on testimonials if applicable. Solicitations of private fund investors are not subject to the current solicitation rule, though they are subject to rule 206(4)–8 and are likely subject to restrictions applicable to private placements under the Federal securities laws. Persons who would be promoters under the final rule that are registered broker-dealers and FINRA members, such as those who transact in privately issued securities, are also subject to FINRA rules applicable to communications, including restrictions on the use of compensated testimonials, and may be subject to Regulation BI. We believe that the costs and benefits of the conditions on the use of testimonials and endorsements in an advertisement will have similar costs and benefits to those described above,936 though these effects will be mitigated to the extent that the adviser was complying with the current solicitation rule. To some extent these effects will also be mitigated to the extent the promoter is a registered broker-dealer and FINRA member; such a promoter could adapt existing compliance systems, for instance, but will need to modify for any differences under the two regulatory constructs. i. Disclosures We expect similar costs and benefits of the disclosure requirements for compensated testimonials and endorsements as described above for non-compensated testimonials and 936 See PO 00000 supra section III.D.4.a. Frm 00085 Fmt 4701 Sfmt 4700 13107 endorsements. For example, we expect investors to benefit from new disclosures, as mitigated to the extent that, for example, conflict of interest disclosures may not necessarily lead to optimal decisions by investors. Further, disclosures may impose compliance costs on advisers and promoters similar to those described above, including costs to draft new disclosures in connection with, for example, advertisements by non-cash compensated promoters and in connection with compensated testimonials or endorsements made to prospective or current investors in private funds advised by the adviser. However, these costs and benefits may be mitigated with respect to compensated testimonials or endorsements for four reasons. First, these costs may be mitigated for communications made by cashcompensated solicitors, given the disclosure requirements under the current solicitation rule. Currently, cash compensated solicitors must provide disclosures to clients pursuant to rule 206(4)–3(b), as well as provide the investment adviser’s Form ADV brochure and their disclosure statement to potential investors. As a result, we expect that these costs will be mitigated to the extent that this type of information is already known and accessible to the investment adviser and promoter, and to the extent that similar information is already provided under the current solicitation rule. Further, the final rule’s requirement to provide disclosure at the time the testimonial or endorsement is disseminated is similar to the current solicitation rule’s requirement to deliver disclosure at the time of any solicitation activities. Second, the final rule exempts from these disclosure requirements certain affiliates of the adviser, provided that the affiliation is readily apparent or disclosed to the client or investors at the time the testimonial or endorsement is disseminated. Third, the costs and benefits of this provision may be mitigated because the final rule includes exemptions from these disclosure requirements. First, there is an exemption from these requirements when a broker-dealer provides a testimonial or endorsement to a retail customer that is a recommendation subject to Regulation BI. Second, when a broker-dealer provides a testimonial or endorsement to an investor that is not a retail customer as defined by Regulation BI, there is an exemption from the requirements to disclose the material terms of any compensation arrangement and a description of any material E:\FR\FM\05MRR2.SGM 05MRR2 13108 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 conflicts of interest. As a result, the extent of the effects of this exemption on investors will vary. Where the testimonial or endorsement is a recommendation to a retail customer subject to Regulation BI, broker-dealers, including those that are also registered as investment advisers, acc will have to comply with the Disclosure Obligation under Regulation BI and will not also be subject to disclosure requirements under the final rule. Although these investors will not receive the investor protection benefits of the marketing rule disclosures, the recommendation will be subject to Regulation BI requirements under the baseline. With respect to testimonials or endorsements by a broker-dealer to investors that are not retail customers (as defined by Regulation BI), although we believe such investors will be able to request from the broker-dealer other information about the solicitation, some may not. These exemptions may, therefore, result in a reduction of costs and benefits of the disclosure provisions for testimonials and endorsements to these investors. These exemptions might also make advisers more likely to compensate a broker-dealer as a promoter rather than promoters that are not broker-dealers, which would give these broker-dealers a competitive advantage. Further, with respect to communications made by broker-dealers that are not so exempted, costs for promoters who are brokerdealers may also be mitigated to the extent that broker-dealers are already preparing similar disclosures in order to comply with other disclosure obligations.937 Finally, because there is no Form ADV brochure delivery requirement under the final rule, as compared to the current solicitation rule, we anticipate a reduction in costs associated with cashcompensated promoters no longer being subject to this requirement. We expect that this will not result in a loss of benefits to clients, however, because they will still receive the brochure from advisers as a result of advisers’ delivery obligations. We recognize, however, that investment advisers and persons who are currently cash-compensated solicitors will bear costs as a result of the replacement of the current rule’s disclosure requirements with the final rule’s disclosure requirements. ii. Oversight and Compliance Investment advisers must have a reasonable belief that the solicitors comply with the provisions of the Advisers Act and rules under the 937 See supra section II.C.2. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 current solicitation rule, and we therefore expect the magnitude of the costs and benefits from the application of the testimonials and endorsements requirements related to oversight and compliance to be relatively small for advisers complying with the current rule and for promoters that are cash solicitors under the current solicitation rule. Under the current solicitation rule, investment advisers must make a bona fide effort to ascertain whether the cashcompensated solicitor has complied with the provisions of its written agreement with the adviser and must have a reasonable basis for so believing. As described above, the final rule has an oversight and compliance provision that requires the investment adviser to have a reasonable basis for believing that a testimonial or endorsement complies with the rule, and as applicable here, the adviser must also have a written agreement with the person giving a testimonial or endorsement that describes the scope of the agreed upon activities when making payments for compensated testimonials and endorsements that are above the de minimis threshold. This provision will help ensure that communications made by promoters comply with the provisions of the final rule. Further, this requirement would entail costs for both advisers and their promoters to devote personnel time and managerial resources to enter into written agreements and update the processes necessary for oversight and compliance of testimonials and endorsements. These benefits and costs may, however, be mitigated for several reasons. First, to the extent that advisers with cash-compensated solicitors are already substantially performing this oversight in connection with their compliance with rule 206(4)–3’s oversight requirements, the rule will not have these full effects. Second, for private placements of private fund shares, the written private placement agreement could meet the written agreement requirement. Third, the final rule includes certain exemptions from the requirement to enter into a written agreement with the adviser. The first such exemption applies where de minimis compensation is provided to the promoter. For example, promoters providing testimonials or endorsements in refer-a-friend programs will likely be eligible for this exemption. The second such exemption applies to certain affiliates of the adviser, provided that the affiliation is readily apparent or disclosed to the client or investors at the time the testimonial or endorsement is disseminated. PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 iii. Disqualification The final rule contains disqualification provisions which prohibit an adviser from compensating a person, directly or indirectly, for any testimonial or endorsement if the adviser knows, or, in the exercise of reasonable care, should have known, that the person is an ineligible person at the time the testimonial or endorsement is disseminated. The rule defines an ‘‘ineligible person’’ to mean a person, who is subject to a disqualifying Commission action or disqualifying event, and certain of that person’s employees and other persons associated with an ineligible person. The definition further encompasses, as appropriate, all general partners or all elected managers of an ineligible person. Ineligible Persons and Disqualifying Events Currently, the solicitation rule categorically bars advisers from making cash payments to certain disqualified persons. The final rule’s disqualification provisions generally expand the set of ineligible persons by including certain disciplinary actions that are not part of the current solicitation rule. For example, under the final rule a disqualifying event is expanded to also include generally actions of the CFTC and self-regulatory organizations. It also newly includes Commission cease and desist orders from committing or causing a violation or future violation of any scienter-based anti-fraud provision of the Federal securities laws, and Section 5 of the Securities Act. The final rule’s prohibition on compensating such ineligible persons could yield benefits for investors by prohibiting investment advisers from hiring promoters most likely to abuse investors’ trust—that is, promoters who have been subject to certain Commission opinions or orders, other regulatory actions, civil actions, or convictions for certain conduct. This prohibition could, however, also yield costs for advisers. For example, an adviser may not be able to hire a solicitor that the adviser otherwise feels to be best able to promote its service. This may reduce the number of persons available to advisers to serve as promoters, increase the cost of obtaining referrals for investment advisers, and impose costs on those promoters who are disqualified. The application of the final rule’s definition of ineligible person could also impose additional compliance and search costs on investment advisers. For example, investment advisers will need to check that a promoter is not an ineligible E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations person. In addition, to the extent the disqualification provisions under the new rule result in an increase in the number of disqualified persons as compared to the current rule, the number of available potential promoters would fall, which could increase the difficulty of finding a promoter for an adviser. We expect that the benefits and costs of this provision may be mitigated for a number of reasons. First, to the extent a solicitor is currently cashcompensated and currently subject to the solicitation rule, the final disqualification provisions are not entirely new, and only those changes from the solicitation rule’s disqualification provisions, including new bars on persons subject to CFTC and self-regulatory organization orders, will have any economic effects. Second, the final rule includes certain exemptions from this requirement. The first such exemption is available for promoters who receive de minimis compensation. The second exemption is available for promoters that are brokers or dealers registered with the Commission in accordance with section 15(b) of the Exchange Act, provided they are not subject to statutory disqualification under the Exchange Act. Broker-dealers currently have similar provisions that protect investors by disqualifying certain individuals from acting as a broker-dealer. This exemption may further have the effect of making it more likely that an adviser will compensate a broker-dealer as a promoter. In addition, persons that are covered by rule 506(d) of Regulation D under the Securities Act with respect to a rule 506 securities offering and whose involvement would not disqualify the offering under that rule (such as persons acting as placement agents for a private fund) will also not be disqualified under this disqualification provision of the final rule, which could similarly encourage the use of such agents in connection with marketing activities for private funds. Finally, the final rule’s disqualification provisions will not disqualify any promoter for any matter(s) that occurred prior to the effective date of the rule, if such matter would not have disqualified the promoter under rule 206(4)–3, as in effect prior to the effective date of the rule. We expect this will reduce the costs and benefits of the disqualification provisions when the rule initially goes into effect. The final rule also provides a conditional carve-out from the definition of disqualifying event, with respect to a person that is subject to VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 certain Commission opinions or orders, provided certain requirements are met. The provisions of this conditional carveout are similar to statements in staff noaction letters in which the staff stated that it would not recommend enforcement action to the Commission under section 206(4) and rule 206(4)–3 if the solicitor’s practices were consistent with certain representations made in connection with those letters. Diligence Standards In addition to changing what promoters are ineligible to be compensated by an adviser, the final rule changes the diligence standards of investment advisers when hiring promoters. It establishes a knowledge or reasonable care standard for the disqualification provisions, which replaces the current solicitation rule’s absolute bar on paying cash for solicitation activities to a person with any disciplinary history enumerated in the rule. In general, we believe that the requirement to exercise reasonable care at the time of dissemination will yield indirect benefits for investors, because it will require advisers to help ensure that the protections of the rule’s disqualification provisions are realized for investors. This standard will also generally impose costs on advisers related to the necessary investigation of the promoter and to ensuring that they remain in compliance. We expect that the benefits and costs of this provision may be mitigated to the extent a solicitor is cash-compensated and previously subject to the solicitation rule. The required diligence standard in the final rule is formally less burdensome than was required under the current solicitation rule, which could lower compliance costs for advisers, including by reducing the likelihood that advisers will inadvertently violate the provision due to disqualifying events that they would not, even in the exercise of reasonable care, have known existed. We do not, however, believe that this standard will significantly affect the client and investor protections of the disqualification provisions, because we do not believe that investigation beyond what is reasonable under the circumstances would yield substantial benefits. Under the final rule, an adviser will need to inquire into the relevant facts of an engagement, with the method or level of due diligence or other inquiry varying depending on the circumstances of the compensated promoter and its arrangement with the adviser.938 To the 938 See PO 00000 supra section II.C.4.a. Frm 00087 Fmt 4701 Sfmt 4700 13109 extent that an engagement presents greater risk, greater screening and compliance mechanisms would be required under the rule, which we believe would preserve these benefits. For example, to the extent that there are indicators suggesting bad actor involvement, increased levels of due diligence will be required. Further, we believe that advisers will generally use many of the same mechanisms that they use today to determine whether a disqualified person is an ineligible person under the final rule. To the extent that the mechanisms currently in use already resemble or satisfy the final rule’s diligence standard, the cost burden of the new standard may be mitigated. 5. Third-Party Ratings The final rule will also restrict the use of third-party ratings in advertisements, subject to certain requirements about the structure of the rating, and clear and prominent disclosures about the date of the rating, the identity of the third party, and compensation provided for obtaining or using the rating. We analyze the costs and benefits of imposing restrictions on the use of third-party ratings on communications subject to these restrictions below. While the current advertising rule does not mention third-party ratings, it prohibits an advertisement that contains a third-party rating if it contains an untrue statement or a material fact or is otherwise false or misleading. Further, the current solicitation rule, like the current advertising rule, does not expressly mention third-party ratings. The staff has taken the position that certain ratings may constitute testimonials and stated it would not recommend enforcement action under the prohibition of testimonials if an adviser made references in an advertisement to third-party ratings that reflect client experiences, based on certain representations.939 Specifically, no-action letters have stated the staff would consider the following when not recommending an enforcement action for potentially false or misleading ratings in an advertisement: Whether the advertisement disclosed the criteria on which the rating was based, whether favorable ratings were selectively disclosed, whether there were any untrue implications of being a top-rated adviser, the identity of who created and conducted the rating, and whether investors can expect similar 939 See DALBAR, Inc., SEC Staff No-Action Letter (Mar. 24, 1998). E:\FR\FM\05MRR2.SGM 05MRR2 13110 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations performance in the future from the investment adviser.940 The disclosure requirements of the final rule will provide investors more information to judge the context of a third-party rating, which might reduce the likelihood that investors will be misled by an investment adviser’s ratings.941 Additionally, the final rule requires that the adviser have a reasonable basis for believing that any questionnaire or survey used in the preparation of a third-party rating be structured to make it equally easy for a participant to provide favorable and unfavorable responses, and not designed or prepared to produce any predetermined result, which might also reduce the likelihood that investors will be misled. Investors will benefit from the disclosure requirements for thirdparty ratings, not only because the disclosures provide investors with additional context to evaluate the information provided in ratings, but also because the required disclosures may dissuade advisers from including misleading third-party ratings. The disclosures required by the final rule might reduce the incentives of investment advisers to include thirdparty ratings that might be stale or otherwise misleading. The requirement to create these disclosures could impose costs on advisers, including compliance costs related to drafting these disclosures and ensuring that they comply with the requirements of the final rule. In addition, the final rule requires that investment advisers make certain disclosures or reasonably believe that such disclosures have been made, which will impose additional costs on investment advisers. Investment advisers and the associated personnel that use third-party ratings in their advertisements will bear costs associated with compliance with this aspect of the final rule.942 These costs could entail the dedication of personnel time and managerial resources to draft disclosures and to satisfy due diligence requirements. However, these costs and benefits may be mitigated because the thirdparty rating requirements of the final rule are similar to the representations made in staff letters in which it has previously stated that it would not recommend enforcement under section 206(4) and rule 206(4)–1. As a result, advisers may only bear the incremental costs of modifying compliance systems to account for the differences of the final rule requirements, though these advisers would also bear the costs of evaluating those differences. We have quantified a subset of the costs associated with requirements for the use of third-party ratings in advertisements, specifically, the burden of information collection costs estimated for the purposes of the Paperwork Reduction Act.943 The disclosure provisions of the requirements for testimonials and endorsements will entail information collection costs, and investment advisers will incur initial implementation costs. We estimate that investment advisers will incur an initial implementation cost of $1,011 for each adviser, or $6,937,482 in total.944 We estimate that investment advisers will incur an ongoing cost of $252.74 per year per adviser, or $1,734,301.88 total ongoing cost per year. We therefore estimate a total industry cost in the first year of $8,671,783.88.945 6. Performance Advertising The final rule includes provisions that impose specific requirements and prohibitions on the inclusion of performance information in advertisements. These provisions include net performance requirements, prescribed time period requirements, prohibitions of statements expressing or implying Commission approval or review of the calculation or presentation of performance results in the advertisement, and requirements for related performance, extracted performance, hypothetical performance, and predecessor performance. We analyze the costs and benefits of imposing these specific requirements on the use of performance advertising in communications below. We have quantified a subset of the costs associated with the restrictions on the use of performance advertising in advertisements, specifically, the burden of information collection costs estimated for purposes of the Paperwork Reduction Act.946 The provisions of the requirements for performance advertising will entail information 943 See jbell on DSKJLSW7X2PROD with RULES2 940 See id.; see Investment Adviser Association, SEC Staff No-Action Letter (Dec. 2, 2005). 941 See supra section III.B. 942 Although the investment advisers bear the legal burden of complying with third-party ratings requirement, we expect that the costs of this requirement will be partially borne by other parties, such as persons communicating on behalf of an investment adviser. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 infra section IV.B.3. cost burden estimate of $1,011 from section IV.B.3. 13,724 × 1⁄2 = 6,862 affected investment advisers. $1,011 × 6,862 = $6,937,482. 945 Ongoing cost estimate includes disclosure, oversight, and annual costs from section IV.B.3. $252.74 × 6,862 = $1,734,301.88. For the total first year cost, $6,937,482 + $1,734,301.88 = $8,671,783.88. 946 See infra section IV.B.4. 944 Initial PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 collection costs and modification of the presentation of performance. These collection of information costs primarily entail an initial cost to update performance calculations, and an ongoing annual cost for investment advisers. We estimate that investment advisers will incur a total initial implementation cost $394,998,740 947 and a total ongoing cost of $273,772,232 per year.948 We therefore estimate the 947 These total cost estimates differ from those in section IV.B.4, because the estimates in those sections amortize the initial implementation costs over three years, while the cost estimates in this section do not. However, both estimates make identical assumptions about the resources required to comply with the rule. The initial burden associated with net performance is based on 15 hours × $337 (compliance manager and compliance attorney, split evenly) = $5,055 for each of the 13,038 investment advisers expected to be affected, implying an initial cost of $65,907,090. The initial burden associated with performance time periods is based on 35 hours × $337 (compliance manager and compliance attorney, split evenly) = $11,795 for each of the 13,038 investment advisers expected to be affected, implying an initial cost of $153,783,210. The initial burden associated with related performance is based on 30 hours × $337 (compliance manager and compliance attorney, split evenly) = $10,110 for each of the 10,979 investment advisers expected to be affected, implying an initial cost of $110,997,690. The initial burden associated with extracted performance is based on 10 hours × $337 (compliance manager and compliance attorney, split evenly) = $3,370 for each of the 686 investment advisers expected to be affected, implying an initial cost of $2,311,820. The initial burden associated with hypothetical performance is based on 15 hours × $337 (compliance manager and compliance attorney, split evenly) + 7 hours × $530 (compliance officer) = $8,765 for each of the 6,862 investment advisers expected to be affected, implying an initial cost of $60,145,430. The initial burden associated with predecessor performance is based on 20 hours × $337 (compliance manager and compliance attorney, split evenly) = $6,740 for each of the 275 investment advisers expected to be affected, implying an initial cost of $1,853,500. Therefore, the total initial industry burden associated with the final rule is $197,721,270 + $153,783,210 + $110,997,690 + $2,311,820 + $60,145,430 + $1,853,500 = $394,998,740. See infra section II.B.4. 948 The ongoing burden associated with net performance is based on 10.5 hours × $337 (compliance manager and compliance attorney, split evenly) = $3,538.50 for each of the 13,038 investment advisers expected to be affected, implying an ongoing cost of $46,134,963. The ongoing burden associated with performance time periods is based on 28 hours × $337 (compliance manager and compliance attorney, split evenly) = $9,436 for each of the 13,038 investment advisers expected to be affected, implying an ongoing cost of $123,026,568. The ongoing burden associated with related performance is based on 17.5 hours × $337 (compliance manager and compliance attorney, split evenly) = $5,897.50 for each of the 10,979 investment advisers expected to be affected, implying an ongoing cost of $64,748,652.50. The ongoing burden associated with extracted performance is based on 7 hours × $337 (compliance manager and compliance attorney, split evenly) = $2,359 for each of the 686 investment advisers expected to be affected, implying an ongoing cost of $1,618,274. The ongoing burden associated with hypothetical performance is based on 10.5 hours × $337 (compliance manager and compliance attorney, E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations total cost in the first year to be $672,544,972.949 jbell on DSKJLSW7X2PROD with RULES2 a. Net Performance Requirement The final rule will prohibit any presentation of gross performance unless the advertisement also presents net performance with at least equal prominence to the presentation of gross performance. In addition, the net performance must be calculated over the same time period, and using the same type of return and methodology as, the gross performance. While the current advertising rule does not mention performance advertising, it prohibits any untrue statement of a material fact and statements that are otherwise false or misleading, which includes statements made in the context of performance advertising. The staff has stated its views about the types of circumstances in which it may view the presentation of performance results as misleading, including, for example, where an adviser did not disclose how advisory fee expenses, commissions, and reinvestment of dividends affect the performance results.950 This provision will likely benefit investors by providing them with additional information about the performance generated by an investment adviser, including the effect of fees and expenses on that performance, and reducing the chance that they are misled by presentations of gross performance. To the extent that investment advisers’ current practices differ from the requirements of this provision, these requirements may impose costs on advisers, including advisers that serve private funds, to compute and include net performance in their marketing communications, to the extent that advisers do not currently compute and include net performance. These costs could involve devoting personnel time, modifying marketing materials, and devoting managerial resources. In addition, some investors may be better able to make their own risk adjusted return assessments, and these investors split evenly) + 3.75 hours × $530 (compliance officer) = $5,526 for each of the 6,862 investment advisers expected to be affected, implying an ongoing cost of $37,919,412. The ongoing burden associated with predecessor performance is based on 3.5 hours × $337 (compliance manager and compliance attorney, split evenly) = $1,179.50 for each of the 275 investment advisers expected to be affected, implying an initial cost of $324,362.50. Therefore, the total initial industry burden associated with the final rule is $138,404,889 + $123,026,568 + $64,748,652.50 + $1,618,274 + $37,919,412 + $324,362.50 = $273,772,232. See infra section II.B.4. 949 $394,998,740 (total initial cost) + $273,772,232 (total ongoing cost) + $3,774,000 (external cost) = $672,544,972 (total first year cost). 950 See supra section III.C.1.b. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 may similarly derive fewer benefits from this requirement. However, these costs and benefits may be mitigated to the extent that this requirement is similar to the circumstances under which the staff has previously stated that it would not recommend enforcement under section 206(4) and rule 206(4)–1. Given that many investment advisers already provide this information in light of staff no-action letters, there are not likely to be significant costs or benefits to this provision. b. Prescribed Time Periods The final rule prohibits the presentation of performance results of any portfolio or any composite aggregation of related portfolios, other than any private fund, in advertisements unless the results for one, five, and ten year periods are presented as well. Each of the required time periods must be presented with equal prominence and end on a date that is no less recent than the most recent calendar-year end.951 If the portfolio was not in existence for the full duration of any of these three periods, the lifetime of the portfolio can be substituted. Under the baseline for current advertisements, there is no such Commission requirement relating to performance advertising. Requiring advertisements to include one, five, and ten year period performance will benefit investors other than private fund investors by giving them standardized information about the performance and limiting the potential that an investor could be unintentionally misled about an investment adviser’s performance through the investment adviser’s selection of performance periods. The requirement will impose costs on investment advisers, who will need to compute the performance for the prescribed time periods, update their advertising materials, and devote personnel time to ensure compliance with the final rule. These costs may disincentivize the presentation of performance results of any portfolio or any composite aggregation of related portfolios. However, these benefits and costs may be mitigated to the extent that this requirement is similar to information currently collected and provided to clients in order to comply with GIPS standards to present performance information. In addition, to the extent that advisers already present, for example, performance information for these time periods, these costs and benefits may also be mitigated. 951 See PO 00000 supra section II.E.2. Frm 00089 Fmt 4701 Sfmt 4700 13111 c. Statements of Commission Approval or Review The final rule prohibits any advertisement that includes a statement, whether express or implied, that the calculation or presentation of performance results has been reviewed or approved by the Commission. This prohibition will benefit investors by preventing misleading advertisements that could lead investors to draw false conclusions about the Commission’s approval of a presentation or calculation of performance. Any such statement would be false, as the Commission does not review or approve of calculations or presentations of performance. The prohibition may likely impose costs associated with legal review of performance presentation, but these costs are likely to remain small. Further, such costs may be mitigated to the extent that advisers currently have procedures to ensure compliance with section 208(a), which contains a similar prohibition from representing or implying that an adviser’s abilities or qualifications have been passed upon by the United States or any agency thereof. d. Related Performance The final rule will condition the presentation of ‘‘related performance’’ in all advertisements on the inclusion of all related portfolios. However, the final rule will allow related performance to exclude related portfolios as long as the advertised performance results are not materially higher than if all related portfolios had been included. This exclusion will be subject to the rule’s requirement that the presentation of performance results of any portfolio include results for one-, five-, and tenyear periods. The final rule will allow related performance to be presented either on a portfolio-by-portfolio basis or as a composite of all related portfolios. The inclusion of related performance in advertisements may give investment advisers flexibility in how they choose to advertise their performance, such as which aspects of their performance they can advertise, and might give investors additional information about how an investment adviser managed portfolios having substantially similar investment policies, objectives and strategies. The requirements for related performance may, however, impose costs on investment advisers related to the creation of composites to the extent that they do not currently create composites or create composites using the final rule’s criteria for related portfolios. For example, the ‘‘not materially higher than’’ requirement for E:\FR\FM\05MRR2.SGM 05MRR2 13112 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations excluding related portfolios may generate an additional need to recalculate performance to verify that the related performance satisfies the requirement. Further, as discussed above, we understand that an adviser will likely be required to calculate the performance of all related portfolios to ensure that any exclusion of certain portfolios meets the rule’s conditions, which may be burdensome on advisers, particularly smaller advisers.952 However, we expect investment advisers to incur these calculation costs only if they expect sufficient benefits from inclusion of related performance. Further, we expect that these costs and benefits may be mitigated to the extent that advisers currently include related performance presentations in their advertisements that comply with the current rule.953 Commenters generally described the related performance definition that was originally proposed as being similar to industry practice.954 In addition, advisers that comply with GIPS standards are permitted to show related performance in advertisements, and presentations that meet the GIPS standard requirements to show all related performance will also satisfy the requirements of this provision to show all related performance. e. Extracted Performance The final rule will condition the presentation of extracted performance in all advertisements on the advertisement providing, or offering to provide promptly, the performance results of the total portfolio from which the performance was extracted. ‘‘Extracted performance’’ means ‘‘the performance results of a subset of investments extracted from a portfolio.’’ 955 While the current advertising rule does not mention extracted performance, it prohibits any untrue statement of a material fact and statements that are otherwise false or misleading, which includes statements made in the context of advertising extracted performance. The use of extracted performance in advertisements will benefit investors by giving them information about performance results applicable to a particular subset of the adviser’s investments, and the accompanying disclosures could help investors contextualize the claims of an jbell on DSKJLSW7X2PROD with RULES2 952 See IAA Comment Letter. use by investment advisers that are also broker-dealers of certain forms of related performance in advertisements may be viewed by FINRA as inconsistent with the content standards in FINRA rule 2210. 954 See MFA Comment Letter I; Proskauer Comment Letter. 955 Final rule 206(4)–1(e)(6). 953 The VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 investment adviser about its extracted performance, thereby reducing the risk that investors might be misled by such extracted performance. Investment advisers who use extracted performance in their advertisements will likely incur costs to prepare the performance results of the total portfolio from which the performance was extracted, to the extent that they do not do this already. The final rule does not prohibit an adviser from presenting a composite of extracts, including composite performance that complies with GIPS standards. However, any presentation of a composite of extracts is subject to the additional protections that apply to hypothetical performance, as discussed below, and as a result, these additional protections may result in additional burdens for advisers that typically present extracted performance from multiple portfolios as a composite, and potentially limit these types of presentations of performance to institutional investors. However, these benefits and costs may be mitigated to the extent that the restrictions imposed by this provision are similar to the manner in which advisers currently present extracted performance, including under GIPS standard requirements applicable to similar presentations of extracted performance, or other requirements. f. Hypothetical Performance The rule also prohibits the use of hypothetical performance in advertisements unless (i) the investment adviser adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement; (ii) provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance; and (iii) provides, or if the intended audience is an investor in a private fund provides, or offers to provide promptly, sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions. The rule defines several types of hypothetical performance—model performance, performance derived from model portfolios; backtested performance, performance that is backtested by the application of a strategy to data from prior time periods when the strategy was not actually used during those periods; and targeted or PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 projected performance returns with respect to any portfolio or to the investment services offered in the advertisement. The current advertising rule does not explicitly address hypothetical performance. The Commission has, however, brought enforcement actions alleging that the presentation of performance results that were not actually achieved would be misleading where certain disclosures were not made, including disclosure that the performance results were hypothetical or disclosure of the relevant limitations inherent in hypothetical results and the reasons why actual results would differ.956 The final rule’s imposes minimum standards for the presentation of hypothetical performance in advertisements, which could potentially increase the willingness of investment advisers to use hypothetical performance. If investment advisers increase their use of hypothetical performance in advertising, investors may benefit from the additional information provided by hypothetical performance advertising, together with information and context that may help investors to better understand it. This additional information could aid an investor in the choice of an investment adviser by helping investors find a better match or reducing costs associated with finding an investment adviser. To the extent that these requirements will help ensure that hypothetical performance is disseminated to the specific investors who have access to the resources to independently analyze this information and who have the financial expertise to understand the risks and limitations of these types of presentations, these requirements on the presentation of hypothetical performance will benefit investors. Although investors will not face any direct costs from the inclusion of hypothetical performance, they may face indirect costs associated with processing and interpreting this new information if investment advisers increase their use of hypothetical performance. Even if investors are provided with sufficient information to contextualize hypothetical performance, they may need time and expertise to interpret that contextual information. Some, investors might have difficulty interpreting the context of hypothetical performance because of a lack of resources of financial expertise, which could lead to poorer matches with investment advisers. However, the final 956 See E:\FR\FM\05MRR2.SGM supra section III.C.1.b. 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations rule requires disclosures and contextual information for hypothetical performance that are sufficient for the intended audience, which should mitigate these costs to investors. Advisers may incur costs associated with complying with the three conditions described above, such as consulting with in-house counsel, time to draft these policies and procedures and disclosures, and requiring firms to pay outside counsel or consultants to draft or review these policies and procedures and disclosures. These requirements could also entail costs such as training of staff to comply with the policies and procedures, and demands on personnel time and counsel to draft and review advertisements and disclosures to ensure compliance with the policies and procedures and the rule’s requirements. We recognize that investment advisers will need to evaluate their intended audiences, as well as ensure that the advertisement is tailored to the audience receiving it, which will cause advisers to incur costs. An adviser may make such evaluations based on past experiences with investor types, including, for example, routine requests from those types of investors in the past, or based on information they have gathered from potential investors (e.g., questionnaires, surveys, or conversations) or academic research.957 Investment advisers are, however, unlikely to incur these costs if they do not expect the benefits of hypothetical performance advertising to exceed the costs associated with screening. The costs and benefits associated with these restrictions may, however, be mitigated to the extent that advisers currently present information that meets the final rule’s definition of ‘‘hypothetical performance’’ in circumstances consistent with the representations made in staff no-action letters. Additionally, to the extent that some investment advisers already maintain policies and procedures to screen prospective clients in order to comply with the GIPS standards, the net costs and benefits associated evaluating an ‘‘intended audience’’ for purposes of complying with this requirement may be mitigated. Under these circumstances, advisers may only bear the incremental costs of modifying compliance systems and disclosures to account for the differences of the final rule’s requirements, though these advisers would also bear the costs of evaluating those differences. 957 See supra section II.E.6.b. VerDate Sep<11>2014 21:12 Mar 04, 2021 g. Predecessor Performance The final rule subjects the presentation of predecessor performance to several requirements: (i) The person or persons who were primarily responsible for achieving the prior performance results manage accounts at the advertising adviser; (ii) the accounts managed at the predecessor investment adviser are sufficiently similar to the accounts managed at the advertising investment adviser that the performance results would provide relevant information to clients or investors; (iii) all accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance and the exclusion of any account does not alter the presentation of any applicable time periods required by the final rule; and (iv) the advertisement includes, clearly and prominently, all relevant disclosures, including that the performance results were from accounts managed at another entity. Under the current advertising rule, predecessor performance is not explicitly addressed; however, the staff has stated in no-action letters that it would not view advertisements that include predecessor performance as misleading under certain circumstances.958 These circumstances are similar to the requirements of the final rule, and costs and benefits may flow from the extent to which the rule imposes requirements for use of predecessor performance. To the extent that the final rule’s provisions permit the use of predecessor performance in advertisements, predecessor performance has the potential to provide additional information and context for investors. This information could improve investor decisions and reduce the costs associated with searching for an investment adviser. However, the rule has requirements that will impose costs on investment advisers that present predecessor performance. Determining the extent to which the personnel and the portfolios of a predecessor adviser are sufficiently similar under the rule can require resources, especially when portfolios are managed by multiple people, or have long or complicated performance histories. Additionally, investment advisers may bear additional costs to analyze any intellectual property issues or non-compete agreements between portfolio management personnel and their previous firms. 958 See Jkt 253001 PO 00000 Horizon Letter. Frm 00091 Fmt 4701 Sfmt 4700 13113 7. Amendments to Form ADV Under the final rule, Form ADV will include additional questions about investment advisers’ advertising practices, including performance advertising, the use of testimonials and endorsements, and compensation for promoters. Current Form ADV does not contain any questions about advertising practices, and the changes to Form ADV will support the Commission’s compliance oversight efforts, thus helping the Commission monitor market practices and the effects of its rules. For example, the changes to Form ADV will allow the Commission to understand the relative popularity of certain advertising practices and compensation practices for promoters. To the extent that these amendments do facilitate compliance oversight, these changes may benefit clients. These investors may also derive benefits from the information provided in the Form ADV, as amended, which may help them make better decisions with respect to which advisers’ services to utilize. Additionally, it will enable the Commission to evaluate the final rule’s requirements, and their impact on how investment advisers choose to advertise. Investment advisers that use advertisements will likely incur additional costs associated with collecting information to answer these questions, as investment advisers will need to accurately track the types of content in their advertisements. We have quantified a subset of the costs associated with changes to Form ADV, specifically the burden of information collection costs estimated for the purposes the Paperwork Reduction Act. The amendments to Form ADV will impose additional ongoing costs for investment advisers. We estimate the marginal increase in the aggregate cost burden of these changes to Form ADV will be $4,355,288 per year for RIAs not obligated to prepare and file relationship summaries, $3,429,942 per year for RIAs obligated to prepare and file relationship summaries, and $171,881 per year for exempt reporting advisers.959 We therefore estimate the total annual cost increase for all advisers to be $7,957,111 per year.960 However, we note that some portion of the increase in costs is due to an increase in the number of RIAs that will bear these costs, and not entirely 959 The total cost increase for exempt reporting advisers reflects an increase in the number of exempt reporting advisers rather than a per adviser cost increase generated by the final rule. 960 See infra section IV.E. Cost estimates were calculated by subtracting current Form ADV cost burdens from the new Form ADV cost burdens. E:\FR\FM\05MRR2.SGM 05MRR2 13114 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations the questionnaire or survey); (iv) if not included in an advertisement, a record of disclosures provided to the client; (v) 8. Recordkeeping documentation substantiating the The amendments to the recordkeeping adviser’s reasonable basis for believing rule will require investment advisers to that a testimonial, endorsement, or make and keep records of all third-party rating complies with the advertisements they disseminate. applicable tailored requirements of the Generally, the amended recordkeeping marketing rule and copies of any written rule will require additional retention of agreement made with promoters; (vi) a written or distributed communications record of certain affiliated personnel of of an investment adviser, including the adviser; and (vii) a record of who the certain oral communications. For ‘‘intended audience’’ is. example, the current recordkeeping rule These requirements will impose requires the retention of advertisements compliance costs on advisers related to disseminated to ten or more individuals. the creation and retention of these In contrast, the amendments require that records. These costs will be associated advisers retain all advertisements, with with additional personnel time to the two exceptions. First, for oral advertisements, the adviser may, instead capture or retain these communications. Notably, retaining documents that form of recording and retaining the the basis of a calculation could be more advertisement, retain a copy of any expensive due to the requirement that written or recorded materials used by advisers retain calculation information the adviser in connection with the oral advertisement.961 Second, if an adviser’s for portfolios (and not only for managed accounts and securities advertisement includes a compensated recommendations). However, we believe oral testimonial or endorsement, the that there is overlap between accounts adviser may, instead of recording and included in ‘‘portfolios’’ and those retaining the advertisement, make and ‘‘managed accounts’’ already captured keep a record of the disclosures by the current recordkeeping rule. provided to investors.962 In addition, if Retaining these documents might the required disclosures with respect to require an investment adviser to a testimonial or endorsement are not evaluate which documents are relevant included in the advertisement, then the for a performance calculation, which adviser must retain copies of such could potentially generate costs for the 963 disclosures provided to investors. The recordkeeping rule will continue to investment adviser. Similarly, advisers will incur costs related to required require that advisers keep a record of records that are not communications, communications other than including a record of who an advertisements (for example, notices, advertisement’s ‘‘intended audience’’ is, circulars, newspaper articles, for example. Creation of these records investment letters, and bulletins) that might involve research and collection of the investment adviser disseminates, information about an investment directly or indirectly, to ten or more adviser’s intended audience. persons. Additionally, there are some types of newly required records that can Furthermore, the recordkeeping rule requires advisers to retain documents be particularly costly to retain. For that support the inclusion of example, creating and retaining records predecessor performance in an of orally delivered disclosures will advertisement, including a requirement impose extra costs on investment to make and keep originals of all written advisers and promoters. These communications received and copies of requirements may result in costs on investment advisers, such as dedicating all written communications sent by an investment adviser relating to personnel time to capture and retain predecessor performance and the these records. The amendments to the recordkeeping performance or rate of return of any portfolios. In contrast, this provision in rule will also require investment the current recordkeeping rule only advisers to make and keep: (i) requires advisers to make and keep Documentation of communications relating to predecessor performance; (ii) originals of all written communications received and copies of all written documentation to support performance communications sent by an investment calculations; (iii) copies of any adviser relating to the performance or questionnaire or survey used in rate of return of any or all managed preparation of a third-party rating (in accounts or securities the event the adviser obtains a copy of recommendations. The recordkeeping rule also requires that a list of certain 961 See final rule 204–2(a)(11)(i)(A)(1). 962 See final rule 204–2(a)(11)(i)(A)(2). affiliated personnel be retained, to 963 See final rule 204–2(a)(11)(i)(A) and (15)(i). parallel the exemption for certain jbell on DSKJLSW7X2PROD with RULES2 due to an increase in the cost burden for an individual RIA. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 affiliated personnel from the compensated testimonials and endorsements requirements. This requirement may generate costs for the investment adviser to retain and update this list. Some of these costs may ultimately be passed on to clients or investors through higher fees. These costs may, however, be mitigated to the extent that advisers are already retaining similar records. Under the current recordkeeping rule, for example, advisers are required to retain originals of documentation supporting the calculation of performance or rate of return of all managed accounts or securities recommendations. The amendments to the recordkeeping rule, in contrast, will also require documentation supporting the calculation of performance or the rate of return for any or all portfolios. As a result, the total costs of compliance for advisers with respect to communications previously included in the definition of an advertisement will be mitigated somewhat. Further, the staff has, for example, taken the position that rule 204–2(a)(16) also applies to a successor’s use of a predecessor’s performance data.964 As a result, retention of some documentation and written communications required to be retained under the recordkeeping rule will impose relatively minor costs on investment advisers with respect to communications currently subject to the existing recordkeeping requirements. Under the baseline, there are no recordkeeping requirements for the communications of solicitors, except for the disclosure documents that solicitors are required to provide to clients pursuant to the current solicitation rule. Investment advisers that currently use solicitors will incur additional costs associated with the substantive changes to the final recordkeeping requirements discussed in this section, as well as the expansion of the definition of advertisement to include testimonials and endorsements. In addition, given that the recordkeeping obligations fall upon investment advisers and not their promoters, we do not anticipate this provision will generate substantial costs or benefits for promoters. We have quantified a subset of the costs associated with the recordkeeping provisions, specifically, the burden of information collection costs estimated for the purposes of the Paperwork Reduction Act. The amendments to the recordkeeping requirements will cause 964 See rule 204–2(a)(16); See Great Lakes Letter (not recommending enforcement action and stating the staff’s view that the requirement in rule 204– 2(a)(16) applies to a successor’s use of a predecessor’s performance data). E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations investment advisers to incur annual ongoing costs related to the creation and retention of records. We estimate these costs to have a total cost of $16,636,198 per year.965 jbell on DSKJLSW7X2PROD with RULES2 E. Efficiency, Competition, Capital Formation We believe the final amendments could have positive effects on efficiency, competition, and capital formation. As discussed below, we expect the amendments could improve efficiency by improving the quantity and quality of information in advertisements. Further, if investors are thereby able to make more informed decisions about investment advisers and more easily learn about the ability and potential fit of investment advisers, investment advisers might have a stronger incentive to invest in the quality of their services, which could promote increased competition among investment advisers. However, if advertisements attract customers for investment advisers in a manner unrelated to the quality of their services, competition among investment advertisers could result in an inefficient ‘‘arms race.’’ To the extent that the final rule results in improved matches in the market for investment advice, potential investors may be drawn to invest additional capital, which could promote capital formation. 1. Efficiency The final rules have the potential to improve the information in investment adviser advertisements by improving the quantity and quality of information available to investors. This in turn could improve the efficiency of the market for investment advice in two ways. First, the final rule could increase the overall amount of information in investment adviser advertisements by increasing the types of information that investment advisers include in their advertisements and prescribing requirements and restrictions on the presentation of certain kinds of information in adviser and private fund advertisements. This could either be directly through the provisions of the rule, or indirectly, through competition among investment advisers on how informative their advertisements are. For example, to the extent that the rules and rescission of existing no-action letters increase certainty for advisers and thereby reduce compliance costs, advisers may increase their use of the types of marketing activities covered by the final rules. This may increase investor access to information regarding 965 See infra section IV.D. VerDate Sep<11>2014 21:12 Mar 04, 2021 the ability and potential fit of investment advisers, which may improve the quality of the matches that investors make with investment advisers. In addition, advertisements can improve the efficiency of the investment adviser search process through the investor protections and disclosures that the final rule will provide. On the other hand, investment advisers, promoters, and related personnel may reduce the overall amount of information in these communications, because of the expanded definition of an advertisement and related costs imposed on communications newly brought within the definition, which could reduce the overall efficiency of an investor’s investment adviser search. The information from testimonials, endorsements, performance data, and third-party ratings presented in accordance with the provisions of the rule can potentially provide valuable information for investors. Better informed investors could improve the efficiency of the market for investment advice by improving the matches between investors and investment advisers and reducing search costs, as they may be better able to evaluate investment advisers based on the information in their advertisements.966 To the extent that the rule improves the usefulness of the recommendations of non-cash compensated promoters, another programmatic benefit of the rule is that it may improve the efficiency of matches between investment advisers and investors. Although the final rule requires additional disclosures when investment advisers include certain elements in their advertisements, the value of these disclosures to investors depends on the extent to which investors are able to utilize the disclosures to better understand the context of an adviser’s claims. By providing information to investors in the required disclosures to aid their evaluation of an adviser’s advertisements, these disclosures could mitigate the potential that advertisements mislead investors, and improve their ability to find the right investment adviser for their needs. Second, the final rule could increase the overall quality of information about investment advisers. To the extent that the rules mitigate misleading or fraudulent advertising practices, investors may be more likely to believe the claims of investment adviser advertisements. Because information in advertisements is more likely to increase the number of investors 966 See Jkt 253001 PO 00000 supra section III.B. Frm 00093 Fmt 4701 Sfmt 4700 13115 interested in an investment adviser, advisers may include more information that will improve the choices of investors. One potential consequence of modifying the regulatory standards for advertisements provided by the final rule is that investment advisers may increase the amount of resources they allocate to advertising their services (including resources aimed to address compliance with the final rule). While additional spending on advertisements may facilitate matching between investment advisers and investors, under some circumstances, this additional spending may be inefficient if the benefits of better matches fall short of the resources required to facilitate better matches. The final rule also merges certain solicitation activity into the definitions of testimonials and endorsements and expands the scope by covering all forms of compensation. The rule also includes persons providing testimonials or endorsements to investors in a private fund. In addition, the rule will continue to require disclosures to make salient the nature of the relationship between a promoter and the investment advisers. These provisions could improve the efficiency of the market for promoters and their investment advisers by ensuring that the provisions for testimonials and endorsements apply to all forms of potential conflicts of interest. If investors are aware of these conflicts of interest through disclosures, they may be better able to interpret testimonials and endorsements and choose an investment adviser that is of higher quality, or a better match. 2. Competition As discussed earlier, the final rule might result in an increase in the efficiency of investment adviser advertisements, providing more useful information to investors about the abilities of an investment adviser than advertisements under the baseline, which would allow them to make better decisions about which investment advisers to choose.967 In this case, if investors make more informed decisions about investment advisers based on the content of their advertisements, investment advisers might have a stronger incentive to invest in the quality of their services, as the final rule will permit them more flexibility to communicate the higher quality of their services by providing additional information about their services. This could promote competition among investment advisers based on the 967 See E:\FR\FM\05MRR2.SGM supra section III.B. 05MRR2 13116 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 quality of their services, and result in a benefit for investors. However, the final rule might instead provide investment advisers with a stronger incentive to invest in the quality of their advertisements rather than the quality of their services. If investment advisers increase spending on advertisements in a way that does not improve the information quality in advertisements, but still attracts investors, the competition could potentially be inefficient. Although the direct costs of advertisements would be borne by the investment adviser, it is possible that some portion of the costs of advertisement will be indirectly borne by investors.968 As a result, investments in advertisements may result in higher fees for investors. The final rule has conditions that can affect market participants in different ways. For example, the final rule’s restriction on the presentation of performance results unless results for one, five, and ten year periods are presented does not restrict the presentation of performance of private funds. This could give investment advisers that are able to advertise both private funds and general funds more options in how they advertise performance, and provide them a competitive advantage over investment advisers that only advertise non-fund performance. Further, to the extent that advisers increase their usage of compensated testimonials or endorsements as a result of the final rule, this could provide competitive advantages to advisers who are better able to pay fees for such testimonials or endorsements, or for larger firms who have larger audiences with which to leverage favorable testimonials and endorsements.969 In addition, provisions for different types of performance advertising can have a disparate impact on newer investment advisers versus older ones. Generally, newer investment advisers have fewer performance advertising options and shorter performance histories than older investment advisers, and might prefer to rely on hypothetical or related performance advertising. To the extent that the final rule’s provisions place 968 Firms that face a change in costs will bear some portion of these costs directly, but will also pass a portion of the cost to their consumers through the price. In a competitive market, the portion of these costs that firms are able to pass on to consumers depends on the relative elasticities of supply and demand. For example, if demand for investment adviser services is elastic relative to supply of investment adviser services, investment advisers will be limited in their ability to pass through costs. For more, see Mankiw, Gregory, Principles of Economics (2017). 969 See NAPFA Comment Letter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 different requirements on these types of performance, newer investment advisers could face competitive disadvantages relative to older investment advisers. In addition, the final rule affects current solicitors by including non-cash compensation in the scope of the rule’s requirements for testimonials and endorsements. The final rule could improve competition among investment advisers and solicitors by subjecting all forms of compensation for testimonials and endorsements to the same requirements, and not imposing a higher regulatory burden on solicitors compensated in cash and their respective investment advisers do not receive a higher regulatory burden. Under the final rule, providers of testimonials or endorsements that prefer or accept cash compensation for their activities will not be subject to a higher burden relative to persons that prefer or accept non-cash compensation. In addition, non-cash compensated promoters will bear additional costs associated with being scoped into the marketing rule. We expect that some portion of these costs will be passed onto investors through higher fees. Differences in the scope of disqualification between investment advisers subject to the disqualification provisions in this final rule, brokerdealers, and promoters of private funds under Regulation D may create competitive disparities in the personnel that are available to provide testimonials or endorsements. Investment advisers that operate as broker-dealers or advise private funds might have more flexibility to use personnel that might be disqualified from providing testimonials or endorsements under the final rule, but are not disqualified under section 3(a)(39) of the Exchange Act for brokerdealers or Regulation D for advisers of private funds. This flexibility could impose an uneven burden on investment advisers, as those that are also registered as broker-dealers or broker-dealer affiliates, or advise private funds, will potentially able to draw upon a larger pool of personnel to provide testimonials or endorsements. 3. Capital Formation To the extent that the final rule results in improved matches in the market for investment advice, potential investors may be drawn to invest additional capital, which could promote capital formation, to the extent that the additional capital does not reduce other forms of capital formation. However, the final rule could induce some investment advisers to increase their advertising such that the additional expenses of PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 advertising may offset any gains to the quality of matches with investors.970 In this case, any benefits to capital formation as a result of the final rule could be reduced or eliminated. Similarly, if the costs associated with the disclosure, oversight, and recordkeeping requirements of the final rule result in a reduction of advertisements, the information available to investors might decrease. This could decrease the quality of matches between investors and investment advisers, leading investors to divert capital away from investment to other uses, hindering capital formation. The final rule’s expansion of the types of compensation subject to solicitor regulation for providers of testimonials or endorsements might improve the efficiency of the ultimate choice of investment adviser that investors make. Improving the efficiency of the investment adviser selection process could improve the efficiency of the investing overall for investors, which may lead them to devote more capital towards investment. In addition, the final rule expands the set of disqualifying events that would bar an adviser from compensating an individual to provide a testimonial or endorsement, which may improve an investor’s confidence in a testimonial or endorsement’s recommendation of an investment adviser, which, in turn, could lead investors to allocate more of their resources towards investment, thus promoting capital formation. F. Reasonable Alternatives 1. Reduce or Eliminate Specific Limitations on Investment Adviser Advertisements We could change the degree to which the marketing rule relies on specific limitations on investment adviser marketing. One alternative to the marketing rule would be reducing or eliminating specific limitations on investment adviser advertising, and instead relying on general prohibitions to achieve the programmatic benefits of the rule. For example, such an alternative might include reducing or eliminating the specific limitations on the different types of hypothetical performance or testimonials and endorsements. The specific prohibitions of the final rule are prophylactic in nature, and many of the advertising practices described in the specific prohibitions would also be prohibited under the general prohibition on fraud 970 See E:\FR\FM\05MRR2.SGM supra sections III.E.1 and III.E.2. 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations and deceit in section 206 of the Act, among other provisions.971 As a consequence, advisers might bear greater compliance costs in interpreting the rule or may otherwise restrict their advertising activities unnecessarily, and may reduce their advertising as a result. Alternatively, advisers may face lower compliance costs associated with the specific prohibitions. In addition, under such an approach, investors may also not obtain some of the benefits associated with the final rule. For example, in the absence of a specific advertising rule, investors would not necessarily obtain the benefits associated with the comparability of performance presentations provided in the proposed rule, or the requirement to provide performance over a variety of periods (except in private fund advertisements) so that an investor may sufficiently evaluate the adviser’s performance. Investors would also not benefit from the specific protections against the potential for misleading hypothetical performance contained in the final rule, such as the requirement to have policies and procedures designed to ensure that such performance is relevant to the likely financial situation and investment objectives of the investor and includes sufficient disclosures to enable persons receiving it to understand how it is calculated and the risks and limitations of relying on it. Although some advisers might provide such information, even in the absence of the final specific requirements to help ensure that their performance presentations comply with section 206 of the Act or other applicable anti-fraud provisions, others may not. As a consequence, this approach may benefit certain advisers by allowing them to avoid the costs of the specific requirements of the final rule, but investors would not receive the benefit of the other protections of the rule. One variation of this alternative would be to eliminate the marketing rule and instead rely solely on the general prohibitions against fraud or deceit in section 206 of the Advisers Act and certain rules thereunder. Under such an approach, a rule specifically targeting adviser advertising practices might be unnecessary. In the absence of a marketing rule, however, an adviser might have not sufficient clarity and guidance on whether certain advertising practices would likely be fraudulent and deceptive. As a consequence, advisers 971 For anti-fraud provisions applicable to the marketing of private funds, see Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, rule 10b–5, and rule 206(4)–8 under the Advisers Act. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 may bear costs in obtaining such guidance or may otherwise restrict their advertising activities unnecessarily in the absence of such clarity and guidance that would be provided through a rule, and may reduce their advertising as a result. Conversely, another alternative to the marketing rule would be to make the rule more prescriptive, prescribing certain specific and standardized disclosures in lieu of the principlesbased approach of the final rule. On the one hand, such an approach may provide investors with disclosures that may be more comparable across advisers, and ease the costs associated with interpretation and compliance. However, standardized disclosures could both impose costs on investment advisers by requiring disclosures when they might not provide much investor protection benefit, and also not require disclosures when an investor might benefit from one. The broad framework of the final rule is designed to permit investment advisers to tailor their disclosures to their specific marketing practices, subject to certain specific requirements. A related alternative to the final rule would be to align the marketing rule more closely with FINRA rule 2210 and related rules. FINRA rule 2210 governs broker-dealers’ communications with the public, including communications with retail and institutional investors, and provides standards for the content, approval, recordkeeping, and filing of communications with FINRA.972 To the extent that such an alternative resembles Rule 2210, this alternative might impose lower compliance cost burdens for dual-registrants who are subject to Rule 2210 and related rules than under the final rule. However, as discussed above, standardized disclosures for investment advisers could be over- or under-inclusive given the variety of investment advisory services and advertising practices associated with investment advisers, and we believe that the final rule’s approach of providing advisers’ with a broad framework within which to determine how best to present advertisements so they are not false and misleading is consistent with the features of the market for investment advice.973 Further, because FINRA rule 2210 does not contain similar provisions to all of the requirements of the final rule, this alternative would not have offered the same investor 972 See supra section III.C.1.b. supra footnote 279 and accompanying text for a discussion of comments we received on this point. 973 See PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 13117 protections of the final rule. For example, FINRA rule 2210 does not contain a similar provision to the final rule’s requirement to disclose compensation for a solicitation or referral or for the conflict of interest that results.974 2. Bifurcate Some Requirements One alternative to the final rule would be to separate requirements of the originally proposed rule that currently apply to all advertisements. For example, one alternative approach to regulation that we considered is prohibiting hypothetical performance in advertisements to retail investors, but not others, provided that certain disclosures were made. Evidence from academic research suggests that investors are highly segmented in their financial literacy and access to resources.975 The fact that certain market segments are susceptible to misconduct suggests that the lack of financial literacy or access to resources may also leave them susceptible to false or misleading statements in advertisements or solicitations. Tailoring requirements to suit the segmented nature of the market for investment advice may yield benefits to investor protection for investors with lower financial literacy or access to resources, as advertisements directed towards these specific market segments vulnerable to misleading statements would face additional requirements. Similarly, advertisements not directed towards those segments would benefit from additional flexibility and information contained in these advertisements. However, bifurcating the requirements in the final rule might also impose additional costs on investment advisers, who may need to expend additional resources to create advertisements that complied with two increasingly different sets of requirements. 974 See supra section II.C.5.c. Financial Literacy Study, supra footnote 846. See also Mark Egan, Gregor Matvos and Amit Seru, The Market for Financial Adviser Misconduct, 127 J. Pol. Econ. 233 (2019). The paper uses the term ‘‘financial advisors,’’ to refer to broker-dealer representatives. The authors argue that brokerdealer representatives target different groups of investors and that this segmentation permits firms with high tolerance for misconduct on the part of their associated persons to coexist with firms maintaining clean records in the current market. They find that misconduct is more common among firms that advise retail investors, and in counties with low education, elderly populations and high incomes (when controlling for other characteristics). 975 See E:\FR\FM\05MRR2.SGM 05MRR2 13118 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations 3. Hypothetical Performance Alternatives One alternative to the final rule’s treatment of hypothetical performance would be to prohibit all forms of hypothetical performance in all advertisements. The Commission considered this alternative because it believes hypothetical performance generally presents a high risk of misleading investors. This alternative would eliminate the possibility that investors are misled by hypothetical performance, but also eliminates the possibility that investors might gain useful information from some types of hypothetical information. This additional information might have been useful for improving the quality of the matches that investors make with investment advisers. While a prohibition on hypothetical performance might improve the efficiency of investment adviser advertising by reducing the chance that investors are misled by advertisements, efficiency can also be reduced if investors are less able to receive relevant information about the investment adviser. Conversely, another alternative would be to permit all hypothetical performance in all advertisements, without any additional requirements. This could increase the relevant hypothetical performance that reaches investors. While such statements would still be subject to the final rule’s general prohibitions, we believe that this approach would still pose a high risk that hypothetical performance would mislead investors. This approach would lack the final rule’s protections that are designed to help ensure that hypothetical performance is disseminated to investors who have access to the resources to independently analyze this information and who have the financial expertise to understand the risks and limitations of these types of presentations. jbell on DSKJLSW7X2PROD with RULES2 4. Alternatives to the Combined Marketing Rule In the proposal, we also considered retaining separate advertising and solicitation rules and instead updating and clarifying each rule separately. However, in the proposal the advertising rule was expanded to permit advertisements containing testimonials and endorsements, subject to certain requirements, which had the potential to subject promoters and solicitors to duplicative requirements from both the advertising and the solicitation rule. These duplicative requirements would have imposed additional costs to VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 promoters and their investment advisers, and potentially decreased the usefulness of the disclosures made to investors. We also considered the alternative of not applying the final amended merged marketing rule to the solicitation of existing and prospective private fund investors. Under this alternative, the rule would apply only to the adviser’s clients (including prospective clients), which, in the case of funds, are the private funds themselves, and would not apply to investors in private funds. However, while investors in private funds may often be financially sophisticated, they may not be aware that the person engaging in the solicitation activity may be compensated by the adviser or aware of the other disclosure items that we are requiring, and we believe investors in such funds should be informed of that fact, those disclosure items and the related conflicts. In addition, we believe that the application of the final merged marketing rule to investors in private funds is consistent with the portions of the rule that concern investment adviser advertising. This consistency could avoid any competitive disparities between investment advisers that advise private funds and those that do not, and reduce the costs that investment advisers bear, by potentially removing costs associated with identifying whether the target of a communication is a private fund investor or not. We believe that harmonizing the scope of the merged rule with the advertising portions of the rule to the extent possible should ease compliance burdens. 5. Alternatives to Disqualification Provisions We also considered an alternative to current rule 206(4)–3 wherein the disqualification provisions of the rule would not apply if the solicitor has performed solicitation activities for the investment adviser during the preceding twelve months and the investment adviser’s compensation payable to the solicitor for those solicitation activities was $1,000 or less (or the equivalent value in non-cash compensation). We considered the alternative of not having any de minimis exemption in the proposal, which would expand the set of individuals for whom the investment adviser would need to assess for disqualification, potentially extending the costs and benefits of the proposed solicitation rule to these solicitation activities, we believe the solicitor’s incentives to defraud an investor are significantly reduced when receiving de minimis compensation, and that the PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 need for heightened safeguards is likewise reduced. Conversely, we also considered the alternative of adopting a higher threshold for a de minimis exemption. However, we believe that an aggregate $1,000 de minimis amount over a trailing year period is consistent with our goal of providing an exception for small or nominal payments. Regarding the trailing period, we understand that a very engaged solicitor who is paid even a small amount per referral could potentially receive a significant amount of compensation from an adviser over time even if the solicitor receives less than $1,000 per year. Over multiple years, such an investment adviser’s compensation could accumulate to a more significant amount. In such a case we believe that investors should be informed of the conflict of interest and gain the benefit of the other provisions of the rule. IV. Paperwork Reduction Act Analysis A. Introduction Certain provisions of our rule amendments will result in new ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).976 The rule amendments will have an impact on the current collection of information burdens of rule 204–2 under the Investment Advisers Act (‘‘the Act’’) and Form ADV. The title of the new collection of information we are proposing is ‘‘Rule 206(4)–1 under the Investment Advisers Act.’’ The Office of Management and Budget (‘‘OMB’’) has not yet assigned a control number for ‘‘Rule 206(4)–1 under the Investment Advisers Act.’’ The titles for the existing collections of information that we are amending are: (i) ‘‘Rule 206(4)–3 under the Investment Advisers Act of 1940 (17 CFR 275.206(4)–3)’’ (OMB number 3235–0242); (ii) ‘‘Rule 204–2 under the Investment Advisers Act of 1940’’ (OMB control number 3235–0278); and (iii) ‘‘Form ADV’’ (OMB control number 3235–0049). The Commission is submitting these collections of information to OMB for review and approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. We published notice soliciting comments on the collection of information requirements in the 2019 Proposing Release and submitted the 976 44 E:\FR\FM\05MRR2.SGM U.S.C. 3501 et seq. 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations proposed collections of information to OMB for review and approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Although we received no comments directly on the proposed collections of information burdens, we did receive three comments on aspects of the economic analysis that implicated estimates we used to calculate the collection of information burdens. Two commenters generally stated that advisers would disseminate new advertisements and update existing advertisements much more frequently than estimated in our proposal, due to the proposed expanded definition of advertisement.977 Two other commenters suggested that our assumptions underestimated the amount of time and costs required to implement the proposed amendments to the advertising and solicitation rules.978 We address these comments below. We discuss below the new collection of information burdens associated with the amendments to rule 206(4)–1, as well as the revised existing collection of information burdens associated with the amendments to rule 204–2 and Form ADV. There will no longer be a collection of information burden with respect to rule 206(4)–3 because we are rescinding this rule. Responses provided to the Commission in the context of its examination and oversight program concerning the amendments to rule 206(4)–1 and rule 204–2 will be kept confidential subject to the provisions of applicable law. However, because some of the information collection pursuant to rule 206(4)–1 requires disclosures to investors, these disclosures will not be kept confidential. Responses to the disclosure requirements of the amendments to Form ADV, which are filed with the Commission, are not kept confidential. B. Rule 206(4)–1 The marketing rule states that, as a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts, practices, or courses of business within the meaning of section 206(4) of the Act, it is unlawful for any investment adviser registered or required to be registered under section 203 of the of the Act, directly or indirectly, to disseminate any advertisement that violates any of paragraphs (a) through (d) of the rule, which include the rule’s general prohibitions, as well as conditions applicable to an adviser’s use of testimonials, endorsements, third-party ratings, and performance information.979 Each requirement under the final rule that an adviser disclose information, offer to provide information, or adopt policies and procedures constitutes a ‘‘collection of information’’ requirement under the PRA. The respondents to these collections of information requirements will be investment advisers that are registered or required to be registered with the Commission. As of August 1, 2020, there were 13,724 investment advisers registered with the Commission.980 Investment adviser marketing is not mandatory; however: (i) Marketing is an essential part of retaining and attracting clients; (ii) marketing may be conducted easily through the internet and social media; and (iii) the definition of ‘‘advertisement’’ expands the scope of the advertising rule. Accordingly, we estimate that all investment advisers will disseminate at least one communication that meets the rule’s definition of ‘‘advertisement’’ and therefore be subject to the requirements of the marketing rule. While commenters claimed that our assumptions in the proposal significantly underestimated the scope of communications that would constitute an advertisement under the proposed amendment to the advertising rule, we made several modifications versus the proposal that will reduce the amount of communications subject to the rule to address commenters’ concerns.981 For example, the marketing rule will exclude certain one-on-one communications from the first prong of the definition and communications to current clients that do not offer new or additional advisory services. These changes from the proposal will significantly reduce the scope of 979 Final 977 Fidelity Comment Letter; IAA Comment jbell on DSKJLSW7X2PROD with RULES2 Letter. 978 MFA/AIMA Comment Letter I. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 rule 206(4)–1(b), (c). supra section III.C.1.c. 981 See MFA/AIMA Comment Letter I; Fidelity Comment Letter. communications subject to the marketing rule. Because the use of testimonials, endorsements, third-party ratings, and performance results in advertisements is voluntary, the percentage of investment advisers that would include these items in an advertisement is uncertain. However, we have made certain estimates of this data, as discussed below, solely for the purpose of this PRA analysis. 1. General Prohibitions The general prohibitions under the rule do not create a collection of information and are, therefore, not discussed, with one exception. The final rule will prohibit advertisements that include a material statement of fact that the adviser does not have a reasonable basis for believing that it will be able to substantiate upon demand by the Commission. As discussed above, advisers would be able to demonstrate this reasonable belief in a number of ways.982 For example, they could make a record contemporaneous with the advertisement demonstrating the basis for their belief. An adviser might also choose to implement policies and procedures to address how this requirement is met. This will create a collection of information burden within the meaning of the PRA. As stated above, we estimate that all investment advisers will disseminate at least one communication that meets the rule’s definition of ‘‘advertisement’’ and therefore be subject to the requirements of the marketing rule. We also estimate that such advertisements will include at least one statement of material fact that will be subject to this general prohibition, for which an adviser will create and/or maintain a record documenting its reasonable belief that it can substantiate the statement. This estimate reflects that many types of statements typically included in an advertisement (e.g. performance) can likely be substantiated by other records that an adviser will be required to create and maintain under the final rule.983 Table 1 summarizes the final PRA estimates for the internal and external burdens associated with this requirement. 980 See PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 13119 982 See 983 See E:\FR\FM\05MRR2.SGM supra section II.B.2. supra section II.B.2. 05MRR2 13120 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations Under the marketing rule, investment advisers are prohibited from including in any advertisement, or providing any compensation for, any testimonial or endorsement unless the adviser discloses, or the investment adviser reasonably believes that the person giving the testimonial or endorsement discloses: (i) Clearly and prominently: (A) That the testimonial was given by a current client or investor, or the endorsement was given by a person other than a current client or investor; (B) that cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and (C) a brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person; (ii) the material terms of any compensation arrangement, including a description of the compensation provided or to be provided, directly or indirectly, to the person for the testimonial or endorsement; and (iii) a description of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person and/or any compensation arrangement.984 The rule also imposes an oversight obligation that requires that an investment adviser have a reasonable basis to believe that the testimonial or endorsement complies with the marketing rule and have a written agreement with the person giving a testimonial or endorsement (except for certain affiliated persons of the adviser) that describes the scope of the agreed upon activities and the terms of the compensation for those activities when making payments for compensated testimonials and endorsements that are above the de minimis threshold.985 This collection of information consists of two components: (i) The requirement to disclose certain information in connection with the testimonial and endorsement, and (ii) the requirement to oversee the testimonial or endorsement, including a written agreement with certain persons giving the testimonial or endorsement. The final rule’s definitions of testimonials and endorsements generally contain three elements: (i) Statements about the client’s/nonclient’s or investor’s experience with the investment adviser or its supervised persons, (ii) statements that directly or indirectly solicit any prospective client or investor in a private fund for the investment adviser, or (iii) statements that refer any prospective client or investor in a private fund to the investment adviser. The first element is drawn from the definitions of these terms in our proposed advertising rule. The second and third elements are drawn from the scope of our proposed solicitation rule.986 Accordingly, our PRA analysis will be drawn from our proposed estimates and discussion of 985 Id. 984 Final rule 206(4)–1(b)(1). VerDate Sep<11>2014 21:12 Mar 04, 2021 986 Id. Jkt 253001 PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 both proposed rules in the 2019 Proposing Release.987 In our advertising rule proposal, from which the first element of these definitions is drawn, we estimated that 50 percent of advisers would include a testimonial or endorsement under the proposed advertising rule. We also estimated in our advertising proposal that an investment adviser that includes testimonials or endorsements in advertisements would use approximately 5 testimonials or endorsements per year, and would create new advertisements with new or updated testimonials and endorsements approximately once per year. In the solicitation rule proposal, from which elements two and three of the definitions are drawn, we estimated that 47.8 percent of advisers would compensate a solicitor for solicitation activity under the proposed solicitation rule.988 We also estimated in our proposal that for each registered investment adviser that would conduct solicitation activity, they would use approximately 30 referrals annually, distributed by an average of three solicitors. We did not receive comment on any of these estimates. We are revising our estimates from the advertising rule proposal to account for the merger of solicitation concepts into the definitions of testimonial and endorsement. We continue to estimate that 50 percent of advisers will use a testimonial or endorsement; however, 987 See 2019 Proposing Release, supra footnote 7, at section IV. 988 See 2019 Proposing Release, supra footnote 7, at section IV. E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.001</GPH> jbell on DSKJLSW7X2PROD with RULES2 2. Testimonials and Endorsements in Advertisements Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations we are increasing our estimate of the amount of testimonials and estimates each adviser will use to reflect the definitions’ inclusion of solicitation concepts.989 Accordingly, we estimate that each adviser will use an average of five promoters and use 35 testimonials or endorsements annually, which includes testimonials and endorsements incorporated into an adviser’s own advertisement and those communicated by promoters directly. This estimate also reflects the elimination of the proposed exemptions for solicitations for impersonal advisory services or by non-profit referral programs, as well as the addition of the final rule’s exemptions for registered broker-dealers and ‘‘covered persons’’ under rule 506(d) of Regulation D. Under the marketing rule, an adviser that uses a testimonial or endorsement will be required to disclose certain information at the time it is disseminated, which incorporates many of the disclosure elements required under the proposed solicitation rule. As such, we are drawing from the burden estimate we attributed to solicitation disclosures in the 2019 Proposing Release in developing the burden estimate for all testimonials and endorsements under the final rule, not just for the types of testimonials and endorsements that were drawn from the proposed rule. To address one commenter’s contention that we underestimated this burden, and recognizing the changes from the proposal, we are revising this estimate upwards to 0.20 hours per disclosure.990 We believe that advisers will incur this same burden each year, since each testimonial and/or endorsement used will likely be different and thus require jbell on DSKJLSW7X2PROD with RULES2 990 MFA/AIMA VerDate Sep<11>2014 Comment Letter I. 21:12 Mar 04, 2021 Jkt 253001 updated disclosures. An investment adviser’s in-house compliance managers and compliance attorneys will likely prepare disclosures, which will likely be included in the advertisement.991 Some of these third-party testimonials and endorsements will require delivery; thus, we estimate that 20 percent of the disclosures would be delivered by the U.S. Postal Service, with the remaining 80 percent delivered electronically or as part of another delivery of documents. For the 20% of advisers that will use physical mail, we estimate that the average annual costs associated with printing and mailing this information will be collectively $500 for all disclosure documents associated with a single registered investment adviser.992 We estimate the average burden hours each year per adviser to oversee testimonials and endorsements will be one hour for each promoter, or five hours in total for each adviser that is subject to this collection of information.993 While the final rule 991 We estimate the hourly wage rate for compliance manager is $309 and a compliance attorney is $337. The hourly wages used are from SIFMA’s Management & Professional Earnings in the Securities Industry 2013 (‘‘SIFMA Report’’), modified by Commission staff to account for an 1800-hour work-year and inflation, and multiplied by 5.35 to account for bonuses, firm size, employee benefits, and overhead. 992 We do not have specific data regarding how the cost of printing and mailing the underlying information would differ, nor are we able to specifically identify how the cost of printing and mailing the underlying information might be affected by the rule. For these reasons, we estimate $500 per year to collectively print and mail, upon request, the underlying information associated with hypothetical performance for purposes of our analysis. In addition, investors may also request to receive the underlying information electronically. We estimate that there would be negligible external costs associated with emailing electronic copies of the underlying information. 993 This estimate is based on the following calculation: 1 hour per each solicitor relationship PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 13121 provides flexibility as to how advisers conduct this oversight, we generally believe that this burden will include contacting solicited clients, prereviewing testimonials or endorsements, or other similar methods. Additionally, we estimate that each adviser will incur an average burden hour of one hour for each promoter, or five hours in total, to prepare the required written agreements. In-house compliance managers and compliance attorneys are likely to provide oversight of the third party testimonials and endorsements and prepare the written agreements. Finally, in response to one commenter who argued that we did not account for upfront implementation costs for using testimonials and endorsements, we estimate that each adviser that uses a compensated testimonial or endorsement will incur an initial burden of two hours to modify its policies and procedures to reflect the adviser’s oversight of testimonials and endorsements.994 We believe that an adviser’s chief compliance officer will complete this task.995 Table 2 summarizes the final PRA estimates for the internal and external burdens associated with these requirements. × 5 promoter relationships. Although in our proposal we estimated that the oversight requirement would impose a burden of 2 hours per adviser, we believe that because the marketing rule does not require a written agreement, the burden to oversee the promoter relationship will be less than proposed. 994 MFA/AIMA Comment Letter I. Accordingly, the amortized average burden will be 0.67 hours for each of the first 3 years. 995 We estimate that the hourly wage for a chief compliance officer is $530. The hourly wage is from SIFMA’s Management & Professional Earnings in the Securities Industry 2013, modified by Commission staff to account for an 1800-hour workyear and inflation, and multiplied by 5.35 to account for bonuses, firm size, employee benefits, and overhead. E:\FR\FM\05MRR2.SGM 05MRR2 13122 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations 3. Third-Party Ratings in Advertisements from 1.5 hours in the advertising rule proposal to address one commenter’s concern that we underestimated this burden.996 As discussed in the advertising rule proposal, because many of these ratings or rankings are done yearly (e.g., 2018 Top Wealth Adviser), we continue to estimate that an adviser that continues to use a third-party rating will incur ongoing, annual costs of 0.75 burden hours to draft the third-party rating disclosure updates.997 Table 3 summarizes the final PRA estimates for the internal and external burdens associated with these requirements. 996 See MFA/AIMA Comment Letter I. Accordingly, we estimate that the amortized average burden will be 1 hour for each of the first 3 years for each investment adviser to comply with the conditions for including third-party ratings in an advertisement (3.0 hours/3 years = 1 hour). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager. 997 We believe that this burden will also be split evenly between an adviser’s compliance attorney and compliance manager. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.002</GPH> jbell on DSKJLSW7X2PROD with RULES2 As discussed above, rule 206(4)–1(c) will prohibit an investment adviser from including a third-party rating in an advertisement unless certain conditions are met, including that the adviser must clearly and prominently disclose (or reasonably believe that the third-party rating clearly and prominently discloses): (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 cash or non-cash compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating. As discussed in the advertising rule proposal, we continue to believe that approximately 50 percent of advisers will use third-party ratings in advertisements, and that they will typically use one third-party rating on an annual basis. We believe that advisers will incur an initial internal burden of 3.0 hours to draft and finalize the required disclosures for third-party ratings, which we are adjusting upwards Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations The marketing rule will impose certain conditions on the presentation of performance results in advertisements, as discussed above. Below we discuss the conditions that create ‘‘collection of information’’ requirements within the meaning of the PRA. First, the rule will prohibit any presentation of gross performance unless the advertisement also presents net performance that meets certain criteria.998 Second, the rule will prohibit any presentation of performance results of any portfolio or any composite aggregation of related portfolios, other than any private fund, unless the advertisement includes performance results of the same portfolio or composite aggregation for one-, five-, and ten-year periods, except that if the relevant portfolio did not exist for a particular prescribed period, then the life of the portfolio must be substituted for that period.999 Third, the rule will prohibit an advertisement from including related performance, unless it includes all related portfolios, subject to a conditional exception.1000 Fourth, the rule will prohibit an advertisement from including extracted performance, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio from which the performance was extracted.1001 Fifth, the rule will also prohibit an advertisement from including 998 Final rule 206(4)–1(d). at (d)(2). 1000 Id. at (d)(4). 1001 Id. at (d)(5). 999 Id. VerDate Sep<11>2014 21:12 Mar 04, 2021 predecessor performance, unless certain conditions are satisfied.1002 Finally, the rule will require that an adviser that advertises hypothetical performance: (i) Adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement; (ii) provide reasonably sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance; and (iii) provide (or, if the intended audience is an investor in a private fund provide, or offers to provide promptly) reasonably sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions. We estimate that almost all advisers provide, or seek to provide, performance information to their clients. Based on staff experience, we estimate that 95 percent, or 13,038 advisers, provide performance information in their advertisements. The estimated numbers of burden hours and costs regarding performance results in advertisements may vary depending on, among other things, the complexity of the calculations, the type of performance and the risks that investors may not understand the limitations of the information, and whether preparation of 1002 Id. Jkt 253001 PO 00000 at (d)(7). Frm 00101 Fmt 4701 Sfmt 4700 the disclosures is performed by internal staff or outside counsel. a. Presentation of Net Performance in Advertisements We estimate that an investment adviser that elects to present gross performance in an advertisement will incur an initial burden of 15 hours in preparing net performance for each portfolio, including the time spent determining and deducting the relevant fees and expenses to apply in calculating the net performance and then actually running the calculations.1003 We have adjusted this estimate upwards from the proposal to reflect one commenter’s claim that we underestimated this burden in the proposal.1004 Based on staff experience, we estimate that the average investment adviser will present performance for 3 portfolios over the course of a year, excluding any related portfolios that an adviser may need to include for purposes of presenting related performance.1005 As noted above, we estimate that 95 percent, or 13,038 advisers, provide performance information in their advertisements and 1003 Accordingly, we estimate that the amortized initial burden will be 5 hours for each of the first 3 years for each investment adviser to prepare net performance (15 hours/3 years = 5 hours/year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (2.5 hours each). 1004 See MFA/AIMA Comment Letter I. 1005 The burden associated with calculating net performance in connection with presenting related performance is discussed in section IV.B.3.c. below. E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.003</GPH> jbell on DSKJLSW7X2PROD with RULES2 4. Performance Advertising 13123 13124 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations thus will be subject to this collection of information burden. We expect that the calculation of net performance may be modified every time an adviser chooses to update the advertised performance. We estimate that after initially preparing net performance for each portfolio, investment advisers will incur a burden of 3 hours to update the net performance for each subsequent presentation. Again, we adjusted this estimate upwards from the proposal to reflect one commenter’s claim that we underestimated this burden in the analysis.1006 For purposes of this analysis, we estimate that advisers will update the relevant performance of each portfolio 3.5 times each year.1007 b. Time Period Requirement in Advertisements We estimate that an investment adviser that elects to present performance results in an advertisement will incur an initial burden of 35 hours in preparing performance results of the same portfolio for one-, five-, and tenyear periods (excluding private funds), taking into account that these results must be prepared on a net basis (and may also be prepared and presented on a gross basis).1008 We estimate that after initially preparing one-, five-, and tenyear performance for each portfolio, investment advisers will incur a burden of 8 hours to update the performance for these time periods for each subsequent presentation. For purposes of this analysis, we estimate that advisers will update the relevant performance 3.5 times each year.1009 We received no comments on these estimates and continue to believe they are appropriate. c. Related Performance We estimate that an investment adviser that elects to present related performance in an advertisement will incur an initial burden of 30 hours, with respect to each advertised portfolio or composite aggregation of portfolios, in preparing the relevant performance of jbell on DSKJLSW7X2PROD with RULES2 1006 See MFA/AIMA Comment Letter I. 1007 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (3 hours × 3.5 times per year = 10.5 hours; 10.5 hours/2 = 5.25 hours each). 1008 Accordingly, we estimate that the amortized initial burden will be 11.67 hours for each of the first 3 years for each investment adviser to prepare performance results that comply with this requirement (35 hours/3 years = 11.67 hours/year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (5.83 hours each). 1009 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (8 hours × 3.5 times per year = 28 hours; 28 hours/2 = 14 hours each). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 all related portfolios.1010 We have revised this estimate upwards to address one commenter’s claim that we underestimated this time burden in the proposal.1011 This time burden will include the adviser’s time spent classifying which portfolios meet the rule’s definition of ‘‘related portfolio’’— i.e., which portfolios have ‘‘substantially similar investment policies, objectives, and strategies as those of the services offered in the advertisement.’’ 1012 This burden also will include time spent determining whether to exclude any related portfolios in accordance with the rule’s provision allowing exclusion of one or more related portfolios if ‘‘the advertised performance results are not materially higher than if all related portfolios had been included’’ and ‘‘the exclusion of any related portfolio does not alter the presentation of the time periods prescribed by paragraph (d)(2).’’ 1013 Finally, this time burden will include the adviser’s time calculating and presenting the net performance of any related performance presented. We continue to estimate that 80 percent of advisers (or 10,979 advisers) will have other portfolios with substantially similar investment policies, objectives, and strategies as those offered in the advertisement and choose to include related performance. We estimate that after initially preparing related performance for each portfolio or composite aggregation of portfolios, investment advisers will incur a burden of 5 hours to update the performance for each subsequent presentation. Although we expect that advisers might update their performance fewer times per year than we had proposed because the final rule permits performance to be shown as of the most recent calendar year end, we continue to estimate that advisers will update the relevant related performance 3.5 times each year.1014 We received no comments on these 1010 Accordingly, we estimate that the amortized initial burden will be 10 hours for each of the first 3 years for each investment adviser to prepare related performance in connection with this requirement (30 hours/3 years = 10 hours/year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (5 hours each). 1011 See MFA/AIMA Comment Letter I. 1012 See final rule 206(4)–1(e)(16). Our estimate accounts for advisers that may already be familiar with any composites that meet the definition of ‘‘related portfolio.’’ 1013 See final rule 206(4)–1(d)(4). 1014 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (5 hours × 3.5 times per year = 17.5 hours; 17.5 hours/2 = 8.75 hours each). PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 estimates and continue to believe they are appropriate. d. Extracted Performance As in the advertising rule proposal, we estimate that an investment adviser that elects to present extracted performance in an advertisement will incur an initial burden of 10 hours in preparing the performance results of the total portfolio from which the performance is extracted in order to provide or offer to provide such performance results to investors.1015 For purposes of this analysis, we continue to assume 5 percent of advisers will include extracted performance. We estimate that after initially preparing the performance of the total portfolio from which extracted performance is extracted, investment advisers will incur a burden of 2 hours to update the performance for each subsequent presentation. For purposes of this analysis, we estimate that advisers will update the relevant total portfolio performance 3.5 times each year.1016 We also estimate that registered investment advisers may incur external costs in connection with the requirement to provide performance results of a total portfolio from which extracted hypothetical performance is extracted. We estimate that the average annual costs associated with printing and mailing this information upon request will be collectively $500 for all documents associated with a single registered investment adviser. We received no comments on these estimates and continue to believe they are appropriate. e. Hypothetical Performance We estimate that an investment adviser that elects to present hypothetical performance in an advertisement will incur an initial burden of 7 hours in preparing and adopting policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement.1017 We 1015 Accordingly, we estimate that the amortized initial burden will be 3.33 hours for each of the first 3 years for each investment adviser to prepare the performance of the total portfolio from which the presentation of extracted performance is extracted (10 hours/3 years = 3.33 hours/year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (1.67 hours each). 1016 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (2 hours × 3.5 times per year = 7 hours; 7 hours/2 = 3.5 hours each). 1017 Accordingly, we estimate that the amortized initial burden will be 2.33 hours for each of the first 3 years for each investment adviser to comply with E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations have revised this estimate upwards from the advertising rule proposal to address one commenter’s claim that we underestimated this time burden.1018 For purposes of this analysis, we continue to estimate that 50 percent of advisers will include hypothetical performance in advertisements. We continue to estimate that advisers that use hypothetical performance will disseminate advertisements containing hypothetical performance 20 times each year, including in certain one-on-one communications that meet the final rule’s definition of advertisement. We estimate that after adopting appropriate policies and procedures, an adviser will incur a burden of 0.25 hours to categorize investors according to their likely financial situation and investment objectives pursuant to the adviser’s policies and procedures.1019 Additionally, we estimate that an investment adviser that elects to present hypothetical performance in an advertisement will incur an initial burden of 20 hours in preparing the information sufficient to understand the criteria used and assumptions made in calculating, as well as risks and limitations in using, the hypothetical performance, in order to provide such information, which may in certain circumstances be upon request.1020 We jbell on DSKJLSW7X2PROD with RULES2 this requirement (7 hours/3 years = 2.33 hours/ year). We believe that an adviser’s chief compliance officer will complete this task. 1018 See MFA/AIMA Comment Letter I. 1019 We believe that an adviser’s chief compliance officer will complete this task (20 presentations per year × 0.25 hours each = 5 hours per year). 1020 Accordingly, we estimate that the amortized initial burden will be 6.67 hours for each of the first 3 years for each investment adviser to comply with this requirement (20 hours/3 years = 6.67 hours/ year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (3.33 hours each). This estimate includes the time spent by an adviser in preparing the information. The time spent calculating the hypothetical performance that is VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 have also revised this estimate upwards from the proposal to address one commenter’s claim that we underestimated this time burden.1021 We estimate that after initially preparing the underlying information, investment advisers will incur a burden of 3 hours to update the information for each subsequent presentation. For purposes of this analysis, we estimate that advisers will update their hypothetical performance, and thus the underlying information, 3.5 times each year.1022 We estimate that registered investment advisers may incur external costs in connection with the requirement to provide this underlying information upon the request of an investor or prospective investor in a private fund. We estimate that the average annual costs associated with printing and mailing this underlying information upon request will be collectively $500 for all documents associated with a single registered investment adviser.1023 f. Predecessor Performance The final rule will impose conditions on an adviser’s use of predecessor performance. We estimate that an investment adviser that elects to present predecessor performance in an advertisement will incur an initial burden of 10 hours in preparing the relevant performance results and associated disclosures.1024 This time based on such information is not accounted for in this estimate, as the rule does not require that an advertisement present hypothetical performance. 1021 See MFA/AIMA Comment Letter I. 1022 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (3 hours × 3.5 times per year = 10.5 hours; 10.5 hours/2 = 5.25 hours each). 1023 See supra footnote 992 for a discussion of estimated mailing costs. 1024 Accordingly, we estimate that the amortized initial burden will be 3.33 hours for each of the first 3 years for each investment adviser to prepare PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 13125 burden will include the adviser’s time spent classifying which performance results are eligible to be ported—i.e., to determine whether accounts at a predecessor adviser are ‘‘sufficiently similar’’ and the persons are ‘‘primarily responsible’’ for the performance, or that the relevant algorithm was responsible for achieving the prior performance results.1025 This burden also will include time spent determining whether to exclude any account in accordance with the rule’s provision allowing exclusion of one or more accounts if the advertised performance results ‘‘would not result in materially higher performance.’’ Finally, this time burden will include the adviser’s time calculating and presenting the net performance and appropriate time periods of any predecessor performance presented. We estimate that 2% of advisers (or 275 advisers) will include predecessor performance in an advertisement. We estimate that after initially preparing predecessor performance, investment advisers will incur a burden of 1 hour to update the relevant disclosures and performance information for each subsequent presentation. For purposes of this analysis, we estimate that advisers will update the relevant disclosures 3.5 times each year.1026 Table 4 summarizes the final PRA estimates for the internal and external burdens associated with these requirements. BILLING CODE 8011–01–P predecessor performance in connection with this requirement (10 hours/3 years = 3.33 hours/year). We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (1.67 hours each). 1025 Final rule 206(4)–1(d)(7)(i)–(ii). 1026 We believe that this burden will be split evenly between an adviser’s compliance attorney and compliance manager (1 hour × 3.5 times per year = 3.5 hours; 3.5 hours/2 = 1.75 hours each). E:\FR\FM\05MRR2.SGM 05MRR2 VerDate Sep<11>2014 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00104 Fmt 4701 Sfmt 4725 E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.004</GPH> jbell on DSKJLSW7X2PROD with RULES2 13126 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations 5. Total Hour Burden Associated With Rule 206(4)–1 Accordingly, we estimate the total annual hour burden for investment advisers registered or required to be registered with the Commission under proposed rule 206(4)-1 to prepare testimonials and endorsements, thirdparty ratings, and performance results disclosures will be 1,414,291 hours, at a time cost of $468,287,816. The total external burden costs would be $4,460,200. The following chart summarizes the various components of the total annual burden for investment advisers. jbell on DSKJLSW7X2PROD with RULES2 Internal hour burden General Prohibitions ........................................................................................................ Testimonials and Endorsements ..................................................................................... Third-Party Ratings .......................................................................................................... Performance .................................................................................................................... Total annual burden ................................................................................................. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 82,344 121,252 12,009 1,198,686 Internal burden time cost External cost burden hours hours hours hours $9,016,668 $41,749,094 4,046,933 413,475,121 ............................ $686,200 ............................ 3,774,000 1,414,291 hours 468,287,121 4,460,200 E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.005</GPH> BILLING CODE 8011–01–C 13127 13128 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 C. Rule 206(4)–3 Rule 206(4)–3 (OMB number 3235– 0242) currently prohibits investment advisers from paying cash fees to solicitors for client referrals unless certain conditions are met. As discussed above, we are rescinding rule 206(4)–3 and merging some of its components into the combined marketing rule. The collection of information burden associated with the requirements of rule 206(4)–3 has been incorporated into the collection of information burden for rule 206(4)–1. There will no longer be a collection of information burden associated with rule 206(4)–3. D. Rule 204–2 Under section 204 of the Advisers Act, investment advisers registered or required to register with the Commission under section 203 of the Advisers Act must make and keep for prescribed periods such records (as defined in section 3(a)(37) of the Exchange Act), furnish copies thereof, and make and disseminate such reports as the Commission, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors. Rule 204–2 sets forth the requirements for maintaining and preserving specified books and records. This collection of information is found at 17 CFR 275.204–2 and is mandatory. The Commission staff uses the collection of information in its examination and oversight program. As noted above, responses provided to the Commission in the context of its examination and oversight program concerning the amendments to rule 204–2 will be kept confidential subject to the provisions of applicable law. We are amending rule 204–2 to require investment advisers to retain copies of all advertisements.1027 The current rule requires investment advisers to retain copies of advertisements to 10 or more persons.1028 For oral advertisements, amended rule 204–2 provides that an adviser may instead retain a copy of any written or recorded materials used by the adviser in connection with the oral advertisement.1029 For compensated oral testimonials and endorsements, the adviser may instead make and keep a record of the disclosures provided to clients or investors required by the final rule.1030 We are also amending the rule to require investment advisers to retain: 1027 See final rule 204–2(a)(11); see also supra section II.I (discussing the amendments to the books and records rule). 1028 Rule 204–2(a)(11). 1029 See final rule 204–2(a)(11)(i)(A)(1). 1030 See id. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 (i) Documentation of communications relating to predecessor performance; (ii) copies of all information provided or offered pursuant to the marketing rule’s conditions on advertising hypothetical performance; and (iii) records of who the ‘‘intended audience’’ relating to the conditions of hypothetical performance. The amendments will not require an adviser to maintain copies of written approvals of advertisements, since we are not adopting the proposed requirement that an adviser review and approve advertisements before dissemination. Amended rule 204–2 will require registered investment advisers to maintain a copy of any questionnaire or survey used in preparation of the thirdparty rating. Advisers must also make and retain: (i) A record of the disclosures provided to clients or investors pursuant to the marketing rule, if not included in the advertisement, (ii) documentation related to the adviser’s determination that it has a reasonable basis for believing that a testimonial, endorsement, or third-party rating complies with the applicable conditions of the marketing rule, and (iii) a record of all affiliated personnel of the adviser.1031 Each of these records will be required to be maintained in the same manner, and for the same period of time, as other books and records required to be maintained under rule 204–2(a). Specifically, investment advisers will be required to maintain and preserve these records in an easily accessible place for not less than 5 years from the end of the fiscal year during which the last entry was made on such record, the first 2 years in an appropriate office of the investment adviser. Requiring maintenance of these records will facilitate the Commission’s ability to inspect and enforce compliance with the marketing rule.1032 The information generally is kept confidential subject to the applicable law.1033 The respondents to this collection of information are investment advisers registered or required to be registered with the Commission. The use of advertisements is not mandatory, but as discussed above, we estimate that 100 percent of investment advisers will disseminate at least one communication meeting the rule’s definition of ‘‘advertisement’’ (including oral advertisements) and therefore be subject to the requirements of the rule. The 1031 See final rule 204–2(a)(15)(i)–(ii). Commission therefore estimates that, based on Form ADV filings as of August 1, 2020, approximately 13,724 investment advisers will be subject to the proposed amendments to rule 204– 2 under the Advisers Act. Based on staff experience, we estimate that 95 percent of advisers (or 13,038 advisers) provide, or seek to provide, performance information to their clients.1034 The amendments to the recordkeeping rule will require advisers to maintain communications to clients or investors that contain performance calculations of portfolios, in addition to those that reference performance of managed accounts and securities recommendations as currently required. We believe based on staff experience that advisers already have recordkeeping processes in place to maintain client communications; however, this amendment will expand the types of communications subject to the recordkeeping rule and thus increase this collection of information burden. The amendments will require advisers to maintain copies of any documents provided or offered to clients or investors explaining the assumptions and criteria underlying the hypothetical performance calculation and the risks and limitations in using hypothetical performance. In addition, the amendments will require advisers to create and maintain a record of who the ‘‘intended audience’’ is in connection with its advertisements that include hypothetical performance. We estimate that approximately 50 percent of advisers (or 6,862 advisers) will use hypothetical performance in an advertisement and therefore be subject to the expanded recordkeeping obligations relating to the retention of documents that support those performance calculations. The recordkeeping rule will also require advisers that present predecessor performance to maintain sufficient records to support the performance results provided. As discussed above, we estimate that 2% of advisers (or 275 advisers) will present predecessor performance thus be subject to this collection of information burden. The rule will require advisers that use a testimonial or endorsement to create and maintain a record of the names of all affiliated personnel of the adviser and documentation substantiating the adviser’s reasonable basis for believing that the testimonial or endorsement complies with the specific conditions of the marketing rule. As discussed above, 1032 Id. 1033 See section 210(b) of the Advisers Act (15 U.S.C. 80b–10(b)). PO 00000 Frm 00106 Fmt 4701 Sfmt 4700 1034 See 2016 Form ADV Amendments Release, supra footnote 249 at 149. E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations we estimate that 50 percent of advisers (or 6,862 advisers) will use a testimonial or endorsement. In addition, we estimate that approximately 50 percent of advisers (or 6,862 advisers) will use third-party ratings in advertisements, and will therefore also be subject to the recordkeeping amendments corresponding to the rule’s conditions relating to the use of third-party ratings. These amendments require that an adviser: (i) Retain a copy of any questionnaire or survey used in the preparation of a third-party rating included or appearing in any advertisement, and (ii) make and retain documentation substantiating the investment adviser’s reasonable basis for believing that the third-party rating complies with the specific conditions of the marketing rule.1035 In a change from the proposal, the marketing rule does jbell on DSKJLSW7X2PROD with RULES2 1035 See supra section III.B.2. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 not require advisers to obtain the questionnaire or survey to satisfy the specific conditions for third-party ratings; instead, advisers can comply with the conditions for third-party ratings by other means (which will not trigger a recordkeeping obligation). Accordingly, we estimate that approximately 50 percent of the investment advisers that will use a third-party rating, or 3,431 advisers, will comply with the third-party ratings conditions of the rule by obtaining the underlying questionnaire or survey. For the recordkeeping amendments relating to testimonials and endorsements, we estimate that the amendments will result in a collection of information burden estimate of 5 hours for each of the estimated 6,862 advisers that will use a testimonial or endorsement. We are revising this estimate upwards versus the proposal to reflect the additional recordkeeping PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 13129 obligations we are adopting, such as the requirement to create documentation of the adviser’s reasonable belief that the testimonial or endorsement complies with the specific conditions of the marketing rule. We also estimate the amendments will result in a collection of information burden of 3 hours for the 50 percent of advisers (or 6,862 advisers) that we estimate will use third-party ratings. Again, we have revised this estimate upwards from the proposal to reflect the additional obligations imposed by the amended recordkeeping rule, such as the requirement to create documentation of the adviser’s reasonable belief that the third-party rating complies with the specific conditions of the marketing rule. Table 5 summarizes the final PRA estimates for the internal and external burdens associated with these requirements. BILLING CODE 8011–01–P E:\FR\FM\05MRR2.SGM 05MRR2 VerDate Sep<11>2014 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00108 Fmt 4701 Sfmt 4725 E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.006</GPH> jbell on DSKJLSW7X2PROD with RULES2 13130 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations As noted above, the approved annual aggregate burden for rule 204–2 is currently 2,435,364 hours, based on an estimate of 13,299 registered advisers, or 183 hours per registered adviser, with a total monetized costs of $154,304,664.1036 We therefore estimate that the amendments to the recordkeeping rule will result in an aggregate increase in the collection of information burden estimate by 18.44 approved total aggregate monetized cost for rule 204–2.1041 These increases are attributable to a larger registered investment adviser population since the most recent approval and adjustments for inflation, as well as the rule 204–2 amendments relating to the new marketing rule. The following chart shows the differences from the approved annual hourly burden for the current books and records rule. Requirement Estimated burden increase or decrease Brief explanation All collections of information under rule 204–2 (including new requirements). 18.44 hour increase. ...................... The overall hour burden per adviser would increase from 183 hours to 201.44 hours. The currently approved burden reflects the current rule’s requirement that investment advisers retain copies of advertisements to 10 or more persons. The amended rule will require that they retain copies of all advertisements, as well as copies of any questionnaires or surveys obtained in connection with third-party ratings in advertisements. The amended rule will also require that advisers that use testimonials, endorsements, or third-party ratings make and retain a record documenting that the adviser has a reasonable belief that these items comply with the applicable conditions of the marketing rule. E. Form ADV jbell on DSKJLSW7X2PROD with RULES2 hours for each of the estimated 13,724 registered advisers, resulting in a total of 201.44 hours per adviser.1037 This would yield an annual estimated aggregate burden of 2,764,563 hours under amended rule 204–2 for all registered advisers,1038 for a monetized cost of $175,980,426.1039 This represents in an increase of 329,199 1040 annual aggregate hours in the hour burden and an annual increase of $21,675,762 from the currently Form ADV (OMB Control No. 3235– 0049) is the investment adviser registration form under the Advisers Act. Rule 203–1 under the Advisers Act requires every person applying for investment adviser registration with the Commission to file Form ADV. Rule 204–4 under the Advisers Act requires certain investment advisers exempt from registration with the Commission (‘‘exempt reporting advisers’’) to file reports with the Commission by 1036 2,435,364 hours/13,299 registered advisers = 183 hours per adviser. 1037 10 hours (advertising retention) + 3 hours (performance retention) × 95% + 3 hours (hypothetical performance) × 50% + 3 hours (predecessor performance) × 2% + 5 hours VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 completing a limited number of items on Form ADV. Rule 204–1 under the Advisers Act requires each registered and exempt reporting adviser to file amendments to Form ADV at least annually, and requires advisers to submit electronic filings through IARD. On June 5, 2019, the Commission adopted amendments to Form ADV and related rules under the Act to add new Form ADV Part 3: Form CRS (relationship summary) requiring certain registered investment advisers to prepare and file a relationship summary for retail investors. The paperwork burdens associated with rules 203–1, 204–1, and 204–4 are included in the approved annual burden associated with Form ADV and thus do not entail separate collections of information. These collections of information are found at 17 CFR 275.203–1, 275.204–1, 275.204–4 and 279.1 (Form ADV itself) and are mandatory. Responses are not kept confidential. We are adopting amendments to Form ADV to add a (testimonials and endorsements) x 50% + 3 hours (third-party ratings) × 50% = 18.44 hours. 1038 13,724 registered investment advisers × 201.44 hours = 2,764,563 hours. 1039 $16,636,198/252,661 hours = $65.84/hour for these amendments; $65.84/hour × 329,199 hours = $21,675,762. $21,675,762 + $154,304,664 = $175,980,426. 1040 2,764,563 hours¥2,435,364 hours = 329,199 hours. 1041 $175,980,426¥$154,304,664 = $21,675,762. PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 E:\FR\FM\05MRR2.SGM 05MRR2 ER05MR21.007</GPH> BILLING CODE 8011–01–C 13131 13132 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations subsection L to Item 5 of Part 1A (‘‘Marketing Activities’’) to require information about an adviser’s use in its advertisements of testimonials, endorsements, third-party ratings, and previous investment advice. Specifically, we will require an adviser to state whether any of its advertisements include performance results, hypothetical performance, or predecessor performance. We will also require an adviser to state whether any of its advertisements includes testimonials, endorsements, or a thirdparty rating, and if so, whether the adviser pays or otherwise provides cash or non-cash compensation, directly or indirectly, in connection with their use. Finally, we will require an adviser to state whether any of its advertisements includes a reference to specific investment advice provided by the adviser. The collection of information is necessary to improve information available to us and to the general public about advisers’ advertising practices. jbell on DSKJLSW7X2PROD with RULES2 Number of advisers included in the currently approved burden. Currently approved total annual hour estimate per adviser. Currently approved aggregate annual hour burden. Currently approved aggregate monetized cost. Our staff will use this information to help prepare for examinations of investment advisers. This information will be particularly useful for staff in reviewing an adviser’s compliance with the marketing rule, including the restrictions and conditions on advisers’ use in advertisements of performance presentations and third-party statements. We are not proposing amendments to Form ADV Parts 2 or 3. 1. Respondents The respondents to current Form ADV are investment advisers registered with the Commission or applying for registration with the Commission and exempt reporting advisers.1042 Based on the IARD system data as of August 1, 2020, approximately 13,724 investment advisers were registered with the Commission, and 4,455 exempt reporting advisers file reports with the Commission. The amendments to Form ADV will increase the information requested in Form ADV Part 1A for registered investment advisers. Because exempt reporting advisers are required to complete a limited number of items in Part 1A of Form ADV, which excludes Item 5, they will not be subject to these amendments and will therefore not be subject to this collection of information.1043 However, these exempt reporting advisers are included in the PRA for purposes of updating the overall Form ADV information collection. In addition, as noted above, in 2019 the Commission adopted amendments to Form ADV to add a new Part 3, requiring registered investment advisers that offer services to retail investors to prepare and file with the Commission, post to the adviser’s website (if it has one), and deliver to retail investors a relationship summary.1044 The burdens associated with completing Part 3 are included in the PRA for purposes of updating the overall Form ADV information collection.1045 The currently approved burdens for Form ADV are set forth below:1046 RIAs not obligated to prepare and file relationship summaries RIAs obligated to prepare and file relationship summaries Exempt reporting advisers All advisers 5,064 + 571 expected newly registered RIAs annually. 29.22 hours ....................... 8,235 + 656 expected newly registered RIAs annually. 37.47 hours ....................... 4,280 + 441 expected new ERAs annually. 17,597 advisers + 1,740 expected new RIAs and ERAs annually. 29.28 annual blended average hours per adviser. 164,655 hours ................... 333,146 hours ................... 16,996 hours ..................... 514,797 hours. $44,950,816 ...................... $90,978,858 ...................... $4,639,908 ........................ $140,569,582. 3.60 hours ......................... Based on updated IARD system data as of August 1, 2020, we estimate that the number of registered investment advisers that are required to complete, amend, and file Form ADV (Part 1 and Part 2) with the Commission, but who are not obligated to prepare and file relationship summaries as of the applicable compliance date for Form ADV Part 3, is 5,506, and we also continue to believe, based on IARD system data, that that 1,227 new advisers will register with us annually, 571 of which will not be required to prepare a relationship summary.1047 Based on updated IARD system data as of August 1, 2020, we estimate that the number of registered investment advisers that are required to complete, amend, and file Form ADV (Part 1 and Part 2) and prepare and file relationship summaries is 8,218, and we continue to believe, based on IARD system data, that that 1,227 new advisers will register with us annually, 656 of which will be required to prepare a relationship summary.1048 Based on updated IARD system data as of August 1, 2020, we estimate that the number of exempt reporting advisers is 4,455; however, we continue to believe that, based on IARD system data, there would be 441 new exempt reporting advisers annually.1049 1042 An exempt reporting adviser is an investment adviser that relies on the exemption from investment adviser registration provided in either section 203(l) of the Advisers Act because it is an adviser solely to one or more venture capital funds or 203(m) of the Advisers Act because it is an adviser solely to private funds and has assets under management in the United States of less than $150 million. 1043 An exempt reporting adviser is not a registered investment adviser and therefore will not be subject to the amendments to Item 5 of Form ADV Part 1A. Exempt reporting advisers are required to complete a limited number of items in Form ADV Part 1A (consisting of Items 1, 2.B., 3, 6, 7, 10, 11 and corresponding schedules), and are not required to complete Part 2. 1044 See Form CRS Relationship Summary; Amendments to Form ADV, Release No. IA–5247 (June 5, 2019) [84 FR 33492 (Jul. 12, 2019)]. 1045 See Updated Supporting Statement for PRA Submission for Amendments to Form ADV Under the Investment Advisers Act of 1940 (the ‘‘Approved Form ADV PRA’’). 1046 The information in the following table is from the Approved Form ADV PRA, id. 1047 As of August 1, 2020, there are 13,724 registered investment advisers, 8,218 of which file a Form CRS. See also Approved Form ADV PRA, id., at text accompanying nn.55–56 (‘‘[W]e estimate that 1,227 new advisers will register with us annually, 656 of which will be required to prepare a relationship summary.’’) 1048 See id. 1049 Id., at n.42. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00110 Fmt 4701 Sfmt 4700 2. Estimated New Annual Hour Burden for Advisers As a result of the proposed amendments to Form ADV Part 1A discussed above, we estimate that the average total annual collection of information burden for registered investment advisers that are not obligated to prepare and file relationship summaries will increase 0.5 hours to 29.72 hours per registered E:\FR\FM\05MRR2.SGM 05MRR2 13133 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations investment adviser per year for Form ADV. We estimate that the average total annual collection of information burden for registered investment advisers who are obligated to prepare and file relationship summaries will increase 0.5 hour to 38.97 hours per registered investment adviser per year for Form ADV. We do not expect that the amendments will increase or decrease the currently approved total burden estimate of 3.60 per exempt reporting adviser completing Form ADV. We are not modifying our estimates from the proposal. Although one commenter claimed that we underestimated the Form ADV burden, this commenter mischaracterized our statements in the Number of advisers to be included in the final burden. Final total annual hour estimate per adviser. Final aggregate burden hours. Final aggregate monetized cost. increases due to increased number in RIAs since the burden estimate was last approved (but a decreased number in ERAs), the revised annual aggregate burden hours for Form ADV (Parts 1, 2 and 3) for all registered advisers and exempt reporting advisers will be 544,053 hours per year, with a monetized value of $148,526,578.1053 This will be an aggregate increase of 29,256 hours, or $7,956,996 in the monetized value of the hour burden, from the currently approved annual aggregate burden estimates, increases which are attributed to the factors described above. Estimated new annual hour burden for advisers: RIAs not obligated to prepare and file relationship summaries RIAs obligated to prepare and file relationship summaries Exempt reporting advisers 5,506 + 571 expected newly registered RIAs annually. 29.72 ................................. 8,218 + 656 expected newly registered RIAs annually. 38.97 ................................. 4,455 + 441 expected new ERAs annually. 180,608 hours ................... 345,819.8 hours ................ 17,625.6 hours .................. 544,053.4 hours. $49,306,104 ...................... $94,408,800 ...................... $4,811,789 ........................ $148,526,578. All advisers 3.60 hours ......................... We are adopting amendments to rule 206(4)–1 (now known as the ‘‘marketing rule’’), which we adopted in 1961 to target advertising practices that the Commission believed were likely to be misleading. We are also incorporating into rule 206(4)–1 certain aspects of rule 206(4)–3 (previously referred to as the ‘‘cash solicitation rule’’), which we adopted in 1979 to help ensure clients are aware that paid solicitors who refer them to advisers have a conflict of interest. We are accordingly eliminating rule 206(4)–3. As discussed above, we are adopting amendments to rule 206(4)–1 to impose: (i) General prohibitions of certain advertising practices applicable to all advertisements; (ii) tailored restrictions or conditions on specific practices applicable to testimonials, endorsements, and third-party ratings; and (iii) tailored requirements for the presentation of performance results, including predecessor performance. The final rule is designed to restrict or place conditions on specific practices we believe may cause investors to be misled without appropriate conditions or limitations. The final rule will also include a new definition of ‘‘advertisement’’ that is intended to be flexible enough to remain relevant and effective in the face of advances in technology and evolving industry practices. The reasons for, and objectives of, the final amendments are discussed in more detail in sections I and II, above. The burdens of these requirements on small advisers are discussed below as well as above in sections III and IV, which discuss the burdens on all advisers. The professional skills required to meet these specific burdens are also discussed in section IV. We believe that our final amendments are appropriate and in the public interest and will improve investor protection. We are adopting amendments to the current rule because while we believe that the concerns that motivated the Commission to adopt rule 206(4)–1 and 206(4)–3 still exist today, we also believe that we can achieve our regulatory goals in a more tailored manner. We believe that our final amendments will update the rule’s coverage to reflect regulatory changes and evolution of industry practices, improve the quality of disclosures to investors, and streamline elements of the rules our 40 years of experience has 1050 In the proposal, we estimated that the amendments would not change the burden for exempt reporting advisers because they will not be required to complete the new portion of Form ADV. 1051 Id., at nn.44–45 and accompanying text, 1052 Id., at nn.46–47 and accompanying text. 1053 544,053.4 aggregate annual hour burden is the sum of: ((i) 29.72 hours × (5,506 RIAs + 571 expected newly registered RIAs annually) = 180,608 total aggregate annual hour burden for RIAs not obligated to prepare and file relationship summaries; (ii) 38.97 hours × (8,218 + 656 expected newly registered RIAs annually) = 345,819.8 total aggregate annual hour burden for RIAs not obligated to prepare and file relationship summaries; (iii) 3.60 hours × (4,455 + 441 expected new ERAs annually) = 17,625.6 total aggregate annual hour burden for ERAs). We believe that performance of this function will most likely be equally allocated between a senior compliance examiner and a compliance manager. Data from the SIFMA Management and Professional Earnings Report suggest that costs for these positions are $237 and $309 per hour, respectively, with a blended rate of $273. Therefore: 544,053.4 hours × $273 = $148,526,578. 1054 5 U.S.C. 603(a). V. Final Regulatory Flexibility Analysis The Commission has prepared the following Final Regulatory Flexibility Analysis (‘‘FRFA’’) in accordance with section 4(a) of the Regulatory Flexibility Act (‘‘RFA’’).1054 It relates to: (i) Final amendments to rule 206(4)–1 under the Investment Advisers Act; (ii) final amendments to rule 204–2, and (iii) final amendments to Form ADV Part 1A. A. Reason for and Objectives of the Final Amendments 1. Final Rule 206(4)–1 jbell on DSKJLSW7X2PROD with RULES2 proposal.1050 We stated in the proposal that the Form ADV amendments would not increase the time required to complete the form for exempt reporting advisers (not registered investment advisers), which we continue to believe is the case. The currently approved annual aggregate burden for Form ADV for all registered advisers and exempt reporting advisers is 514,797 hours, for a monetized cost of $140,569,582.1051 This is an annual blended average per adviser burden for Form ADV of 29.28 hours, and $7,996 per adviser.1052 Factoring in the new questions on Part 1 of Form ADV that will be required for all registered investment advisers (but not for exempt reporting advisers), and VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 E:\FR\FM\05MRR2.SGM 05MRR2 13134 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 suggested may no longer be necessary for investor protection. 2. Final Rule 204–2 We are also adopting related amendments to rule 204–2, the books and records rule, which sets forth requirements for maintaining, making, and retaining advertisements. We are amending the rule to require investment advisers to make and keep records of all advertisements they disseminate. In addition, we are adopting the provisions to the books and records rule that will explicitly require investment advisers: (i) That use third-party ratings in an advertisement to record and keep a copy of any questionnaire or survey used in the preparation of the third-party rating; and (ii) to maintain documentation of communications relating to predecessor performance and to support performance calculations. We are also adopting the recordkeeping requirement that corresponds to the amendments related to testimonials, endorsements, and third-party ratings under the final rule such that advisers must retain: (i) If not included in the advertisement, a record of the disclosures provided to clients or investors pursuant to final rule 206(4)–1; (ii) documentation substantiating the adviser’s reasonable basis for believing that the testimonial or endorsement complies with the final rule and that the third-party rating complies with the final rule 206(4)– 1(c)(1); and (iii) a record of the names of all persons who are an investment adviser’s partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person. As discussed above, we are adopting these amendments to rule 204–2 to: (i) Conform the books and records rule to the final rule; (ii) help ensure that an investment adviser retains records of all its advertisements; and (iii) facilitate the Commission’s inspection and enforcement capabilities. The reasons for and objectives of, the final amendments to the books and records rule are discussed in more detail in section II.I above. The burdens of these requirements on small advisers are discussed below as well as above in our Economic Analysis and Paperwork Reduction Act Analysis, which discuss the burdens on all advisers. The professional skills required to meet these specific burdens are also discussed in Section IV. 3. Final Amendments to Form ADV We are also adopting amendments to Item 5 of Part 1A of Form ADV to VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 improve information available to us and to the general public about advisers’ advertising practices. We will be adding a subsection L (‘‘Marketing Activities’’) to require information about an adviser’s use in its advertisements of performance results, its previous investment advice, testimonials, endorsements, and third-party ratings. Specifically, we will require an adviser to state whether any of its advertisements includes testimonials, endorsements, or a third-party rating, and if so, whether the adviser pays cash or non-cash compensation, directly or indirectly, in connection with their use. We will also require an adviser to state whether any of its advertisements includes performance results or a reference to specific investment advice provided by the adviser. Finally, we will require an adviser to state whether any of its advertisements include hypothetical or predecessor performance. Our staff will use this information to help prepare for examinations of investment advisers. This information will be particularly useful for staff in reviewing an adviser’s compliance with the final rule, including the restrictions and conditions on advisers’ use in advertisements of performance presentations, testimonials and endorsements, and third-party ratings. The reasons for and objectives of, the final amendments to Form ADV are discussed in more detail in section II.A.8 above. The burdens of these requirements on small advisers are discussed below as well as above in our Economic Analysis and Paperwork Reduction Act Analysis, which discuss the burdens on all advisers. The professional skills required to meet these specific burdens are also discussed in Section IV. B. Significant Issues Raised by Public Comments In the 2019 Proposing Release, we requested comment on the matters discussed in the IRFA, including the number of small entities subject to the proposed amendments to rules 206(4)– 1, 206(4)–3, and 204–2, and Form ADV, as well as the potential impacts discussed in this analysis; and whether the proposal could have an effect on small entities that has not been considered. We requested that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of such impact. In addition, we included in the proposal a ‘‘Feedback Flyer’’ as Appendix C thereto. The ‘‘Feedback Flyer’’ solicited feedback from smaller advisers on the effects on small entities PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 subject to our proposal, and the estimated compliance burdens of our proposal and how they would affect small entities. After consideration of the comments we received on the proposed rules and amendments, we are adopting the amendments with several modifications that are designed to reduce certain operational challenges that commenters identified, while maintaining protections for investors and providing investors with useful and important disclosures. However, none of the modifications was significant to the small-entity cost burden estimates discussed below. Revisions to the estimates are instead based on updated figures regarding the number of small entities affected by the new rule and amendments and updated estimated wage rates. C. Legal Basis The Commission is adopting amendments to rule 206(4)–1 under the Advisers Act under the authority set forth in sections 203(d), 206(4), 211(a) and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–3(d), 10b– 6(4) and 80b–11(a) and (h)]. The Commission is adopting amendments to rule 204–2 under the Advisers Act under the authority set forth in sections 204 and 211 of the Investment Advisers Act of 1940 [15 U.S.C. 80b–4 and 80b– 11]. The Commission is adopting amendments to Form ADV under section 19(a) of the Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2) of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15 U.S.C. 7sss(a)], section 38(a) of the Investment Company Act of 1940 [15 U.S.C. 80a– 37(a)], and sections 203(c)(1), 204, and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–3(c)(1), 80b–4, and 80b–11(a)]. D. Small Entities Subject to the Rule and Rule Amendments In developing these amendments, we have considered their potential impact on small entities that would be subject to the final amendments. The final amendments will affect many, but not all, investment advisers registered with the Commission, including some small entities. Under Commission rules, for the purposes of the Advisers Act and the RFA, an investment adviser generally is a small entity if it: (1) Has assets under management having a total value of less than $25 million; (2) did not have total assets of $5 million or more on the last day of the most recent fiscal year; and E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations (3) does not control, is not controlled by, and is not under common control with another investment adviser that has assets under management of $25 million or more, or any person (other than a natural person) that had total assets of $5 million or more on the last day of its most recent fiscal year.1055 Our final amendments will not affect most investment advisers that are small entities (‘‘small advisers’’) because they are generally registered with one or more state securities authorities and not with the Commission. Under section 203A of the Advisers Act, most small advisers are prohibited from registering with the Commission and are regulated by state regulators. Based on IARD data, we estimate that as of August 1, 2020, approximately 545 SEC-registered advisers are small entities under the RFA.1056 1. Small Entities Subject to Amendments to Marketing Rule As discussed above in section III. (the Economic Analysis), the Commission estimates that based on IARD data as of August 1, 2020, approximately 13,724 investment advisers would be subject to the final amendments to rule 206(4)–1 under the Advisers Act and the related final amendments to rule 204–2 under the Advisers Act.1057 All of the approximately 545 SECregistered advisers that are small entities under the RFA will be subject to the amended rule 206(4)–1 and corresponding amendments to rule 204– 2. This is because, as discussed above in the PRA, we estimate that all investment advisers will disseminate at least one communication meeting the final rule’s definition of ‘‘advertisement’’ and therefore be subject to the requirements of the final rule.1058 Furthermore, the rule’s additional conditions and 1055 Advisers Act rule 0–7(a). on SEC-registered investment adviser responses to Items 5.F. and 12 of Form ADV. Only SEC- registered investment advisers with RAUM of less than $25 million, as indicated in Form ADV Item 5.F.(2)(c) are required to respond to Form ADV Item 12. For purposes of this analysis, a registered investment adviser is classified as a ‘‘small business’’ or ‘‘small organization’’ if they respond ‘‘No’’ to Form ADV Item 12.A., 12.B.(1), 12.B.(2), 12.C.(1), and 12.C.(2). These responses indicate that the registered investment adviser had RAUM of less than $25 million, did not have total assets of $5 million or more on the last day of the most recent fiscal year; and does not control, is not controlled by, and is not under common control with another investment adviser that has RAUM of $25 million or more, or any person (other than a natural person) that had total assets of $5 million or more on the last day of the most recent fiscal year, consistent with the definition of a small entity under the Advisers Act for purposes of the RFA. 1057 See supra footnote 1038 and accompanying text. 1058 See PRA discussion, above, at sections IV.A and B. jbell on DSKJLSW7X2PROD with RULES2 1056 Based VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 restrictions on testimonials, endorsements, and third-party ratings, as well as certain presentations of performance, will apply to many advertisements under the rule.1059 2. Small Entities Subject to Amendments to the Books and Records Rule 204–2 As discussed above, there are approximately 545 small advisers currently registered with us, and we estimate that 100 percent of advisers registered with us will be subject to amendments to the books and records rule. 3. Small Entities Subject to Amendments to Form ADV As discussed above, there are approximately 545 small advisers currently registered with us, and we estimate that 100 percent of advisers registered with us will be subject to amendments to Form ADV. E. Projected Reporting, Recordkeeping and Other Compliance Requirements 1. Final Rule 206(4)–1 Final rule 206(4)–1 will impose certain reporting and compliance requirements on certain investment advisers, including those that are small entities. All registered investment advisers that distribute advertisements under the rule, which we estimate to be all advisers, will be required to comply with the final rule’s general prohibition of fraudulent or misleading advertisements. In addition, all advisers that use testimonials, endorsements, and third-party ratings will be required to include disclosures and comply with other conditions. Small entity advisers will be required to comply with restrictions and other conditions related to the presentation of certain performance results in advertisements. The final amendments, including compliance and recordkeeping requirements, are summarized in this FRFA (section V.A., above). All of these final requirements are also discussed in detail, above, in sections I and II, and these requirements and the burdens on respondents, including those that are small entities, are discussed above in sections III and IV (the Economic Analysis and Paperwork Reduction Act Analysis, respectively) and below. The 1059 As discussed above, the use of testimonials, endorsements, and third-party ratings in advertisements is voluntary but we estimate that approximately 50% of registered investment advisers would use testimonials or endorsements in advertisements, and approximately 50% of registered investment advisers would use thirdparty ratings in advertisements. See PRA discussion, above, at sections IV.A and B. PO 00000 Frm 00113 Fmt 4701 Sfmt 4700 13135 professional skills required to meet these specific burdens are also discussed in section IV. As discussed above, there are approximately 545 small advisers currently registered with us, and we estimate that 100 percent of advisers registered with us will be subject to amendments to the marketing rule. As discussed above in our Paperwork Reduction Act Analysis in section III above, we estimate that the final amendments to rule 206(4)–1 under the Advisers Act, which will require advisers to prepare disclosures for testimonials and endorsements, thirdparty ratings, and performance results, will create a new annual burden of approximately 98 hours per adviser, or 56,135 hours in aggregate for small advisers.1060 We therefore expect the annual monetized aggregate cost to small advisers associated with our final amendments to be $18,596,390.1061 2. Final Amendments to Rule 204–2 The final amendments to rule 204–2 will require investment advisers to retain records of all advertisements they disseminate. 1062 We are also requiring investment advisers that use a thirdparty rating in an advertisement to retain a copy of any questionnaire or survey used in preparation of the thirdparty rating, as well as documentation of communications relating to predecessor performance and supporting performance calculations.1063 To correspond to the provisions with respect to testimonials, endorsements, and third-party ratings, we are amending the books and records rule to require investment advisers to make and keep records of: (i) If not included in the advertisement, a record of the disclosures provided to clients or investors pursuant to the final rule 206(4)–1; (ii) documentation substantiating the adviser’s reasonable basis for believing that the testimonial or endorsement complies with the final rule and that the third-party rating complies with rule 206(4)–1(c)(1); and (iii) a record of the names of all persons who are an investment adviser’s partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person, pursuant to 1060 1,414,291 hours/13,724 advisers = 103 hours per adviser. 103 hours × 545 small advisers = 56,135 hours. 1061 $468,287,816 total cost × (545 small advisers/ 13,724 advisers) = $18,596,390. 1062 See final rule 204–2(a)(11)(i)(A). 1063 See final rule 204–2(a)(7)(iv), (11)(ii), and (16). E:\FR\FM\05MRR2.SGM 05MRR2 13136 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations the final rule 206(4)–1(b)(4)(ii).1064 Each of these records will be required to be maintained in the same manner, and for the same period of time, as other books and records required to be maintained under rule 204–2(a). As discussed above, there are approximately 545 small advisers currently registered with us, and we estimate that 100 percent of advisers registered with us will be subject to amendments to the books and records rule. As discussed above in our Paperwork Reduction Act Analysis in section IV.D above, the amendments to rule 204–2 under the Advisers Act will increase the annual burden by approximately 18.44 hours per adviser, or 10,049.8 hours in aggregate for small advisers.1065 We therefore believe the annual monetized aggregate cost to small advisers associated with our amendments will be $6,960,596.1066 jbell on DSKJLSW7X2PROD with RULES2 3. Final Amendments to Form ADV Final amendments to Form ADV will impose certain reporting and compliance requirements on certain investment advisers, including those that are small entities, requiring them to provide information about their use in its advertisements of performance results, previous investment advice, testimonials, endorsements, and thirdparty ratings. The final amendments, including recordkeeping requirements, are summarized above in this FRFA (section V.A). All of these final requirements are also discussed in detail, above, in section II.I, and these requirements and the burdens on respondents, including those that are small entities, are discussed above in sections III and IV (the Economic Analysis and Paperwork Reduction Act Analysis) and below. The professional skills required to meet these specific burdens are also discussed in section IV. Our Economic Analysis, discussed in section III above, discusses these costs and burdens for respondents, which include small advisers. As discussed above in our Paperwork Reduction Act Analysis in section IV.E above, the final amendments to Form ADV will increase the annual burden for advisers (other than exempt reporting advisers, who will not be required to respond to the new Form ADV questions) by approximately 0.5 hours per adviser, or 272.5 hours in aggregate for small advisers (other than exempt reporting 1064 See final rule 204–2(a)(15)(i) through (ii). hour × 545 small advisers = 10,049.8 1065 18.44 hours. 1066 545 registered investment advisers × 201.44 hours = 109,784.8 hours. (17% × 109,784.8 hours × $70) + (83% × 109,784.8 hours × $62) = $6,960,596. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 advisers).1067 We therefore expect the annual monetized aggregate cost to small advisers (other than exempt reporting advisers, for whom there will be no additional cost) associated with our final amendments will be $74,392.50.1068 F. Duplicative, Overlapping, or Conflicting Federal Rules 1. Final Rule 206(4)–1 Other than existing rule 206(4)–1 and the prohibitions contained in section 208(a)–(c) of the Act, investment advisers do not have obligations under the Act specifically for adviser advertisements. As discussed above in section II.A.4., we recognize that advisers to private funds, who would be included in the scope of the final rule 206(4)–1, are prohibited from making misstatements or materially misleading statements to investors under rule 206(4)–8.1069 Although the final marketing rule may overlap with the prohibitions in rule 206(4)–8 in certain circumstances, just as it overlaps with section 206 with respect to an adviser’s clients and prospective clients, we believe it is important from an investor protection standpoint to delineate these obligations to all investors in the advertising context and provide a framework for an adviser’s advertisements to comply with these obligations. We also understand that many private fund advisers already consider the current staff positions related to the current advertising rule when preparing their marketing communications. As a result, we believe that our application of the final rule to advertisements to private fund investors would result in limited additional regulatory or compliance costs for many of these advisers. We also recognize that advisers have other compliance oversight obligations under the Federal securities laws, including the Act. For example, advisers are subject to the Act’s compliance rule, which we adopted in 2003.1070 Therefore, when an adviser utilizes a promoter as part of its business, the adviser must have in place under the 1067 38.97 hour × 545 small advisers = 21,238.6 hours. 1068 272.5 hours × $273 = $74,392.50. See supra footnote 1053 for a discussion of who we believe would perform this function, and the applicable blended rate. 1069 There may be other legal protections of investors from fraud. See, e.g., section 17(a) of the Securities Act, as well as section 10(b) of the Exchange Act and rule 10b–5 thereunder. 1070 See supra footnote 371 and accompanying text. The compliance rule contains principles based requirements for advisers to adopt compliance policies and procedures that are tailored to their businesses. Id. PO 00000 Frm 00114 Fmt 4701 Sfmt 4700 Act’s compliance rule policies and procedures that address this relationship and are reasonably designed to ensure that the adviser is in compliance with the final rule. We believe the final rule’s adviser oversight and compliance provision applicable to testimonials and endorsements will work well with the Act’s compliance rule, as both are principles-based and will allow advisers to tailor their compliance with the final rule as appropriate for each adviser. There are no duplicative, overlapping, or conflicting Federal rules with respect to the final amendments to rule 204–2. With respect to testimonials and endorsements, our amendments to rule 206(4)–1 will eliminate some regulatory duplication. For example, rule 206(4)–3 has had a duplicative requirement that a solicitor deliver to clients the adviser’s Form ADV brochure, even though advisers are already required to deliver their ADV brochures to their clients under rule 204–3. To the extent that both advisers and solicitors currently deliver the adviser’s Form ADV brochure, the final rule will reduce the redundancy of disclosures. In addition, as discussed above, the final rule’s disqualification provisions will apply to situations in which an adviser compensates a person, directly or indirectly, for a testimonial or endorsement. This includes persons who provide testimonials or endorsements to private fund investors such as broker-dealers. Such brokerdealers may also be subject to the statutory disqualification provisions under the Exchange Act. To the extent that a person is subject to both disqualification provisions, there would be some overlapping categories of disqualifying events (i.e., certain bad acts would disqualify a person under both provisions). For instance, certain types of final orders of certain Federal and foreign regulators would be disqualifying events under both provisions. Accordingly, as discussed above, we are providing an exemption from the disqualification provisions for registered broker-dealers that are subject to and complying with the statutory disqualification provisions under the Exchange Act. We understand that some promoters will also be subject to the ‘‘bad actor’’ disqualification requirements, which disqualify securities offerings from reliance on exemptions if the issuer or other relevant persons (such as underwriters, placement agents and the directors, officers and significant shareholders of the issuer) have been convicted of, or are subject to court or administrative sanctions for, securities E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 fraud or other violations of specified laws.1071 Some types of bad acts could disqualify a person from engaging in certain capacities in a securities offering under Rule 506 of Regulation D under the Securities Act, as well as from engaging as a promoter under the final rule. Accordingly, as discussed above, we are providing an exemption from the disqualification provisions for covered persons that are subject to and not disqualified under Rule 506 of Regulation D under the Securities Act. As discussed above, the final rule’s required disclosures provisions will apply to all testimonials and endorsements, including those that are provided by registered broker-dealers in certain circumstances. Such brokerdealers may also be subject to other regulatory disclosure provisions such as under Regulation Best Interest. To the extent that a broker-dealer’s testimonial or endorsement is a recommendation subject to Regulation BI, then there would be some overlapping requirements with our final rule (i.e., disclosing compensation arrangements and material conflicts of interest under both provisions). For instance, under the Regulation BI disclosure obligations, when making a recommendation to a retail customer, a broker-dealer must disclose all material facts about the scope and terms of its relationship with a retail customer, such as the material fees and costs the customer will incur as well as all material facts relating to its conflicts of interest associated with the recommendation, including thirdparty payments and compensation arrangements.1072 Similarly, under the final rule, when soliciting for an adviser, the broker-dealer would have to disclose any material conflicts of interest on his or her part resulting from their relationship and/or any compensation arrangement with the adviser.1073 Accordingly, as discussed above, we are providing an exemption from the final rule’s required disclosures provisions for testimonials and endorsements that are disseminated by registered broker-dealers to the extent that such testimonials or endorsements are recommendations subject to Regulation BI in order to help eliminate regulatory duplication. In addition to testimonials and endorsements that are recommendations subject to Regulation BI, we are providing a partial exemption from 1071 See Disqualification of Felons and Other ‘‘Bad Actors’’ from Rule 506 Offerings, Release No. 33–9414 (July 10, 2013) [78 FR 44729 (July 24, 2013). 1072 See Regulation Best Interest Release, supra footnote 146, at 14. 1073 See final rule 206(4)–1(b)(1)(iii). VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 certain disclosure requirements where a broker-dealer provides a testimonial or endorsement to an investor that is not a retail customer as defined in Regulation BI. As discussed above in section II.C.5.c., we believe that the clear and prominent disclosures such a broker-dealer will be required to provide under our final rule are sufficient to alert an investor that is not a retail customer that a testimonial or endorsement is a paid solicitation. In addition, we believe that these investors will be able to request from the brokerdealer other information about the solicitation. 2. Final Amendments to Form ADV Our new subsection L (‘‘Marketing Activities’’) to Item 5 of Part 1A of Form ADV will require information about an adviser’s use in its advertisements of performance results, testimonials, endorsements, third-party ratings and its previous investment advice. These final requirements will not be duplicative of, or overlap with, other information advisers are required to provide on Form ADV. G. Significant Alternatives 1. Final Rule 206(4)–1 The RFA directs the Commission to consider significant alternatives that would accomplish our stated objectives, while minimizing any significant adverse impact on small entities. We considered the following alternatives for small entities in relation to the final rule and the corresponding amendments to rule 204–2 under the Advisers Act and to Form ADV: (i) Differing compliance or reporting requirements that take into account the resources available to small entities; (ii) the clarification, consolidation, or simplification of compliance and reporting requirements under the final rule for such small entities; (iii) the use of performance rather than design standards; and (iv) an exemption from coverage of the final rule, or any part thereof, for such small entities. Regarding the first and fourth alternatives, the Commission believes that establishing different compliance or reporting requirements for small advisers, or exempting small advisers from the final rule, or any part thereof, would be inappropriate under these circumstances.1074 Because the 1074 For example, one commenter stated that smaller advisers would face challenges under the proposed rule in demonstrating that the performance of a representative account is no higher than if all related portfolios had been included. See IAA Comment Letter. See also proposed rule 206(4)–1(c)(1)(iii)(A). However, we do not believe that providing smaller advisers with PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 13137 protections of the Advisers Act are intended to apply equally to clients of both large and small firms, it would be inconsistent with the purposes of the Advisers Act to specify differences for small entities under the final rule and corresponding changes to rule 204–2 and Form ADV. However, we are adopting an exemption for de minimis compensation with respect to the use of testimonials and endorsements, which we expect will apply to some small entities that offer de minimis compensation to promoters.1075 Although, as discussed above, we believe heightened safeguards would generally be appropriate for an adviser’s use of testimonials or endorsements, a promoter’s incentives are significantly reduced when receiving de minimis compensation. We believe the need for heightened safeguards for de minimis compensation is likewise reduced. As discussed above, we believe that the final rule will result in multiple benefits to clients. For example, the final rule’s disclosure requirements and other conditions applicable to the use of advertisements will provide investors with information they need to assess the adviser’s advertising claims (for performance results) and third-party claims about the adviser (for testimonials, endorsements, and thirdparty ratings). In particular, the disclosures related to testimonials and endorsements will: (i) Help to ensure that investors are aware that promoters have a conflict of interest in referring them to advisers that compensate them for the referral; (ii) extend the current solicitation rule’s investor protection to investors whose advisers compensate their promoters with non-cash compensation; (iii) extend the rule to private fund investors; and (iv) eliminate duplicative disclosures. We believe that these benefits should apply the benefit of presenting a single representative account that is not subject to prescribed conditions would justify the risks of cherry-picking related portfolios with higher-than-usual returns. As a result, we are not adopting different compliance requirements or exemptions for smaller advisers. Instead, we have modified our final rule to allow all advisers to include performance returns of a single portfolio if they can demonstrate that the performance is not materially higher than if all related portfolios had been included, and the performance meets the rule’s general prohibitions. See final rule 206(4)–1(d)(4)(i). See also section II.E.4. (discussing related performance). 1075 Specifically, the disqualification provisions of the rule related to testimonials and endorsements will not apply if the person has provided testimonials or endorsements for the investment adviser during the preceding twelve months and the investment adviser’s compensation payable to such person for those testimonials or endorsements is $1,000 or less (or the equivalent value in non-cash compensation). E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13138 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations to clients of smaller firms as well as larger firms. We also believe that the rule’s disqualification provisions with respect to testimonials and endorsements will result in transparency and consistency for advisory clients, promoters, and advisers, as the provisions will generally eliminate the need for advisers to seek separate relief from the rule. In addition, as discussed above, we believe that our final rule’s placing guardrails on displays of performance will increase investor protection and the utility of the information provided and decrease the likelihood that it is misleading. Establishing different promoter disqualification provisions or performance provisions for large and small advisers would negate these benefits. Also, as discussed above, our staff will use the corresponding information that advisers report on the amended Form ADV to help prepare for examinations of investment advisers. Establishing different conditions for large and small advisers that advertise their services to investors would negate these benefits. Regarding the second alternative, we believe the final rule is clear and that further clarification, consolidation, or simplification of the compliance requirements is not necessary. As discussed above, the final rule will provide general anti-fraud principles applicable to all advertisements under the rule; will provide further restrictions and conditions on certain specific types of presentations, such as testimonials and endorsements; and will provide additional conditions for advertisements containing certain performance information. These provisions will address a number of common advertising practices that have not been explicitly addressed or broadly restricted (e.g., the current advertising rule prohibits testimonials concerning the investment adviser or its services, and direct or indirect references to specific profitable recommendations that the investment adviser has made in the past). The proposed provisions will clarify and modernize the advertising regime, which has come to depend on a large number of no-action letters over the years to fill the gaps. Regarding the third alternative, we determined to use a combination of performance and design standards. The general prohibitions will be principlesbased and will give advisers a broad framework within which to determine how best to present advertisements so they are not false or misleading. There will also be the principles-based requirement that an adviser must have a reasonable basis for believing that a VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 person providing a testimonial or endorsement has complied with the final rule. We believe that providing advisers with the flexibility to determine how to implement the requirements of the rule allows them the opportunity to tailor these obligations to the facts and circumstances of their particular arrangements. The final rule will also contain design standards, as it contains additional conditions for certain third-party statements, and certain restrictions and conditions on performance claims. These restrictions and conditions are narrowly tailored to prevent certain types of advertisements that are not a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) of the Act from misleading investors. The corresponding changes to rule 204–2 and Form ADV are also narrowly tailored to reflect the final rule. We also considered an alternative that would not have included design standards, and that would have relied entirely on performance standards. In this alternative, as discussed in the Economic Analysis at section III above, we would reduce the limitations on investment adviser advertising, and rely on the general prohibitions to achieve the programmatic costs and benefits of the rule. As discussed in the Economic Analysis, we believe that many of the types of advertisements that would be prohibited by the final rule’s limitations have the potential to be fraudulent or misleading. We do not believe that removal of the limitations on advertisements we are adopting would, in comparison with the final rule, permit advertisements that would not be inherently fraudulent or misleading. In addition, we believe that the removal of limitations may create uncertainty about what types of advertisements would fall under the general prohibitions. Statutory Authority The Commission is adopting amendments to rule 206(4)–1 under the Advisers Act under the authority set forth in sections 203(d), 206(4), 211(a), and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–3(d), 10b– 6(4) and 80b–11(a) and (h)]. The Commission is rescinding rule 206(4)–3 under the Advisers Act under the authority set forth in sections 203(d), 206(4), 211(a), and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–2(d), 80b–6(4), and 80b– 11(a) and (h)]. The Commission is adopting amendments to rule 204–2 under the Advisers Act under the authority set forth in sections 204 and 211 of the Investment Advisers Act of PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 1940 [15 U.S.C. 80b–4 and 80b–11]. The Commission is adopting amendments to Form ADV under section 19(a) of the Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2) of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15 U.S.C. 7sss(a)], section 38(a) of the Investment Company Act of 1940 [15 U.S.C. 80a–37(a)], and sections 203(c)(1), 204, and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 80b–3(c)(1), 80b–4, and 80b– 11(a)]. List of Subjects in 17 CFR Parts 275 and 279 Reporting and recordkeeping requirements; Securities. Text of Amendments For the reasons set out in the preamble, title 17, chapter II of the Code of Federal Regulations is amended as follows: PART 275—RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940 1. The authority citation for part 275 continues to read in part as follows: ■ Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– 2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– 4a, 80b–6(4), 80b–6a, and 80b–11, unless otherwise noted. * * * * * Section 275.204–2 is also issued under 15 U.S.C 80b–6. * * * * * 2. Amend § 275.204–2 by a. Revising paragraphs (a)(7)(iv), (a)(11), (15), and (16); and ■ b. Adding paragraph (a)(19). The revisions and addition read as follows: ■ ■ § 275.204–2 Books and records to be maintained by investment advisers. (a) * * * (7) * * * (iv) Predecessor performance (as defined in § 275.206(4)–1(e)(12) of this chapter) and the performance or rate of return of any or all managed accounts, portfolios (as defined in § 275.206(4)– 1(e)(11) of this chapter), or securities recommendations; Provided, however: (A) That the investment adviser shall not be required to keep any unsolicited market letters and other similar communications of general public distribution not prepared by or for the investment adviser; and (B) That if the investment adviser sends any notice, circular, or other advertisement (as defined in § 275.206(4)–1(e)(1) of this chapter) E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations offering any report, analysis, publication or other investment advisory service to more than ten persons, the investment adviser shall not be required to keep a record of the names and addresses of the persons to whom it was sent; except that if such notice, circular, or advertisement is distributed to persons named on any list, the investment adviser shall retain with the copy of such notice, circular, or advertisement a memorandum describing the list and the source thereof. * * * * * (11) (i) A copy of each (A) Advertisement (as defined in § 275.206(4)–1(e)(1) of this chapter) that the investment adviser disseminates, directly or indirectly, except: (1) For oral advertisements, the adviser may instead retain a copy of any written or recorded materials used by the adviser in connection with the oral advertisement; and (2) For compensated oral testimonials and endorsements (as defined in § 275.206(4)–1(e)(17) and (5) of this chapter), the adviser may instead make and keep a record of the disclosures provided to clients or investors pursuant to § 275.206(4)–1(b)(1) of this chapter; and (B) Notice, circular, newspaper article, investment letter, bulletin, or other communication that the investment adviser disseminates, directly or indirectly, to ten or more persons (other than persons associated with such investment adviser); and (C) If such notice, circular, advertisement, newspaper article, investment letter, bulletin, or other communication recommends the purchase or sale of a specific security and does not state the reasons for such recommendation, a memorandum of the investment adviser indicating the reasons therefor; and (ii) A copy of any questionnaire or survey used in the preparation of a third-party rating included or appearing in any advertisement in the event the adviser obtains a copy of the questionnaire or survey. * * * * * (15) (i) If not included in the advertisement, a record of the disclosures provided to clients or investors pursuant to § 275.206(4)– 1(b)(1)(ii) and (iii) of this chapter; (ii) Documentation substantiating the adviser’s reasonable basis for believing that a testimonial or endorsement (as defined in § 275.206(4)–1(e)(17) and (5) of this chapter) complies with § 275.206(4)–1 and that the third-party rating (as defined in § 275.206(4)– 1(e)(18) of this chapter) complies with § 275.206(4)–1(c)(1) of this chapter. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 (iii) A record of the names of all persons who are an investment adviser’s partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person pursuant to § 275.206(4)–1(b)(4)(ii) of this chapter. (16) All accounts, books, internal working papers, and any other records or documents that are necessary to form the basis for or demonstrate the calculation of any performance or rate of return of any or all managed accounts, portfolios (as defined in § 275.206(4)– 1(e)(11) of this chapter), or securities recommendations presented in any notice, circular, advertisement (as defined in § 275.206(4)–1(e)(1) of this chapter), newspaper article, investment letter, bulletin, or other communication that the investment adviser disseminates, directly or indirectly, to any person (other than persons associated with such investment adviser), including copies of all information provided or offered pursuant to § 275.206(4)–1(d)(6) of this chapter; provided, however, that, with respect to the performance of managed accounts, the retention of all account statements, if they reflect all debits, credits, and other transactions in a client’s or investor’s account for the period of the statement, and all worksheets necessary to demonstrate the calculation of the performance or rate of return of all managed accounts shall be deemed to satisfy the requirements of this paragraph. * * * * * (19) A record of who the ‘‘intended audience’’ is pursuant to § 275.206(4)– 1(d)(6) and(e)(10)(ii)(B) of this chapter. * * * * * ■ 3. Revise § 275.206(4)–1 to read as follows: § 275.206(4)–1 Marketing. Investment Adviser As a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts, practices, or courses of business within the meaning of section 206(4) of the Act (15 U.S.C. 80b– 6(4)), it is unlawful for any investment adviser registered or required to be registered under section 203 of the Act (15 U.S.C. 80b–3), directly or indirectly, to disseminate any advertisement that violates any of paragraphs (a) through (d) of this section. (a) General prohibitions. An advertisement may not: (1) Include any untrue statement of a material fact, or omit to state a material fact necessary in order to make the PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 13139 statement made, in the light of the circumstances under which it was made, not misleading; (2) Include a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission; (3) Include information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser; (4) Discuss any potential benefits to clients or investors connected with or resulting from the investment adviser’s services or methods of operation without providing fair and balanced treatment of any material risks or material limitations associated with the potential benefits; (5) Include a reference to specific investment advice provided by the investment adviser where such investment advice is not presented in a manner that is fair and balanced; (6) Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced; or (7) Otherwise be materially misleading. (b) Testimonials and endorsements. An advertisement may not include any testimonial or endorsement, and an adviser may not provide compensation, directly or indirectly, for a testimonial or endorsement, unless the investment adviser complies with the conditions in paragraphs (b)(1) through (3) of this section, subject to the exemptions in paragraph (b)(4) of this section. (1) Required disclosures. The investment adviser discloses, or reasonably believes that the person giving the testimonial or endorsement discloses, the following at the time the testimonial or endorsement is disseminated: (i) Clearly and prominently: (A) That the testimonial was given by a current client or investor, and the endorsement was given by a person other than a current client or investor, as applicable; (B) That cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and (C) A brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person; (ii) The material terms of any compensation arrangement, including a description of the compensation provided or to be provided, directly or E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13140 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations indirectly, to the person for the testimonial or endorsement; and (iii) A description of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the investment adviser’s relationship with such person and/or any compensation arrangement. (2) Adviser oversight and compliance. The investment adviser must have: (i) A reasonable basis for believing that the testimonial or endorsement complies with the requirements of this section, and (ii) A written agreement with any person giving a testimonial or endorsement that describes the scope of the agreed-upon activities and the terms of compensation for those activities. (3) Disqualification. An investment adviser may not compensate a person, directly or indirectly, for a testimonial or endorsement if the adviser knows, or in the exercise of reasonable care should know, that the person giving the testimonial or endorsement is an ineligible person at the time the testimonial or endorsement is disseminated. This paragraph shall not disqualify any person for any matter(s) that occurred prior to May 4, 2021, if such matter(s) would not have disqualified such person under § 275.206(4)–3(a)(1)(ii) of this chapter, as in effect prior to May 4, 2021. (4) Exemptions. (i) A testimonial or endorsement disseminated for no compensation or de minimis compensation is not required to comply with paragraphs (b)(2)(ii) and (3) of this section; (ii) A testimonial or endorsement by the investment adviser’s partners, officers, directors, or employees, or a person that controls, is controlled by, or is under common control with the investment adviser, or is a partner, officer, director or employee of such a person is not required to comply with paragraphs (b)(1) and (2)(ii) of this section, provided that the affiliation between the investment adviser and such person is readily apparent to or is disclosed to the client or investor at the time the testimonial or endorsement is disseminated and the investment adviser documents such person’s status at the time the testimonial or endorsement is disseminated; (iii) A testimonial or endorsement by a broker or dealer registered with the Commission under section 15(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(a)) is not required to comply with: (A) Paragraph (b)(1) of this section if the testimonial or endorsement is a recommendation subject to § 240.15l–1 VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 of this chapter (Regulation Best Interest) under that Act; (B) Paragraphs (b)(1)(ii) and (iii) of this section if the testimonial or endorsement is provided to a person that is not a retail customer (as that term is defined in § 240.15l–1 of this chapter (Regulation Best Interest) under the Securities Exchange Act of 1934 (15 U.S.C. 78o(a)); and (C) Paragraph (b)(3) of this section if the broker or dealer is not subject to statutory disqualification, as defined under section 3(a)(39) of that Act; and (iv) A testimonial or endorsement by a person that is covered by rule 506(d) of Regulation D under the Securities Act of 1933 (§ 230.506(d) of this chapter) with respect to a rule 506 securities offering under the Securities Act of 1933 (§ 230.506 of this chapter) and whose involvement would not disqualify the offering under that rule is not required to comply with paragraph (b)(3) of this section. (c) Third-party ratings. An advertisement may not include any third-party rating, unless the investment adviser: (1) Has a reasonable basis for believing that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result; and (2) Clearly and prominently discloses, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses: (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 directly or indirectly by the adviser in connection with obtaining or using the third-party rating. (d) Performance. An investment adviser may not include in any advertisement: (1) Any presentation of gross performance, unless the advertisement also presents net performance: (i) With at least equal prominence to, and in a format designed to facilitate comparison with, the gross performance; and (ii) Calculated over the same time period, and using the same type of return and methodology, as the gross performance. (2) Any performance results, of any portfolio or any composite aggregation of related portfolios, in each case other than any private fund, unless the PO 00000 Frm 00118 Fmt 4701 Sfmt 4700 advertisement includes performance results of the same portfolio or composite aggregation for one-, five-, and ten-year periods, each presented with equal prominence and ending on a date that is no less recent than the most recent calendar year-end; except that if the relevant portfolio did not exist for a particular prescribed period, then the life of the portfolio must be substituted for that period. (3) Any statement, express or implied, that the calculation or presentation of performance results in the advertisement has been approved or reviewed by the Commission. (4) Any related performance, unless it includes all related portfolios; provided that related performance may exclude any related portfolios if: (i) The advertised performance results are not materially higher than if all related portfolios had been included; and (ii) The exclusion of any related portfolio does not alter the presentation of any applicable time periods prescribed by paragraph (d)(2) of this section. (5) Any extracted performance, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio from which the performance was extracted. (6) Any hypothetical performance unless the investment adviser: (i) Adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement; (ii) Provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance; and (iii) Provides (or, if the intended audience is an investor in a private fund, provides, or offers to provide promptly) sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions; Provided that the investment adviser need not comply with the other conditions on performance in paragraphs (d)(2), (4), and (5) of this section. (7) Any predecessor performance unless: (i) The person or persons who were primarily responsible for achieving the prior performance results manage accounts at the advertising adviser; (ii) The accounts managed at the predecessor investment adviser are sufficiently similar to the accounts E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations managed at the advertising investment adviser that the performance results would provide relevant information to clients or investors; (iii) All accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance and the exclusion of any account does not alter the presentation of any applicable time periods prescribed in paragraph (d)(2) of this section; and (iv) The advertisement clearly and prominently includes all relevant disclosures, including that the performance results were from accounts managed at another entity. (e) Definitions. For purposes of this section: (1) Advertisement means: (i) Any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance, that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser, but does not include: (A) Extemporaneous, live, oral communications; (B) Information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication; or (C) A communication that includes hypothetical performance that is provided: (1) In response to an unsolicited request for such information from a prospective or current client or investor in a private fund advised by the investment adviser; or (2) To a prospective or current investor in a private fund advised by the investment adviser in a one-on-one communication; and (ii) Any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly, but does not include any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication. VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 (2) De minimis compensation means compensation paid to a person for providing a testimonial or endorsement of a total of $1,000 or less (or the equivalent value in non-cash compensation) during the preceding 12 months. (3) A disqualifying Commission action means a Commission opinion or order barring, suspending, or prohibiting the person from acting in any capacity under the Federal securities laws. (4) A disqualifying event is any of the following events that occurred within ten years prior to the person disseminating an endorsement or testimonial: (i) A conviction by a court of competent jurisdiction within the United States of any felony or misdemeanor involving conduct described in paragraph (2)(A) through (D) of section 203(e) of the Act; (ii) A conviction by a court of competent jurisdiction within the United States of engaging in, any of the conduct specified in paragraphs (1), (5), or (6) of section 203(e) of the Act; (iii) The entry of any final order by any entity described in paragraph (9) of section 203(e) of the Act, or by the U.S. Commodity Futures Trading Commission or a self-regulatory organization (as defined in the Form ADV Glossary of Terms)), of the type described in paragraph (9) of section 203(e) of the Act; (iv) The entry of an order, judgment or decree described in paragraph (4) of section 203(e) of the Act, and still in effect, by any court of competent jurisdiction within the United States; and (v) A Commission order that a person cease and desist from committing or causing a violation or future violation of: (A) Any scienter-based anti-fraud provision of the Federal securities laws, including without limitation section 17(a)(1) of the Securities Act of 1933 (15 U.S.C. 77q(a)(1)), section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b)) and § 240.10b–5 of this chapter, section 15(c)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(c)(1)), and section 206(1) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–6(1)), or any other rule or regulation thereunder; or (B) Section 5 of the Securities Act of 1933 (15 U.S.C. 77e); (vi) A disqualifying event does not include an event described in paragraphs (e)(4)(i) through (v) of this section with respect to a person that is also subject to: (A) An order pursuant to section 9(c) of the Investment Company Act of 1940 PO 00000 Frm 00119 Fmt 4701 Sfmt 4700 13141 (15 U.S.C. 80a–9) with respect to such event; or (B) A Commission opinion or order with respect to such event that is not a disqualifying Commission action; provided that for each applicable type of order or opinion described in paragraphs (e)(4)(vi)(A) and (B) of this section: (1) The person is in compliance with the terms of the order or opinion, including, but not limited to, the payment of disgorgement, prejudgment interest, civil or administrative penalties, and fines; and (2) For a period of ten years following the date of each order or opinion, the advertisement containing the testimonial or endorsement must include a statement that the person providing the testimonial or endorsement is subject to a Commission order or opinion regarding one or more disciplinary action(s), and include the order or opinion or a link to the order or opinion on the Commission’s website. (5) Endorsement means any statement by a person other than a current client or investor in a private fund advised by the investment adviser that: (i) Indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons; (ii) Directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) Refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser. (6) Extracted performance means the performance results of a subset of investments extracted from a portfolio. (7) Gross performance means the performance results of a portfolio (or portions of a portfolio that are included in extracted performance, if applicable) before the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio. (8) Hypothetical performance means performance results that were not actually achieved by any portfolio of the investment adviser. (i) Hypothetical performance includes, but is not limited to; (A) Performance derived from model portfolios; (B) Performance that is backtested by the application of a strategy to data from E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13142 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations prior time periods when the strategy was not actually used during those time periods; and (C) Targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to securities offered in the advertisement, however: (ii) Hypothetical performance does not include: (A) An interactive analysis tool where a client or investor, or prospective client, or investor, uses the tool to produce simulations and statistical analyses that present the likelihood of various investment outcomes if certain investments are made or certain investment strategies or styles are undertaken, thereby serving as an additional resource to investors in the evaluation of the potential risks and returns of investment choices; provided that the investment adviser: (1) Provides a description of the criteria and methodology used, including the investment analysis tool’s limitations and key assumptions; (2) Explains that the results may vary with each use and over time; (3) If applicable, describes the universe of investments considered in the analysis, explains how the tool determines which investments to select, discloses if the tool favors certain investments and, if so, explains the reason for the selectivity, and states that other investments not considered may have characteristics similar or superior to those being analyzed; and (4) Discloses that the tool generates outcomes that are hypothetical in nature; or (B) Predecessor performance that is displayed in compliance with paragraph (d)(7) of this section. (9) Ineligible person means a person who is subject to a disqualifying Commission action or is subject to any disqualifying event, and the following persons with respect to the ineligible person: (i) Any employee, officer, or director of the ineligible person and any other individuals with similar status or functions within the scope of association with the ineligible person; (ii) If the ineligible person is a partnership, all general partners; and (iii) If the ineligible person is a limited liability company managed by elected managers, all elected managers. (10) Net performance means the performance results of a portfolio (or portions of a portfolio that are included in extracted performance, if applicable) after the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 investment advisory services to the relevant portfolio, including, if applicable, advisory fees, advisory fees paid to underlying investment vehicles, and payments by the investment adviser for which the client or investor reimburses the investment adviser. For purposes of this rule, net performance: (i) May reflect the exclusion of custodian fees paid to a bank or other third-party organization for safekeeping funds and securities; and/or (ii) If using a model fee, must reflect one of the following: (A) The deduction of a model fee when doing so would result in performance figures that are no higher than if the actual fee had been deducted; or (B) The deduction of a model fee that is equal to the highest fee charged to the intended audience to whom the advertisement is disseminated. (11) Portfolio means a group of investments managed by the investment adviser. A portfolio may be an account or a private fund and includes, but is not limited to, a portfolio for the account of the investment adviser or its advisory affiliate (as defined in the Form ADV Glossary of Terms). (12) Predecessor performance means investment performance achieved by a group of investments consisting of an account or a private fund that was not advised at all times during the period shown by the investment adviser advertising the performance. (13) Private fund has the same meaning as in section 202(a)(29) of the Act. (14) Related performance means the performance results of one or more related portfolios, either on a portfolioby-portfolio basis or as a composite aggregation of all portfolios falling within stated criteria. (15) Related portfolio means a portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered in the advertisement. (16) Supervised person has the same meaning as in section 202(a)(25) of the Act. (17) Testimonial means any statement by a current client or investor in a private fund advised by the investment adviser: (i) About the client or investor’s experience with the investment adviser or its supervised persons; (ii) That directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) That refers any current or prospective client or investor to be a PO 00000 Frm 00120 Fmt 4701 Sfmt 4700 client of, or an investor in a private fund advised by, the investment adviser. (18) Third-party rating means a rating or ranking of an investment adviser provided by a person who is not a related person (as defined in the Form ADV Glossary of Terms), and such person provides such ratings or rankings in the ordinary course of its business. § 275.206(4)–3 ■ [Removed and reserved] 4. Remove and reserve § 275.206(4)–3. PART 279—FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 1940 5. The authority citation for part 279 continues to read as follows: ■ Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b–1, et seq., Pub. L.111– 203, 124 Stat. 1376. 6. Amend Form ADV (referenced in § 279.1) by: ■ a. Adding Item 5.L to Part 1A; ■ b. Revising the instructions to the form, in the section entitled ‘‘Form ADV: Glossary of Terms;’’ ■ c. Revising the instructions to the form, in the section entitled ‘‘Part 2A of Form ADV: Firm Brochure,’’ by removing the phrase ‘‘SEC rule 206(4)– 3’’ in the Note in Item 14.B. and adding, in its place, ‘‘SEC rule 206(4)–1.’’ The addition and revision read as follows: ■ Note: The text of Form ADV does not, and this amendment will not, appear in the Code of Federal Regulations. FORM ADV (Paper Version) • UNIFORM APPLICATION FOR INVESTMENT ADVISER REGISTRATION AND • REPORT BY EXEMPT REPORTING ADVISERS PART lA * * * * * Item 5: Information About Your Advisory Business ADVISORY ACTIVITIES L. Marketing Activities (1) Do any of your advertisements include: a. Performance results? Y N b. A reference to specific investment advice provided by you (as that phrase is used in rule 206(4)–1(a)(5))? Y N c. Testimonials (other than those that satisfy rule 206(4)–1(b)(4)(ii))? Y N d. Endorsements (other than those that satisfy rule 206(4)–1(b)(4)(ii))? Y N e. Third-party ratings? E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 Y N (2) If you answer ‘‘yes’’ to L(1)(c), (d), or (e) above, do you pay or otherwise provide cash or non-cash compensation, directly or indirectly, in connection with the use of testimonials, endorsements, or third-party ratings? Y N (3) Do any of your advertisements include hypothetical performance? Y N (4) Do any of your advertisements include predecessor performance? Y N * * * * * FORM ADV: GLOSSARY OF TERMS 1. Advertisement: (i) Any direct or indirect communication an investment adviser makes to more than one person, or to one or more persons if the communication includes hypothetical performance, that offers the investment adviser’s investment advisory services with regard to securities to prospective clients or investors in a private fund advised by the investment adviser or offers new investment advisory services with regard to securities to current clients or investors in a private fund advised by the investment adviser, but does not include: (A) Extemporaneous, live, oral communications; (B) information contained in a statutory or regulatory Notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication; or (C) a communication that includes hypothetical performance that is provided: (1) In response to an unsolicited request for such information from a prospective or current client or investor in a private fund advised by the investment adviser; or (2) to a prospective or current investor in a private fund advised by the investment adviser in a one-on-one communication; and (ii) any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly, but does not include any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication. [Used in: Part 1A, Item 5] 2. Advisory Affiliate: Your advisory affiliates are (1) all of your officers, partners, or directors (or any person performing similar functions); (2) all persons directly or indirectly controlling or controlled by you; and (3) all of your current employees (other than employees performing only clerical, VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 administrative, support or similar functions). If you are a ‘‘separately identifiable department or division’’ (SID) of a bank, your advisory affiliates are: (1) All of your bank’s employees who perform your investment advisory activities (other than clerical or administrative employees); (2) all persons designated by your bank’s board of directors as responsible for the day-to-day conduct of your investment advisory activities (including supervising the employees who perform investment advisory activities); (3) all persons who directly or indirectly control your bank, and all persons whom you control in connection with your investment advisory activities; and (4) all other persons who directly manage any of your investment advisory activities (including directing, supervising or performing your advisory activities), all persons who directly or indirectly control those management functions, and all persons whom you control in connection with those management functions. [Used in: Part 1A, Items 7, 11, DRPs; Part 1B, Item 2] 3. Annual Updating Amendment: Within 90 days after your firm’s fiscal year end, your firm must file an ‘‘annual updating amendment,’’ which is an amendment to your firm’s Form ADV that reaffirms the eligibility information contained in Item 2 of Part 1A and updates the responses to any other item for which the information is no longer accurate. [Used in: General Instructions; Part 1A, Instructions, Introductory Text, Item 2; Part 2A, Instructions, Appendix 1 Instructions; Part 2B, Instructions] 4. Borrowings: Borrowings include secured borrowings and unsecured borrowings, collectively. Secured borrowings are obligations for borrowed money in respect of which the borrower has posted collateral or other credit support and should include any reverse repos (i.e., any sale of securities coupled with an agreement to repurchase the same (or similar) securities at a later date at an agreed price). Unsecured borrowings are obligations for borrowed money in respect of which the borrower has not posted collateral or other credit support. [Used in: Part 1A, Instructions, Item 5, Schedule D] 5. Brochure: A written disclosure statement that you must provide to clients and prospective clients. See SEC rule 204–3; Form ADV, Part 2A. [Used in: General Instructions; Used throughout Part 2] 6. Brochure Supplement: A written disclosure statement containing information about certain of your supervised persons that your firm is required by Part 2B of Form ADV to PO 00000 Frm 00121 Fmt 4701 Sfmt 4700 13143 provide to clients and prospective clients. See SEC rule 204–3; Form ADV, Part 2B. [Used in: General Instructions; Used throughout Part 2] 7. Charged: Being accused of a crime in a formal complaint, information, or indictment (or equivalent formal charge). [Used in: Part 1A, Item 11; DRPs] 8. Client: Any of your firm’s investment advisory clients. This term includes clients from which your firm receives no compensation, such as family members of your supervised persons. If your firm also provides other services (e.g., accounting services), this term does not include clients that are not investment advisory clients. [Used throughout Form ADV and Form ADV– W] 9. Commodity Derivative: Exposures to commodities that you do not hold physically, whether held synthetically or through derivatives (whether cash or physically settled). [Used in: Part 1A, Schedule D] 10. Control: The power, directly or indirectly, to direct the management or policies of a person, whether through ownership of securities, by contract, or otherwise. • Each of your firm’s officers, partners, or directors exercising executive responsibility (or persons having similar status or functions) is presumed to control your firm. • A person is presumed to control a corporation if the person: (i) Directly or indirectly has the right to vote 25 percent or more of a class of the corporation’s voting securities; or (ii) has the power to sell or direct the sale of 25 percent or more of a class of the corporation’s voting securities. • A person is presumed to control a partnership if the person has the right to receive upon dissolution, or has contributed, 25 percent or more of the capital of the partnership. • A person is presumed to control a limited liability company (‘‘LLC’’) if the person: (i) Directly or indirectly has the right to vote 25 percent or more of a class of the interests of the LLC; (ii) has the right to receive upon dissolution, or has contributed, 25 percent or more of the capital of the LLC; or (iii) is an elected manager of the LLC. • A person is presumed to control a trust if the person is a trustee or managing agent of the trust. [Used in: General Instructions; Part 1A, Instructions, Items 2, 7, 10, 11, 12, Schedules A, B, C, D, R; DRPs] 11. Credit Derivative: Single name credit default swap, including loan credit default swap, credit default swap referencing a standardized basket of E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13144 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations credit entities, including credit default swap indices and indices referencing leveraged loans, and credit default swap referencing bespoke basket or tranche of collateralized debt obligations and collateralized loan obligations (including cash flow and synthetic) other than mortgage backed securities. [Used in: Part 1A, Schedule D] 12. Custody: Holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. You have custody if a related person holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them, in connection with advisory services you provide to clients. Custody includes: • Possession of client funds or securities (but not of checks drawn by clients and made payable to third parties) unless you receive them inadvertently and you return them to the sender promptly, but in any case within three business days of receiving them; • Any arrangement (including a general power of attorney) under which you are authorized or permitted to withdraw client funds or securities maintained with a custodian upon your instruction to the custodian; and • Any capacity (such as general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities. [Used in: Part 1A, Item 9; Part 1B, Instructions, Item 2; Part 2A, Items 15, 18] 13. Discretionary Authority or Discretionary Basis: Your firm has discretionary authority or manages assets on a discretionary basis if it has the authority to decide which securities to purchase and sell for the client. Your firm also has discretionary authority if it has the authority to decide which investment advisers to retain on behalf of the client. [Used in: Part 1A, Instructions, Item 8; Part 1B, Instructions; Part 2A, Items 4, 16, 18; Part 2B, Instructions] 14. Employee: This term includes an independent contractor who performs advisory functions on your behalf. [Used in: Part 1A, Instructions, Items 1, 5, 11; Part 2B, Instructions] 15. Endorsement: Any statement by a person other than a current client or investor in a private fund advised by the investment adviser that: (i) Indicates approval, support, or recommendation VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons; (ii) directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) refers any current or prospective client of, or an investor in a private fund advised by, the investment adviser. [Used in: Part 1A, Item 5] 16. Enjoined: This term includes being subject to a mandatory injunction, prohibitory injunction, preliminary injunction, or a temporary restraining order. [Used in: Part 1A, Item 11; DRPs] 17. Equity Derivative: Includes both listed equity derivative and derivative exposure to unlisted securities. Listed equity derivative includes all synthetic or derivative exposure to equities, including preferred equities, listed on a regulated exchange. Listed equity derivative also includes a single stock future, equity index future, dividend swap, total return swap (contract for difference), warrant and right. Derivative exposure to unlisted equities includes all synthetic or derivative exposure to equities, including preferred equities, that are not listed on a regulated exchange. Derivative exposure to unlisted securities also includes a single stock future, equity index future, dividend swap, total return swap (contract for difference), warrant and right. [Used in: Part 1A, Schedule D] 18. Exempt Reporting Adviser: An investment adviser that qualifies for the exemption from registration under section 203(l) of the Advisers Act because it is an adviser solely to one or more venture capital funds, or under rule 203(m)–1 of the Advisers Act because it is an adviser solely to private funds and has assets under management in the United States of less than $150 million. [Used in: Throughout Part 1A; General Instructions; Form ADV–H; Form ADV–NR] 19. Felony: For jurisdictions that do not differentiate between a felony and a misdemeanor, a felony is an offense punishable by a sentence of at least one year imprisonment and/or a fine of at least $1,000. The term also includes a general court martial. [Used in: Part 1A, Item 11; DRPs; Part 2A, Item 9; Part 2B, Item 3] 20. Filing Adviser: An investment adviser eligible to register with the SEC that files (and amends) a single umbrella registration on behalf of itself and each of its relying advisers. [Used in: General Instructions; Part 1A, Items 1, 2, 3, 10 and 11; Schedule R] PO 00000 Frm 00122 Fmt 4701 Sfmt 4700 21. FINRA CRD or CRD: The Web Central Registration Depository (‘‘CRD’’) system operated by FINRA for the registration of broker-dealers and broker-dealer representatives. [Used in: General Instructions; Part 1A, Item 1, Schedules A, B, C, D, R, DRPs; Form ADV–W, Item 1] 22. Foreign Exchange Derivative: Any derivative whose underlying asset is a currency other than U.S. dollars or is an exchange rate. Cross-currency interest rate swaps should be included in foreign exchange derivatives and excluded from interest rate derivatives. [Used in: Part 1A, Schedule D] 23. Foreign Financial Regulatory Authority: This term includes (1) a foreign securities authority; (2) another governmental body or foreign equivalent of a self-regulatory organization empowered by a foreign government to administer or enforce its laws relating to the regulation of investment-related activities; and (3) a foreign membership organization, a function of which is to regulate the participation of its members in the activities listed above. [Used in: Part 1A, Items 1, 11, DRPs; Part 2A, Item 9; Part 2B, Item 3] 24. Found: This term includes adverse final actions, including consent decrees in which the respondent has neither admitted nor denied the findings, but does not include agreements, deficiency letters, examination reports, memoranda of understanding, letters of caution, admonishments, and similar informal resolutions of matters. [Used in: Part 1A, Item 11; Part 1B, Item 2; Part 2A, Item 9; Part 2B, Item 3] 25. Government Entity: Any state or political subdivision of a state, including (i) any agency, authority, or instrumentality of the state or political subdivision; (ii) a plan or pool of assets controlled by the state or political subdivision or any agency, authority, or instrumentality thereof; and (iii) any officer, agent, or employee of the state or political subdivision or any agency, authority, or instrumentality thereof, acting in their official capacity. [Used in: Part 1A, Item 5] 26. Gross Notional Value: The gross nominal or notional value of all transactions that have been entered into but not yet settled as of the reporting date. For contracts with variable nominal or notional principal amounts, the basis for reporting is the nominal or notional principal amounts as of the reporting date. For options, use delta adjusted notional value. [Used in: Part 1A, Schedule D] 27. High Net Worth Individual: An individual who is a qualified client or who is a ‘‘qualified purchaser’’ as defined in section 2(a)(51)(A) of the E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations Investment Company Act of 1940. [Used in: Part 1A, Item 5] 28. Home State: If your firm is registered with a state securities authority, your firm’s ‘‘home state’’ is the state where it maintains its principal office and place of business. [Used in: Part 1B, Instructions] 29. Hypothetical Performance: Performance results that were not actually achieved by any portfolio of the investment adviser. (i) Hypothetical performance includes, but is not limited to: (A) Performance derived from model portfolios; (B) performance that is backtested by the application of a strategy to data from prior time periods when the strategy was not actually used during those time periods; and (C) targeted or projected performance returns with respect to any portfolio or to the investment services offered in the advertisement; however: (ii) Hypothetical performance does not include: (A) An interactive analysis tool where a client or investor, or prospective client, or investor, uses the tool to produce simulations and statistical analyses that present the likelihood of various investment outcomes if certain investments are made or certain investment strategies or styles are undertaken, thereby serving as an additional resource to investors in the evaluation of the potential risks and returns of investment choices; provided that the investment adviser: (1) Provides a description of the criteria and methodology used, including the investment analysis tool’s limitations and key assumptions; (2) explains that the results may vary with each use and over time; (3) if applicable, describes the universe of investments considered in the analysis, explains how the tool determines which investments to select, discloses if the tool favors certain investments and, if so, explains the reason for the selectivity, and states that other investments not considered may have characteristics similar or superior to those being analyzed; and (4) discloses that the tool generates outcomes that are hypothetical in nature; or (B) predecessor performance that is displayed in compliance with rule 206(4)–1(d)(7). [Used in: Part 1A, Item 5] 30. Impersonal Investment Advice: Investment advisory services that do not purport to meet the objectives or needs of specific individuals or accounts. [Used in: Part 1A, Instructions; Part 2A, Instructions; Part 2B, Instructions] 31. Independent Public Accountant: A public accountant that meets the standards of independence described in rule 2–01(b) and (c) of Regulation S–X VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 (17 CFR 210.2–01(b) and (c)). [Used in: Part 1A, Item 9; Schedule D] 32. Interest Rate Derivative: Any derivative whose underlying asset is the obligation to pay or the right to receive a given amount of money accruing interest at a given rate. Cross-currency interest rate swaps should be included in foreign exchange derivatives and excluded from interest rate derivatives. This information must be presented in terms of 10-year bond equivalents. [Used in: Part 1A, Schedule D] 33. Investment Adviser Representative: Any of your firm’s supervised persons (except those that provide only impersonal investment advice) is an investment adviser representative, if — • the supervised person regularly solicits, meets with, or otherwise communicates with your firm’s clients, • the supervised person has more than five clients who are natural persons and not high net worth individuals, and • more than ten percent of the supervised person’s clients are natural persons and not high net worth individuals. Note: If your firm is registered with the state securities authorities and not the SEC, your firm may be subject to a different state definition of ‘‘investment adviser representative.’’ Investment adviser representatives of SECregistered advisers may be required to register in each state in which they have a place of business. [Used in: General Instructions; Part 1A, Item 5; Part 2B, Item 1] 34. Investment-Related: Activities that pertain to securities, commodities, banking, insurance, or real estate (including, but not limited to, acting as or being associated with an investment adviser, broker-dealer, municipal securities dealer, government securities broker or dealer, issuer, investment company, futures sponsor, bank, or savings association). [Used in: Part 1A, Items 7, 11, Schedule D, DRPs; Part 1B, Item 2; Part 2A, Items 9 and 19; Part 2B, Items 3, 4 and 7] 35. Involved: Engaging in any act or omission, aiding, abetting, counseling, commanding, inducing, conspiring with or failing reasonably to supervise another in doing an act. [Used in: Part 1A, Item 11; Part 2A, Items 9 and 10; Part 2B, Items 3 and 7] 36. Legal Entity Identifier: A ‘‘legal entity identifier’’ assigned by a utility endorsed by the Global LEI Regulatory Oversight Committee (ROC) or accredited by the Global LEI Foundation (GLEIF). [Used in: Part 1A, Item 1, Schedules D and R] PO 00000 Frm 00123 Fmt 4701 Sfmt 4700 13145 37. Management Persons: Anyone with the power to exercise, directly or indirectly, a controlling influence over your firm’s management or policies, or to determine the general investment advice given to the clients of your firm. Generally, all of the following are management persons: • Your firm’s principal executive officers, such as your chief executive officer, chief financial officer, chief operations officer, chief legal officer, and chief compliance officer; your directors, general partners, or trustees; and other individuals with similar status or performing similar functions; • The members of your firm’s investment committee or group that determines general investment advice to be given to clients; and • If your firm does not have an investment committee or group, the individuals who determine general investment advice provided to clients (if there are more than five people, you may limit your firm’s response to their supervisors). [Used in: Part 1B, Item 2; Part 2A, Items 9, 10 and 19] 38. Managing Agent: A managing agent of an investment adviser is any person, including a trustee, who directs or manages (or who participates in directing or managing) the affairs of any unincorporated organization or association that is not a partnership. [Used in: General Instructions; Form ADV–NR; Form ADV–W, Item 8] 39. Minor Rule Violation: A violation of a self-regulatory organization rule that has been designated as ‘‘minor’’ pursuant to a plan approved by the SEC. A rule violation may be designated as ‘‘minor’’ under a plan if the sanction imposed consists of a fine of $2,500 or less, and if the sanctioned person does not contest the fine. (Check with the appropriate self- regulatory organization to determine if a particular rule violation has been designated as ‘‘minor’’ for these purposes.) [Used in: Part 1A, Item 11] 40. Misdemeanor: For jurisdictions that do not differentiate between a felony and a misdemeanor, a misdemeanor is an offense punishable by a sentence of less than one year imprisonment and/or a fine of less than $1,000. The term also includes a special court martial. [Used in: Part 1A, Item 11; DRPs; Part 2A, Item 9; Part 2B, Item 3] 41. Non-Resident: (a) An individual who resides in any place not subject to the jurisdiction of the United States; (b) a corporation incorporated in or that has its principal office and place of business in any place not subject to the jurisdiction of the United States; and (c) a partnership or other unincorporated E:\FR\FM\05MRR2.SGM 05MRR2 jbell on DSKJLSW7X2PROD with RULES2 13146 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations organization or association that is formed in or has its principal office and place of business in any place not subject to the jurisdiction of the United States. [Used in: General Instructions; Form ADV–NR] 42. Notice Filing: SEC-registered advisers may have to provide state securities authorities with copies of documents that are filed with the SEC. These filings are referred to as ‘‘notice filings.’’ [Used in: General Instructions; Part 1A, Item 2; Execution Page(s); Form ADV–W] 43. Order: A written directive issued pursuant to statutory authority and procedures, including an order of denial, exemption, suspension, or revocation. Unless included in an order, this term does not include special stipulations, undertakings, or agreements relating to payments, limitations on activity or other restrictions. [Used in: Part 1A, Items 2 and 11, Schedules D and R; DRPs; Part 2A, Item 9; Part 2B, Item 3] 44. Other Derivative: Any derivative that is not a commodity derivative, credit derivative, equity derivative, foreign exchange derivative or interest rate derivative. [Used in: Part 1A, Schedule D] 45. Parallel Managed Account: With respect to any registered investment company or series thereof or business development company, a parallel managed account is any managed account or other pool of assets that you advise and that pursues substantially the same investment objective and strategy and invests side by side in substantially the same positions as the identified investment company or series thereof or business development company that you advise. [Used in: Part 1A, Schedule D] 46. Performance-Based Fee: An investment advisory fee based on a share of capital gains on, or capital appreciation of, client assets. A fee that is based upon a percentage of assets that you manage is not a performance-based fee. [Used in: Part 1A, Item 5; Part 2A, Items 6 and 19] 47. Person: A natural person (an individual) or a company. A company includes any partnership, corporation, trust, limited liability company (‘‘LLC’’), limited liability partnership (‘‘LLP’’), sole proprietorship, or other organization. [Used throughout Form ADV and Form ADV–W] 48. Predecessor Performance: Investment performance achieved by a group of investments consisting of an account or a private fund that was not advised at all times during the period shown by the investment adviser VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 advertising the performance. [Used in: Part 1A, Item 5] 49. Principal Office and Place of Business: Your firm’s executive office from which your firm’s officers, partners, or managers direct, control, and coordinate the activities of your firm. [Used in: Part 1A, Instructions, Items 1 and 2; Schedules D and R; Form ADV–W, Item 1] 50. Private Fund: An issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) of that Act. [Used in: General Instructions; Part 1A, Instructions, Items 2, 5, 7, and 9; Part 1A, Schedule D] 51. Proceeding: This term includes a formal administrative or civil action initiated by a governmental agency, selfregulatory organization or foreign financial regulatory authority; a felony criminal indictment or information (or equivalent formal charge); or a misdemeanor criminal information (or equivalent formal charge). This term does not include other civil litigation, investigations, or arrests or similar charges effected in the absence of a formal criminal indictment or information (or equivalent formal charge). [Used in: Part 1A, Item 11, DRPs; Part 1B, Item 2; Part 2A, Item 9; Part 2B, Item 3] 52. Qualified Client: A client that satisfies the definition of qualified client in SEC rule 205–3. [Used in: General Instructions; Part 1A, Schedule D] 53. Related Person: Any advisory affiliate and any person that is under common control with your firm. [Used in: Part 1A, Items 7, 8 and 9; Schedule D; Form ADV–W, Item 3; Part 2A, Items 10, 11, 12 and 14; Part 2A, Appendix 1, Item 6] 54. Relying Adviser: An investment adviser eligible to register with the SEC that relies on a filing adviser to file (and amend) a single umbrella registration on its behalf. [Used in: General Instructions; Part 1A, Items 1, 7 and 11; Schedules D and R] 55. Self-Regulatory Organization or SRO: Any national securities or commodities exchange, registered securities association, or registered clearing agency. For example, the Chicago Board of Trade (‘‘CBOT’’), FINRA and New York Stock Exchange (‘‘NYSE’’) are self-regulatory organizations. [Used in: Part 1A, Item 11; DRPs; Part 1B, Item 2; Part 2A, Items 9 and 19; Part 2B, Items 3 and 7] 56. Sovereign Bonds: Any notes, bonds and debentures issued by a national government (including central government, other governments and central banks but excluding U.S. state PO 00000 Frm 00124 Fmt 4701 Sfmt 4700 and local governments), whether denominated in a local or foreign currency. [Used in: Part 1A, Schedule D] 57. Sponsor: A sponsor of a wrap fee program sponsors, organizes, or administers the program or selects, or provides advice to clients regarding the selection of, other investment advisers in the program. [Used in: Part 1A, Item 5, Schedule D; Part 2A, Instructions, Appendix 1 Instructions] 58. State Securities Authority: The securities commissioner or commission (or any agency, office or officer performing like functions) of any state of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States. [Used throughout Form ADV] 59. Supervised Person: Any of your officers, partners, directors (or other persons occupying a similar status or performing similar functions), or employees, or any other person who provides investment advice on your behalf and is subject to your supervision or control. [Used throughout Part 2] 60. Testimonial: Any statement by a current client or investor in a private fund advised by the investment adviser: (i) About the client or investor’s experience with the investment adviser or its supervised persons (ii) that directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or (iii) that refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser. [Used in: Part 1A, Item 5] 61. Third-party Rating: A rating or ranking of an investment adviser provided by a person who is not a related person and such person provides such ratings or rankings in the ordinary course of its business. [Used in: Part 1A, Item 5] 62. Umbrella Registration: A single registration by a filing adviser and one or more relying advisers who collectively conduct a single advisory business and that meet the conditions set forth in General Instruction 5. [Used in: General Instructions; Part 1A, Items 1, 2, 3, 7, 10 and 11, Schedules D and R] 63. United States Person: This term has the same meaning as in rule 203(m)–1 under the Advisers Act, which includes any natural person that is resident in the United States. [Used in: Part 1A, Instructions, Item 5; Schedule D] 64. Wrap Brochure or Wrap Fee Program Brochure: The written disclosure statement that sponsors of E:\FR\FM\05MRR2.SGM 05MRR2 Federal Register / Vol. 86, No. 42 / Friday, March 5, 2021 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES2 wrap fee programs must provide to each of their wrap fee program clients. [Used in: Part 2, General Instructions; Used throughout Part 2A, Appendix 1] 65. Wrap Fee Program: Any advisory program under which a specified fee or fees not based directly upon transactions in a client’s account is VerDate Sep<11>2014 21:12 Mar 04, 2021 Jkt 253001 charged for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisers) and the execution of client transactions. [Used in: Part 1, Item 5; Schedule D; Part 2A, Instructions, Item 4, used PO 00000 throughout Appendix 1; Part 2B, Instructions] By the Commission. Dated: December 22, 2020. Vanessa A. Countryman, Secretary. [FR Doc. 2020–28868 Filed 3–4–21; 8:45 am] BILLING CODE 8011–01–P Frm 00125 Fmt 4701 Sfmt 9990 13147 E:\FR\FM\05MRR2.SGM 05MRR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 86, Number 42 (Friday, March 5, 2021)]
[Rules and Regulations]
[Pages 13024-13147]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28868]



[[Page 13023]]

Vol. 86

Friday,

No. 42

March 5, 2021

Part II





Securities and Exchange Commission





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17 CFR Part 275 and 279





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Investment Adviser Marketing; Final Rule

Federal Register / Vol. 86 , No. 42 / Friday, March 5, 2021 / Rules 
and Regulations

[[Page 13024]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275 and 279

[Release No. IA-5653; File No. S7-21-19]
RIN 3235-AM08


Investment Adviser Marketing

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'' or 
the ``SEC'') is adopting amendments under the Investment Advisers Act 
of 1940 (the ``Advisers Act'' or the ``Act'') to update rules that 
govern investment adviser marketing. The amendments will create a 
merged rule that will replace both the current advertising and cash 
solicitation rules. These amendments reflect market developments and 
regulatory changes since the advertising rule's adoption in 1961 and 
the cash solicitation rule's adoption in 1979. The Commission is also 
adopting amendments to Form ADV to provide the Commission with 
additional information about advisers' marketing practices. Finally, 
the Commission is adopting amendments to the books and records rule 
under the Advisers Act.

DATES: 
    Effective date: This rule is effective May 4, 2021.
    Compliance dates: The applicable compliance dates are discussed in 
section II.K.

FOR FURTHER INFORMATION CONTACT: Juliet Han, Emily Rowland, Aaron Russ, 
or Christine Schleppegrell, Senior Counsels; Thoreau Bartmann or 
Melissa Roverts Harke, Senior Special Counsels; or Melissa Gainor, 
Assistant Director, at (202) 551-6787 or [email protected], Investment 
Adviser Regulation Office, Division of Investment Management, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to 17 
CFR 275.206(4)-1 (rule 206(4)-1) and 17 CFR 275.204-2 (rule 204-2) 
under the Investment Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.],\1\ 
and amendments to 17 CFR 279.1 (Form ADV) under the Advisers Act. The 
Commission is rescinding 17 CFR 275.206(4)-3 (rule 206(4)-3) under the 
Advisers Act.
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    \1\ Unless otherwise noted, when we refer to the Advisers Act, 
or any section of the Advisers Act, we are referring to 15 U.S.C. 
80b, at which the Advisers Act is codified. When we refer to rules 
under the Advisers Act, or any section of those rules, we are 
referring to title 17, part 275 of the Code of Federal Regulations 
[17 CFR part 275], in which these rules are published.
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Table of Contents

I. Introduction
    Advertising and Solicitation Rules and Proposed Amendments
    Merged Marketing Rule
II. Discussion
    A. Scope of the Rule: Definition of ``Advertisement''
    1. Overview
    2. Definition of Advertisement: Communications Other Than 
Compensated Testimonials and Endorsements
    3. Definition of Advertisement: Compensated Testimonials and 
Endorsements, Including Solicitations
    4. Investors in Private Funds
    B. General Prohibitions
    1. Untrue Statements and Omissions
    2. Unsubstantiated Material Statements of Fact
    3. Untrue or Misleading Implications or Inferences
    4. Failure To Provide Fair and Balanced Treatment of Material 
Risks or Material Limitations
    5. Anti-Cherry Picking Provisions: References to Specific 
Investment Advice and Presentation of Performance Results
    6. Otherwise Materially Misleading
    C. Conditions Applicable to Testimonials and Endorsements, 
Including Solicitations
    1. Overview
    2. Required Disclosures
    3. Adviser Oversight and Compliance
    4. Disqualification for Persons Who Have Engaged in Misconduct
    5. Exemptions
    D. Third-Party Ratings
    E. Performance Advertising
    1. Net Performance Requirement; Elimination of Proposed Schedule 
of Fees Requirement
    2. Prescribed Time Periods
    3. Statements About Commission Approval
    4. Related Performance
    5. Extracted Performance
    6. Hypothetical Performance
    F. Portability of Performance, Testimonials, Endorsements, 
Third-Party Ratings, and Specific Investment Advice
    G. Review and Approval of Advertisements
    H. Amendments to Form ADV
    I. Recordkeeping
    J. Existing Staff No-Action Letters
    K. Transition Period and Compliance Date
    L. Other Matters
III. Economic Analysis
    A. Introduction
    B. Broad Economic Considerations
    C. Baseline
    1. Market for Investment Advisers for the Advertising Rule
    2. Market for Solicitation Activity
    3. RIA Clients
    D. Costs and Benefits of the Final Rule and Form Amendments
    1. Quantitative Estimates of Costs and Benefits
    2. Definition of Advertisement
    3. General Prohibitions
    4. Conditions Applicable to Testimonials and Endorsements, 
Including Solicitations
    5. Third-Party Ratings
    6. Performance Advertising
    7. Amendments to Form ADV
    8. Recordkeeping
    E. Efficiency, Competition, Capital Formation
    1. Efficiency
    2. Competition
    3. Capital Formation
    F. Reasonable Alternatives
    1. Reduce or Eliminate Specific Limitations on Investment 
Adviser Advertisements
    2. Bifurcate Some Requirements
    3. Hypothetical Performance Alternatives
    4. Alternatives to the Combined Marketing Rule
    5. Alternatives to Disqualification Provisions
IV. Paperwork Reduction Act Analysis
    A. Introduction
    B. Rule 206(4)-1
    1. General Prohibitions
    2. Testimonials and Endorsements in Advertisements
    3. Third-Party Ratings in Advertisements
    4. Performance Advertising
    5. Total Hour Burden Associated With Rule 206(4)-1
    C. Rule 206(4)-3
    D. Rule 204-2
    E. Form ADV
V. Final Regulatory Flexibility Analysis
    A. Reason for and Objectives of the Final Amendments
    1. Final Rule 206(4)-1
    2. Final Rule 204-2
    3. Final Amendments to Form ADV
    B. Significant Issues Raised by Public Comments
    C. Legal Basis
    D. Small Entities Subject to the Rule and Rule Amendments
    1. Small Entities Subject to Amendments to Marketing Rule
    2. Small Entities Subject to Amendments to the Books and Records 
Rule 204-2
    3. Small Entities Subject to Amendments to Form ADV
    E. Projected Reporting, Recordkeeping and Other Compliance 
Requirements
    1. Final Rule 206(4)-1
    2. Final Amendments to Rule 204-2
    3. Final Amendments to Form ADV
    F. Duplicative, Overlapping, or Conflicting Federal Rules
    1. Final Rule 206(4)-1
    2. Final Amendments to Form ADV
    G. Significant Alternatives
    1. Final Rule 206(4)-1
Statutory Authority
Appendix A: Changes to Form ADV
Appendix B: Form ADV Glossary of Terms

I. Introduction

    We are adopting an amended rule, rule 206(4)-1, under the Advisers 
Act, which addresses advisers marketing their services to clients and 
investors (the ``marketing rule''). The marketing rule amends existing 
rule 206(4)-1 (the ``advertising rule''), which we adopted

[[Page 13025]]

in 1961 to target advertising practices that the Commission believed 
were likely to be misleading.\2\ The rule also replaces rule 206(4)-3 
(the ``solicitation rule''), which we adopted in 1979 to help ensure 
clients are aware that paid solicitors who refer them to advisers have 
a conflict of interest.\3\ We have not substantively updated either 
rule since adoption.\4\ In the decades since the adoption of both 
rules, however, advertising and referral practices have evolved. 
Simultaneously, the technology used for communications has advanced, 
the expectations of investors shopping for advisory services have 
changed, and the profiles of the investment advisory industry have 
diversified.
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    \2\ Advertisements by Investment Advisers, Release No. IA-121 
(Nov. 1, 1961) [26 FR 10548 (Nov. 9, 1961)] (``Advertising Rule 
Adopting Release'').
    \3\ See Requirements Governing Payments of Cash Referral Fees by 
Investment Advisers, Release No. 688 (July 12, 1979) [44 FR 42126 
(Jul 18, 1979)] (``1979 Adopting Release'').
    \4\ The advertising rule has been amended once, when the 
Commission revised the introductory text of paragraph (a) as part of 
a broader amendment of several rules under the Advisers Act to 
reflect changes made by the National Securities Market Improvement 
Act of 1996. Rules Implementing Amendments to the Investment 
Advisers Act of 1940, Release No. IA-1633 (May 15, 1997) [62 FR 
28112, 28135 (May 22, 1997)] (``Release 1633''). We have not amended 
the solicitation rule since adoption.
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    Our marketing rule recognizes these changes and our experience 
administering the advertising and solicitation rules. Accordingly, the 
rule contains principles-based provisions designed to accommodate the 
continual evolution and interplay of technology and advice. The rule 
also contains tailored restrictions and requirements for certain types 
of advertisements, such as performance advertising, testimonials and 
endorsements, and third-party ratings. Compensated testimonials and 
endorsements, which include traditional referral and solicitation 
activity, will be subject to disqualification provisions. We believe 
the final marketing rule will allow advisers to provide existing and 
prospective investors with useful information as they choose among 
investment advisers and advisory services, subject to conditions that 
are reasonably designed to prevent fraud.
    Finally, we are adopting related amendments to Form ADV that are 
designed to provide the Commission with additional information about 
advisers' marketing practices, and related amendments to the Advisers 
Act books and records rule, rule 204-2.

Advertising and Solicitation Rules and Proposed Amendments

    Advertisements can provide existing and prospective investors with 
useful information as they contemplate whether to utilize and pay for 
investment advisory services, whether to approach particular investment 
advisers, and how to choose among their available options. At the same 
time, advertisements present risks of misleading investors because an 
investment adviser's interest in attracting investors may conflict with 
the investors' interests, and the adviser is in control of the design, 
content, format, media, timing, and placement of its advertisements. As 
a consequence, advertisements may mislead existing and prospective 
investors about the advisory services they will receive, including 
indirectly through the services provided to private funds.\5\ The 
advertising rule was designed to address the potential harm to 
investors from misleading advertisements.
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    \5\ The final rule covers marketing activities by investment 
advisers to clients and prospective clients as well as investors and 
prospective investors in private funds that those advisers manage. 
See 15 U.S.C. 80b-2(a)(29) (defining a ``private fund'' as ``an 
issuer that would be an investment company, as defined in section 3 
of the Investment Company Act of 1940, but for section 3(c)(1) or 
3(c)(7) of that Act''). Unless we specify otherwise, for purposes of 
this release, we refer to any of these persons generally as 
``investors,'' and we refer specifically to investors in private 
funds managed by those advisers as ``private fund investors.''
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    Advisers also attract investors by compensating individuals or 
firms to solicit new investors. Some investment advisers directly 
employ individuals to solicit new investors on their behalf, and some 
investment advisers arrange for related entities or third parties, such 
as broker-dealers, to solicit new investors. The person or entity 
compensated has a financial incentive to recommend the adviser to the 
investor.\6\ Without appropriate disclosure, this compensation creates 
a risk that an investor would mistakenly view the recommendation as 
being an unbiased opinion about the adviser's ability to manage the 
investor's assets and would rely on that recommendation more than the 
investor would if the investor knew of the incentive. The solicitation 
rule was designed to help expose to clients the conflicts of interest 
posed by cash compensation.
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    \6\ While we traditionally referred to those who engaged in 
compensated solicitation activity under the current solicitation 
rule as ``solicitors,'' we use the term ``promoter'' in this release 
to refer to a person providing a testimonial or endorsement, whether 
compensated or uncompensated. We also use the term ``provider'' at 
times when discussing a person providing an uncompensated 
testimonial or endorsement.
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    The concerns that motivated the Commission to adopt the advertising 
and solicitation rules still exist today, but investment adviser 
marketing has evolved with advances in technology. In the decades since 
the adoption of both the advertising and solicitation rules, the use of 
the internet, mobile applications, and social media has become an 
integral part of business communications. Consumers today often rely on 
these forms of communication to obtain information, including reviews 
and referrals, when considering buying goods and services. Advisers and 
third parties also rely on these same types of outlets to attract and 
refer potential customers.
    The nature and profiles of the investment advisory industry and 
investors seeking those advisory services have also changed since the 
Commission adopted the advertising and solicitation rules. Some 
investors today rely on digital investment advisory programs, sometimes 
referred to as ``robo-advisers,'' for investment advice, which is 
provided exclusively through electronic platforms using algorithmic-
based programs. In addition, passage of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act'') required many 
investment advisers to private funds that were previously exempt from 
registration to register with the Commission and become subject to 
additional provisions of the Advisers Act and the rules thereunder. 
Private funds and their advisers often hire promoters to obtain 
investors in the funds. Referral practices also have expanded to 
include, for example, various types of compensation, including non-cash 
compensation, in referral arrangements.
    In light of these developments, we proposed amendments to the 
advertising rule to: (i) Modify the definition of ``advertisement'' to 
be more ``evergreen'' in light of ever-changing technology; (ii) 
replace four per se prohibitions with general prohibitions of certain 
advertising practices applicable to all advertisements; (iii) provide 
certain restrictions and conditions on testimonials, endorsements, and 
third-party ratings; and (iv) include tailored requirements for the 
presentation of performance results, based on an advertisement's 
intended audience.\7\

[[Page 13026]]

The proposed rule also would have required internal review and approval 
of most advertisements. Finally, we proposed amendments requiring each 
adviser to report additional information regarding its advertising 
practices in its Form ADV.
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    \7\ See Investment Adviser Advertisements; Compensation for 
Solicitations, Release No. IA-5407 (Nov. 4, 2019) [84 FR 67518 (Dec. 
10, 2019)] (``2019 Proposing Release'').
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    Additionally, we proposed amendments to the solicitation rule to: 
(i) Expand the rule to cover solicitation arrangements involving all 
forms of compensation, rather than only cash compensation; (ii) expand 
the rule to apply to the solicitation of current and prospective 
investors in any private fund, rather than only to ``clients'' 
(including prospective clients) of the investment adviser; (iii) 
eliminate requirements duplicative of other rules; (iv) include 
exceptions for de minimis payments and certain non-profit programs; and 
(v) expand the types of disciplinary events that would trigger the 
rule's disqualification provisions.
    We received more than 90 comment letters on the proposal.\8\ The 
Commission also received feedback flyers from individual investors on 
investment adviser marketing and from smaller advisers on the 
proposal's effects on small entities.\9\ Commenters generally supported 
modernizing these rules and agreed with our general approach. Many 
commenters, however, expressed concern that several aspects of the 
proposed amendments to the advertising rule would increase an 
investment adviser's compliance burden.\10\ For example, some 
commenters suggested removing the proposed internal pre-use review and 
approval requirement and narrowing the proposed definition of 
``advertisement.'' \11\ Others requested that we provide additional 
guidance on various topics, such as how the general prohibitions will 
apply in certain scenarios.\12\ Commenters also expressed concern that 
the proposed amendments to the solicitation rule would significantly 
expand several aspects of the existing rule. For example, some 
commenters argued that the proposed definition of ``solicitor'' was too 
broad and suggested alternatives or limitations.\13\ Others disagreed 
with the proposed expansion of the rule to include non-cash 
compensation and solicitations of private fund investors.\14\ 
Commenters also recommended modifications to the disqualification 
provisions, such as aligning them with disqualification provisions in 
our other rules and limiting the scope of affiliate 
disqualification.\15\
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    \8\ The comment letters on the 2019 Proposing Release (File No. 
S7-21-19) are available at https://www.sec.gov/comments/s7-21-19/s72119.htm.
    \9\ The feedback forms are available in the comment file at 
https://www.sec.gov/comments/s7-21-19/s72119.htm.
    \10\ See, e.g., Comment Letter of Wellington Management Company 
LLP (Feb. 10, 2020) (``Wellington Comment Letter''); Comment Letter 
of Fidelity Management Research Company LLC (Feb. 10, 2020) 
(``Fidelity Comment Letter'');
    \11\ See, e.g., Comment Letter of Investment Adviser Association 
(Feb. 10, 2020) (``IAA Comment Letter''); Comment Letter of the 
National Society of Compliance Professionals (Feb. 7, 2020) (``NSCP 
Comment Letter'').
    \12\ See, e.g., Comment Letter of LinkedIn Corporation (Feb. 10, 
2020) (``LinkedIn Comment Letter''); Comment Letter of the North 
American Securities Administrators Association (NASAA) (Feb. 10, 
2020) (``NASAA Comment Letter'').
    \13\ See, e.g., Comment Letter of Financial Services Institute 
(Feb. 12, 2020) (``FSI Comment Letter''); Comment Letter of SIFMA 
Asset Management Group on proposed solicitation rule (Feb. 10, 2020) 
(``SIFMA AMG Comment Letter I'').
    \14\ See, e.g., Comment Letter of Fried, Frank, Harris, Shriver 
& Jacobson LLP (Feb. 10, 2020) (``Fried Frank Comment Letter''); 
Comment Letter of Sidley Austin LLP (Feb. 10, 2020) (``Sidley Austin 
Comment Letter'').
    \15\ See, e.g., Comment Letter of Credit Suisse Securities (USA) 
LLC (Feb. 10, 2020) (``Credit Suisse Comment Letter''); SIFMA AMG 
Comment Letter I.
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    Commenters generally supported our approach to permit testimonials 
and endorsements; \16\ however, they highlighted the difficulty in 
assessing when compensated testimonials and endorsements under the 
proposed advertising rule would also trigger the application of the 
proposed solicitation rule.\17\ Commenters argued that applying both 
rules to the same conduct is duplicative and burdensome.\18\ Some 
commenters suggested that we regulate endorsements and testimonials 
only under the advertising rule,\19\ whereas others suggested various 
ways to limit the conduct that would be subject to both rules.\20\
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    \16\ See, e.g., Comment Letter of the Small Business Investor 
Alliance (Feb. 7, 2020) (``SBIA Comment Letter''); Comment Letter of 
the Consumer Federation of America (Feb. 10, 2020) (``Consumer 
Federation Comment Letter'').
    \17\ See, e.g., Comment Letter of SIFMA Asset Management Group 
on proposed advertising rule (Feb. 10, 2020) (``SIFMA AMG Comment 
Letter II''); Comment Letter of Joseph H. Nesler (Jan. 15, 2020) 
(``Nesler Comment Letter'').
    \18\ See e.g., FSI Comment Letter; SIFMA AMG Comment Letter II.
    \19\ See, e.g., IAA Comment Letter; SIFMA AMG Comment Letter II; 
Comment Letter of Mercer Advisors (Feb. 10, 2020) (``Mercer Comment 
Letter''). See also FSI Comment Letter.
    \20\ See e.g., SIFMA AMG Comment Letter II; FSI Comment Letter; 
IAA Comment Letter; Comment Letter of the Money Management Institute 
(Feb. 10, 2020) (``MMI Comment Letter''); Nesler Comment Letter.
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Merged Marketing Rule

    After considering comments, we are adopting a rule with several 
modifications.\21\ We believe it is appropriate to regulate investment 
adviser advertising and solicitation activity through a single rule: 
The marketing rule. This approach is designed to balance the 
Commission's goals of protecting investors from misleading 
advertisements and solicitations, while accommodating current marketing 
practices and their continued evolution.
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    \21\ The final rule will apply to all investment advisers 
registered, or required to be registered, with the Commission. Like 
the proposal, the final rule will not apply to advisers that are not 
required to register as investment advisers with the Commission, 
such as exempt reporting advisers or state-registered advisers.
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     The final marketing rule will include an expanded 
definition of ``advertisement,'' relative to the current advertising 
rule, that will encompass an investment adviser's marketing activity 
for investment advisory services with regard to securities. We have 
determined not to expand the definition of advertisement to include 
communications addressed to one person as proposed, and instead will 
retain the current rule's exclusion of one-on-one communications from 
the definition, except with regard to compensated testimonials and 
endorsements and certain communications that include hypothetical 
performance information.\22\ In addition, the definition will not 
include communications designed to retain existing investors. The final 
definition also will include exceptions for extemporaneous, live, oral 
communications; and information contained in a statutory or regulatory 
notice, filing, or other required communication.
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    \22\ Hypothetical performance information that is provided in 
response to an unsolicited investor request or to a private fund 
investor in a one-on-one communication is excluded from the first 
prong of the definition of advertisement.
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     Largely as proposed, the final rule will apply to certain 
communications sent to clients and private fund investors, but will not 
apply to advertisements about registered investment companies or 
business development companies.
     A set of seven principles-based general prohibitions will 
apply to all advertisements. These are drawn from historic anti-fraud 
principles under the Federal securities laws and are tailored 
specifically to the type of communications that are within the scope of 
the rule.
     The final rule will permit an adviser's advertisement to 
include testimonials and endorsements, subject generally to the 
following conditions: Required disclosures; adviser oversight and 
compliance, including a written

[[Page 13027]]

agreement for certain promoters; and, in some cases, disqualification 
provisions. We are adopting partial exemptions for de minimis 
compensation, affiliated personnel, registered broker-dealers, and 
certain persons to the extent they are covered by rule 506(d) of 
Regulation D under the Securities Act with respect to a securities 
offering.
     An adviser's advertisement may include a third-party 
rating, if the adviser forms a reasonable belief that the third-party 
rating clearly and prominently discloses certain information.
     The final rule will apply to performance advertising and 
will require presentation of net performance information whenever gross 
performance is presented, and performance data over specific periods. 
In addition, the final rule will impose requirements on advisers that 
display related performance, extracted performance, hypothetical 
performance, and--in a change from the proposal--predecessor 
performance. We are not adopting, however, the proposed separate 
requirements for performance advertising for retail and non-retail 
investors.
     We are amending the recordkeeping rule and Form ADV to 
reflect the final rule and enhance the data available to support our 
staff's enforcement and examination functions.
     In a change from the proposal, the final rule will not 
require investment advisers to review and approve their advertisements 
prior to dissemination.
     Finally, certain staff no-action letters will be withdrawn 
in connection with the final rule as those positions are either 
incorporated into the final rule or will no longer apply.

II. Discussion

A. Scope of the Rule: Definition of ``Advertisement''

1. Overview
    Under the final marketing rule, the definition of an advertisement 
includes two prongs.\23\ The first prong includes any direct or 
indirect communication an investment adviser makes that: (i) Offers the 
investment adviser's investment advisory services with regard to 
securities to prospective clients or investors in a private fund 
advised by the investment adviser (``private fund investors''), or (ii) 
offers new investment advisory services with regard to securities to 
current clients or private fund investors.\24\ This prong will capture 
traditional advertising, and will not include one-on-one 
communications, unless the communication includes hypothetical 
performance information that is not provided: (i) In response to an 
unsolicited investor request or (ii) to a private fund investor. It 
also excludes (i) extemporaneous, live, oral communications; and (ii) 
information contained in a statutory or regulatory notice, filing, or 
other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication.\25\
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    \23\ See final rule 206(4)-1(e)(1)(i) and (ii).
    \24\ See final rule 206(4)-1(e)(1)(i).
    \25\ See final rule 206(4)-1(e)(1)(i)(A) and (B).
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    The new second prong will cover compensated testimonials and 
endorsements, which will include a similar scope of activity as 
traditional solicitations under the current solicitation rule.\26\ This 
prong will include oral communications and one-on-one communications to 
capture traditional one-on-one solicitation activity, in addition to 
solicitations for non-cash compensation. It will exclude certain 
information contained in a statutory or regulatory notice, filing, or 
other required communication.\27\
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    \26\ See final rule 206(4)-1(e)(1)(ii). As discussed below, 
uncompensated testimonials and endorsements that are included in 
certain adviser communications would meet the first prong of the 
definition of advertisement. See infra ``Adoption and entanglement'' 
section.
    \27\ See final rule 206(4)-1(e)(1)(ii).
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2. Definition of Advertisement: Communications Other Than Compensated 
Testimonials and Endorsements
    Proposed rule 206(4)-1(e)(1) would have defined an advertisement as 
any communication, disseminated by any means, by or on behalf of an 
investment adviser, that offers or promotes the investment adviser's 
investment advisory services or that seeks to obtain or retain one or 
more investment advisory clients or private fund investors, subject to 
certain enumerated exclusions. Although some commenters supported the 
proposed definition,\28\ most commenters stated that it was overly 
broad.\29\ Some commenters stated that the proposed definition would 
chill adviser communications to existing investors, increase compliance 
burdens for advisers, and complicate communications with various third 
parties.\30\
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    \28\ See, e.g., SBIA Comment Letter; Consumer Federation Comment 
Letter; Comment Letter of the Institutional Limited Partners 
Association (Feb. 10, 2020) (``ILPA Comment Letter'').
    \29\ See, e.g., Wellington Comment Letter; Pickard Djinis 
Comment Letter; Comment Letter of Managed Funds Association and 
Alternative Investment Management Association (Feb. 10, 2020) 
(``MFA/AIMA Comment Letter I'').
    \30\ See, e.g., Fidelity Comment Letter; NSCP Comment Letter; 
IAA Comment Letter.
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    After considering comments, we are making several modifications to 
hone the scope of the rule to the communications that have a greater 
risk of misleading investors, ease compliance burdens that commenters 
suggested would result from the proposed rule's scope, and facilitate 
communications with existing investors.
a. Specific Provisions
    In a textual (but not substantive) change from the proposal, the 
final rule will not include the phrase ``disseminated by any means'' 
and instead will reference any direct or indirect communication the 
adviser makes. We believe these two formulations carry the same 
meaning, but understand from commenters that the phrase ``direct or 
indirect'' is more familiar to advisers. This reference to direct or 
indirect communications will replace the current advertising rule's 
requirement that an advertisement be a ``written'' communication or a 
notice or other announcement ``by radio or television.'' We are 
deleting references in the current advertising rule to specific types 
of communications to ensure that the final rule reflects modern 
communication methods, rather than the methods that were most common 
when the Commission adopted the current rule (e.g., newspapers, 
television, and radio). Commenters generally did not oppose omitting 
the current rule's references to specific methods of communication and 
supported such modernization of the current rule.\31\
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    \31\ See, e.g., NYC Bar Comment Letter; Comment Letter of the 
Financial Planning Association (Feb. 10, 2020) (``FPA Comment 
Letter'').
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    This revision will expand the scope of the current rule to 
encompass all offers of an investment adviser's investment advisory 
services with regard to securities regardless of how they are 
disseminated, with the limited exceptions discussed below. An adviser 
may disseminate such communications through emails, text messages, 
instant messages, electronic presentations, videos, films, podcasts, 
digital audio or video files, blogs, billboards, and all manner of 
social media, as well as by paper, including in newspapers, magazines, 
and the mail. We recognize that electronic media (including social 
media and other internet communications) and mobile communications play 
a significant role in current advertising practices. We also believe 
this revision will help the

[[Page 13028]]

definition remain evergreen in the face of evolving technology and 
methods of communication.
i. Any Direct or Indirect Communication an Investment Adviser Makes
    The first prong of the final marketing rule's definition of 
``advertisement'' includes an adviser's direct or indirect 
communications. In addition to communicating directly with prospective 
investors, we understand that investment advisers often provide 
intermediaries, such as consultants, other advisers (e.g., in a fund-
of-funds or feeder funds structure), and promoters, with advertisements 
for dissemination. Those advertisements are indirect communications 
because they are statements provided by the adviser for dissemination 
by a third party. This aspect of the definition also will capture 
certain communications distributed by an adviser that incorporate 
statements or other content prepared by a third party.\32\
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    \32\ See infra ``Adoption and entanglement'' section.
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    The final rule text reflects a change from the proposal, which 
would have applied to any communications ``by or on behalf of'' an 
adviser.\33\ Commenters generally suggested that we remove the ``on 
behalf of'' clause from the definition, citing concerns that advisers 
would not be able to collaborate with third parties to prepare and 
disseminate advertising materials and that it would stifle 
communications between advisers and certain third parties.\34\ Certain 
commenters requested safe harbors for communications with the press and 
removal of profane or illegal materials.\35\ Commenters also requested 
clarification on how the rule would apply to funds-of-funds, model 
providers, solicitors, and employee use of social media.\36\
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    \33\ See proposed rule 206(4)-1(e)(1).
    \34\ See, e.g., SIFMA AMG Comment Letter II; FSI Comment Letter; 
Comment Letter of the CFA Institute (Feb. 24, 2020) (``CFA Institute 
Comment Letter''); Comment Letter of ICE Data Pricing & Reference 
Data, LLC (Feb. 10, 2020) (``ICE Comment Letter'').
    \35\ See, e.g., LinkedIn Comment Letter; Comment Letter of 
Resolute Investment Managers (Feb. 10, 2020) (``Resolute Comment 
Letter''); IAA Comment Letter.
    \36\ See, e.g., Comment Letter of the American Investment 
Council (Feb. 10, 2020) (``AIC Comment Letter''); Nesler Comment 
Letter; SIFMA AMG Comment Letter II; CFA Institute Comment Letter.
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    We believe communications that investment advisers use to offer 
their advisory services have an equal potential to mislead--and should 
be subject to the rule--regardless of whether the adviser communicates 
directly or indirectly through a third party, such as a consultant, 
intermediary, or related person.\37\ Likewise, an adviser should not be 
able to avoid application of the rule when it incorporates third-party 
content into its communications.\38\ To address commenters' concerns 
about the clarity of the standard, however, we replaced ``on behalf 
of'' with ``directly or indirectly.'' Our view is that these phrases 
largely have the same meaning, but that ``directly or indirectly'' is 
more commonly used, broadly understood, and consistent with the 
language in the current rule. In addition, we believe that the phrase 
``direct or indirect communication an investment adviser makes'' better 
focuses on an adviser's participation in making a particular 
communication subject to the rule.
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    \37\ Section 208 of the Advisers Act states that ``[i]t shall be 
unlawful for any person indirectly, or through or by any other 
person, to do any act or thing which it would be unlawful for such 
person to do directly . . .'' See, e.g., In the Matter of Profitek, 
Inc., Release No. IA-1764 (Sept. 29, 1998) (settled order) (The 
Commission brought an enforcement action against an investment 
adviser, asserting that it directly or indirectly distributed 
materially false and misleading advertisements, including by 
submitting performance information in questionnaires submitted to 
online databases that were made available to subscribers nationwide 
and by providing misleading performance information to a newspaper 
that reported the performance in an article.).
    \38\ See infra ``Adoption and entanglement'' section.
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    Whether a particular communication is a communication made by the 
adviser is a facts and circumstances determination. Where the adviser 
has participated in the creation or dissemination of an advertisement, 
or where an adviser has authorized a communication, the communication 
would be a communication of the adviser. For example, if an adviser 
provides marketing material to a third party for dissemination to 
potential investors, the communication is a communication made by the 
adviser. In addition, we would generally view any advertisement about 
the adviser that is distributed and/or prepared by a related person as 
an indirect communication by the adviser, and thus subject to the final 
rule.\39\ Although the final marketing rule will not require an adviser 
to oversee all activities of a third party, the adviser is responsible 
for ensuring that its advertisements comply with the rule, regardless 
of who creates or disseminates them.
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    \39\ An adviser's ``related person'' is defined in Form ADV's 
Glossary of Terms as ``[a]ny advisory affiliate and any person that 
is under common control with [the adviser's] firm.'' Italicized 
terms are defined in the Form ADV Glossary. See Form ADV Glossary.
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    An adviser might collaborate with a third party to prepare 
marketing materials in other circumstances that would not constitute 
dissemination by an adviser. If an adviser provides comments on a 
marketing piece, but a third party does not accept the adviser's 
comments or the third party makes unauthorized modifications, the 
adviser will not be responsible for the third party's subsequent 
modifications that were made independently of the adviser and that the 
adviser did not approve.\40\ This analysis would be based on the facts 
and circumstances. Formal authorization of dissemination, or lack 
thereof, by the adviser is not dispositive, although it would be 
considered part of the analysis.
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    \40\ However, the adviser will remain responsible for the 
accuracy of the marketing material provided to and disseminated by 
the third party even if the third party makes formatting changes 
that do not affect the content of that marketing material or 
prominence of particular disclosures therein.
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    Commenters sought clarification on how the definition of 
``advertisement'' would apply in the fund-of-funds and master-feeder 
contexts.\41\ If an adviser to an underlying fund provides marketing 
materials to the adviser of a fund-of-funds (or a feeder fund) and the 
adviser to the fund-of-funds (or a feeder fund) provides those 
materials to investors, the underlying fund adviser would be 
responsible for the material it prepared or authorized for 
distribution.\42\ The underlying fund adviser would not be responsible 
for modifications the adviser of the fund-of-funds made to the 
underlying fund adviser's original advertisement if the underlying fund 
adviser did not approve the adviser's edits. Similarly, a third-party 
model provider would not be responsible for modifications the end-user 
adviser made to the third-party model used in an advertisement if done 
without the model provider's involvement or authorization.
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    \41\ See, e.g., AIC Comment Letter; Comment Letter of JG 
Advisory Services, LLC (Jan. 9, 2020) (``JG Advisory Comment 
Letter'').
    \42\ In this discussion, the acquiring fund adviser (or the 
adviser to, or sponsor of, a feeder fund in a master-feeder 
structure) generally would be treated as an intermediary and not as 
an investor in the underlying fund (or the master fund in a master-
feeder structure).
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Adoption and Entanglement
    Depending on the particular facts and circumstances, third-party 
information also may be attributable to an adviser under the first 
prong of the final rule. For example, an adviser may distribute 
information generated by a third party or a third party could include 
information about an adviser's investment advisory services in the 
third party's materials. In these scenarios, whether the third-party 
information is attributable to the adviser

[[Page 13029]]

will require an analysis of the facts and circumstances to determine 
(i) whether the adviser has explicitly or implicitly endorsed or 
approved the information after its publication (adoption) or (ii) the 
extent to which the adviser has involved itself in the preparation of 
the information (entanglement).\43\
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    \43\ See Interpretive Guidance on the Use of Company websites, 
Release No. IC-28351 (Aug. 1, 2008) [73 FR 45862 (Aug. 7, 2008)] 
(``2008 Release'') (``[W]hether third-party information is 
attributable to a company depends upon whether the company has: (1) 
involved itself in the preparation of the information, or (2) 
explicitly or implicitly endorsed or approved the information.''); 
Use of Electronic Media, Release No. 34-42728 (Apr. 28, 2000) [65 FR 
25843 (May 4, 2000)] (``2000 Release'') at nn.52, 54; Use of 
Electronic Media for Delivery Purposes, Release No. 34-36345 (Oct. 
6, 1995) [60 FR 53458 (Oct. 13, 1995)] (``1995 Release'').
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    An adviser ``adopts'' third-party information when it explicitly or 
implicitly endorses or approves the information.\44\ For example, if an 
adviser incorporates information it receives from a third party into 
its performance advertising, the adviser has adopted the third-party 
content, and the third-party content will be attributed to the 
adviser.\45\ An adviser is liable for such third-party content under 
the marketing rule just as it would be liable for content it produced 
itself.\46\ In addition, an adviser may have ``entangled'' itself in a 
third-party communication if the adviser involves itself in the third 
party's preparation of the information.\47\
---------------------------------------------------------------------------

    \44\ See 2008 Release, supra footnote 43.
    \45\ See, e.g., In the Matter of BB&T Securities, LLC, Release 
No. IA-4506 (Aug. 25, 2016) (settled order) (The Commission brought 
an enforcement action against an SEC-registered investment adviser 
alleging that it negligently relied on a third party's materially 
inflated, and hypothetical and backtested, performance track record 
in preparing advertisements that the adviser sent to advisory 
clients and prospective clients.).
    \46\ See infra section II.B.
    \47\ See 2000 Release, supra footnote 43 (``[L]iability under 
the `entanglement' theory would depend upon an issuer's level of 
pre-publication involvement in the preparation of the 
information.'').
---------------------------------------------------------------------------

    Nevertheless, we would not view an adviser's edits to an existing 
third-party communication to result in attribution of that 
communication to the adviser if the adviser edits a third party's 
communication based on pre-established, objective criteria (i.e., 
editing to remove profanity, defamatory or offensive statements, 
threatening language, materials that contain viruses or other harmful 
components, spam, unlawful content, or materials that infringe on 
intellectual property rights, or editing to correct a factual error) 
that are documented in the adviser's policies and procedures and that 
are not designed to favor or disfavor the adviser.\48\ In these 
circumstances, we would not view the adviser as endorsing or approving 
the remaining content by virtue of such limited editing.
---------------------------------------------------------------------------

    \48\ For example, an adviser could not have a policy to remove 
only negative comments about the adviser.
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Guidance on Social Media
    Questions about whether a communication is attributable to an 
adviser may commonly arise in the context of an adviser's use of 
websites or other social media. For example, an adviser might include a 
hyperlink in an advertisement to an independent web page on which 
third-party content sits. An adviser should consider the adoption and 
entanglement concepts discussed above to determine whether the 
hyperlinked third-party content would be attributed to the adviser.\49\ 
At the same time, an adviser's hyperlink to third-party content that 
the adviser knows or has reason to know contains an untrue statement of 
material fact or materially misleading information would also be 
fraudulent or deceptive under section 206 of the Act and other 
applicable anti-fraud provisions.
---------------------------------------------------------------------------

    \49\ We previously stated that an adviser should consider the 
application of rule 206(4)-1, including the existing prohibition of 
testimonials, before including hyperlinks to third-party websites on 
its website or in its electronic communications. See 2008 Release, 
supra footnote 43.
---------------------------------------------------------------------------

    Whether content posted by third parties on an adviser's own website 
or social media page would be attributed to the investment adviser also 
depends on the facts and circumstances surrounding the adviser's 
involvement.\50\ For example, permitting all third parties to post 
public commentary to the adviser's website or social media page would 
not, by itself, render such content attributable to the adviser, so 
long as the adviser does not selectively delete or alter the comments 
or their presentation and is not involved in the preparation of the 
content.\51\ We believe such treatment of third-party content on the 
adviser's own website or social media page is appropriate even if the 
adviser has the ability to influence the commentary but does not 
exercise this authority. For example, if the social media platform 
allows the investment adviser to sort the third-party content in such a 
way that more favorable content appears more prominently, but the 
investment adviser does not actually do such sorting, then the ability 
to sort content would not, by itself, render such content attributable 
to the adviser. In addition, if an adviser merely permits the use of 
``like,'' ``share,'' or ``endorse'' features on a third-party website 
or social media platform, we would not interpret the adviser's 
permission as implicating the final rule.
---------------------------------------------------------------------------

    \50\ Other content that offers or promotes the adviser's 
services on an adviser's own website or social media page would 
likely meet the definition of ``advertisement'' under the final 
rule.
    \51\ See supra ``Adoption and entanglement'' section (discussing 
an adviser's ability to edit third-party material based on objective 
criteria).
---------------------------------------------------------------------------

    Conversely, if the investment adviser takes affirmative steps to 
involve itself in the preparation or presentation of the comments, to 
endorse or approve the comments, or to edit posted comments, those 
comments would be attributed to the adviser. This would apply to the 
affirmative steps an adviser takes both on its own website or social 
media pages, as well as on third-party websites. For example, if an 
adviser substantively modifies the presentation of comments posted by 
others by deleting or suppressing negative comments or prioritizing the 
display of positive comments, then we would attribute the comments to 
the adviser (i.e., the communication would be an indirect statement of 
the adviser) because the adviser would have modified third-party 
comments with the goal of marketing its advisory business. However, as 
discussed above, we would not view an adviser's merely editing profane, 
unlawful, or other such content according to a neutral pre-existing 
policy as the adviser adopting the content.
    Some commenters sought assurances that the definition of 
advertisement would not cover an adviser's associated persons' activity 
on their personal social media accounts.\52\ We have concerns that, 
under certain circumstances, it could be difficult for an investor to 
differentiate a communication of the associated person in his/her 
personal capacity from a communication the associated person made for 
the adviser. With respect to social media postings to associated 
persons' own accounts, it would be a facts and circumstances analysis 
relating to the adviser's supervision and compliance efforts. If the 
adviser adopts and implements policies and procedures reasonably 
designed to prevent the use of an associated person's social media 
accounts for marketing the adviser's advisory services, we generally 
would not view such communication as the adviser marketing its advisory

[[Page 13030]]

services.\53\ To achieve effective supervision and compliance, an 
adviser may consider also prohibiting such communications, conducting 
periodic training, obtaining attestations, and periodically reviewing 
content that is publicly available on associated persons' social media 
accounts.
---------------------------------------------------------------------------

    \52\ See, e.g., SIFMA AMG Comment Letter II; LinkedIn Comment 
Letter; IAA Comment Letter. We believe that our modifications to the 
first prong of the definition of advertisement also will alleviate 
commenters' concerns as there are now fewer scenarios in which 
communications on employee social media accounts would meet the 
definition of advertisement.
    \53\ An associated person who, notwithstanding these policies 
and procedures, engages in communications inconsistent with the rule 
may, depending on the facts and circumstances, be held responsible 
for violations of the rule.
---------------------------------------------------------------------------

ii. To More Than One Person
    Consistent with the current rule's exclusion of one-on-one 
communications, the first prong of the final definition of 
``advertisement'' generally does not include communications to one 
person. While our proposed rule would have treated communications 
directed to ``one or more'' persons as advertisements, commenters 
generally opposed this expansion.\54\ In particular, commenters argued 
that subjecting one-on-one communications to the requirements of the 
proposed rule would create untenable burdens given the proposed review 
and approval obligation (including enhanced recordkeeping 
requirements).\55\ Commenters also stated that it would chill adviser/
investor communications.\56\ According to commenters, scoping a one-on-
one communication into the rule would require advisers to review each 
communication to determine whether it is an advertisement, which could 
prevent an adviser from providing timely information to investors and 
satisfying its fiduciary obligations.\57\ We received comments that 
communications to existing investors are already subject to the anti-
fraud provisions of the Advisers Act, and therefore communications to 
existing investors need not be subject to the final rule.\58\
---------------------------------------------------------------------------

    \54\ See, e.g., IAA Comment Letter; AICPA Comment Letter.
    \55\ See, e.g., Comment Letter of Commonwealth Financial Network 
(Feb. 10, 2020) (``Commonwealth Comment Letter'') (stating that the 
lack of complete overlap with FINRA rules would make compliance 
especially burdensome for dual registrants); Comment Letter of the 
National Regulatory Services (Feb. 10, 2020) (``NRS Comment 
Letter''). Commenters also noted that advisers have adopted long-
standing practices in reliance on the existing exclusion of one-on-
one communications. See, e.g., Comment Letter of the New York City 
Bar (Feb. 10, 2020) (``NYC Bar Comment Letter'').
    \56\ See, e.g., IAA Comment Letter (stating that the proposed 
rule ``would blur the line between client servicing and 
marketing''); Wellington Comment Letter; Fidelity Comment Letter; 
MFA/AIMA Comment Letter I.
    \57\ See, e.g., CFA Institute Comment Letter; Comment Letter of 
the Council of Institutional Investors (Feb. 11, 2020) (``CII 
Comment Letter'').
    \58\ See, e.g., SIFMA AMG Comment Letter II.
---------------------------------------------------------------------------

    After considering the comments, we have determined to exclude one-
on-one communications from the first prong of the definition and retain 
the ``more than one'' language in the current advertising rule, unless 
such communications include hypothetical performance information that 
is not provided: (i) In response to an unsolicited investor request or 
(ii) to a private fund investor. We have made this change to avoid the 
possibility that the rule would impede typical communications between 
advisers and their existing and prospective investors. An adviser might 
have been dis-incentivized to communicate regularly with its investors 
if it believed it would have to analyze every communication for 
compliance with the proposed rule.\59\
---------------------------------------------------------------------------

    \59\ As discussed below, we also have eliminated the element of 
the proposed rule that would apply to communications to retain 
investors.
---------------------------------------------------------------------------

    Because we are excluding one-on-one communications from the first 
prong of the definition of advertisement under most circumstances, we 
are modifying the proposed exclusion for an adviser's responses to 
unsolicited requests.\60\ Although commenters generally supported the 
exclusion and recommended expanding it,\61\ we believe excluding most 
one-on-one communications addresses commenter concerns in a more 
comprehensive manner than the unsolicited request exclusion would have 
addressed them. The definition will exclude an adviser's responses to 
an unsolicited investor request for hypothetical performance 
information, as well as hypothetical performance information provided 
to a private fund investor in a one-on-one communication, as discussed 
below. Unless subject to this or another exclusion, the definition of 
advertisement will capture communications that include hypothetical 
performance information even in a one-on-one communication.\62\
---------------------------------------------------------------------------

    \60\ See proposed rule 206(4)-1(e)(1)(ii). We proposed to 
exclude from the definition of ``advertisement'' any communication 
by an investment adviser ``that does no more than respond to an 
unsolicited request'' for ``information specified in such request 
about the investment adviser or its services'' other than a 
communication to a retail person that includes performance results 
or a communication that includes hypothetical performance.
    \61\ See, e.g., Wellington Comment Letter; MFA/AIMA Comment 
Letter I; IAA Comment Letter.
    \62\ See final rule 206(4)-1(e)(1)(i)(A)-(C).
---------------------------------------------------------------------------

    We also recognize that advisers have one-on-one interactions with 
prospective investors and that prospective investors may ask questions 
of an adviser or ask for additional information. In adopting the 
current advertising rule, the Commission limited the definition of 
``advertisement'' due to concerns that a broad definition could 
encompass even ``face to face conversations between an investment 
counsel and his prospective client.'' \63\ The Commission stated that 
it would not include a ``personal conversation'' with a client or 
prospective client.\64\ We believe that the same concerns that 
influenced the Commission's prior approach continue to exist. We also 
believe that the remaining provisions of the definition, as well as 
other provisions of the Federal securities laws, are adequate to 
satisfy our investor protection goals with respect to communications 
directed only to a single individual or entity.\65\
---------------------------------------------------------------------------

    \63\ See Prohibited Advertisements, Release No. IA-119 (Aug. 8, 
1961) [26 FR 7552, 7553 (Nov. 15, 1961)].
    \64\ Id.
    \65\ See, e.g., section 206 of the Act; rule 206(4)-8 under the 
Act.
---------------------------------------------------------------------------

    The one-on-one exclusion in the definition's first prong applies 
regardless of whether the adviser makes the communication to a natural 
person with an account or multiple natural persons representing a 
single entity or account.\66\ The exclusion applies to a single adviser 
and a single investor. For example, if an adviser's prospective 
investor is an entity, the exclusion permits the adviser to provide 
communications to multiple natural persons employed by or owning the 
entity without those communications being subject to the rule. For 
purposes of this exclusion, we also interpret the term ``person'' to 
mean one or more investors that share the same household. For example, 
a communication to a married couple that shares the same household 
would qualify for the one-on-one exclusion.\67\
---------------------------------------------------------------------------

    \66\ See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter 
(stating that the Commission should ``make clear in the adopting 
release that the same communication to multiple natural persons 
representing a single institution or client/account counts as a 
communication to a single person'').
    \67\ See, e.g., rule 30e-1(f) under the Investment Company Act.
---------------------------------------------------------------------------

    Some commenters advocated that we increase the ``more than one'' 
threshold from the current rule to communications with ``more than 
ten'' or ``more than 25'' persons.\68\ They argued that such a change 
would reduce compliance costs and better align with traditional 
concepts of advertising.\69\ We decline to make this change. The

[[Page 13031]]

exclusion from the first prong of the definition of advertisement for 
one-on-one communications will allow an adviser to engage in routine 
investor communications and have personal conversations with 
prospective investors, without subjecting those communications to the 
final marketing rule's requirements. However, we continue to believe 
that the final rule should cover typical marketing communications, even 
if sent to a limited number of persons. Creating a higher threshold, as 
suggested by commenters, may incentivize advisers to limit 
communications to just below the threshold number of persons, and may 
defeat the purposes of our final rule.
---------------------------------------------------------------------------

    \68\ See, e.g., IAA Comment Letter (suggesting the more than 25 
person threshold because FINRA rule 2210 uses this approach and 
stating that consistency would ease compliance burdens).
    \69\ See, e.g., FPA Comment Letter.
---------------------------------------------------------------------------

    While the first prong of the final rule will generally not apply to 
communications to one person, changes in technology since the adoption 
of the existing rule permit advisers to create communications that 
appear to be personalized to single investors and are ``addressed to'' 
only one person, but are actually widely disseminated to multiple 
persons. While communications such as bulk emails or algorithm-based 
messages are nominally directed at or ``addressed to'' only one person, 
they are in fact widely disseminated to numerous investors and 
therefore would be subject to the final rule.\70\ Similarly, 
customizing a template presentation or mass mailing by filling in the 
name of an investor and/or including other basic information about the 
investor would not result in a one-on-one communication.
---------------------------------------------------------------------------

    \70\ See, e.g., NSCP Comment Letter.
---------------------------------------------------------------------------

    Likewise, an adviser cannot use duplicate inserts in an otherwise 
customized communication in an effort to circumvent application of the 
rule.\71\ For example, if an adviser maintains a database of 
performance information inserts or tables that it uses in otherwise 
customized investor communications, the adviser must treat the 
duplicated inserts as advertisements subject to the rule. Of course, if 
the adviser provides an existing investor with performance information 
pertaining to the investor's account, the rule would not apply because 
this is a one-on-one communication.\72\
---------------------------------------------------------------------------

    \71\ The fact that there may be some similarities in the 
information provided in one-on-one communications, however, will not 
result in the application of the rule to those communications.
    \72\ In addition, the communication does not fall within the 
definition of advertisement because the purpose of the communication 
is not to offer services to a new investor or to provide new 
services to an existing investor. See infra section II.A.2.a.iv.
---------------------------------------------------------------------------

    One commenter expressed concern that the public dissemination of a 
seemingly one-on-one communication could subject the communication to 
the final rule.\73\ We believe that if, for example, an adviser 
responds to a request for proposal (``RFP'') from an entity and the 
entity subsequently makes such responses available to the public 
pursuant to a Freedom of Information Act request or other public 
disclosure requirements, this would not be an advertisement merely by 
virtue of the entity's disclosure.\74\ An adviser should consider 
adopting compliance policies and procedures that are reasonably 
designed to determine whether a communication nominally directed to a 
single person is actually a communication to more than one person, or 
contains duplicated inserts as part of that communication. In these 
circumstances, the duplicated information is an advertisement because 
it is sent to more than one person and would not qualify for the 
exclusion.
---------------------------------------------------------------------------

    \73\ See Resolute Comment Letter (seeking clarification on the 
treatment of ``account statements and similar reports intended for 
Non-Retail Persons, such as public entities, that are required to 
make such information publicly available''). If the entity is an 
existing investor of the adviser, communications to the entity would 
not be considered an advertisement unless the communications offer 
or promote new advisory products or services of the adviser.
    \74\ See also supra section II.A.2.a.i for a discussion of an 
adviser's direct or indirect communications.
---------------------------------------------------------------------------

    Because of the specific concerns raised by hypothetical 
performance, hypothetical performance information would not qualify for 
the one-on-one exclusion unless provided in response to an unsolicited 
investor request or to a private fund investor.\75\ Hypothetical 
performance included in all other one-on-one communications that offer 
investment advisory services with regard to securities must be 
presented in accordance with the requirements discussed below.
---------------------------------------------------------------------------

    \75\ See infra section II.E.6. These communications would be 
eligible for the exclusions from the definition of advertisement for 
extemporaneous, live, oral communications and regulatory notices in 
final rule 206(4)-1(e)(1)(i)(A) and (B).
---------------------------------------------------------------------------

    We proposed a similar approach for hypothetical performance 
provided in response to an unsolicited request under the proposed 
definition of advertisement.\76\ Some commenters suggested that the 
Commission permit an adviser to provide hypothetical performance in 
response to unsolicited requests to eliminate the need to assess the 
requirements related to hypothetical performance.\77\ These commenters 
stated that the need to assess these requirements would slow down the 
flow of information to investors, require investors to provide more 
information earlier in the diligence process, or limit the hypothetical 
performance information shared in response to such an unsolicited 
request. Some commenters stated that private fund investors often seek 
hypothetical performance information, particularly targets and 
projections, to evaluate private fund investments.\78\ After 
considering these comments, we believe that, in most circumstances, the 
protections for hypothetical performance should be available to 
investors receiving communications that include offers of investment 
advisory services with regard to securities, to the extent such offers 
include hypothetical performance information. We believe our 
modifications to the first prong of the definition of advertisement and 
to the requirements for presenting hypothetical performance, discussed 
below, will reduce the associated compliance burdens for providing 
hypothetical performance information to investors and will, therefore, 
alleviate some of commenters' concerns.
---------------------------------------------------------------------------

    \76\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.2. (proposing that communications to any person that contain 
hypothetical performance would not qualify for the unsolicited 
request exclusion to the extent they contain such results); proposed 
rule 206(4)-1(e)(1)(ii)(B).
    \77\ See IAA Comment Letter; ILPA Comment Letter.
    \78\ See IAA Comment Letter; Comment Letter of Managed Funds 
Association and Alternative Investment Management Association (Sept. 
11, 2020) (``MFA/AIMA Comment Letter III'').
---------------------------------------------------------------------------

    However, where an investor affirmatively seeks hypothetical 
performance information from an investment adviser and the investment 
adviser has not directly or indirectly solicited the request, 
hypothetical performance information provided in response to the 
request will be excluded from the definition of advertisement under the 
final rule.\79\ In the case of an unsolicited request, an investor 
seeks hypothetical performance information for the investor's own 
purposes, rather than responding to a communication disseminated by an 
adviser offering its investment advisory services with regard to 
securities. Similarly, where the hypothetical performance information 
is provided in a one-on-one communication to a private fund investor, 
we believe a private fund investor will have the ability and 
opportunity to ask questions and assess the limitations of this 
information. In these limited circumstances, we do not believe it is 
necessary to treat the hypothetical performance information

[[Page 13032]]

as an advertisement subject to the rule.\80\
---------------------------------------------------------------------------

    \79\ Any affirmative effort by the investment adviser intended 
or designed to induce an investor to request hypothetical 
performance information would render the request solicited and thus 
not eligible for this exclusion.
    \80\ The hypothetical performance information would be subject 
to the Advisers Act's anti-fraud provisions and rule 206(4)-8 under 
the Advisers Act.
---------------------------------------------------------------------------

iii. Offers Investment Advisory Services With Regard to Securities to 
Prospective Clients or Investors in a Private Fund Advised by the 
Investment Adviser
    The marketing rule's definition of ``advertisement'' includes 
communications that offer the investment adviser's investment advisory 
services. As discussed in more detail below, we are implementing a 
number of changes from the proposal, which would have defined 
advertisements to include communications that offer or promote the 
investment adviser's investment advisory services or that seek to 
obtain or retain one or more investment advisory clients or investors 
in any pooled investment vehicle advised by the investment adviser.\81\ 
First, we are limiting the application of this element of the 
definition to communications directed to prospective clients or 
prospective private fund investors, rather than existing clients or 
private fund investors to avoid an overbroad application of the rule. 
Accordingly, this aspect of the final rule will retain the current 
rule's scope.
---------------------------------------------------------------------------

    \81\ See proposed rule 206(4)-1(e)(1).
---------------------------------------------------------------------------

    Second, we also are not adopting the ``or promote'' wording from 
the proposed definition of advertisement. Commenters generally opposed 
including the term ``promote,'' suggesting that this term could expand 
the definition of ``advertisement'' to cover certain materials not 
subject to the current rule,\82\ the text of which is limited to 
communications that ``offer'' advisory services.\83\ As we indicated in 
the proposal, the ``offer or promote'' clause reflects the current 
rule's application and was designed to capture communications that are 
commonly considered advertisements.\84\ We added the ``or promote'' 
wording to the proposed definition for clarity, but after considering 
comments we realize this wording may instead cause confusion. For 
example, commenters sought clarification that statements about an 
advisory firm's culture, philanthropy, or community activity would not 
fall within the definition of advertisement.\85\ We did not intend for 
our proposed definition and the inclusion of the term ``promote'' to 
include such communications. Accordingly, the final rule will not 
include the term ``promote'' as it is our intent to retain the current 
rule's scope in this respect.\86\
---------------------------------------------------------------------------

    \82\ See, e.g., MFA/AIMA Comment Letter I; Comment Letter of 
Association for Corporate Growth (Feb. 10, 2020) (``ACG Comment 
Letter'').
    \83\ Under the current advertising rule, an ``advertisement'' 
includes any written communication addressed to more than one 
person, or any notice or other announcement in any publication or by 
radio or television, which offers ``any other investment advisory 
service with regard to securities.'' See current rule 206(4)-1.
    \84\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.2.
    \85\ See SIFMA AMG Comment Letter II; FSI Comment Letter.
    \86\ See SEC v. C.R. Richmond & Co., 565 F.2d 1101, 1105 (9th 
Cir. 1977) (``Investment advisory material which promotes advisory 
services for the purpose of inducing potential clients to subscribe 
to those services is advertising material within [the current 
rule].'').
---------------------------------------------------------------------------

    Third, consistent with the current rule, we are limiting the 
application of the definition to offers about an investment adviser's 
investment advisory services with regard to securities. We were 
persuaded by commenters who urged us to retain the current rule's 
scope, arguing that expanding the definition to cover services that are 
not related to securities could result in an overbroad application of 
the rule.\87\ Importantly, however, the anti-fraud provisions of the 
Act and related rules continue to apply to an adviser's advertisements 
and other communications about its other non-securities related 
services.\88\
---------------------------------------------------------------------------

    \87\ See NYC Bar Comment Letter; ACG Comment Letter.
    \88\ See section 206 of the Act; rule 206(4)-8 under the Act. 
See also Commission Interpretation Regarding Standard of Conduct for 
Investment Advisers, Release No. IA-5248 (June 5, 2019) [84 FR 33669 
(July 12, 2019)] (``Fiduciary Interpretation'') (stating that 
``[t]he investment adviser's fiduciary duty is broad and applies to 
the entire adviser-client relationship.''), at n.17 (citing SEC v. 
Lauer, 2008 WL 4372896, at 24 (S.D. Fla. Sept. 24, 2008) `` `Section 
206 of the Advisers Act does not require that the activity be `in 
the offer or sale of any' security or `in connection with the 
purchase or sale of any security.' ' '').
---------------------------------------------------------------------------

    Finally, the definition will not include communications that seek 
to obtain one or more investment advisory clients or investors in any 
pooled investment vehicle advised by the investment adviser. We 
determined that this clause was superfluous of the rest of the 
definition; we believe these communications are captured within an 
adviser's offer of investment advisory services with regard to 
securities to prospective investors in a private fund advised by the 
adviser.\89\
---------------------------------------------------------------------------

    \89\ As discussed below, the definition of advertisement in the 
final rule also will not include communications designed to 
``retain'' investors. See infra section II.A.2.a.iv.
---------------------------------------------------------------------------

iv. Offers New Investment Advisory Services With Regard to Securities 
to Current Clients or Investors in a Private Fund Advised by the 
Investment Adviser
    The proposed definition of ``advertisement'' included 
communications that seek ``to obtain or retain'' investors. Commenters 
generally stated that the ``or retain'' clause would unnecessarily 
include communications made in the ordinary course of an adviser 
providing services to current investors as all communications with 
current investors are, at least in part, designed to both service and 
retain investors.\90\
---------------------------------------------------------------------------

    \90\ See, e.g., Wellington Comment Letter; IAA Comment Letter; 
JG Advisory Comment Letter (stating that ``the rule should treat 
communications to existing investors differently from communications 
to prospective investors'').
---------------------------------------------------------------------------

    Several commenters asked us to confirm the scope of the definition 
as applied to communications with existing investors.\91\ For example, 
some commenters suggested an exclusion for all communications with 
existing investors,\92\ while others supported a more limited exclusion 
for routine investor communications.\93\ Commenters generally agreed 
that the rule should treat communications with existing investors that 
offer new or additional advisory services as advertisements.\94\ 
Commenters that supported a complete or partial exclusion for 
communications to existing investors stated that such communications 
are part of the advisory service and not advertisements.\95\
---------------------------------------------------------------------------

    \91\ See, e.g., SIFMA AMG Comment Letter II (discussing market 
commentary, investment outlooks, performance reviews); JG Advisory 
Comment Letter (seeking clarification on whether the proposed 
definition would scope in monthly or quarterly letters to existing 
investors where such letters discuss account performance and include 
market commentary).
    \92\ See, e.g., MFA/AIMA Comment Letter I.
    \93\ See, e.g., MMI Comment Letter.
    \94\ See, e.g., Wellington Comment Letter; IAA Comment Letter; 
Pickard Djinis Comment Letter.
    \95\ Our staff has indicated that it would not recommend 
enforcement action under the current rule with respect to written 
communications by an adviser to an existing investor about the 
performance of securities in the investor's account because such 
communications would not be ``offers'' of advisory services, and 
instead are ``part of'' those advisory services (unless the context 
in which the communication is provided suggests otherwise). See 
Investment Counsel Association of America, Inc., SEC Staff No-Action 
Letter (Mar. 1, 2004) (``ICAA Letter''). Any staff guidance or no-
action letters discussed in this release represent the views of the 
staff of the Division of Investment Management. They are not a rule, 
regulation, or statement of the Commission. Furthermore, the 
Commission has neither approved nor disapproved their content. Staff 
guidance has no legal force or effect; it does not alter or amend 
applicable law, and it creates no new or additional obligations for 
any person.

---------------------------------------------------------------------------

[[Page 13033]]

    We agree that the rule should treat only those communications that 
offer new or additional advisory services with regard to securities to 
current investors as advertisements because they raise the same 
concerns as other advertisements. Our intent is not to chill ordinary 
course communications with current investors. We believe that other 
protections prevent advisers from engaging in activities that mislead 
or deceive existing investors.\96\ For example, existing and 
prospective advisory clients receive the anti-fraud protections of the 
Advisers Act and an adviser's fiduciary duty.\97\ Accordingly, under 
the final rule a communication to a current investor is an 
advertisement when it offers new or additional investment advisory 
services with regard to securities. We believe that this modification 
will allow advisers to continue to provide current investors with 
timely information regarding their accounts and the market without 
subjecting those communications to the marketing rule.\98\
---------------------------------------------------------------------------

    \96\ See, e.g., section 206 of the Advisers Act; rule 206(4)-8 
under the Advisers Act.
    \97\ See Fiduciary Interpretation, supra footnote 88. See also 
IAA Comment Letter; Pickard Djinis Comment Letter.
    \98\ Their exclusion from the definition of advertisement will 
not prevent these account statements or transaction reports from 
being subject to the other provisions of the Federal securities 
laws, including section 17(a) of the Securities Act or section 10(b) 
of the Exchange Act (and rule 10b-5 thereunder), to the extent those 
provisions would otherwise apply. Likewise, regardless of whether a 
communication to an existing or prospective investor is an 
``advertisement'' under the marketing rule, the communication is 
subject to the anti-fraud provisions of section 206 of the Act and 
the aforementioned provisions of the Federal securities laws.
---------------------------------------------------------------------------

    In summary, we view an adviser seeking to offer new or additional 
investment advisory services with regard to securities to current 
investors as posing the same risks to investors as an adviser seeking 
to offer such services to new investors and therefore we believe this 
activity warrants the same treatment under the final marketing rule.
v. Brand Content, General Educational Material, and Market Commentary
    Other commenters asked us to confirm that brand content, general 
educational material, and market commentary are not advertisements 
under the rule.\99\ Whether a communication is an advertisement depends 
on the facts and circumstances (e.g., whether the communication 
``offers'' the adviser's investment advisory services with regard to 
securities). Generally, generic brand content, educational material, 
and market commentary would not meet the revised definition of an 
advertisement.
---------------------------------------------------------------------------

    \99\ See, e.g., SIFMA AMG Comment Letter II; JG Advisory Comment 
Letter; MMI Comment Letter; IAA Comment Letter; MFA/AIMA Comment 
Letter I.
---------------------------------------------------------------------------

    Brand content. Determining whether a communication including 
``brand'' content (e.g., displays of the advisory firm name in 
connection with sponsoring sporting events, supporting community 
service activities, or supporting philanthropic efforts) is an 
advertisement would depend on the facts and circumstances.\100\ If such 
a communication is designed to raise the profile of the adviser 
generally, but does not offer any investment advisory services with 
regard to securities, the communication would not fall within the 
definition of an advertisement under the rule. For example, a 
communication that simply notes that an event is ``brought to you by 
XYZ Advisers'' would not qualify as an advertisement, as it is not 
offering any advisory services with regard to securities.
---------------------------------------------------------------------------

    \100\ See SIFMA AMG Comment Letter II.
---------------------------------------------------------------------------

    General educational information and market commentary. We believe 
that the same analysis applies for communications that provide only 
general educational information and market commentary.\101\ Educational 
communications that are limited to providing general information about 
investing, such as information about types of investment vehicles, 
asset classes, strategies, certain geographic regions, or commercial 
sectors, do not constitute offers of an adviser's investment advisory 
services with regard to securities.
---------------------------------------------------------------------------

    \101\ See, e.g., SIFMA AMG Comment Letter II; Mercer Comment 
Letter; IAA Comment Letter; Wellington Comment Letter.
---------------------------------------------------------------------------

    Similarly, materials that provide an adviser's general market 
commentary (including during press interviews) are unlikely to offer 
advisory services with regard to securities. Market commentary aims to 
inform current and prospective investors, including private fund 
investors, of market and regulatory developments in the broader 
financial ecosystem. These materials also help current investors 
interpret market and regulatory shifts by providing context when 
reviewing investments in their portfolios, and educate investors.\102\ 
In contrast, for example, we would view an article or white paper that 
provides general market commentary and concludes with a description of 
how the adviser's securities-related services can help prospective 
investors invest in the market as offering the adviser's services. 
Accordingly, that portion of the white paper would be an advertisement.
---------------------------------------------------------------------------

    \102\ See, e.g., MMI Comment Letter (emphasizing the importance 
of allowing general market commentary to provide investors with the 
tools to challenge the assumptions of those who counsel them on 
financial management).
---------------------------------------------------------------------------

b. Exclusions
    The rule will generally exclude two types of communications from 
the first prong of the definition of advertisement: (i) Extemporaneous, 
live, oral communications; and (ii) information required by statute or 
regulation.\103\
---------------------------------------------------------------------------

    \103\ As discussed above, the rule also excludes from the first 
prong of the advertisement definition a communication that includes 
hypothetical performance that is provided in response to an 
unsolicited investor request for such information or to a private 
fund investor in a one-on-one communication. See final rule 206(4)-
1(e)(1)(i)(C)(1) and (2).
---------------------------------------------------------------------------

i. Extemporaneous, Live, Oral Communications
    In a change from the proposal, the definition of advertisement will 
not include extemporaneous, live, oral communications, regardless of 
whether they are broadcast and regardless of whether they take place in 
a one-on-one context and involve discussion of hypothetical 
performance. We proposed an exclusion for live, oral communications 
that are not broadcast on radio, television, the internet, or any other 
similar medium. Commenters generally supported the exclusion, but had 
questions about certain aspects. For example, some commenters expressed 
concern about the treatment of written materials that accompany or are 
used to prepare for oral presentations, stating that treating such 
materials as advertisements would hamper an adviser's ability to 
prepare for a presentation.\104\ Other commenters questioned the scope 
of the exclusion, with some arguing that it was too narrow \105\ and 
others arguing that it was too broad.\106\
---------------------------------------------------------------------------

    \104\ See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter 
(stating that ``written materials prepared in conjunction with any 
live oral communications should not be considered `advertisements' 
and should be able to rely on the exclusion if (i) they are in draft 
form, (ii) they are internal documents not created for distribution, 
or (iii) all or portions of their content may not be provided to any 
prospective or current investor.'').
    \105\ See SIFMA AMG Comment Letter II (arguing that it is not 
clear how to define communications that are broadcast and widely 
disseminated versus those that are not); AIC Comment Letter.
    \106\ See, e.g., NASAA Comment Letter; CFA Comment Letter; ILPA 
Comment Letter.
---------------------------------------------------------------------------

    The goal of the exclusion for live, oral communications was to 
avoid treating extemporaneous statements as advertisements, in light of 
the difficulties in ensuring that they comply with the requirements of 
the rule, and to avoid chilling adviser communications with investors. 
If

[[Page 13034]]

remarks are extemporaneous, they cannot be simultaneously monitored for 
regulatory compliance, and to require otherwise may simply cause 
advisers to cease extemporaneous speech to the overall detriment of 
investors. However, we believe that communications prepared in advance 
can and should be subject to the rule. Accordingly, the final exclusion 
will apply only to extemporaneous, live, oral communications.\107\
---------------------------------------------------------------------------

    \107\ A communication need not be in-person to qualify for the 
exclusion so long as it is live and oral. For example, a phone call 
or live video communication between an adviser and an investor could 
qualify for this exclusion.
---------------------------------------------------------------------------

    Extemporaneous communications do not include prepared remarks or 
speeches, such as those delivered from scripts.\108\ In addition, 
slides or other written materials that are distributed or presented to 
the audience would also be included as advertisements if they otherwise 
meet the definition. On the other hand, live, extemporaneous, oral 
discussions with a group of investors or interviews with the press that 
are not based on prepared remarks will be eligible for the exclusion. 
This approach aligns with the purpose of the exclusion, which is to 
avoid a chilling effect on extemporaneous, oral speech that might occur 
if such communications were required to comply with the requirements of 
the final rule.
---------------------------------------------------------------------------

    \108\ As discussed in the recordkeeping section below, a live, 
oral communication by an adviser that is not extemporaneous (but 
that otherwise satisfies the definition of advertisement) would be 
an advertisement and a record of the advertisement must be 
maintained pursuant to rule 204-2(a)(11)(i)(A). The record of the 
advertisement could be a copy of the prepared remarks, other written 
preparatory materials, or a recording of the oral communication.
---------------------------------------------------------------------------

    Some commenters recommended that we further expand the exclusion to 
apply to certain written communications.\109\ While we appreciate that 
other modern communication methods facilitate instantaneous written 
conversations (e.g., text messages, chat), this exclusion is limited to 
extemporaneous, live, oral communications, because in those 
circumstances a speaker often does not have sufficient time to edit and 
reflect on the content of the communication.\110\
---------------------------------------------------------------------------

    \109\ See, e.g., AIC Comment Letter (stating that live written 
communications (e.g., live text chats) should also qualify for the 
exclusion in order to reflect modern communication methods).
    \110\ We consider a communication to still be ``oral'' even if 
closed captioning is used, but not if the oral communication is 
transcribed and the transcription is then directly or indirectly 
redistributed by the adviser. See, e.g., Mercer Comment Letter 
(seeking clarification that closed captioning would not prevent a 
communication from qualifying for the exclusion).
---------------------------------------------------------------------------

    Some commenters suggested that we exclude all broadcast 
communications and adopt an approach similar to FINRA.\111\ Commenters 
also sought guidance on the meaning of the following terms: 
``broadcast'' \112\ and ``widely disseminated.'' \113\ In response to 
commenters' concerns, we are not adopting the requirement that the 
live, oral communication is ``not broadcast.'' We believe the concerns 
that prompted this exclusion apply equally to extemporaneous, live, 
oral communications regardless of whether they are broadcast. We also 
believe that the exclusion should not allow an adviser to avoid 
application of the rule for a previously prepared live, oral 
communication in a non-broadcast setting, such as a luncheon seminar 
designed to attract new investors. In addition, commenters raised a 
variety of concerns with identifying whether a communication is 
broadcast in light of modern media tools, suggesting that line drawing 
as to when a communication is broadcast may be challenging in 
practice.\114\ As a result, the exclusion will apply to a broadcast 
communication, such as a webcast, that is an extemporaneous, live, oral 
communication.
---------------------------------------------------------------------------

    \111\ See, e.g., SIFMA AMG Comment Letter II; Fidelity Comment 
Letter.
    \112\ See, e.g., Fidelity Comment Letter (noting that (i) 
advisers may use various forms of technology to communicate with 
clients, including web chats or videos and (ii) further limiting the 
exclusion ``would capture routine communications between advisers 
and their clients merely because of the medium in which they are 
being conducted.''); SIFMA AMG Comment Letter II (arguing that it is 
not clear how to define communications that are broadcast and widely 
disseminated versus those that are not).
    \113\ See, e.g., SIFMA AMG Comment Letter II; Consumer 
Federation Comment Letter.
    \114\ See, e.g., SIFMA AMG Comment Letter II; Fidelity Comment 
Letter.
---------------------------------------------------------------------------

    The exclusion will apply to ``live'' oral communications, as 
proposed. Accordingly, previously recorded oral communications 
disseminated by the adviser would not qualify as live because the 
adviser had time to review and edit the recording before such 
dissemination and thus can ensure compliance with the marketing rule. 
In these circumstances, an adviser would need to treat its subsequent 
dissemination of the recording as an advertisement under the rule if 
the recording offers the adviser's investment advisory services with 
regard to securities. However, we believe that an oral communication 
would be ``live'' even if there is a time lag (e.g., streaming delay), 
a translation program is used, or adaptive technology is used to create 
a personal transcription (e.g., voice to text technology or other tools 
that assist the deaf, hard-of-hearing, or hearing loss communities).
ii. Information Contained in a Statutory or Regulatory Notice, Filing, 
or Other Required Communication
    The final rule excludes from the definition of advertisement 
``[i]nformation contained in a statutory or regulatory notice, filing, 
or other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication.'' \115\ In response to commenters, we 
have broadened the proposed exclusion, which would have applied to 
``[a]ny information required to be contained in a statutory or 
regulatory notice, filing, or other communication.'' \116\ Commenters 
generally supported the proposed exclusion,\117\ but recommended we 
expand it to ease compliance burdens and avoid duplicative regulation 
that would have resulted from applying another layer of review to 
mandatory filings.\118\
---------------------------------------------------------------------------

    \115\ Final rule 206(4)-1(e)(1)(i)(B). As with the exclusion for 
extemporaneous, live, oral communications, the exclusion for 
regulatory notices will apply regardless of whether the notice 
includes a discussion of hypothetical performance.
    \116\ Proposed rule 206(4)-1(e)(1)(iv).
    \117\ See, e.g., Mercer Comment Letter; NRS Comment Letter.
    \118\ See, e.g., Comment Letter of Ropes & Gray LLP (Feb. 10, 
2020) (``Ropes & Gray Comment Letter''); (noting that the proposal 
raises questions as to what information is required in Commission 
filings, especially for publicly traded advisers); Comment Letter of 
BlackRock, Inc. (Feb. 10, 2020) (``BlackRock Comment Letter'') 
(same); SIFMA AMG Comment Letter II (noting that advisers are 
already subject to legal duties and potential liability for 
information included in regulatory filings making it unlikely that 
advisers would include excess information in such filings).
---------------------------------------------------------------------------

    Specifically, commenters stated that compliance personnel would 
have difficulty determining exactly which information contained in a 
regulatory filing is strictly and explicitly required by applicable law 
versus which information is not (and would therefore be subject to the 
rule). In response to these comments, we broadened the exclusion to 
cover information in a statutory or regulatory, notice, filing or other 
required communication, provided the information is reasonably designed 
to satisfy the requirements, rather than information required to be 
contained in such a communication.\119\ For example, information 
reasonably designed to satisfy the requirements of Form ADV Part 2 or 
Form CRS will not be an advertisement.\120\
---------------------------------------------------------------------------

    \119\ See final rule 206(4)-1(e)(1)(i)(B).
    \120\ See Form CRS Relationship Summary; Amendments to Form ADV, 
Release No. IA-5247 (June 5, 2019) [88 FR 33573 (July 12, 2019)] 
(``Form CRS Adopting Release'') (noting that the relationship 
summary is designed to serve as disclosure, rather than marketing 
material).

---------------------------------------------------------------------------

[[Page 13035]]

    This exclusion will apply to information that an adviser provides 
to an investor under any statute or regulation under Federal or state 
law, including rules promulgated by regulatory agencies. We generally 
do not believe that communications that are prepared as a requirement 
of statutes, rules, or regulations should be viewed as advertisements 
under the final rule.\121\ However, if an adviser includes in such a 
communication information that is not reasonably designed to satisfy 
its obligations under applicable law, and such additional information 
offers the adviser's investment advisory services with regard to 
securities, then that information will be considered an 
``advertisement'' for purposes of the rule.
---------------------------------------------------------------------------

    \121\ However, information that is required to be provided or 
offered by the final rule will not qualify for this exclusion. For 
example, final rule 206(4)-1(d)(2) requires an adviser to provide 
performance results over one-, five-, and ten-year periods. This 
information is part of the advertisement and subject to the rule.
---------------------------------------------------------------------------

3. Definition of Advertisement: Compensated Testimonials and 
Endorsements, Including Solicitations
    To reflect the merger of the two rules, the final rule's definition 
of ``advertisement'' includes a new second prong that applies to ``any 
endorsement or testimonial for which an investment adviser provides 
compensation, directly or indirectly'' subject to an exclusion for 
certain regulatory notices, filings, and other required 
communications.\122\ A compensated testimonial or endorsement will meet 
the definition of advertisement's second prong regardless of whether 
the communication is made orally or in writing, to one or more 
persons.\123\ By contrast, an uncompensated testimonial or endorsement 
would have to meet the elements of prong one in order to be considered 
an ``advertisement.''
---------------------------------------------------------------------------

    \122\ Final rule 206(4)-1(e)(1)(ii).
    \123\ See id. The definition of advertisement's second prong 
includes a testimonial or endorsement for which an adviser directly 
or indirectly provides de minimis compensation (as defined below). 
However, these types of testimonials and endorsements will be exempt 
from some of the final rule's prescribed conditions for testimonials 
and endorsements. See infra section II.C.5.
---------------------------------------------------------------------------

a. Definitions of Testimonial and Endorsement
    The final definition of testimonial includes any statement by a 
current client or private fund investor about the client's or private 
fund investor's experience with the investment adviser or its 
supervised persons.\124\ The definition of endorsement includes any 
statement by a person other than a current client or private fund 
investor that indicates approval, support, or recommendation of the 
investment adviser or its supervised persons or describes that person's 
experience with the investment adviser or its supervised persons.\125\ 
This scope of how these activities are defined is similar to the 
proposal, with a few changes described below, including adding 
solicitation and referral activities drawn from the proposed definition 
of solicitor.
---------------------------------------------------------------------------

    \124\ Final rule 206(4)-1(e)(17)(i). We proposed to define 
``testimonial'' as ``any statement of a client's or investor's 
experience with the investment adviser or its advisory affiliates, 
as defined in the Form ADV Glossary of Terms.'' See proposed rule 
206(4)-1(e)(15).
    \125\ Final rule 206(4)-1(e)(5)(i). We proposed to define 
``endorsement'' as ``any statement by a person other than a client 
or investor indicating approval, support, or recommendation of the 
investment adviser or its advisory affiliates, as defined in the 
Form ADV Glossary of Terms.'' See proposed rule 206(4)-1(e)(2). To 
align the definitions of testimonial and endorsement better, and 
address situations where an endorser who is not a client 
nevertheless provides statements about the endorser's experience 
with the adviser, the final definition of endorsement includes any 
statement made by a non-investor that describes the endorser's 
experience with the adviser or its supervised persons, like under 
the definition of testimonial.
---------------------------------------------------------------------------

    These definitions include statements about the adviser's 
``supervised persons,'' rather than the proposed inclusion of 
statements about the adviser's ``advisory affiliates.'' \126\ One 
commenter recommended this change, stating that an endorsement or 
testimonial regarding a supervised person is more likely to provide 
relevant information to an investor than a statement about an adviser's 
advisory affiliate.\127\
---------------------------------------------------------------------------

    \126\ Final rule 206(4)-1(e)(5)(i) and (17)(i). Under the final 
rule, supervised person has the same meaning as in section 2(a)(25) 
of the Act. Final rule 206(4)-1(e)(16). See also proposed rule 
206(4)-1(e)(2) and (15) (referring to advisory affiliates).
    \127\ See Pickard Djinis Comment Letter.
---------------------------------------------------------------------------

    We received a variety of comments about the statements these 
definitions would capture. One commenter supported a broad approach 
that would include statements about an adviser's traits, such as 
trustworthiness, to reflect the commenter's belief that prospective 
clients typically select an adviser based on emotion.\128\ Another 
commenter requested that we limit the definitions to include only 
statements that explicitly discuss the adviser's services or 
capabilities as an adviser.\129\
---------------------------------------------------------------------------

    \128\ See Comment Letter of William A. Jacobson, Esq., Clinical 
Professor of Law, Cornell Law School, and Director, Cornell 
Securities Law Clinic (Feb. 3, 2020) (``Prof. Jacobson Comment 
Letter'').
    \129\ See SIFMA AMG Comment Letter II.
---------------------------------------------------------------------------

    Under the final marketing rule, testimonials and endorsements will 
include opinions or statements by persons about the investment advisory 
expertise or capabilities of the adviser or its supervised 
persons.\130\ Testimonials and endorsements also include statements in 
an advertisement about an adviser or its supervised person's qualities 
(e.g., trustworthiness, diligence, or judgment) or expertise or 
capabilities in other contexts, when the statements suggest that the 
qualities, capabilities, or expertise are relevant to the advertised 
investment advisory services. We believe that an investor would likely 
perceive these statements as relevant to the adviser's investment 
advisory services.\131\
---------------------------------------------------------------------------

    \130\ Complete or partial client lists that do no more than 
identify certain of the adviser's clients or private fund investors 
will not be treated as testimonials. See also 2019 Proposing 
Release, supra footnote 7, at 78.
    \131\ See Dan Gallagher, Staff No-Action Letter (pub. avail. 
July 10, 1995) (stating that the staff could not assure that it 
would not recommend enforcement action for a violation of rule 
206(4)-1 if the letter writer used client testimonials describing 
its character and skills in relation to matters other than the 
letter writer's role as an investment adviser). See also Guidance on 
the Testimonial Rule and Social Media, Division of Investment 
Management Guidance Update No. 2014-04 (Mar. 2014) (``IM Staff 
Social Media Guidance'') (withdrawing staff position in the 
Gallagher Staff No-Action Letter). See infra section II.J.
---------------------------------------------------------------------------

    The definitions of testimonial and endorsement under the final rule 
also include solicitation and referral activities drawn from the 
proposed definition of solicitor.\132\ After considering comments on 
the overlapping scope of testimonials, endorsements, and solicitations 
under the proposed advertising and solicitation rules, we are adding 
solicitation activities to the definitions of testimonial and 
endorsement. The definition of testimonial includes any statement by a 
current client or private fund investor that directly or indirectly 
solicits any investor to be the adviser's client or a private fund 
investor, or refers any investor to be the adviser's client or a 
private fund investor. The definition of endorsement includes any such 
statements by a person other than a current client or private fund 
investor. This change will address compensated

[[Page 13036]]

testimonials and endorsements under one rule with one set of 
conditions. For example, a person providing an endorsement or 
testimonial under the final rule might be a firm that solicits for an 
adviser (such as a broker-dealer or a bank), an individual at a 
soliciting firm who engages in solicitation activities for an adviser 
(such as a bank representative or an individual registered 
representative of a broker-dealer), or both. Other examples could be an 
unaffiliated fund-of-funds or a feeder fund that solicits investors in 
an underlying fund or a master fund, respectively.
---------------------------------------------------------------------------

    \132\ Final rule 206(4)-1(e)(5)(ii) and (iii), and (e)(17)(ii) 
and (iii). See also proposed rule 206(4)-3(c)(4) (proposing to 
define ``solicitor'' as ``any person who, directly or indirectly, 
solicits any client or private fund investor for, or refers any 
client or private fund investor to, an investment adviser''). Both 
the proposal's definition of ``solicitor'' and the final rule's 
inclusion of solicitation and referral activities are drawn from the 
current cash solicitation rule's definition of ``solicitor,'' with 
the exception that the current rule does not apply to solicitation 
of private fund investors. See rule 206(4)-3(d)(1).
---------------------------------------------------------------------------

b. Cash and Non-Cash Compensation
    The second prong of the final marketing rule's definition of 
advertisement is triggered by any form of compensation--whether cash or 
non-cash--that an adviser provides, directly or indirectly, for an 
endorsement or testimonial. This mirrors the types of compensation that 
we stated would trigger the proposed solicitation rule and the proposed 
advertising rule's compensation disclosure requirement in connection 
with a testimonial, endorsement, or third-party rating.\133\ As we 
stated about both proposed rules, compensation an adviser provides, 
directly or indirectly, for these activities can incentivize a person 
to provide a positive statement about, solicit an investor for, or 
refer an investor to, the investment adviser.\134\ Therefore, we 
believe that the marketing rule's protections should apply.
---------------------------------------------------------------------------

    \133\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.4 and II.B.2 and text accompanying n.172.
    \134\ See id. at n.372. The proposed solicitation rule would 
have applied to an adviser's direct and indirect compensation to a 
solicitor for any solicitation activities. See proposed rule 206(4)-
3(a). The current cash solicitation rule also covers direct and 
indirect cash compensation. See rule 206(4)-3(a). Similarly, our 
proposed advertising rule would have required disclosure, if 
applicable, that cash or non-cash compensation has been provided by 
or on behalf of the adviser in connection with obtaining or using 
the testimonial or endorsement. See proposed rule 206(4)-
1(b)(1)(ii).
---------------------------------------------------------------------------

    Some commenters agreed that non-cash compensation creates the same 
conflicts of interest as cash compensation for solicitation.\135\ These 
commenters also agreed that investors should be made aware of the 
solicitor's conflict of interest regardless of the form of 
compensation. Other commenters, however, raised concerns about 
extending the rule to cover certain forms of non-cash compensation, 
such as gifts and entertainment,\136\ or non-transferable advisory fee 
waivers in connection with refer-a-friend arrangements.\137\ Some 
commenters argued that the final rule should only apply to 
solicitations for which the adviser provides incentive-based 
compensation tied to the funding of an advisory account and the 
solicitation activities are directed at specific clients.\138\ 
Commenters generally opposed applying the proposed solicitation rule to 
communications to investors in private funds, which we address 
below.\139\
---------------------------------------------------------------------------

    \135\ See Consumer Federation Comment Letter; Mercer Comment 
Letter.
    \136\ See MFA/AIMA Comment Letter I; MMI Comment Letter (stating 
that the rule should not apply to an adviser that sends a gift to a 
third-party adviser or broker-dealer with which it routinely does 
business, and such third party completely unrelatedly refers a 
client to the adviser, unless the third party has a reasonable 
expectation that it will receive some form of compensation from the 
adviser in exchange for that referral).
    \137\ See IAA Comment Letter (also recommending that the rule 
exclude refer-a-friend programs that involve a small amount of 
compensation per referral). While the final marketing rule will 
apply to all compensated refer-a-friend programs (regardless of the 
form of compensation), we expect that many advisers that engage in 
these programs will fall under the de minimis exemption, and be 
subject to fewer conditions than other compensated testimonials and 
endorsements. See infra footnote 481.
    \138\ See SIFMA AMG Comment Letters I & III; FSI Comment Letter.
    \139\ See infra section II.A.4.
---------------------------------------------------------------------------

    Forms of compensation under the final marketing rule will include 
fees based on a percentage of assets under management or amounts 
invested, flat fees, retainers, hourly fees, reduced advisory fees, fee 
waivers, and any other methods of cash compensation, and cash or non-
cash rewards that advisers provide for endorsements and testimonials, 
including referral and solicitation activities.\140\ They also include 
directed brokerage that compensates brokers for soliciting 
investors,\141\ sales awards or other prizes, gifts and entertainment, 
such as outings, tours, or other forms of entertainment that an adviser 
provides as compensation for testimonials and endorsements. In 
addition, compensated endorsements and testimonials may or may not be 
contingent on the endorsement or testimonial resulting in a new 
advisory relationship or a new investment in a private fund. We believe 
that non-cash compensation, including forms of entertainment, can 
incentivize persons to provide a positive statement about an adviser, 
or make a referral or solicitation on an adviser's behalf and should be 
included in the rule to make clients aware of such incentive. Whether 
an adviser provides cash or non-cash compensation in exchange for a 
testimonial or endorsement depends on the particular facts and 
circumstances.\142\
---------------------------------------------------------------------------

    \140\ See 2019 Proposing Release, supra footnote 7, at nn.357 
and 358 and accompanying text (discussing, for example, refer-a-
friend programs).
    \141\ Advisers are currently required to disclose to clients in 
the Form ADV brochure if they consider, in selecting or recommending 
broker-dealers, whether they or a related person receives client 
referrals from a broker-dealer or third party. As proposed, broker-
dealers or dual registrants that receive brokerage for solicitation 
of client accounts in wrap fee programs that they do not sponsor 
will be subject to the final marketing rule if they solicit those 
clients to participate in the wrap fee program. See 2019 Proposing 
Release, supra footnote 7, at section II.B.2.
    \142\ Although commenters did not specifically address to what 
extent compensation paid to an adviser's personnel, such as an 
employee, would implicate the proposed solicitation rule, we are 
clarifying that compensation for purposes of prong two of the 
definition of advertisement will not include regular salary or 
bonuses paid to an adviser's personnel for their investment advisory 
activities or for clerical, administrative, support or similar 
functions.
---------------------------------------------------------------------------

    Some commenters requested that we exclude training or meetings that 
educate solicitors about the adviser's services, even if there are some 
incidental benefits associated with such training.\143\ We continue to 
believe, as we stated in the 2019 Proposing Release, that attendance at 
training and education meetings, including company-sponsored meetings 
such as annual conferences, will not be non-cash compensation, provided 
that attendance at these meetings or trainings is not provided in 
exchange for solicitation activities.\144\
---------------------------------------------------------------------------

    \143\ See, e.g., MMI Comment Letter; MFA/AIMA Comment Letter I 
(discussing training for certain fund-of-funds arrangements); SIFMA 
AMG Comment Letter III (encouraging the Commission to draw from a 
FINRA 2016 proposal relating to non-cash compensation, which the 
commenter states includes conditions such as prior approval, 
attendance not being preconditioned on the achievement of certain 
sales targets, appropriate location (whether an office or other 
facility) and no payment for additional guests).
    \144\ See 2019 Proposing Release, supra footnote 7, at n.360.
---------------------------------------------------------------------------

    Some commenters also raised concerns about potentially conflicting 
regulations for advisers dually registered as broker-dealers with 
respect to the inclusion of sales awards as non-cash compensation under 
the proposed solicitation rule.\145\ While we acknowledge that other 
Commission rules for broker-dealers address concerns underlying non-
cash compensation in the context of recommendations, the final 
marketing rule covers a broader range of activities and types of 
promoters.\146\ Thus, we do

[[Page 13037]]

not believe that an exemption for sales awards or contests from the 
final marketing rule would be appropriate on these grounds. As 
discussed further below, however, we are adopting a partial exemption 
for broker-dealers from the rule's disqualification provisions. We are 
also adopting partial exemptions from the disclosure provisions when a 
broker-dealer provides a testimonial or endorsement to a retail 
customer that is a recommendation subject to Regulation Best Interest 
(``Regulation BI'') under the Securities Exchange Act of 1934 (the 
``Exchange Act'') and from certain disclosure requirements when a 
broker-dealer provides a testimonial or endorsement to a person that is 
not a retail customer (as that term is defined in Regulation BI).\147\
---------------------------------------------------------------------------

    \145\ See SIFMA AMG Comment Letters I & III (requesting 
alignment with FINRA's 2016 non-cash compensation rule proposal); 
FSI Comment Letter.
    \146\ See, e.g., Regulation Best Interest, Release No. 34-86031 
(June 5, 2019) [84 FR at 33400 (July 12, 2019)] (``Regulation Best 
Interest Release'') (adopting rule 15l-1 under the Exchange Act, 
requiring broker-dealers to establish written policies and 
procedures reasonably designed to identify and eliminate any sales 
contests, sales quotas, bonuses, and non-cash compensation that are 
based on the sale of specific securities or the sale of specific 
types of securities within a limited period of time, noting that 
these compensation practices create high-pressure situations for 
associated persons to increase the sales of specific securities or 
specific types of securities within a limited period of time and 
thus compromise the best interests of their retail customers). The 
policies and procedures required thereunder must also be reasonably 
designed to identify and mitigate any conflicts of interest 
associated with the broker-dealer's recommendations to retail 
customers that create an incentive for the broker-dealer's 
associated persons to place their interest or the interest of the 
broker-dealer ahead of the retail customer's interest. Id.
    \147\ See id. Regulation BI defines a retail customer as a 
``natural person, or the legal representative of such natural 
person.'' See id., at 768.
---------------------------------------------------------------------------

    Other commenters stated non-cash compensation could capture 
benefits that advisers provide in the ordinary course of business 
unrelated to any solicitation activity.\148\ Relatedly, some commenters 
considered our proposed view of ``indirect'' compensation overly broad, 
particularly with respect to non-cash compensation.\149\ These 
commenters recommended that we apply the final rule only to 
compensation an adviser provides to a solicitor after its solicitation 
activities, unless the solicitation agreement between the adviser and 
solicitor specifically includes compensation provided prior to the 
solicitation; or replace the solicitation rule's reference to 
compensation that an adviser provides ``indirectly'' with compensation 
that is direct or ``in connection with solicitation activities.'' \150\ 
Others expressed concerns that, under our proposed solicitation rule, 
every mutually beneficial arrangement between an investment adviser and 
a potential facilitator of client relationships would be subject to 
scrutiny for indicia of quid pro quo solicitation.\151\
---------------------------------------------------------------------------

    \148\ See, e.g., MFA/AIMA Comment Letter I; Fidelity Comment 
Letter; Fried Frank Comment Letter; IAA Comment Letter; Mercer 
Comment Letter; SIFMA AMG Comment Letter I.
    \149\ See, e.g., SIFMA AMG Comment Letters I & III; FSI Comment 
Letter.
    \150\ See SIFMA AMG Comment Letter III.
    \151\ See, e.g., MFA/AIMA Comment Letter I; Mercer Comment 
Letter.
---------------------------------------------------------------------------

    We believe the timing of compensation relative to an endorsement or 
testimonial is relevant in determining whether an adviser is providing 
compensation for the testimonial or endorsement. In addition, we 
believe that there will be a mutual understanding of a quid pro quo, 
whether explicit or inferred based on facts and circumstances, for most 
compensated endorsements or testimonials.\152\ However, we decline to 
draw bright lines around either the timing of the compensation or the 
establishment of a mutual understanding. We believe such bright lines 
would unnecessarily limit the final rule and would encourage advisers 
to structure their arrangements to avoid application of the rule in 
situations where it would otherwise apply. In addition, we believe that 
in many cases compensation will be in connection with testimonials and 
endorsements. We decline to remove the word ``indirectly'' from the 
rule for the same reasons discussed above.\153\
---------------------------------------------------------------------------

    \152\ We would expect that, where required, the written 
agreement would be evidence of such a mutual understanding in most 
circumstances. See infra section II.C.3.
    \153\ For example, an adviser will be subject to the rule's 
provisions for compensated testimonials and endorsements when the 
adviser's parent company pays a third party to endorse the adviser 
to the third party's network of members that are prospective 
clients. See final rule 206(4)-1(b). Such indirect compensation 
could include the adviser's parent company providing representatives 
to the third party and compensating them to promote the adviser's 
business.
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c. Activities That Constitute a Testimonial or Endorsement
    Some commenters requested guidance on whether certain activities 
would constitute solicitation or referral activities under the proposed 
amendments to the solicitation rule.\154\ Since the combined marketing 
rule includes statements that solicit investors for, or refer investors 
to, an investment adviser as testimonials or endorsements, we are 
addressing these comments in the context of these definitions.
---------------------------------------------------------------------------

    \154\ See, e.g., FSI Comment Letter; SIFMA AMG Comment Letter I; 
MFA/AIMA Comment Letter I; Fried Frank Comment Letter; IAA Comment 
Letter.
---------------------------------------------------------------------------

    For example, some commenters questioned whether lead-generation 
firms or adviser referral networks (collectively, ``operators'') would 
fall into the scope of the rule. One commenter described these 
operators as networks operated by non-investors where an adviser 
compensates the operator to solicit investors for, or refer investors 
to, the adviser.\155\ Another commenter described these operators as 
for-profit or non-profit entities that make third-party advisory 
services (such as model portfolio providers) accessible to investors, 
and stated that the operators do not promote or recommend particular 
services or products accessible on the platform.\156\ In both examples, 
the operator's website likely meets the final marketing rule's 
definition of endorsement. An operator may tout the advisers included 
in its network, and/or guarantee that the advisers meet the network's 
eligibility criteria. In addition, because operators typically offer to 
``match'' an investor with one or more advisers compensating it to 
participate in the service, operators typically engage in solicitation 
or referral activities.\157\
---------------------------------------------------------------------------

    \155\ See Commonwealth Comment Letter. This commenter stated 
that such operators typically offer to ``match'' an investor with an 
adviser. When an investor clicks on a link, the investor provides 
information to the operator (e.g., age, investable assets, and 
goals) and the operator matches the investor to one or more advisers 
participating in the service. Advisers generally pay a flat fee and/
or a per-lead fee to receive matches of potential investors from the 
operator.
    \156\ See MMI Comment Letter (stating that in some cases, the 
operator charges an administrative or service fee to the investment 
advisers whose products and services are accessible through the 
operator).
    \157\ See final rule 206(4)-1(e)(5)(ii) and (iii) and (17)(ii) 
and (iii).
---------------------------------------------------------------------------

    Similarly, a blogger's website review of an adviser's advisory 
service would be a testimonial or an endorsement under the final 
marketing rule because it indicates approval, support, or a 
recommendation of the investment adviser, or because it describes its 
experience with the adviser.\158\ If the adviser directly or indirectly 
compensates the blogger for its review, for example by paying the 
blogger based on the amount of assets deposited in new accounts from 
client referrals or the number of accounts opened, the testimonial or 
endorsement will be an advertisement under the definition's second 
prong.\159\ Depending on the facts and circumstances, a lawyer or other 
service provider that refers an investor to an adviser, even 
infrequently, may

[[Page 13038]]

also meet the rule's definition of testimonial or endorsement.
---------------------------------------------------------------------------

    \158\ See final rule 206(4)-1(5)(i) and (17)(i).
    \159\ See final rule 206(4)-1(e)(1)(ii).
---------------------------------------------------------------------------

    On the other hand, where an adviser pays a third-party marketing 
service or news publication to prepare content for and/or disseminate a 
communication, we generally would not treat this communication as an 
endorsement under the second prong of the definition of 
``advertisement.'' \160\ Similarly, a non-investor selling an adviser a 
list containing the names and contact information of prospective 
investors typically would not, without more, meet the definition of 
endorsement.\161\ This activity typically would not fall within the 
plain text of the definition of endorsement (e.g., the seller does not 
indicate approval, support, or recommendation of the investment 
adviser, or describe its experience with the adviser, or engage in the 
solicitation or referral activities described therein).
---------------------------------------------------------------------------

    \160\ However, such a communication would be an advertisement 
under the first prong of the definition of ``advertisement.'' See 
supra section II.A.2.
    \161\ See Nesler Comment Letter.
---------------------------------------------------------------------------

    One commenter requested an exclusion from the definition of 
solicitor under the proposed solicitation rule for an investment 
consultant that administers a RFP to aid one or more investors in 
selecting an investment adviser or a private fund investment 
vehicle.\162\ The commenter stated that the investor typically hires 
the consultant (the ``agent''), subject to the understanding that the 
investor will only enter into a transaction with an investment adviser 
that agrees to pay the expenses of the agent for providing this 
service.\163\ In these circumstances, we do not believe the adviser 
typically compensates the agent to endorse the adviser because the 
investor engages the agent to evaluate the adviser based on criteria 
that the investor provides.\164\
---------------------------------------------------------------------------

    \162\ See IAA Comment Letter (alternately requesting, in the 
absence of an exclusion, clarification as to status under the 
proposed solicitation rule). This commenter stated that these agents 
facilitate submissions by investment advisers in the RFP process and 
prepare reports for prospective investors regarding investment 
advisers under consideration. Furthermore, in many cases the adviser 
must enter into an agreement with the agent to participate in the 
RFP process.
    \163\ We understand that the consultant is typically not an 
advisory client of the advisers it selects to participate in the RFP 
process, and therefore the final rule's testimonial provision would 
usually not apply.
    \164\ Though a quid pro quo is not always determinative of 
whether the compensation element of this prong of the definition of 
advertisement is satisfied, these facts suggest a lack of quid pro 
quo and, without more, would not implicate the second prong of the 
definition. The adviser in this scenario will likely also not 
implicate the first prong of the definition of advertisement because 
the adviser is not making a direct or indirect communication to more 
than one person that offers the investment adviser's investment 
advisory services with regard to securities to investors. See final 
rule 206(4)-1(e)(1)(i). See also supra section II.A.2.
---------------------------------------------------------------------------

d. Exclusion for Regulatory Communications; Inclusion of One-on-One and 
Extemporaneous, Live, Oral Communications
    The second prong of the definition of advertisement excludes any 
information contained in a statutory or regulatory notice, filing, or 
other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication.\165\ As with the same exclusion in the 
first prong of the definition, this exclusion reflects our belief that 
communications that are prepared as a requirement of statutes, rules, 
or regulations should not be viewed as advertisements under the rule.
---------------------------------------------------------------------------

    \165\ See final rule 206(4)-1(e)(1)(ii).
---------------------------------------------------------------------------

    Unlike the first prong of the definition of advertisement, however, 
this prong does not exclude extemporaneous, live, oral communications 
or one-on-one communications. These types of communications are 
precisely what the second prong of the definition seeks to address, 
along with other types of endorsement and testimonial activities. The 
current solicitation rule has also addressed these types of 
communications. In addition, the second prong does not exclude 
communications that include hypothetical performance information.
    Compensated testimonials and endorsements have the potential to 
mislead given a promoter's financial incentive to recommend the 
adviser. Without appropriate safeguards, a compensated testimonial or 
endorsement creates a risk that the investor would mistakenly view the 
promoter's recommendation as being an unbiased opinion about the 
adviser's ability to manage the investor's assets and would rely on 
that recommendation more than the investor otherwise would if the 
investor knew of the promoter's incentive.
    Finally, some commenters requested an exclusion from the proposed 
solicitation rule for persons registered with the Commission as broker-
dealers under the Exchange Act.\166\ We continue to believe that the 
final rule's investor protections should apply to compensated 
endorsements and testimonials by any person, including a registered 
broker-dealer. However, we are adopting a partial exemption from the 
rule's disqualification provisions for certain compensated testimonials 
and endorsements made by a registered broker-dealer.\167\ We also are 
adopting a partial exemption from the rule's disclosure provisions when 
a broker-dealer provides a testimonial or endorsement to a retail 
customer that is a recommendation subject to Regulation BI.\168\
---------------------------------------------------------------------------

    \166\ See Credit Suisse Comment Letter (citing the ``robust 
regulatory framework'' already applicable to SEC-registered broker-
dealers); MFA/AIMA Comment Letter I.
    \167\ See infra section II.C.5.
    \168\ See id.
---------------------------------------------------------------------------

e. Investment Adviser and Broker-Dealer Status and Registration for 
Persons Who Provide Endorsements or Testimonials
    We proposed to withdraw our position that a solicitor who engages 
in solicitation activities in accordance with paragraph (a)(2)(iii) of 
the cash solicitation rule will be, at least with respect to those 
activities, an associated person of an investment adviser and therefore 
will not be required to register individually under the Advisers Act 
solely as a result of those activities (the ``1979 position'').\169\ 
Although the 1979 position will no longer apply upon the rescission of 
the current solicitation rule, we are not adopting a similar position 
with respect to endorsements and testimonials under the final marketing 
rule.
---------------------------------------------------------------------------

    \169\ See 2019 Proposing Release, supra footnote 7, at n.346. 
Two commenters argued that, as a matter of statutory interpretation, 
solicitors fall within the Act's definition of ``person associated 
with an investment adviser.'' See SIFMA AMG Comment Letter II; 
Credit Suisse Comment Letter.
---------------------------------------------------------------------------

    A promoter may, depending on the facts and circumstances, be acting 
as an investment adviser within the meaning of section 202(a)(11) of 
the Act.\170\ Investment adviser status and registration questions 
require analysis of the applicable facts and circumstances, including, 
for example, whether a person is ``advising'' others within the meaning 
of section 202(a)(11) of the Act.\171\ A promoter also may be acting as 
a broker or dealer within the meaning

[[Page 13039]]

of section 3(a)(4) or 3(a)(5) of the Exchange Act, for example, when 
soliciting investors for, or referring investors to, an adviser or a 
private fund advised by the adviser. Any promoter must determine 
whether it is subject to statutory or regulatory requirements under 
Federal law, including the requirement to register as an investment 
adviser pursuant to the Act and/or as a broker-dealer pursuant to 
section 15(a) of the Exchange Act, respectively. If the promoter is a 
supervised person of the adviser for which it is providing a 
testimonial or endorsement, the promoter does not need to separately 
register with the Commission as an investment adviser solely as a 
result of his or her activities as a promoter.\172\ A promoter also 
must determine whether it is subject to certain state law and certain 
FINRA rules, including any applicable state licensing requirements 
applicable to individuals.\173\ To be clear, we are not making a 
presumption that a person providing an endorsement or testimonial meets 
the definition of investment adviser or broker-dealer and must register 
under the Act or the Exchange Act, respectively. Nor are we making a 
presumption that such person may or may not be an associated person of 
a registered investment adviser. Indeed, we agree that some promoters 
may meet the definition of associated person of an investment adviser 
depending on the facts and circumstances.\174\ Others may not.\175\ 
Under the final marketing rule, if an adviser determines that a person 
providing an endorsement or testimonial is an associated person, the 
adviser should have requisite control of such person.\176\
---------------------------------------------------------------------------

    \170\ Depending on the facts and circumstances, a promoter may 
also be acting as an investment adviser under applicable state law.
    \171\ Commission staff previously stated that a person providing 
advice to a client as to the selection or retention of an investment 
manager or managers also, under certain circumstances, would be 
deemed to be ``advising'' others within the meaning of section 
202(a)(11) of the Act. See Applicability of the Investment Advisers 
Act to Financial Planners, Pension Consultants, and Other Persons 
Who Provide Investment Advisory Services as a Component of Other 
Financial Services, Release No. IA-1092 (Oct. 8, 1987) [52 FR 38400 
(Oct. 16, 1987)], at footnote 6 and accompanying text. However, 
solicitation of clients may not involve providing investment advice 
on behalf of an adviser. See Release 1633, supra footnote 4, at text 
accompanying n.123. See also Commission Interpretation Regarding the 
Solely Incidental Prong of the Broker-Dealer Exclusion to the 
Definition of Investment Adviser, Release No. IA-5249 (June 5, 2019) 
[84 FR 33669 (July 12, 2019)].
    \172\ An adviser's registration with the Commission covers its 
supervised persons, provided that their advisory activities are 
undertaken on the adviser's behalf.
    \173\ Most states impose registration, licensing, or 
qualification requirements on investment adviser representatives who 
have a place of business in the state, regardless of whether the 
investment adviser is registered with the Commission or the state. 
See Staff of the U.S. Securities and Exchange Commission, Study on 
Investment Advisers and Broker-Dealers As Required by Section 913 of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 
2011), available at https://www.sec.gov/news/studies/2011/913studyfinal.pdf, at 86. See also rule 203A-3(a)(1) (definition of 
``investment adviser representative''). In some states, a third-
party solicitor will be subject to state qualification requirements 
to the extent state investment adviser statutes apply to solicitors. 
See Release 1633, supra footnote 4, at text accompanying n.125.
    \174\ See Nesler Comment Letter (arguing that an SEC-registered 
adviser should be entitled to treat a non-employee solicitor as an 
``associated person'' as long as the adviser exercises control and 
supervision over such solicitor in connection with the performance 
of its solicitation activities).
    \175\ See Pickard Djinis Comment Letter (describing that 
solicitors that perform paid unscripted media campaigns on behalf of 
advisers, may not be under the adviser's control). Such a paid 
solicitor may not be a ``person associated with the investment 
adviser,'' depending on the facts and circumstances.
    \176\ See rule 204A-1(a) (requiring adviser codes of ethics 
that, among other things, require supervised persons to comply with 
applicable Federal securities laws).
---------------------------------------------------------------------------

4. Investors in Private Funds
    Both prongs of the definition of ``advertisement'' will expressly 
include marketing communications to private fund investors. The term 
``private fund'' is defined in section 202(a)(29) of the Advisers Act 
and means an issuer that would be an investment company, as defined in 
section 3 of the Investment Company Act of 1940 (``Investment Company 
Act''), but for section 3(c)(1) or 3(c)(7) of that Act. This is 
consistent with the scope of the proposed amendments to the 
solicitation rule.\177\ We are not adopting the broader scope of the 
proposed amendments to the advertising rule, which generally would have 
applied to advertisements sent to investors in ``pooled investment 
vehicles,'' as defined in rule 206(4)-8 under the Act.\178\ In 
connection with these changes, we have eliminated the need for the 
proposed exclusion for advertisements, other sales materials, and sales 
literature of registered investment companies (``RICs'') and business 
development companies (``BDCs'') that are within the scope of rule 482 
or 156 under the Securities Act of 1933 (``Securities Act'').\179\
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    \177\ See proposed rule 206(4)-3(c)(2).
    \178\ See proposed rule 206(4)-1(e)(9). See also definition of 
``pooled investment vehicle'' in rule 206(4)-8 under the Act.
    \179\ Commenters recommended that the final rule exclude all 
communications to investors in RICs and BDCs because the statutory 
anti-fraud provisions and other Commission rules apply to these 
communications. See, e.g., IAA Comment Letter; Comment Letter of the 
European Fund and Asset Management Association (Feb. 13, 2020) 
(``EFAMA Comment Letter'') (suggesting that the final rule also 
exclude non-U.S. funds that are publicly offered (including UCITS)); 
ICI Comment Letter (recommending that the Commission exclude all 
registered fund communications from the scope of the rule, including 
sales literature subject to rule 34b-1 under the Investment Company 
Act and generic advertisements subject to rule 135a under the 
Securities Act). Given the regulatory framework applicable to 
communications to investors in RICs and BDCs, we do not believe the 
additional protections of the Advisers Act marketing rule are 
necessary.
---------------------------------------------------------------------------

    Although we used different terms in each proposal, the scope of the 
proposals effectively would have covered only certain communications to 
private fund investors. In our advertising rule proposal, we included 
all pooled investment vehicles and then excepted RIC or BDC 
advertisements that were subject to rule 482 or 156 under the 
Securities Act.\180\ We did not seek to apply the proposed solicitation 
rule to promotional activity involving RICs and BDCs because we 
believed that the primary goal of the proposal was already satisfied by 
other regulatory requirements.\181\ Most notably, prospective investors 
in RICs and BDCs sold through a broker-dealer or other financial 
intermediary already receive disclosure about the conflicts of interest 
that may be created due to the fund or its related companies paying the 
intermediary for the sale of its shares and related services.\182\
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    \180\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.; proposed rule 206(4)-1(e)(9).
    \181\ See 2019 Proposing Release, supra footnote 7, at section 
II.B.3.
    \182\ See Item 8 of Form N-1A. See also FINRA rule 2341(l)(4) 
(generally prohibiting member firms from accepting any cash 
compensation from an investment company, an adviser to an investment 
company, a fund administrator, an underwriter or any affiliated 
person (as defined in section 2(a)(3) of the Investment Company Act) 
of such entities unless such compensation is described in a current 
prospectus of the investment company).
---------------------------------------------------------------------------

    Commenters generally opposed applying the two rules to 
communications to private fund investors.\183\ They stated that 
existing, general anti-fraud provisions provide sufficient protection 
and any additional regulation would be unnecessary and 
duplicative.\184\ Other commenters supported explicitly including 
private funds in the scope of the rules, arguing that doing so would 
provide important protections to investors in these funds.\185\
---------------------------------------------------------------------------

    \183\ See, e.g., AIC Comment Letter; MFA/AIMA Comment Letter I; 
Comment Letter of the National Venture Capital Association (Feb. 14, 
2020) (``NVCA Comment Letter''); IAA Comment Letter.
    \184\ See, e.g., AIC Comment Letter (citing rule 206(4)-1(a)(5) 
and rule 206(4)-8 under the Advisers Act); NVCA Comment Letter 
(citing rule 156(b)(3)(ii) under the Securities Act).
    \185\ See, e.g., ILPA Comment Letter; SBIA Comment Letter. See 
also Consumer Federation Comment Letter; EFAMA Comment Letter 
(supporting additional protections for investors in pooled 
investment vehicles, but seeking an exception for certain non-U.S. 
domiciled funds).
---------------------------------------------------------------------------

    We recognize that rule 206(4)-8 prohibits advisers to private funds 
from making misstatements or materially misleading statements to 
investors in those vehicles.\186\ An adviser's general anti-fraud 
obligations to investors in private funds under rule 206(4)-8 parallel 
an adviser's general anti-fraud

[[Page 13040]]

obligations to all clients and prospective clients under section 206 of 
the Act. Accordingly, although the final marketing rule overlaps with 
the prohibitions in rule 206(4)-8 in certain circumstances, just as it 
overlaps with section 206 with respect to an adviser's clients and 
prospective clients, we believe it is important from an investor 
protection standpoint to delineate these obligations to all investors 
in the advertising context and provide a framework for an adviser's 
advertisements to comply with these obligations.
---------------------------------------------------------------------------

    \186\ Section 206(4) of the Advisers Act authorizes the 
Commission to adopt rules and regulations that ``define, and 
prescribe means reasonably designed to prevent, such acts, 
practices, and courses of business as are fraudulent, deceptive, or 
manipulative.'' 15 U.S.C. 80b-6(4). See rule 206(4)-8(a)(1). We are 
adopting this rule under the same authority of section 206(4) of the 
Advisers Act on which we relied in adopting rule 206(4)-8. See 
Prohibition of Fraud by Advisers to Certain Pooled Investment 
Vehicles, Release No. IA-2628 (Aug. 3, 2007) [75 FR 44756 (Aug. 9, 
2007)].
---------------------------------------------------------------------------

    By including marketing communications to private fund investors, 
the final rule will provide more specificity (and certainty) regarding 
what we believe to be untrue or misleading statements that advisers 
must avoid in their advertisements.\187\ The general prohibitions, for 
example, will provide advisers with a principles-based framework to 
assess private fund advertisements and will provide greater clarity, 
compared to the anti-fraud provisions of the Act, on marketing 
practices that are likely misleading.\188\ This approach is consistent 
with some commenters who stated that the Commission should finalize 
rules in a manner that provides guidance to advisers on how to comply 
with a principles-based approach without creating overly prescriptive 
requirements that can be difficult to apply in practice.\189\
---------------------------------------------------------------------------

    \187\ For example, rule 206(4)-8 prohibits investment advisers 
to pooled investment vehicles from engaging in any act, practice, or 
course of business that is fraudulent, deceptive, or manipulative 
with respect to any investor or prospective investor in the pooled 
investment vehicle. The final rule will include more specific 
provisions in the context of advertisements. See final rule 206(4)-
1(b) through (d). To the extent that an advertising practice would 
violate a specific restriction imposed by the final rule, rule 
206(4)-8 may already prohibit the practice.
    \188\ We recognize that a single investor could invest in both 
private funds managed by the adviser and other products (e.g., 
separately managed accounts) managed by the adviser. The final rule 
would ensure that advisers apply the same principles-based framework 
across products and services, which could reduce advisers' 
compliance burdens.
    \189\ See MFA/AIMA Comment Letter III. But see supra footnotes 
183-184.
---------------------------------------------------------------------------

    We understand that many private fund advisers already consider the 
current staff positions related to the current advertising rule when 
preparing their marketing communications.\190\ As a result, we believe 
that our application of the final rule to advertisements to private 
fund investors would result in limited additional regulatory or 
compliance costs for many of these advisers.
---------------------------------------------------------------------------

    \190\ See SBIA Comment Letter; NRS Comment Letter.
---------------------------------------------------------------------------

    We also believe that the modifications from the proposal will 
reduce potential costs and alleviate commenters' concerns regarding the 
application of the final rule to an adviser's advertisements to private 
fund investors. For example, the first prong of the definition of 
advertisement will not include one-on-one communications to private 
fund investors or communications with existing investors; as such, 
those communications will be subject to rule 206(4)-8 and not the 
advertising rule.\191\ The first prong of the definition of 
advertisement also excludes live, oral, extemporaneous communications. 
Further, we are not adopting a requirement for an adviser to pre-review 
all advertisements prior to dissemination or requirements for retail 
versus non-retail advertisements, as discussed below.\192\ 
Collectively, we believe these changes appropriately scope 
advertisements that would be subject to the rule.
---------------------------------------------------------------------------

    \191\ These communications also are subject to various statutory 
and regulatory anti-fraud provisions, such as section 17(a) of the 
Securities Act, section 10(b) of the Exchange Act, and rule 10b-5 
thereunder.
    \192\ See infra sections II.E. and II.G. See also NYC Bar 
Comment Letter (discussing the administrative and compliance burdens 
and costs associated with applying the standards for Retail 
Advertisements and Non-Retail Advertisements (each as defined below) 
for private funds under the proposed advertising rule).
---------------------------------------------------------------------------

    Not all communications to private fund investors would be 
advertisements under the final rule. Most commenters stated that 
private placement memoranda (``PPMs'') should not be treated as 
advertisements.\193\ We agree that information included in a PPM about 
the material terms, objectives, and risks of a fund offering is not an 
advertisement of the adviser.\194\ Private fund account statements, 
transaction reports, and other similar materials delivered to existing 
private fund investors, and presentations to existing clients 
concerning the performance of funds they have invested in (for example, 
at annual meetings of limited partners) also would not be considered 
advertisements under the final rule. However, pitch books or other 
materials accompanying PPMs could fall within the definition of an 
advertisement.
---------------------------------------------------------------------------

    \193\ See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter; 
Proskauer Comment Letter.
    \194\ PPMs are subject to the anti-fraud provisions of the 
Federal securities laws. See also supra footnote 88 (discussing an 
adviser's fiduciary duties). Whether particular information included 
in a PPM constitutes an advertisement of the adviser depends on the 
relevant facts and circumstances. For example, if a PPM contained 
related performance information of separate accounts the adviser 
manages, that related performance information is likely to 
constitute an advertisement.
---------------------------------------------------------------------------

    Some commenters sought clarification that due diligence rooms and 
their contents would not be considered advertisements.\195\ While due 
diligence rooms themselves are not advertisements, it is possible that 
some of the information they contain could qualify as an advertisement 
if the materials satisfy the requirements of the advertisement 
definition.
---------------------------------------------------------------------------

    \195\ See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; 
ILPA Comment Letter (seeking clarification that non-promotional 
material contained in a data room would not be subject to the rule).
---------------------------------------------------------------------------

    Some commenters recommended expanding the final rule to other types 
of unregistered pooled investment vehicles, and one commenter specified 
which other types of unregistered pooled investment vehicles should be 
subject to the rule.\196\ While these commenters generally supported 
the idea of extending the scope of the rule, they did not explain why. 
Accordingly, we believe that the scope of the final rule is appropriate 
at this time.
---------------------------------------------------------------------------

    \196\ See, e.g., EFAMA Comment Letter (supporting the 
Commission's proposal to increase protections to investors in 
collective investment schemes, but recommending that the Commission 
exclude (i) non-U.S. domiciled publicly offered, closed-end and 
open-end investment funds, including UCITS, and (ii) alternative 
investment funds and other non-U.S. domiciled funds that would be an 
investment company, as defined in section 3 of the Investment 
Company Act, but for sections 3(c)(1) or 3(c)(7) of that Act); ILPA 
Comment Letter (recommending expanding to funds excluded from the 
definition of investment company by reason of section 3(c)(5) or 
3(c)(11) of the Investment Company Act).
---------------------------------------------------------------------------

    A commenter specifically sought confirmation that the proposed 
rules would not apply to an adviser whose principal office and place of 
business is outside the United States (offshore adviser) with regard to 
any of its non-U.S. clients even if the non-U.S. client is a fund with 
U.S. investors.\197\ This commenter and others also asked the 
Commission to clarify the application of the proposals to 
communications with non-U.S. investors in funds domiciled outside of 
the United States.\198\ We have previously stated, and continue to take 
the position, that most of the substantive provisions of the Advisers 
Act do not apply with respect to the non-U.S. clients (including funds) 
of a registered offshore adviser.\199\ This

[[Page 13041]]

approach was designed to provide appropriate flexibility where an 
adviser has its principal office and place of business outside of the 
United States.\200\ We believe it is appropriate to continue to apply 
this approach in this context. For an adviser whose principal office 
and place of business is in the United States (onshore adviser), the 
Advisers Act and rules thereunder apply with respect to the adviser's 
U.S. and non-U.S. clients.\201\
---------------------------------------------------------------------------

    \197\ See Sidley Austin Comment Letter; see also Registration 
Under the Advisers Act of Certain Hedge Fund Advisers, Release No. 
IA-2333 (Dec. 2, 2004) [69 FR 72054, 72072 (Dec. 10, 2004)] (``Hedge 
Fund Adviser Release'').
    \198\ See IAA Comment Letter; EFAMA Comment Letter.
    \199\ See Exemptions for Advisers to Venture Capital Funds, 
Private Fund Advisers With Less Than $150 Million in Assets Under 
Management, and Foreign Private Advisers, Release No. IA-3222 (June 
22, 2011) [76 FR 39645 (July 6, 2011)] (Most of the substantive 
provisions of the Advisers Act do not apply to the non-U.S. clients 
of a non-U.S. adviser registered with the Commission.); Hedge Fund 
Adviser Release, supra footnote 197 (stating that the following 
rules under the Advisers Act would not apply to a registered 
offshore adviser, assuming it has no U.S. clients: Compliance rule, 
custody rule, and proxy voting rule and stating that the Commission 
would not subject an offshore adviser to the rules governing adviser 
advertising [17 CFR 275.206(4)-1], or cash solicitations [17 CFR 
275.206(4)-3] with respect to offshore clients); American Bar 
Association, SEC Staff No-Action Letter (Aug. 10, 2006) (confirming 
that the substantive provisions of the Act do not apply to offshore 
advisers with respect to those advisers' offshore clients (including 
offshore funds) to the extent described in those letters and the 
Hedge Fund Adviser Release); IM Information Update No. 2017-03.
    \200\ See Hedge Fund Adviser Release, supra footnote 197 (noting 
that U.S. investors in an offshore fund generally would not expect 
the full protection of the U.S. securities laws and that U.S. 
investors may be precluded from an opportunity to invest in an 
offshore fund if their participation would result in full 
application of the Advisers Act and rules thereunder, but that a 
registered offshore adviser would be required to comply with the 
Advisers Act and rules thereunder with respect to any U.S. clients 
it may have).
    \201\ See, e.g., Hedge Fund Adviser Release supra footnote 197.
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B. General Prohibitions

    We are adopting, largely as proposed, the general prohibitions of 
certain marketing practices as a means reasonably designed to prevent 
fraudulent, deceptive, or manipulative acts. We believe these practices 
are associated with a significant risk of being false or misleading. We 
therefore believe it is in the public interest to prohibit these 
practices, rather than permit them subject to specified conditions. The 
general prohibitions will apply to all advertisements to the extent 
that an adviser directly or indirectly disseminates such advertisement. 
Specifically, in any advertisement, an adviser may not:
    (1) Include any untrue statement of a material fact, or omit to 
state a material fact necessary in order to make the statement made, in 
the light of the circumstances under which it was made, not misleading;
    (2) Include a material statement of fact that the adviser does not 
have a reasonable basis for believing it will be able to substantiate 
upon demand by the Commission;
    (3) Include information that would reasonably be likely to cause an 
untrue or misleading implication or inference to be drawn concerning a 
material fact relating to the investment adviser;
    (4) Discuss any potential benefits to clients or investors 
connected with or resulting from the investment adviser's services or 
methods of operation without providing fair and balanced treatment of 
any material risks or material limitations associated with the 
potential benefits;
    (5) Include a reference to specific investment advice provided by 
the investment adviser where such investment advice is not presented in 
a manner that is fair and balanced;
    (6) Include or exclude performance results, or present performance 
time periods, in a manner that is not fair and balanced; or
    (7) Otherwise be materially misleading.
    As noted in the proposal, to establish a violation of the rule, the 
Commission will not need to demonstrate that an investment adviser 
acted with scienter; negligence is sufficient.\202\
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    \202\ See SEC v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992). 
As we noted when we adopted rule 206(4)-8, the court in Steadman 
analogized section 206(4) of the Advisers Act to section 17(a)(3) of 
the Securities Act, which the Supreme Court had held did not require 
a finding of scienter (citing Aaron v. SEC, 446 U.S. 680 (1980)). 
See also Steadman at 643, n.5. In discussing section 17(a)(3) and 
its lack of a scienter requirement, the Steadman court observed 
that, similarly, a violation of section 206(2) of the Advisers Act 
could rest on a finding of simple negligence. See also Fiduciary 
Interpretation, supra footnote 88, at n.20.
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    Many commenters supported the prohibitions' principles-based 
framework.\203\ However, other commenters found the proposed general 
prohibitions confusing and redundant and suggested streamlining them 
into fewer standards (or eliminating them altogether) and relying on 
the general anti-fraud standard instead.\204\ After considering 
comments, we are making certain modifications, as discussed below. We 
continue to believe that prohibiting certain marketing practices is 
appropriate and that the final provisions provide important 
requirements for investment advisers and protections for investors. In 
our view, the general prohibitions provide greater clarity on marketing 
practices that are likely misleading compared to just relying on the 
anti-fraud provisions of the Act. We also believe that the general 
prohibitions we are adopting provide appropriate flexibility and 
regulatory certainty for advisers considering how to market their 
investment advisory services.
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    \203\ See, e.g., Wellington Comment Letter; ILPA Comment Letter; 
IAA Comment; NRS Comment Letter; and NAPFA Comment Letter.
    \204\ See, e.g., MFA/AIMA Comment Letter I; Comment Letter of 
Managed Funds Association and Alternative Investment Management 
Association (May 8, 2020) (``MFA/AIMA Comment Letter II''). One 
commenter also argued that withdrawing the SEC staff no-action 
letters would create confusion and lack of guidance. NYC Bar Comment 
Letter (citing, for example, Clover Capital Mgmt., Inc., SEC Staff 
No-Action Letter (Oct. 28, 1986) (``Clover Letter''), Stalker 
Advisory Services, SEC Staff No-Action Letter (Jan. 18,1994) 
(Stalker Letter''), F. Eberstadt & Co., Inc., SEC Staff No-Action 
Letter (July 2, 1978) (``Eberstadt Letter''), TCW Group, SEC Staff 
No-Action Letter (Nov. 7, 2008) (``TCW Letter''), and Franklin 
Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998) 
(``Franklin Letter''). However, we do not view the principles of the 
general prohibitions to be substantive departures from the positions 
in existing staff no-action letters and guidance.
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    In applying the general prohibitions, an adviser should consider 
the facts and circumstances of each advertisement. The nature of the 
audience to which the advertisement is directed is a key factor in 
determining how the general prohibitions should be applied.\205\ For 
instance, the amount and type of information that may need to be 
included in an advertisement directed at retail investors may differ 
from the information that may need to be included in an advertisement 
directed at sophisticated institutional investors.
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    \205\ The nature of the audience would be relevant if an adviser 
chooses to tailor the content of an advertisement to a specific 
audience because the content is not appropriate for a broader 
audience. FINRA has a similar requirement under its General 
Standards regarding Communications with the Public. See FINRA rule 
2210(d)(1)(E) (``Members must consider the nature of the audience to 
which the communication will be directed and must provide details 
and explanations appropriate to the audience.'').
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    We discuss below each of the general prohibitions and the comments 
we received.
1. Untrue Statements and Omissions
    As proposed, the final rule will prohibit advertisements that 
include any untrue statements of a material fact, or that omit a 
material fact necessary in order to make the statement made, in the 
light of the circumstances under which it was made, not 
misleading.\206\ One commenter argued that this prohibition would be 
duplicative of sections 206(1) and (2) of the Advisers Act, which 
prohibit advisers from ``employ[ing] any device, scheme or artifice to 
defraud any client or prospective client'' and ``engag[ing] in any 
transaction, practice, or course of business which operates as a fraud 
or deceit upon any client or prospective

[[Page 13042]]

client.'' \207\ However, we view this prohibition as complementary to, 
rather than duplicative of, the statutory anti-fraud prohibitions cited 
by the commenter.\208\ We continue to believe that this prohibition, 
together with the other general prohibitions under the rule, is 
appropriately designed to prevent fraud under the Act, specifically in 
the context of marketing. Moreover, this provision retains the 
substance of current rule 206(4)-1(a)(5).\209\
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    \206\ Final rule 206(4)-1(a)(1).
    \207\ NYC Bar Comment Letter. This commenter also noted that 
section 206(4) prohibits investment advisers from ``engag[ing] in 
any act, practice, or course of business which is fraudulent, 
deceptive, or manipulative.''
    \208\ While we acknowledge there may be circumstances that are 
covered by both the anti-fraud prohibitions and this provision, we 
believe that this provision helps provide specificity when 
addressing an adviser's marketing activities. In addition, to the 
extent possible, this rule can serve as a resource for identifying 
an adviser's obligations with respect to marketing generally, and 
thus we believe that retaining this general prohibition will serve 
to assist advisers in meeting their compliance obligations.
    \209\ Current rule 206(4)-1(a)(5) prohibits an advertisement 
that contains any untrue statement of a material fact and uses 
similar wording as other anti-fraud provisions in the Federal 
securities laws. See, e.g., 17 CFR 240.10b-5; 15 U.S.C. 77q(a)(2); 
17 CFR 230.156(a); rule 206(4)-8.
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    As with similar anti-fraud provisions in the Federal securities 
laws, whether a statement is false or misleading depends on the context 
in which the statement or omission is made.\210\ For example, as under 
the current rule, advertising that an adviser's performance was 
positive during the last fiscal year may be misleading if the adviser 
omitted that an index or benchmark consisting of a substantively 
comparable portfolio of securities experienced significantly higher 
returns during the same period. To avoid making a misleading statement, 
the adviser in this example could include the relevant index or 
benchmark or otherwise disclose that the adviser's performance, 
although positive, significantly underperformed the market.\211\
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    \210\ When we use the phrase ``false or misleading statements'' 
in this release, we are referring to this general prohibition 
against advertisements that include any untrue statements of a 
material fact, or omissions of a material fact necessary in order to 
make a statement, in the light of the circumstances under which it 
was made, not misleading.
    \211\ Although one commenter stated that an adviser should be 
required to show returns of an appropriate benchmark for the same 
periods as presented for the adviser's performance, we do not 
believe that it is necessary to prescribe such disclosures and that 
such decisions should be left at the discretion of the adviser, 
subject to the general prohibitions of the final rule and the 
general anti-fraud provisions of the Federal securities laws. See 
CFA Institute Comment Letter. Accordingly, we are not requiring the 
inclusion of a relevant index or benchmark to avoid making any 
presentation of performance misleading.
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    Under the final rule, it would be misleading for an adviser to 
compensate a person to refer investors to the adviser by stating that 
the person had a ``positive experience'' with the adviser when such 
person is not a client or private fund investor of the adviser for its 
advisory services. To avoid making such a statement misleading, the 
adviser could disclose that the experience does not relate to any 
advisory services. It would also be misleading for an adviser to use a 
promoter's testimonial or endorsement that the adviser knows or 
reasonably should know to be fraudulent, misleading, or untrue, 
regardless of whether the adviser compensates the promoter. For 
instance, an adviser may not provide a testimonial on its website where 
a client falsely claims that the client has worked with the adviser for 
over 20 years when the adviser has only been in business for five 
years.
    The current rule contains an explicit prohibition on advertisements 
that contain statements to the effect that a report, analysis, or other 
service will be furnished free of charge, unless the analysis or 
service is actually free and without condition.\212\ We continue to 
believe that this practice will be captured by the final rule's 
prohibition on untrue statements or omissions. As a result, the final 
rule will not contain separate explicit prohibitions of such 
statements. In addition, depending on the disclosures provided and the 
extent to which an adviser in fact does provide investment advice 
solely based on such materials, it may be false or misleading under 
this provision to represent, directly or indirectly, in an 
advertisement that any graph, chart, or formula can by itself be used 
to determine which securities to buy or sell.\213\
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    \212\ See current rule 206(4)-1(a)(4); see also Dow Theory 
Forecasts, Inc., SEC Staff No-Action Letter (May 21, 1986) (``Dow 
Theory Letter'') (staff declined to provide no-action recommendation 
where an offer for ``free'' subscription was subject to conditions).
    \213\ An adviser's use of graphs, charts, or formulas to 
represent, directly or indirectly, that such graphs, charts, or 
formulas can in and of themselves be used to determine which 
securities to buy or sell, or when to buy or sell them, is 
explicitly prohibited in the current rule. See current rule 206(4)-
1(a)(3) (also prohibiting an advertisement from representing, 
directly or indirectly, that any graph, chart, formula or other 
device being offered will assist any person in making his own 
decisions as to which securities to buy, sell, or when to buy or 
sell them, without disclosing the limitations and difficulties with 
respect to the use of such a graph, chart, formula or other device).
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2. Unsubstantiated Material Statements of Fact
    The proposed rule would have prohibited advertisements that include 
any material claim or statement that is unsubstantiated.\214\ 
Commenters argued that the proposed ``substantiation'' requirement 
would be overly burdensome.\215\ For example, two commenters argued 
that it would require advisers to obtain evidence to support every 
claim or statement in an advertisement out of uncertainty as to what 
might be ``material.'' \216\ Commenters also found the requirement 
unclear, questioning whether, for example, such a prohibition would 
effectively foreclose any statements of opinion.\217\ We are sensitive 
to commenters' concerns regarding the burdens and lack of clarity of 
this proposed provision. As a result, we are making two changes to the 
requirement.
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    \214\ See proposed rule 206(4)-1(a)(2).
    \215\ See, e.g., MFA/AIMA Comment Letter I (stating that this 
requirement would greatly increase cost and operational burdens and 
curb the flow of information to clients and investors); FPA Comment 
Letter; NVCA Comment Letter; Fried Frank Comment Letter.
    \216\ See MFA/AIMA Comment Letter I; Fried Frank Comment Letter.
    \217\ See, e.g., MFA/AIMA Comment Letter I; FPA Comment Letter; 
Fried Frank Comment Letter.
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    First, we are limiting the substantiation requirement to matters of 
material fact rather than any material claim or statement. We do not 
believe that this would be unduly burdensome for advisers as such 
material statements of fact, as opposed to opinions, should be 
verifiable. For instance, material facts might include a statement that 
each of its portfolio managers holds a particular certification or that 
it offers a certain type or number of investment products. Claims about 
performance would also be statements about material facts.\218\ 
Conversely, statements that clearly provide an opinion would not be 
statements of material fact.
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    \218\ For example, we would view performance returns included in 
an advertisement to be material statements of fact that an adviser 
would need a reasonable basis for believing that it will be able to 
substantiate. Because current rule 204-2(a)(16) already requires the 
maintenance of records ``to support the basis for or demonstrate the 
calculation of the performance or rate of return of any or all 
managed accounts or securities recommendations in any . . . 
advertisement,'' we believe that any recordkeeping burden related to 
performance information included in an advertisement will not be 
significantly new or altered. See current rule 204-2(a)(16). Final 
rule 204-2(a)(16) will similarly require advisers to retain records 
or documents necessary to form the basis for or demonstrate the 
calculation of the performance or rate of return of any or all 
managed accounts, portfolio or securities recommendations presented 
in any advertisement. See final rule 204-2(a)(16).
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    Second, we are requiring advisers to have a reasonable basis to 
believe that they can substantiate material claims of fact upon demand 
by the Commission.\219\ This change is designed

[[Page 13043]]

to reduce burdens on advisers and allow them to avoid the need to 
develop and maintain a file of substantiating materials for every 
advertisement.\220\
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    \219\ Final rule 206(4)-1(a)(2). Demand by the Commission 
includes demand by the Commission's examiners or other 
representatives. The adviser's obligation to produce such materials 
on demand will last as long as the relevant advertisement needs to 
be retained under the recordkeeping rule. See current rule 204-
2(e)(1).
    \220\ See, e.g., MFA/AIMA Comment Letter I; NVCA Comment Letter.
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    Advisers would be able to demonstrate this reasonable belief in a 
number of ways. For example, they could make a record contemporaneous 
with the advertisement demonstrating the basis for their belief.\221\ 
An adviser might also choose to implement policies and procedures to 
address how this requirement is met. However, if an adviser is unable 
to substantiate the material claims of fact made in an advertisement 
when the Commission demands it, we will presume that the adviser did 
not have a reasonable basis for its belief. We believe that the burden 
on advisers to have a reasonable basis for believing they will be able 
to substantiate a material statement of fact upon demand by the 
Commission is justified by the importance of ensuring that advisers do 
not advertise material claims of fact that cannot be substantiated and 
the need to facilitate our staff's examination of advisers.
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    \221\ Some advisers likely will (and some already do) maintain 
records to substantiate non-performance material statements of fact 
included in an advertisement when the advertisement is created; 
however, this is not required as long as the adviser has a 
reasonable basis for believing it will be able to substantiate the 
information upon demand by the Commission.
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3. Untrue or Misleading Implications or Inferences
    The proposed rule would have prohibited any advertisement that 
includes an untrue or misleading implication about, or is reasonably 
likely to cause an untrue or misleading inference to be drawn 
concerning, a material fact relating to an investment adviser.\222\ 
After considering comments, we are adopting this prohibition but 
modifying it to add the reasonableness standard to ``implication,'' and 
not only to ``inference.'' \223\ Accordingly, the final rule will 
prohibit an adviser from including, in any advertisement, information 
that would reasonably be likely to cause an untrue or misleading 
implication or inference to be drawn concerning a material fact 
relating to an investment adviser.\224\
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    \222\ See proposed rule 206(4)-1(a)(3).
    \223\ See Flexible Plan Investments Comment Letter II.
    \224\ Final rule 206(4)-1(a)(3). An adviser's statements in an 
advertisement also are subject to section 208(a) of the Act, which 
generally states that it is unlawful for a registered investment 
adviser to represent or imply that it has been sponsored, 
recommended, or approved by any agency of the United States. Section 
208(b) of the Act generally states that Section 208(a) shall not be 
construed to prohibit a person from stating that he is registered 
with the Commission as an investment adviser if the statement is 
true and if the effect of his registration is not misrepresented. 
Nevertheless, an adviser's use of the phrase ``registered investment 
adviser'' (or the initials ``RIA'' or ``R.I.A.'') to state or imply 
that it has a level of professional competence, education or other 
special training could be misleading under the final rule.
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    One commenter suggested eliminating this prohibition altogether and 
instead relying on the prohibition against untrue statements or 
omissions, stating that it is difficult to enforce when something is 
``implied'' or ``inferred.'' \225\ However, we continue to believe that 
this prohibition appropriately addresses certain activities that would 
not be subject to the first prohibition, such as those raised in 
previous staff no-action letters.\226\ For example, this provision will 
prohibit an adviser from making a series of statements in an 
advertisement that literally are true when read individually, but whose 
overall effect is reasonably likely to create an untrue or misleading 
inference or implication about the investment adviser.\227\ For 
instance, if an adviser were to state accurately in an advertisement 
that it has ``more than a hundred clients that have stuck with me for 
more than ten years,'' we believe it may create a misleading 
implication if the adviser actually has a very high turnover rate of 
clients. Additionally, this provision will prohibit an adviser from 
stating that all of its clients have seen profits, even if true, 
without providing appropriate disclosures if it only has two clients, 
as it may be reasonably likely to cause a misleading inference by 
potential clients that they would have a high chance of profit by 
hiring the adviser as well.
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    \225\ CFA Institute Comment Letter.
    \226\ See, e.g., Clover Letter (stating the use of performance 
results in an advertisement in the staff's view would be false or 
misleading if it implies, or a reader would infer from it, something 
about the adviser's competence or about future investment results 
that would not be true had the advertisement included all material 
facts); Stalker Letter (stating that copies of articles printed in 
independent publications that contain performance information of an 
adviser would be prohibited if they implied false or misleading 
information absent additional facts); Eberstadt Letter (stating that 
advertisements could be misleading if they imply positive facts 
about the adviser when additional facts, if also provided, would 
cause the implication not to arise).
    \227\ See In the Matter of Spear & Staff, Inc., Release No. IA-
188 (Mar. 25, 1965) (settled order) (the Commission brought an 
enforcement action against an investment adviser asserting, in part, 
that the adviser's advertisements, which recounted a number of 
factually accurate stories highlighting the outstanding investment 
success of certain selected clients collectively created ``illusory 
hopes of immediate and substantial profit'').
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    Commenters requested more guidance regarding when advertised 
testimonials would comply with this general prohibition.\228\ Two 
commenters argued that it would effectively eliminate an adviser's 
ability to use testimonials if advisers had to present negative 
testimonials alongside positive ones, particularly in the context of 
online and social media platforms.\229\
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    \228\ See AIC Comment Letter (``The Proposing Release does not 
suggest how an adviser may ascertain whether a testimonial is 
representative of that adviser's investors. Such a determination may 
require that an adviser poll or survey a material sample of its 
investors.''); IAA Comment Letter; SIFMA AMG Comment Letter I; 
Comment Letter of Truth in Advertising, Inc. (Feb. 10, 2020) (``TINA 
Comment Letter'').
    \229\ See SIFMA AMG Comment Letter II and IAA Comment Letter.
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    We do not believe that the general prohibition requires an adviser 
to present an equal number of negative testimonials alongside positive 
testimonials in an advertisement, or balance endorsements with negative 
statements in order to avoid giving rise to a misleading inference, as 
certain commenters suggested.\230\ Rather, the general prohibition 
requires the adviser to consider the context and totality of 
information presented such that it would not reasonably be likely to 
cause any misleading implication or inference. General disclaimer 
language (e.g., ``these results may not be typical of all investors'') 
would not be sufficient to overcome this general prohibition. However, 
one approach that we believe would generally be consistent with the 
general prohibitions would be for an adviser to include a disclaimer 
that the testimonial provided was not representative, and then provide 
a link to, or other means of accessing (such as oral directions to go 
to the relevant parts of an adviser's website), all or a representative 
sample of the testimonials about the adviser.
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    \230\ See, e.g., IAA Comment Letter; SIFMA AMG Commenter Letter 
I.
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    As discussed in further detail in section II.B.5. below, we believe 
this provision (along with the other provisions discussed below) will 
prohibit ``cherry picking'' of past investments or investment 
strategies of the adviser--that is, including favorable results while 
omitting unfavorable ones in a manner that is not fair and balanced.
4. Failure To Provide Fair and Balanced Treatment of Material Risks or 
Material Limitations
    The proposed rule would have prohibited advertisements that discuss

[[Page 13044]]

or imply any potential benefits connected with or resulting from the 
investment adviser's services or methods of operation without clearly 
and prominently discussing associated material risks or other 
limitations associated with the potential benefits.\231\ We are 
generally retaining this requirement with some modifications in 
response to comments.\232\
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    \231\ Proposed rule 206(4)-1(a)(4).
    \232\ See final rule 206(4)-1(a)(4).
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    Some commenters suggested eliminating this prohibition, arguing 
that it is redundant since Form ADV Part 2 already requires the 
disclosure of material risks.\233\ Commenters also expressed concern 
that this prohibition would expand the amount of required disclosures, 
dramatically lengthen advertisements, and overwhelm the content 
included in the advertisement.\234\ One commenter recommended removing 
``or imply'' from this prohibition, stating that it would be difficult 
for the Commission staff to prove something is implied.\235\ Several 
commenters requested that the Commission permit the use of hyperlinks 
and layered disclosures to satisfy the requirement that the necessary 
disclosures be made ``clearly and prominently,'' arguing that such an 
approach would be consistent with the Commission's stated goal of 
modernizing the advertising rule.\236\ Commenters also suggested that 
requiring an adviser to include detailed risk disclosures required 
under the proposed general prohibition in a clear and prominent manner 
may not be feasible in certain formats without the use of 
hyperlinks.\237\
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    \233\ See, e.g., Ropes & Gray Comment Letter and MFA/AIMA 
Comment Letter I.
    \234\ See MFA/AIMA Comment Letter I.
    \235\ CFA Institute Comment Letter.
    \236\ See, e.g., Fidelity Comment Letter; Ropes & Gray Comment 
Letter; IAA Comment Letter; Comment Letter of T. Rowe Price (Feb. 
10, 2020) (``T. Rowe Price Comment Letter''); LinkedIn Comment 
Letter; SIFMA AMG Comment Letter II.
    \237\ See, e.g., MFA/AIMA Comment Letter I; LinkedIn Comment 
Letter; Ropes & Gray Comment Letter.
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    In response to these concerns, we have modified this provision to 
prohibit advertisements that discuss any potential benefits connected 
with or resulting from the investment adviser's services or methods of 
operation without providing fair and balanced treatment of any material 
risks or material limitations associated with the potential 
benefits.\238\ We continue to believe that advertisements should 
provide an accurate portrayal of both the risks and benefits of the 
adviser's services. However, as proposed, the prohibition may have led 
advisers to provide overly voluminous disclosure of associated material 
risks, as well as overly inclusive disclosure of ``other limitations.'' 
We believe this could have resulted in lengthy, boilerplate disclosure 
that could reduce the salience of the risk and limitation information 
for investors.
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    \238\ Final rule 206(4)-1(a)(4). For the sake of clarity, the 
materiality standard will explicitly apply to both the risks and the 
limitations.
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    Because we are requiring fair and balanced treatment of material 
risks or material limitations associated with the benefits advertised, 
we no longer believe the requirement to ``clearly and prominently'' 
provide material risk disclosures is necessary.\239\ The proposed 
prohibition was designed to mitigate the risk that an adviser's 
advertisement might discuss only the benefits of its services but not 
include sufficient information about the material risks that the client 
may face. We believe that the requirement to provide benefits and 
material risks in a fair and balanced manner similarly achieves this 
goal. In addition, it will promote a more digestible discussion for 
investors by making clear that advisers need not discuss every 
potential risk or limitation in detail, but must instead discuss the 
material risks and material limitations associated with the benefits in 
a fair and balanced manner.\240\
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    \239\ As we discussed in the proposal, this general prohibition 
was drawn from FINRA rule 2210's general standards. See FINRA rule 
2210(d)(1)(D). The final rule's use of ``fair and balanced'' is more 
closely aligned with FINRA 2210, and accordingly, we believe that 
advisers that are familiar with those standards may be able to use 
that experience as a guide in complying with this requirement.
    \240\ For example, if an adviser states that it will reduce an 
investor's taxes through its tax-loss harvesting strategies, the 
adviser should also discuss the associated material risks or 
material limitations, including that any reduction in taxes would 
depend on an investor's tax situation.
---------------------------------------------------------------------------

    We expect that this approach will help facilitate layered 
disclosure. For example, an advertisement could comply with this 
requirement by identifying one benefit of an adviser's services, 
accompany the discussion of the benefit with fair and balanced 
treatment of material risks associated with that benefit within the 
four corners of that advertisement, and then include a hyperlink \241\ 
to additional content that discusses additional benefits and additional 
risks of the adviser's services in a fair and balanced manner. So long 
as each layer of a layered advertisement complies with the requirement 
to provide benefits and risks in a fair and balanced manner, providing 
hyperlinks to additional content would meet the requirement of this 
general prohibition. However, an adviser should not use layered 
disclosure or hyperlinks to obscure important information. For 
instance, it would not be sufficient to advertise only an adviser's 
past profits on a web page and then include a hyperlink to another page 
that included all material risks and material limitations as that would 
violate the fair and balanced presentation requirement.
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    \241\ In addition to hyperlinks, advisers may use other tools to 
provide investors with layered disclosure, including QR codes or 
mouse-over windows.
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    We are also removing the term ``imply'' from this general 
prohibition, which a commenter found unclear.\242\ Removing the term 
imply will make this provision more consistent with similar 
requirements with which many advisers are already familiar.\243\ In 
addition, we believe that the other general prohibitions (including the 
prohibition on information that could cause a misleading implication or 
inference to be drawn), address the concerns that led us to include the 
term imply in this general prohibition at proposal.
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    \242\ See CFA Institute Comment Letter.
    \243\ See rule 156(b)(3)(i); FINRA rule 2210(d)(1).
---------------------------------------------------------------------------

    We believe this prohibition differs in scope from the disclosures 
required by Form ADV. For example, Item 8 of Form ADV Part 2A requires 
material risk disclosures more specifically with respect to investing 
in securities and certain investment strategies and risks involved. 
Moreover, an investment adviser must provide its brochure prepared in 
accordance with Form ADV to its clients, but not to investors in 
private funds it manages. The marketing rule's prohibition requires 
risk disclosures related to any potential benefits advertised to both 
clients and private fund investors. We believe that providing such 
disclosures in advertisements is necessary in order to avoid misleading 
potential investors as well as existing investors in connection with 
new services or investments.
5. Anti-Cherry Picking Provisions: References to Specific Investment 
Advice and Presentation of Performance Results
    The final rule contains, as proposed, two other provisions designed 
to address concerns about investment advisers presenting potentially 
cherry-picked information in advertisements.
a. References to Specific Investment Advice
    As proposed, the final rule will prohibit a reference in an 
advertisement to specific investment advice that is not presented in a 
fair and balanced manner.\244\ Commenters supported

[[Page 13045]]

replacing the current rule's per se prohibition against past specific 
recommendations with this principles-based restriction on the 
presentation of specific investment advice.\245\ One commenter also 
supported the new fair and balanced standard.\246\ However, some 
commenters requested more guidance on how to satisfy the fair and 
balanced standard.\247\ Other commenters requested clarification that 
the principles from certain staff no-action letters would not be the 
sole means to comply with the fair and balanced standard.\248\ One 
commenter asked whether we intend to incorporate the body of judicial 
or administrative decisions regarding FINRA rule 2210 and other similar 
provisions.\249\
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    \244\ See final rule 206(4)-1(a)(5).
    \245\ See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; 
T. Rowe Price Comment Letter.
    \246\ NRS Comment Letter.
    \247\ See, e.g., ILPA Comment Letter (requesting clarification 
in the context of private equity funds); NASAA Comment Letter; 
Consumer Federation Comment Letter.
    \248\ See MFA/AIMA Comment Letter I; T. Rowe Price Comment 
Letter (noting that an adviser could mention security selections in 
a fair and balanced manner without complying with past staff 
positions).
    \249\ See NASAA Comment Letter. The phrase ``fair and balanced'' 
is used in FINRA rule 2210, which requires, among other things, that 
broker-dealer communications ``must be fair and balanced and must 
provide a sound basis for evaluating the facts in regard to any 
particular security or type of security, industry, or service.'' See 
FINRA rule 2210(d)(1)(A).
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    We continue to believe this limitation requiring advertisements to 
have only fair and balanced inclusions of, or references to, specific 
investment advice is appropriate. The factors relevant to when an 
advertisement's presentation of specific investment advice is fair and 
balanced will vary depending on the facts and circumstances. We provide 
examples of such factors below to illustrate the principles.\250\ While 
in some cases advisers may wish to consider FINRA's interpretations 
related to the meaning of ``fair and balanced'' for issues we have not 
specifically addressed, FINRA Rule 2210 and its body of decisions are 
not controlling or authoritative interpretations with respect to our 
final rule.
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    \250\ For selecting and presenting performance information, 
these factors are in addition to the requirements and restrictions 
on presentation of performance discussed in section II.A.5. See 
final rule 206(4)-1(c). In addition, other provisions of the general 
prohibitions may prohibit a reference to specific investment advice, 
depending on the facts and circumstances. See 2019 Proposing 
Release, supra footnote 7.
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i. Examples Regarding the Presentation of Past Specific Investment 
Advice
    An advertisement that references favorable or profitable past 
specific investment advice without providing sufficient information and 
context to evaluate the merits of that advice is not fair and balanced. 
For example, an adviser may wish to share a ``thought piece'' to 
describe the specific investment advice it provided in response to a 
major market event. This would be permissible under the final rule, 
provided the advertisement included disclosures with appropriate 
contextual information for investors to evaluate those recommendations 
(e.g., the circumstances of the market event, such as its nature and 
timing, and any relevant investment constraints, such as liquidity 
constraints, during that time).
    One practice currently used by advisers is to provide unfavorable 
or unprofitable past specific investment advice in addition to the 
favorable or profitable advice.\251\ An adviser also may consider 
listing some, or all, of the specific investment advice of the same 
type, kind, grade, or classification as those specific investments 
presented in the advertisement.
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    \251\ As stated in the proposal, an adviser may consider the 
current rule's required disclosures when furnishing a list of all 
past specific recommendations made by the adviser within the 
immediately preceding period of not less than one year. See rule 
206(4)-1(a)(2). However, the final rule will not require that an 
adviser include such disclosures, and such disclosures will not be 
the only way of satisfying paragraph (a)(4).
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    As an example, an investment adviser might provide a list of 
certain investments it recommended based upon certain selection 
criteria, such as the top holdings by value in a given strategy at a 
given point in time. The criteria investment advisers use to determine 
such lists in an advertisement, as well as how the criteria are 
applied, should produce fair and balanced results. We continue to 
believe that consistent application of the same selection criteria 
across measurement periods limits an investment adviser's ability to 
reference specific investment advice in a manner that unfairly reflects 
only positive or favorable results.\252\ For example, in deciding what 
to include in an advertisement, an adviser may wish to apply non-
performance related selection criteria across portfolio holdings, such 
as listing them on an alphabetical or rotational basis.\253\
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    \252\ An investment adviser should be mindful of the general 
prohibitions when selecting the measurement periods as well.
    \253\ Our staff has previously stated that it would not 
recommend enforcement action under rule 206(4)-1 relating to an 
advertisement that includes performance-based past specific 
recommendations based on certain representations, including that the 
adviser would use objective, non-performance based criteria to 
select the specific securities that it lists and discusses in the 
advertisement. See Franklin Letter. Although an adviser may find 
such staff positions helpful in complying with the final rule, the 
final rule does not include requirements corresponding to the 
specific representations in the Franklin letter.
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    Some commenters questioned whether this aspect of the final rule 
would permit case studies, which are popular in the private equity 
industry.\254\ We believe that case studies and any other similar 
information about the performance of portfolio companies are specific 
investment advice, subject to this general prohibition. For example, it 
would not be fair and balanced for an adviser to present, in an 
advertisement, case studies only reflecting profitable investments 
(when there are also similar unprofitable investments). To meet the 
fair and balanced standard, an adviser may, for example, disclose the 
overall performance of the relevant investment strategy or private fund 
for at least the relevant period covered by the list of investments. 
Case studies that include performance information also will be subject 
to the final rule's restrictions and requirements for performance 
advertising.\255\
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    \254\ See AIC Comment Letter; ILPA Comment Letter.
    \255\ See final rule 206(4)-1(d).
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    In determining how to present information in a fair and balanced 
manner, advisers should consider the facts and circumstances of the 
advertisement, including the nature and sophistication of the audience. 
For example, in an advertisement intended for a retail investor, an 
adviser may include certain disclosures to help the investor understand 
that past specific investment advice does not guarantee future results 
such as an explanation of the particular or unique circumstances of the 
previous investment advice and how those circumstances are no longer 
relevant. Less detailed disclosure may be needed in an advertisement 
solely for sophisticated institutional investors, who more likely 
understand the risks associated with past specific investment advice.
    In response to the commenters who asked for clarification that the 
methods described in past staff no-action letters on presenting past 
specific recommendations would not be the only way to meet the fair and 
balanced standard,\256\ we are not prescribing any of the factors in 
those letters under the final rule. While advisers may wish to refer to 
these letters for examples, we agree with commenters that an adviser 
may satisfy the fair and balanced standard in other ways.\257\
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    \256\ See MFA/AIMA Comment Letter I; T. Rowe Price Comment 
Letter.
    \257\ For example, our staff has stated that it would not 
recommend enforcement action under the current rule with respect to 
charts in an advertisement containing an adviser's best and worst 
performers in certain circumstances. See the TCW Letter. Our staff 
has also stated that it would not recommend enforcement action under 
current rule 206(4)-1 relating to an advertisement that includes 
performance-based past specific recommendations if the adviser uses 
objective, non-performance based criteria to select the specific 
securities that it lists and discusses in the advertisement in 
certain circumstances. See Franklin Letter.

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[[Page 13046]]

    The final rule applies to any reference in an advertisement to 
specific investment advice given by the investment adviser, regardless 
of whether the investment advice is current or occurred in the past. 
This provision will apply regardless of whether the advice was acted 
upon, or reflected actual portfolio holdings, or was profitable. In 
addition, the provision applies to discretionary investments because 
the adviser is implementing its recommendation or advice in such a 
context.\258\ We continue to believe that including current as well as 
past references to specific investment advice in the final rule is 
appropriate because it avoids questions about when a current 
recommendation becomes past, which arise under the current advertising 
rule. In addition, we continue to believe that selective references to 
current investment recommendations in advertisements could mislead 
investors in the same manner as selective references to past 
recommendations.
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    \258\ We understand there has been confusion under the current 
advertising rule's prohibition against past specific 
``recommendations'' as to whether an adviser makes a 
``recommendation'' when it implements its strategy in a 
discretionary account because an adviser would not contact its 
client to make a recommendation that the client then either chooses 
to implement or decline. We believe an adviser's recommendation, or 
investment advice, is implicit in the exercise of discretion.
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b. Presentation of Performance Results
    As proposed, the final rule will prohibit an investment adviser 
from including or excluding performance results, or presenting 
performance time periods, in a manner that is not fair and balanced in 
an advertisement.\259\ One commenter supported the proposed 
prohibition,\260\ while two others argued that the fair and balanced 
standard is subjective and difficult to enforce in this context.\261\ 
Some commenters requested more guidance by way of example to 
demonstrate how performance advertising could comply with the fair and 
balanced standard.\262\
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    \259\ See final rule 206(4)-1(a)(6).
    \260\ See Ropes & Gray Comment Letter.
    \261\ Consumer Federation Comment Letter; NASAA Comment Letter.
    \262\ CFA Institute Comment Letter; Ropes & Gray Comment Letter; 
NASAA Comment Letter; ILPA Comment Letter.
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    We continue to believe that this prohibition appropriately 
addresses the concern that an adviser may ``cherry-pick'' the periods 
used to generate performance results in advertisements.\263\ As with 
specific investment advice, the factors that are relevant to whether an 
advertisement's reference to performance information is presented in a 
fair and balanced manner will vary based on the facts and 
circumstances. For example, presenting performance results over a very 
short period of time (e.g., two months), or over inconsistent periods 
of time, may result in performance portrayals that are not reflective 
of the adviser's general results and thus generally would not be fair 
and balanced. Additionally, an advertisement that highlights one period 
of extraordinary performance with only a footnote disclosure of unusual 
circumstances that have contributed to such performance may not be fair 
and balanced, depending on whether there are other sufficient clear and 
prominent disclosures, as discussed below.\264\
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    \263\ An advertisement that includes only favorable performance 
results or excludes only unfavorable performance results may also be 
``misleading'' to the extent that such an advertisement would 
reasonably be likely to cause an untrue or misleading implication or 
inference to be drawn concerning the investment adviser that would 
not be implied or inferred were certain additional facts--i.e., any 
performance results excluded from the advertisement--disclosed. See 
final rule 206(4)-1(a)(3).
    \264\ See Amendments to Investment Company Advertising Rules, 
Release No. IC-26195 (Oct. 3, 2003) [68 FR 57760 (Oct. 6, 2003)].
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    In cases where additional information is necessary for an investor 
to assess performance results, failure to provide such information in 
an advertisement is not consistent with the fair and balanced standard. 
For example, in order to provide investors with a fair and balanced 
portrayal of its performance results, an adviser should consider 
providing information related to the state of the market at the time, 
any unusual circumstances, and other material factors that contributed 
to such performance. In section II.E, we discuss further specific 
requirements and conditions for portrayals of certain types of 
performance in advertisements that we are also adopting as part of this 
final rule.
6. Otherwise Materially Misleading
    Finally, we are adopting a catch-all provision, as proposed, that 
will prohibit any advertisement that is otherwise materially 
misleading.\265\ We did not receive any comments on this catch-all 
provision. We continue to believe this prohibition will help ensure 
that materially misleading practices not specifically covered by the 
other prohibitions will be addressed. For example, if an adviser 
provided accurate disclosures, but presented them in an unreadable 
font, such an advertisement would be materially misleading and 
prohibited under this provision.
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    \265\ Final rule 206(4)-1(a)(7).
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    Because we are prohibiting a variety of specific types of 
advertisement practices within the general prohibitions, most of which 
include an element of materiality, as discussed above, we are focusing 
the catch-all provision on only those advertisements that are otherwise 
materially misleading. We continue to believe that limiting the catch-
all to materially misleading advertisements will be more appropriate 
within the overall structure of the prohibitions while still achieving 
our goal of prohibiting misleading conduct that may affect an 
investor's decision-making process. We also continue to believe that, 
in light of the rule's prohibition on making untrue statements and 
omissions of material fact, including ``false'' is unnecessary in the 
catch-all provision as it is already covered by another 
prohibition.\266\
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    \266\ See final rule 206(4)-1(a)(1).
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C. Conditions Applicable to Testimonials and Endorsements, Including 
Solicitations

1. Overview
    Consistent with the proposal, the final rule permits advisers to 
include testimonials and endorsements in an advertisement, subject to 
the rule's general prohibitions and additional conditions.\267\ These 
conditions differ depending on whether the testimonial or endorsement 
is compensated or uncompensated, which is similar to the framework we 
proposed.\268\
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    \267\ Statements made by an adviser that would be prohibited 
under the final rule's general prohibitions of certain marketing 
practices would also be prohibited in an adviser's advertisement if 
made by a third party in a covered testimonial or endorsement. For 
example, as we stated in the Proposing Release, we would generally 
view an advertisement as unlikely to be presented in a manner that 
is fair and balanced if it contains a testimonial, endorsement, or 
third-party rating that references performance information or 
specific investment advice provided by the adviser that was 
profitable but is not representative of the experience of the 
adviser's investors. 2019 Proposing Release, supra footnote 7, at 
section II.A.2.e.
    \268\ Final rule 206(4)-1(b).
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    Numerous commenters supported the proposed expansion from the 
current advertising rule to permit advisers to include testimonials and 
endorsements in advertisements.\269\ Commenters

[[Page 13047]]

explained that consumer preferences have shifted to rely increasingly 
on third-party resources to inform purchasing decisions.\270\ Other 
commenters opposed permitting any testimonials or endorsements, paid or 
unpaid, in adviser advertisements.\271\ These commenters were concerned 
that permitting advisers to advertise paid testimonials and 
endorsements would increase puffery and cause a ``race to the bottom'' 
for advisers seeking paid endorsements.\272\
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    \269\ See, e.g., Consumer Federation Comment Letter; IAA Comment 
Letter; LinkedIn Comment Letter; Fidelity Comment Letter; TINA 
Comment Letter.
    \270\ See Consumer Federation Comment Letter; IAA Comment 
Letter.
    \271\ See Comment Letter of TABR Capital Management, LLC (Jan. 
6, 2020); Comment Letter of the Institute for the Fiduciary Standard 
(Feb. 10, 2020) (``Fiduciary Institute Comment Letter'').
    \272\ See NAPFA Comment Letter; Mercer Comment Letter (arguing 
that permitting paid endorsements will lead to largest advisers 
vying for endorsements from celebrities and popular ``financial 
gurus'').
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    As discussed above, we have expanded the definitions of both 
testimonial and endorsement to include certain solicitation 
activity.\273\ This expansion recognizes the overlap between our 
approach to solicitation under the proposal and compensated 
testimonials and endorsements.\274\ It is also designed to capture 
solicitation activities that previously have been subject to the cash 
solicitation rule and subject them to the marketing rule. The final 
rule includes conditions for an adviser's use of testimonials and 
endorsements designed to address concerns raised by commenters. These 
conditions include disclosure requirements to make prospective clients 
and investors aware of the conflicts of interest associated with 
testimonials and endorsements and a requirement that an investment 
adviser have a reasonable basis to believe that the testimonial or 
endorsement complies with the marketing rule. In addition, because we 
believe compensated testimonials and endorsements present a heightened 
risk for conflicts and misleading investors, the final rule will 
prevent advisers from using certain compensated testimonials and 
endorsements made by certain ``bad actors'' and other ineligible 
persons. The final rule will also require that an investment adviser 
have a written agreement with certain persons giving a testimonial or 
endorsement for compensation above the de minimis threshold.\275\
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    \273\ See supra section II.A.3.
    \274\ Final rule 206(4)-1(e)(6) and (16).
    \275\ See final rule 206(4)-1(b) (imposing disclosure, adviser 
oversight, and disqualification conditions). This approach derives 
from the current solicitation rule. See also final rule 206(4)-
1(b)(4)(i).
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2. Required Disclosures
    The final rule will require advertisements that include any 
testimonials or endorsements to provide disclosures of certain 
information similar to what was proposed under each of the advertising 
and solicitation rules, subject to certain exceptions, as discussed 
below. Specifically, the final rule will require that the investment 
adviser disclose, or reasonably believe that the person giving the 
testimonial or endorsement discloses, the following at the time the 
testimonial or endorsement is disseminated:
    (i) Clearly and prominently:
    (A) That the testimonial was given by a current client or private 
fund investor, and the endorsement was given by a person other than a 
current client or private fund investor, as applicable;
    (B) That cash or non-cash compensation was provided for the 
testimonial or endorsement, if applicable; and
    (C) A brief statement of any material conflicts of interest on the 
part of the person giving the testimonial or endorsement resulting from 
the investment adviser's relationship with such person;
    (ii) The material terms of any compensation arrangement including a 
description of the compensation provided or to be provided, directly or 
indirectly, to the person for the testimonial or endorsement; and
    (iii) A description of any material conflicts of interest on the 
part of the person giving the testimonial or endorsement resulting from 
the investment adviser's relationship with such person and/or any 
compensation arrangement.\276\
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    \276\ Final rule 206(4)-1(b)(1). We proposed the final 
disclosure requirements separately under the proposed amendments to 
the advertising rule and solicitation rule. The proposed advertising 
rule amendments would have required disclosures that: (1) The 
testimonial was given by a client or investor, and the endorsement 
was given by a non-client or non-investor, as applicable; and (2) if 
applicable, cash or non-cash compensation has been provided by or on 
behalf of the adviser in connection with obtaining or using the 
testimonial or endorsement. See proposed rule 206(4)-1(b)(1). The 
proposed amendments to the solicitation rule would have required 
disclosure of the terms of the compensation arrangement and 
description of any material conflicts of interest. See proposed 
rules 206(4)-3(a)(1)(iii)(D) and (E).
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    We are not adopting the proposed requirement under the solicitation 
rule to disclose the amount of any additional cost to the investor as a 
result of solicitation for the reasons discussed below.\277\ We believe 
that disclosures are needed to inform and protect investors effectively 
when they are presented with testimonials and endorsements. We also 
share the concerns raised by some commenters that permitting paid 
testimonials and endorsements would increase the likelihood that 
personal bias will mislead investors.\278\ To address these issues in 
particular, we are adopting two disclosure requirements that we 
proposed under the solicitation rule--the disclosure of compensation 
arrangements and material conflicts of interest--under the final rule. 
We believe that these disclosures will benefit investors by providing 
them with a fuller context when presented with a testimonial or 
endorsement, without overly burdening those providing the testimonial 
or endorsement.
---------------------------------------------------------------------------

    \277\ See proposed rule 206(4)-3(a)(1)(iii)(F).
    \278\ See NAPFA Comment Letter; Mercer Comment Letter.
---------------------------------------------------------------------------

    Some commenters suggested that we should align our disclosure 
approach with FINRA's rule 2210 to ease the compliance burdens of 
investment advisers that are registered broker-dealers or affiliated 
with broker-dealers.\279\ However, instead of aligning our disclosures 
with FINRA's, such as FINRA's specific, standardized disclosures in 
rule 2210(d)(6),\280\ we believe the final rule should provide advisers 
with a broad framework within which to determine how best to present 
testimonials and endorsements so they are not false or misleading. 
Accordingly, we are not adopting standardized disclosure requirements 
under our final rule. As a result, dually registered advisers and 
broker-dealers, that are not subject to the exemptions discussed below, 
that provide testimonials and endorsements with the disclosures 
required by FINRA should consider what additional or different 
disclosures they would need to make to comply with the final marketing 
rule.\281\
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    \279\ MMI Comment Letter; Mercer Comment Letter.
    \280\ FINRA's rule 2210(d)(6) requires, among other things, that 
a testimonial disclose the following: (i) The fact that it may not 
be representative of the experience of other customers; (ii) the 
fact that the testimonial is no guarantee of future performance or 
success; and (iii) if more than $100 in value is paid for the 
testimonial, the fact that it is a paid testimonial. FINRA rule 
2210(d)(6)(B).
    \281\ For example, unlike under FINRA rule 2210, an adviser 
would be required to disclose the material terms of compensation for 
a testimonial, even where a person receives de minimis compensation, 
under the final marketing rule.
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a. Clearly and Prominently
    The final rule will require that particular disclosures with 
respect to testimonials and endorsements be made clearly and 
prominently.\282\ The

[[Page 13048]]

proposed advertising rule would have required clear and prominent 
disclosure of: (1) Whether the testimonial or endorsement was given by 
a client or investor or a non-client or investor; and (2) if 
applicable, that compensation was provided by or on behalf of the 
adviser in connection with the testimonial or endorsement.\283\ The 
proposed solicitation rule would have required that, under the terms of 
the written agreement, the solicitor or adviser provide the investor at 
the time of solicitation activities with a separate disclosure that 
includes, among other matters, the terms of any compensation 
arrangement, including a description of the compensation provided or to 
be provided to the solicitor, and a description of any potential 
material conflicts of interest on the part of the solicitor resulting 
from the investment adviser's relationship with the solicitor and/or 
the compensation arrangement.\284\ In merging the two rules under the 
final rule, we have determined to preserve that testimonials and 
endorsements must provide for certain concise disclosures to be made 
clearly and prominently as well as for certain additional disclosures 
to be made at the time the testimonial or endorsement is disseminated.
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    \282\ See final rule 206(4)-1(b)(1)(i). If the promoter provides 
the disclosures, the investment adviser must reasonably believe that 
the promoter provides such disclosures clearly and prominently. See 
final rule 206(4)-1(b)(1).
    \283\ See proposed rule 206(4)-1(b)(1).
    \284\ See proposed rule 206(4)-3(a)(1)(iii).
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    We continue to believe that certain required disclosures should be 
made clearly and prominently to help prevent misleading testimonials 
and endorsements.\285\ In addition to the two disclosures required 
under the proposed advertising rule, we also are requiring that a brief 
statement of any material conflicts of interest on the part of the 
person giving the testimonial or endorsement be made clearly and 
prominently. In order to be clear and prominent, the disclosures must 
be at least as prominent as the testimonial or endorsement. In other 
words, we believe that the ``clear and prominent'' standard requires 
that the disclosures be included within the testimonial or endorsement, 
or in the case of an oral testimonial or endorsement, provided at the 
same time.\286\
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    \285\ We believe this will help reduce the risk of having 
misleading testimonials or endorsements in addition to the general 
prohibitions, which prohibit advertisements from being materially 
false or misleading. See 206(4)-1(a).
    \286\ See infra section II.C.2.f. (discussing oral testimonials 
and endorsements). The discussion in this section also applies to 
other parts of the final rule that include a clear and prominent 
disclosure standard, including the required disclosures related to 
third-party ratings and predecessor performance. Accordingly, such 
required disclosures should be included within the advertisement.
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    As discussed above, many commenters requested more flexibility with 
respect to hyperlinked disclosures under the clear and prominent 
standard.\287\ With respect to the disclosures for testimonials and 
endorsements that are subject to the clear and prominent standard, we 
believe such disclosures must be provided clearly and prominently 
within the testimonial or endorsement.\288\ Specifically, we believe 
such disclosures should appear close to the associated statement such 
that the statement and disclosures are read at the same time, rather 
than referring the reader somewhere else to obtain the disclosures. In 
cases in which an oral testimonial or endorsement is provided, it would 
be consistent with the clear and prominent standard if the disclosures 
are provided in a written format, so long as they are provided at the 
time of the testimonial or endorsement.\289\ The requirement to provide 
the disclosures with respect to testimonials and endorsements ``clearly 
and prominently'' may necessitate formatting and tailoring based on the 
form of the communication.\290\
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    \287\ See section II.B.4. (discussing commenters' concerns with 
respect to the clear and prominent standard). See, e.g., MMI Comment 
Letter; T. Rowe Price Comment Letter; Fidelity Comment Letter; IAA 
Comment Letter.
    \288\ See final rule 206(4)-1(b)(1)(i)(A) through (C).
    \289\ Accordingly, in the case of a compensated oral testimonial 
or endorsement, the adviser may, instead of recording and retaining 
the entire oral testimonial or endorsement, make and keep a record 
of the disclosures provided to investors. See final rule 204-
2(a)(11)(i)(A)(2). See also infra section II.C.2.f and II.I. 
(discussing oral testimonials and endorsements). If an adviser or 
promoter provides an investor with written disclosures in connection 
with an oral testimonial or endorsement, instead of delivering the 
disclosures orally, the adviser or promoter should alert the 
investor to the importance of the disclosures, particularly with 
respect to the disclosures that must be provided clearly and 
prominently. See final rule 206(4)-1(b)(1)(i). If an adviser did not 
inform the investor about the importance of such disclosures, it 
would violate the general prohibition against false or misleading 
statements. See final rule 206(4)-1(a)(1).
    \290\ An advertisement intended to be viewed on a mobile device, 
for example, may meet the standard in a different way than one 
intended to be seen as a print advertisement (e.g., a person viewing 
a mobile device could be automatically redirected to the required 
disclosure before viewing the substance of an advertisement).
---------------------------------------------------------------------------

    However, after considering comments, we are requiring advisers to 
provide only certain disclosures regarding testimonials and 
endorsements clearly and prominently, as discussed in more detail 
below.\291\ We believe that the disclosures required to be provided 
clearly and prominently are integral to the concerns associated with 
testimonials and endorsements in an advertisement. Our approach is 
consistent with the Federal Trade Commission's (``FTC'') guidance, 
which also requires disclosures that are integral to the claim to 
accompany the claim to prevent deception.\292\ We also believe that 
these disclosures can be provided succinctly within the testimonial or 
endorsement such that advisers may advertise their services using 
modern technology and platforms that limit the size or characters of an 
advertisement. Moreover, we expect that succinctly providing these 
disclosures will promote their salience and impact. Other required 
disclosures, which provide investors with additional useful information 
but that are not integral to the concerns related to these 
advertisements, may be provided through hyperlinks, in a separate 
disclosure document or any other similar methods.
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    \291\ See infra section II.C.2.a.i. through iii. (discussing 
status as a client or non-client, fact of compensation, and 
statement of material conflicts of interest).
    \292\ See, e.g., Fidelity Comment Letter; IAA Comment Letter; 
SIFMA AMG Comment Letter II (suggesting that we adopt, or adopt an 
approach consistent with, the FTC approach to hyperlinks). See also 
Federal Trade Commission, Dot Com Disclosures Guidance Update (Mar. 
2013). While the FTC guidance permits the use of hyperlinks, it 
generally allows the use of hyperlinks to provide disclosures that 
are ``not integral to the triggering claim'' and places a number of 
conditions on the ability to provide hyperlinks.
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i. Status as a Client or Non-Client
    Similar to what we proposed under the advertising rule, the final 
rule will require clear and prominent disclosure that a testimonial was 
given by a current client or investor, and that an endorsement was 
given by a person other than a current client or investor.\293\ We 
believe that this disclosure will provide investors with important 
context for weighing the relevance of the testimonial or endorsement. 
For example, an investor might reasonably give more weight to a 
statement made about an adviser by a current investor rather than 
someone who was never an investor.\294\ Additionally, without clearly 
attributing an endorsement to someone other than an investor, the 
advertisement could mislead investors who may assume the

[[Page 13049]]

endorsement reflects the endorser's experience as an investor.\295\
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    \293\ Final rule 206(4)-1(b)(1)(i)(A). See proposed rule 206(4)-
1(b)(1)(i). The promoter may be an entity or a natural person.
    \294\ Client status will be assessed at the time that a 
testimonial or endorsement is disseminated. However, depending on 
the facts and circumstances, a former client may be considered a 
client for these purposes. For example, if a person is giving a 
statement about his or her recent prior experience with the adviser, 
the communication could be treated as a testimonial.
    \295\ Testimonials and endorsements are subject to the rule's 
general prohibitions. Whether a testimonial or endorsement would 
reasonably be likely to cause an untrue or misleading implication or 
inference to be drawn concerning a material fact relating to the 
investment adviser would depend on the facts and circumstances. For 
instance, it would be misleading for an adviser to provide investors 
with a testimonial claiming a positive experience with the adviser 
by a former client, without mentioning that the person has not been 
a client for 20 years.
---------------------------------------------------------------------------

    The proposed solicitation rule would have required disclosure of 
the name of the solicitor.\296\ However, similar to the proposed 
advertising rule, the final rule will not require the disclosure of the 
name of the promoter.\297\ We did not receive any comments on the 
requirement under the proposed solicitation rule to disclose the name 
of the solicitor. We expect that advisers may still choose to disclose 
the full name of the promoter because disclosing the name of the 
promoter could help an investor assess the reputation or other 
qualifications of the person. However, we believe our final approach is 
appropriate for privacy reasons and takes into account cases where a 
promoter may not wish to give his or her name.\298\ We also believe 
that in cases where a name is not provided, the rule's general 
prohibitions will protect investors from fraudulent or misleading 
testimonials or endorsements. An investor may also give less weight to 
that particular testimonial or endorsement.
---------------------------------------------------------------------------

    \296\ See proposed rule 206(4)-3(a)(1)(iii)(B). The proposed 
rule would have also required disclosure of the adviser's name. 
Proposed rule 206(4)-3(a)(1)(iii)(A).
    \297\ Final rule 206(4)-1(b)(1)(i) through (ii). The proposed 
advertising rule would have only required disclosure of the client 
or non-client status of the person providing the testimonial or 
endorsement and whether compensation has been provided for the 
testimonial or endorsement. See proposed rule 206(4)-1(b)(1).
    \298\ In the case of testimonials and endorsements where 
compensation paid is above the de minimis threshold, advisers are 
required to maintain a written agreement with a promoter. See final 
rule 206(4)-1(b)(2)(ii) and (b)(4)(i). In such cases, the agreement 
would provide a record of the name of such promoter. See rule 204-
2(a)(10), which currently requires that advisers retain ``[a]ll 
written agreements (or copies thereof) entered into by the 
investment adviser with any client or otherwise relating to the 
business of such investment adviser as such.''
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ii. Fact of Compensation
    Similar to what we proposed under the advertising rule, the final 
rule will require clear and prominent disclosure that cash or non-cash 
compensation was provided for the testimonial or endorsement, if 
applicable.\299\ Similar to the disclosure of a promoter's status as a 
current investor or person other than a current investor, we continue 
to believe that this disclosure will provide investors with important 
context for weighing the relevance of the testimonial or endorsement. 
Two commenters specifically supported requiring advisers to disclose 
whether they paid for testimonials or endorsements under the proposed 
advertising rule.\300\ One of these commenters stated that without 
requiring clear and prominent disclosure that a particular testimonial 
or endorsement is effectively a ``paid-for advertisement,'' investors 
would not be able to determine whether they are consuming an authentic, 
unbiased review of the adviser.\301\ We agree, and we believe that this 
simple but clear disclosure is one that is both beneficial for 
investors and easy to implement for advisers, including on space-
constrained platforms. For example, when providing a testimonial or 
endorsement on a social media platform, an adviser must clearly and 
prominently label the testimonial or endorsement as being a paid 
testimonial or endorsement.
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    \299\ Final rule 206(4)-1(b)(1)(i)(B). See proposed rule 206(4)-
1(b)(1)(ii).
    \300\ Consumer Federation Comment Letter; SBIA Comment Letter.
    \301\ Consumer Federation Comment Letter.
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iii. Statement of Material Conflicts of Interest
    The final rule will require clear and prominent disclosure of a 
brief statement of any material conflicts of interest on the part of 
the promoter resulting from its relationship with the investment 
adviser.\302\ Similar to the other disclosures subject to the clear and 
prominent standard, we expect this disclosure to be succinct. For 
example, it would be sufficient for an adviser to simply state that the 
testimonial or endorsement was provided by an affiliate of the adviser, 
or that the promoter is related to the adviser, if this relationship is 
the source of the conflict.\303\
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    \302\ Final rule 206(4)-1(b)(1)(i)(C).
    \303\ We expect this brief statement of any material conflicts 
of interest to be substantially shorter than the description of any 
material conflicts of interest that is required, as discussed below. 
See final rule 206(4)-1(b)(1)(ii).
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    We believe the required disclosures result in information that 
informs and protects investors, yet can be provided succinctly within 
the testimonial or endorsement. We also believe this form of layered 
disclosure enhances the salience of this information and may help 
investors better focus on the presence of conflicts of interest than 
requiring potentially more lengthy disclosures. We require a fuller 
description of any material conflicts of interests resulting from the 
promoter's relationship with the adviser and/or the promoter's 
compensation arrangement with the adviser as part of the disclosures 
provided with respect to testimonials or endorsements, but this is not 
subject to the clear and prominent standard.\304\
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    \304\ See final rule 206(4)-1(b)(1)(iii).
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b. Material Terms of Compensation Arrangement
    The final rule will require disclosure of the material terms of any 
compensation arrangement, including a description of the compensation 
provided or to be provided, directly or indirectly, to the person for 
the testimonial or endorsement.\305\ This provision is based on the 
disclosure requirement of the proposed solicitation rule. The proposed 
solicitation rule would have required the disclosure of the terms of 
any compensation arrangement, including a description of the 
compensation provided or to be provided to the solicitor.\306\ Some 
commenters stated that the disclosure requirement was overbroad and 
unclear.\307\ For instance, one commenter stated that it is unclear 
whether an adviser should disclose reimbursing a solicitor for third-
party expenses in the solicitation process under this requirement.\308\ 
The final rule requires disclosure of compensation provided, directly 
or indirectly, for the testimonial or endorsement. If payment of third-
party expenses is part of the compensation arrangement for the 
testimonial or endorsement, then such payment should be disclosed under 
the final rule.
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    \305\ Final rule 206(4)-1(b)(1)(ii).
    \306\ See proposed rule 206(4)-3(a)(1)(iii)(D).
    \307\ See, e.g., Comment Letter of Flexible Plan Investments, 
Ltd. on proposed solicitation rule (Feb. 10, 2020) (``Flexible Plan 
Investments Comment Letter I''); Comment Letter of Proskauer Rose 
LLP (Feb. 10, 2020) (``Proskauer Comment Letter'').
    \308\ Flexible Plan Investments Comment Letter I.
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    If a specific amount of cash compensation is paid, the 
advertisement should disclose that amount.\309\ If the compensation 
takes the form of a percentage of the total advisory fee over a period 
of time, then the advertisement should disclose such percentage and 
time period.\310\ With respect to non-cash

[[Page 13050]]

compensation, if the value of the non-cash compensation is readily 
ascertainable, the disclosures should include that amount. Moreover, if 
all or part of the compensation, cash or non-cash, is payable upon 
dissemination of the testimonial or endorsement or is deferred or 
contingent on a certain future event, such as an investor's 
continuation or renewal of its advisory relationship, agreement, or 
investment, then the advertisement should disclose those terms.\311\
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    \309\ This is consistent with the Commission's position 
regarding the disclosure requirements under the existing cash 
solicitation rule. See 1979 Adopting Release, supra footnote 3, at 
text accompanying nn.15 and 16.
    \310\ This is similar to the Commission's position under the 
existing cash solicitation rule. See 1979 Adopting Release, supra 
footnote 3, at text accompanying nn.15 and 16.
    \311\ This is also similar to the Commission's position under 
the existing cash solicitation rule. See 1979 Adopting Release, 
supra footnote 3, at text accompanying nn.15 and 16.
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    In response to this requirement under our proposed solicitation 
rule, one commenter argued that requiring detailed disclosures about 
compensation arrangements would result in lengthy disclosures that 
would be confusing for, and irrelevant to, investors.\312\ The 
commenter suggested that the rule require solicitors to disclose only 
that they are receiving compensation for the solicitation. This 
commenter stated that this disclosure would adequately alert investors 
to the inherent conflict of interest associated with such compensation. 
At the same time, several commenters considered additional compensation 
information about a compensated solicitor's referral, including the 
amount paid to the solicitor for referring the adviser, whether there 
would be any additional cost to the investor, and the solicitor's 
relationship to the adviser, ``very important.'' \313\
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    \312\ See Proskauer Comment Letter.
    \313\ See Investment Adviser Marketing Feedback Form.
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    Although we believe that a simple disclosure that compensation was 
provided is sufficient for purposes of the clear and prominent 
disclosures, we continue to believe that the disclosure related to the 
terms of the compensation arrangement help convey to the investor the 
nature and magnitude of the person's incentive to refer the investor to 
the adviser.\314\ The incentive might vary based on the structure of 
the compensation arrangement. A promoter that receives a flat or fixed 
fee from an adviser for a set number of referrals might have a 
different incentive in referring to the adviser than another that 
receives a fee, such as a percentage of the investor's assets under 
management, for each investor that becomes a client of, or a private 
fund investor with, the adviser. Furthermore, trailing fees (i.e., fees 
that are continuing) that are contingent on the investor's relationship 
with the adviser continuing for a specified period of time present 
additional considerations in evaluating the promoter's incentives. It 
would be relevant to an investor to know that a promoter continues to 
receive compensation after the investor becomes a client of, or private 
fund investor with, the adviser, as well as the period of time over 
which the promoter continues to receive compensation for such 
solicitation. A longer trailing period can present a greater incentive 
to solicit the investor. In addition, if, as part of the compensation 
arrangement between the adviser and promoter, an investor would pay 
increased advisory fees for becoming a client as a result of the 
promoter's testimonial or endorsement, then this information would be 
relevant so that the investor can make such considerations when 
choosing an adviser.\315\
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    \314\ As stated in our proposal, the materiality of the 
incentive to solicit investors to an investor's evaluation of the 
referral depends on the type and magnitude of the compensation. We 
believe that the description of a compensation arrangement will be 
helpful for investors to consider the types and levels of incentives 
present. 2019 Proposing Release, supra footnote 7, at section 
II.B.4.
    \315\ If the amount of increased fees for the investor is known 
or could reasonably be obtained, then such amount should be 
disclosed as part of this requirement.
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    After considering comments, we are requiring that the disclosures 
only include the material terms of any compensation arrangement. 
Accordingly, these disclosures need not include immaterial aspects of a 
compensation arrangement. These disclosures also need not include 
detailed information about the calculation of the compensation payable 
to each person giving a testimonial or endorsement; they need not be 
lengthy to convey the magnitude and nature of the conflict. In 
addition, these disclosures should not include all compensation 
arrangements that an adviser has with any and all promoters, as one 
commenter suggested, but rather should include only information about 
the relevant compensation arrangement between an adviser and a specific 
promoter in order for the disclosure to be effective.\316\ As modified, 
this provision will require disclosures about any compensation 
arrangement with a promoter for its testimonial or endorsement.
---------------------------------------------------------------------------

    \316\ Proskauer Comment Letter (stating that this requirement 
would result in ``very extensive'' disclosures, particularly if an 
adviser has multiple arrangements with multiple solicitors).
---------------------------------------------------------------------------

    An adviser may arrange to compensate a third-party marketing 
company to advertise and refer potential clients to the adviser. If the 
compensation arrangement calls for a percentage of fees collected from 
the referred clients, then the disclosures should state so and describe 
what that percentage is. An adviser may also have a directed brokerage 
arrangement with a third-party brokerage firm, in which the adviser 
will direct brokerage to the firm as compensation for the firm's 
solicitation of clients for, or referral of clients to, the 
adviser.\317\ In these cases, the adviser or firm should disclose the 
material terms of this arrangement, including a brief description of 
the compensation provided or to be provided to the firm. As part of the 
disclosure of the material terms of the compensation, the disclosure 
should state the range of commissions that the firm charges for 
investors directed to it by the adviser. Furthermore, if the 
solicitation or referral is contingent upon the firm receiving a 
particular threshold of directed brokerage (and other services, if 
applicable) from the adviser, the disclosure should say so. Additional 
disclosure would be required, for example, if the firm and the adviser 
agree that as compensation for the firm's endorsement of the adviser, 
the adviser's directed brokerage activities would extend to other 
clients such as the solicited client's friends and family.
---------------------------------------------------------------------------

    \317\ Such activities will fall under the definition of 
endorsement.
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    The final rule will require the advertisement to disclose 
compensation that the adviser provides directly or indirectly to a 
person for a testimonial or endorsement.\318\ For example, if an 
individual solicits an investor and the adviser compensates a related 
person of that individual for such solicitation (such as an employer or 
another entity that is associated with the individual), the adviser or 
individual will need to include this compensation in its disclosures. 
If a person, such as a broker-dealer, refers clients to advisers that 
recommend the broker-dealer's or its affiliate's proprietary investment 
products or recommend products that have revenue sharing or other 
pecuniary arrangements with the broker-dealer or its affiliate, the 
disclosures must say so.\319\ Regardless of whether the adviser's 
arrangement is with an individual or the individual's firm, 
compensation to the firm for any testimonial or endorsement will 
constitute compensation under the rule, as it would be likely to affect 
the

[[Page 13051]]

individual's salary, bonus, commission or continued association with 
the firm.
---------------------------------------------------------------------------

    \318\ See final rule 206(4)-1(e)(1)(ii).
    \319\ See also Fiduciary Interpretation, supra footnote 88, at 
23 (``an adviser must eliminate or at least expose through full and 
fair disclosure all conflicts of interest which might incline an 
investment adviser--consciously or unconsciously--to render advice 
which was not disinterested.'').
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c. Material Conflicts of Interest
    The proposed solicitation rule would have required a description of 
any potential material conflicts of interest on the part of the 
solicitor resulting from the investment adviser's relationship with the 
solicitor and/or compensation arrangement.\320\ We have slightly 
modified this proposed requirement by removing the word ``potential'' 
from ``potential material conflicts of interest,'' as discussed in 
detail below. Accordingly, the final rule will require a description of 
any material conflicts of interest on the part of the person giving the 
testimonial or endorsement resulting from the investment adviser's 
relationship with such person and/or any compensation arrangement.\321\
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    \320\ Proposed rule 206(4)-3(a)(1)(iii)(E).
    \321\ Final rule 206(4)-1(b)(1)(iii). The materiality standard 
applies to the investor(s) being solicited by the promoter. In other 
words, if an investor would consider a particular conflict of 
interest on the part of the promoter to be material to his or her 
decision to choose an investment adviser, then such conflict of 
interest should be disclosed.
---------------------------------------------------------------------------

    One commenter to the proposed advertising rule requested that we 
broaden the disclosure provision and require disclosure of all 
``material connections,'' stating that there are types of connections 
besides the fact of compensation that could ``materially affect the 
weight or credibility'' of a testimonial or endorsement.\322\ With 
respect to the proposed solicitation rule requirement, some commenters 
supported making clear to investors that a conflict of interest may 
result from an adviser's relationship with the solicitor and/or their 
compensation arrangement.\323\ Others stated that the disclosure of 
potential material conflicts of interest would likely be redundant with 
the required disclosure of the terms of any compensation 
arrangement.\324\ Commenters also argued that such a requirement would 
result in disclosure that is too lengthy without much benefit.\325\ 
These commenters stated that registered investment advisers and broker-
dealers who act as solicitors are already subject to similar disclosure 
obligations under Form ADV Part 2 and Regulation BI, respectively.\326\
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    \322\ See TINA Comment Letter.
    \323\ See Proskauer Comment Letter; Mercer Comment Letter.
    \324\ See, e.g., MFA/AIMA Comment Letter I.
    \325\ See, e.g., Fidelity Comment Letter.
    \326\ See, e.g., Fidelity Comment Letter, which also stated that 
Form CRS would be an additional place where investors may find 
similar information.
---------------------------------------------------------------------------

    We believe our modification of removing the word ``potential'' from 
the proposed requirement will help reduce the burden on advisers as 
well as the length of the disclosures without eliminating any material 
information provided to investors. We do not believe the compensation 
arrangement disclosure alone is sufficient as it merely implies the 
conflict. Rather, there should be explicit disclosure that the 
promoter, due to such compensation, has an incentive to recommend the 
adviser, resulting in a material conflict of interest. Additionally, we 
believe a promoter could have other material conflicts of interest 
based on a relationship with the investment adviser that could affect 
the credibility of the testimonial or endorsement. Accordingly, to the 
extent that there is any material conflict of interest, the rule will 
require a description of such material conflict of interest.
    We recognize that persons who are also registered as investment 
advisers or broker-dealers have other disclosure obligations relating 
to conflicts of interest, such as the requirements of Form ADV.\327\ We 
do not believe that disclosures provided in Form ADV would sufficiently 
satisfy this provision. For example, although Form ADV Part 2 requires 
disclosure of material conflicts of interest, the disclosure required 
by the form is limited to conflicts related to relationships with 
specific personnel such as the adviser's supervised persons and related 
persons.\328\ Moreover, we do not believe that an adviser that is 
acting as a promoter would be required to deliver its Form ADV Part 2 
to a person the adviser was soliciting to become a client of another 
investment adviser. On the other hand, in circumstances where 
Regulation BI applies to a broker-dealer's activity as a promoter, we 
believe the Disclosure Obligation under Regulation BI is sufficiently 
similar to satisfy the disclosure provisions under our final rule.\329\ 
Accordingly, as discussed below, we are adopting a partial exemption 
from the final rule's required disclosures in certain 
circumstances.\330\
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    \327\ Such persons would also have disclosure obligations under 
the anti-fraud provisions of the Federal securities laws. If a 
person meets the definition of ``investment adviser,'' as defined 
under section 202(a)(11) of the Advisers Act, such person has a 
fiduciary duty to clients, regardless of whether the adviser is 
registered or required to be registered, and is thus liable under 
the anti-fraud provisions of the Advisers Act and other Federal 
securities laws for failure to disclose conflicts of interest.
    \328\ See, e.g., Item 4.A. of Form ADV, Part 2 (requires 
disclosure if a relationship between adviser and supervised person's 
other financial industry activities creates a material conflict of 
interest with clients); Item 5.E of Form ADV, Part 2 (requires 
disclosure of conflict of interest to the extent that the adviser or 
any of its supervised persons accepts compensation for the sale of 
securities or other investment products); Item 10.C. of Form ADV, 
Part 2 (requires description of material conflict of interests with 
related persons, as defined in Form ADV, and only if the 
relationship or arrangement with the related person creates a 
material conflict of interest with clients); Item 10.D. of Form ADV, 
Part 2 (requires disclosure of material conflict of interest if the 
adviser receives compensation from or has other business 
relationships with other advisers).
    \329\ The Disclosure Obligation requires that a broker-dealer 
disclose in writing all material facts about the scope and terms of 
its relationship with a retail customer, including the material fees 
and costs the customer will incur as well as all material facts 
relating to its conflicts of interest associated with the 
recommendation, including third-party payments and compensation 
arrangements. See Regulation Best Interest Release, supra footnote 
146, at 14. See also infra section II.C.5. (discussing exemptions).
    \330\ See infra section II.C.5. (discussing exemptions). To the 
extent that a broker-dealer's testimonial or endorsement under rule 
206(4)-1 is a recommendation to a retail customer of a securities 
transaction or investment strategy involving securities by a broker-
dealer, the Disclosure Obligation under Regulation BI would apply to 
the broker-dealer's testimonial or endorsement.
---------------------------------------------------------------------------

    We had proposed under the solicitation rule to require disclosure 
of the amount of any additional cost to the investor as a result of the 
testimonial or endorsement. We did not receive any comments on this 
proposed requirement. After further contemplation, we believe that such 
a requirement under the final rule, which would apply to all 
testimonials and endorsements, would create burdens that are not 
commensurate with the benefits of the disclosure and are accordingly 
eliminating this requirement.\331\ Such costs could vary by client and 
over time, making it difficult for advisers to disclose concisely in an 
advertisement. Moreover, to the extent that an adviser knows or 
reasonably should know that an investor would pay increased advisory 
fees as a result of its compensation arrangement or relationship with a 
promoter, then such disclosures would be made under another provision 
of the rule as discussed above.\332\
---------------------------------------------------------------------------

    \331\ This will be a change from the current solicitation rule's 
requirement that the solicitor state whether the client will pay a 
specific fee to the adviser in addition to the advisory fee, and 
whether the client will pay higher advisory fees than other clients 
(and the difference in such fees) because the client was referred by 
the solicitor. See current rule 206(4)-3(b)(6).
    \332\ See section II.C.2.b. (discussing material terms of 
compensation arrangement disclosure).
---------------------------------------------------------------------------

d. Reasonable Belief
    Under the final rule, an adviser that does not provide the required

[[Page 13052]]

disclosures must reasonably believe that the promoter discloses the 
required information. We proposed a reasonable belief standard under 
the advertising rule and continue to believe that the standard is 
appropriate in ensuring that the required disclosures are 
provided.\333\
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    \333\ See proposed rule 206(4)-1(b)(1) and (2) (each requiring a 
reasonable belief standard for investment advisers). See also 
proposed rule 206(4)-3(a)(2) (requiring a reasonable basis for 
believing that solicitor has complied with the written agreement 
requirement).
---------------------------------------------------------------------------

    To have a reasonable belief, an adviser may provide the required 
disclosures to a promoter and seek to confirm that the promoter 
provides those disclosures to investors. For example, if a blogger or 
social media influencer is endorsing and referring clients to the 
adviser through his or her website or platform, the adviser may provide 
such blogger or influencer with the required disclosures and confirm 
that they are provided appropriately on his or her respective pages. 
The adviser may choose to include provisions in its written agreement 
with the promoter, requiring the promoter to provide the required 
disclosures to investors.\334\ The aforementioned ways are only 
examples of how an adviser may demonstrate that it has a reasonable 
belief.
---------------------------------------------------------------------------

    \334\ See final rule 206(4)-1(b)(2)(ii). To the extent that the 
promoter's testimonial or endorsement falls under the de minimis 
exemption, advisers would not be required to, but may choose to, 
enter into a written agreement and include such provisions. Final 
rule 206(4)-1(b)(2)(ii) and (b)(4)(i).
---------------------------------------------------------------------------

e. Timing of Disclosures
    Under the final rule, the required disclosures with respect to 
testimonials and endorsements must be delivered at the time the 
testimonial or endorsement is disseminated.\335\ The proposed 
solicitation rule would have required delivery of a separate solicitor 
disclosure at the time of any solicitation activities (or in the case 
of a mass communication, as soon as reasonably practicable 
thereafter).\336\ Given that the final rule requires certain 
disclosures to be included within the testimonial or endorsement per 
the clear and prominent standard, rather than delivered separately, as 
discussed below, we are not adopting the proposed alternative to 
provide the disclosures as soon as reasonably practicable thereafter in 
the case of mass communications.
---------------------------------------------------------------------------

    \335\ Final rule 206(4)-1(b)(1). This is similar to the existing 
cash solicitation rule, which requires that the solicitor disclosure 
be delivered at the time of any solicitation activities. See current 
rule 206(4)-3(a)(2)(iii)(A).
    \336\ Proposed rule 206(4)-3(a)(1)(iii).
---------------------------------------------------------------------------

    We continue to believe the timing of disclosures is important.\337\ 
If the disclosures are not provided at the time the testimonial or 
endorsement is disseminated, many of the disclosures may not have the 
same impact on investors.\338\ Some commenters to the proposed 
solicitation rule suggested that the rule require delivery of solicitor 
disclosure after a prospective client expresses interest in the 
adviser's services or becomes a client of the adviser, rather than at 
the time of solicitation.\339\ We decline to make this change as we 
continue to believe these disclosures should be provided at the time of 
dissemination of the testimonial or endorsement to protect against 
investor confusion.\340\
---------------------------------------------------------------------------

    \337\ The timing for several aspects of the proposed 
solicitation rule was ``at the time'' of solicitation. See 2019 
Proposing Release, supra footnote 7, at section II.B.4 (discussing 
solicitor disclosure), section II.B.5. (discussing written 
agreement), section II.B.6. (discussing adviser oversight and 
compliance) and section II.B.7 (discussing disqualification).
    \338\ The current solicitation rule requires that the solicitor 
deliver the solicitor disclosure ``at the time of any solicitation 
activities.'' Rule 206(4)-3(a)(2)(ii).
    \339\ See IAA Comment Letter; Flexible Plan Investments Comment 
Letter I (``. . . delivery should simply be required before the 
recipient of the solicitation or referral becomes a client of the 
adviser.''); Nesler Comment Letter.
    \340\ The exemption for broker-dealers subject to Regulation BI 
would allow for the related disclosures to be provided prior to or 
at the time of a recommendation, which may, in some cases, precede a 
particular testimonial or endorsement for private fund investors. 
However, unless the broker-dealer had made previous recommendations 
subject to Regulation BI to the investor, the testimonial or 
endorsement would likely be the first time the investor is receiving 
the disclosure. See Regulation Best Interest Release, supra footnote 
146 (``Broker-dealers could meet the Disclosure Obligation by making 
certain required disclosures of information regarding conflicts of 
interest to their customers at the beginning of a relationship, and 
this form of disclosure may be standardized. However, if 
standardized disclosure, provided at such time, does not 
sufficiently identify the material facts relating to conflicts of 
interest associated with any particular recommendation, the 
disclosure would need to be supplemented so that such disclosure is 
tailored to the particular recommendation.'').
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f. No Separate Disclosure Requirement
    We are not adopting the proposed requirement for a separate 
solicitor's disclosure.\341\ In light of the merger of the advertising 
and solicitation rules, we believe that requiring certain disclosures 
be provided clearly and prominently within the testimonial or 
endorsement, and other disclosures be otherwise provided, is a more 
practical and effective approach to informing investors and 
clients.\342\ For example, if an adviser compensates a podcast host for 
endorsing the adviser in its podcast or as an advertisement during the 
podcast, including certain of the required disclosures in the podcast 
itself would give greater prominence to these disclosures and have a 
greater impact on the potential investor than a separate disclosure 
document with all of the required disclosures.
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    \341\ See proposed rule 206(4)-3(a)(1)(iii). The current 
solicitation rule also requires delivery of a separate disclosure.
    \342\ See final rule 206(4)-1(b)(1)(i). See also section 
II.C.2.a. (discussing clear and prominent standard).
---------------------------------------------------------------------------

    Commenters raised concerns about separate solicitor disclosure, 
noting that the extra documentation would burden investment advisers 
and overwhelm clients.\343\ These commenters also suggested providing 
flexibility to include the disclosures within other solicitation 
materials or incorporating the solicitor disclosure into other required 
disclosures, such as the Form ADV Part 2A. We believe that it would 
reduce the effectiveness of the disclosures for testimonials and 
endorsements to allow them all to be included within other solicitation 
materials given our view that particular disclosures should be provided 
clearly and prominently.
---------------------------------------------------------------------------

    \343\ See, e.g., MFA/AIMA Comment Letter I; SIFMA AMG Comment 
Letter I (responding to our request for comment in the Proposing 
Release as to whether the disclosure should be separate, as 
proposed).
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    In a change from the proposal, the final rule will not permit the 
delivery of the solicitor disclosure as soon as reasonably practicable 
after the time of any solicitation activities in the case of a mass 
communication. We believe that the changes under the final rule, such 
as the elimination of a separate disclosure requirement, eliminate the 
need to provide a different delivery requirement for the required 
disclosures. In fact, as noted above, we believe that the required 
disclosures should be provided at the time that such testimonial or 
endorsement is disseminated in all cases in order to have a meaningful 
impact on investors.
    Under the proposed solicitation rule, either the adviser or the 
solicitor would have been able to give the disclosures. Commenters 
generally supported this flexibility.\344\ Accordingly, under the final 
rule, either the adviser or the promoter may provide the required 
disclosures, subject to the other conditions of the rule.\345\ We do 
not believe the impact of the disclosures will be undermined by 
permitting either

[[Page 13053]]

the adviser or the promoter to provide the disclosures.
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    \344\ See, e.g., SIFMA AMG Comment Letter I; IAA Comment Letter.
    \345\ See final rule 206(4)-1(b)(1). This is also similar to the 
proposed advertising rule, which required that the investment 
adviser clearly and prominently disclose or reasonably believe that 
the testimonial or endorsement clearly and prominently disclosed 
certain information. See proposed rule 206(4)-1(b)(1).
---------------------------------------------------------------------------

    Our final rule does not require an adviser or promoter to present 
the required disclosures in paper.\346\ One commenter stated that an 
investor would not grasp the importance of the disclosure if it is not 
in a paper document.\347\ We disagree that electronic or oral 
communication cannot be effective. We believe that providing 
flexibility regarding disclosure format is necessary to allow the 
disclosures to be provided at the time of dissemination of a 
testimonial or endorsement. We also believe that our adopted disclosure 
requirements will be adaptable to different types of testimonial and 
endorsement arrangements. Because disclosures must be clear and 
prominent, the final rule mitigates concerns that investors will not 
read or hear electronic disclosures.
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    \346\ If the disclosures are made in writing, we have stated 
that an ``in writing'' requirement could be satisfied either through 
paper or electronic means consistent with existing Commission 
guidance on electronic delivery of documents. See Regulation Best 
Interest Release, supra footnote 146, at text accompanying nn.499-
500. If delivery of the required disclosure is made electronically, 
it should be done in accordance with the Commission's guidance 
regarding electronic delivery. See Use of Electronic Media by 
Broker-Dealers, Transfer Agents, and Investment Advisers for 
Delivery of Information; Additional Examples Under the Securities 
Act of 1933, Securities Exchange Act of 1934, and Investment Company 
Act of 1940, Release No. 34-37182 (May 9, 1996) [61 FR 24644 (May 
15, 1996)]; see also 2000 Release, supra footnote 43; and see also 
1995 Release, supra footnote 43.
    \347\ See NASAA Comment Letter (``Emails, text messages, instant 
messages, electronic presentations, videos, podcasts, and other 
modern methods of communications . . . do not adequately ensure that 
the investor will read, hear, or understand the importance of the 
disclosures. Furthermore, these and similar electronic 
communications are ill-suited to allowing the client to retain a 
copy of the disclosure in a form and location that can easily be 
recalled when necessary.'').
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    Regardless of the format, the adviser will be required, under the 
Act's books and records rule, to make and keep true, accurate, and 
current copies of the advertisement.\348\ In some circumstances, a copy 
of the advertisement (i.e., the testimonial or endorsement) may include 
all of the required disclosures with respect to the testimonial or 
endorsement.\349\ In the case of a compensated oral testimonial or 
endorsement, the adviser may, instead of recording and retaining the 
entire oral testimonial or endorsement, make and keep a record of the 
disclosures provided to investors.\350\ Additionally, in response to 
one commenter,\351\ we are clarifying that if an adviser disseminates 
the required disclosures orally in connection with an oral testimonial 
or endorsement, the adviser may choose, consistent with applicable law, 
to record the oral disclosures either prior to or at the time of the 
dissemination of the testimonial or endorsement.\352\
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    \348\ To the extent that a testimonial or endorsement is 
disseminated by an adviser indirectly through a third party, an 
adviser should retain such records as well. See final rule 204-
2(a)(11)(i)(A), which requires that advisers retain a copy of each 
advertisement.
    \349\ In addition to the disclosures that are required to be 
provided clearly and prominently within the testimonial or 
endorsement, an adviser may choose to provide the other disclosures 
that are not subject to the clear and prominent standard within the 
testimonial or endorsement. See supra section II.C.2.a. (discussing 
clear and prominent standard). In circumstances in which an adviser 
does not provide the other disclosures within the advertisement, an 
adviser would be required to maintain such disclosures under the 
recordkeeping rule. See final rule 204-2(a)(15)(i).
    \350\ See final rule 204-2(a)(11)(i)(A)(2). If the required 
disclosures are provided in a written format, then only the written 
disclosures would need to be maintained. If the required disclosures 
are provided orally, however, this record need not necessarily be an 
actual recording of the oral disclosures provided, but must contain 
the fact that the oral disclosures were provided, the substance of 
what was provided, and when.
    \351\ See Nesler Comment Letter (asking the Commission to 
clarify that if disclosures are provided orally, such disclosure in 
oral form needs to be recorded prior to being provided to a client, 
and not at the time it is provided to the client).
    \352\ In order to avoid duplicative records, advisers may 
maintain records of a script or reading of a script of disclosures 
provided orally.
---------------------------------------------------------------------------

3. Adviser Oversight and Compliance
    All testimonials and endorsements, including those that are 
compensated and those that are uncompensated and meet prong one of the 
definition of advertisement, will be subject to an adviser oversight 
and compliance provision under the final rule.\353\ The final rule will 
require the investment adviser to have: (i) A reasonable basis for 
believing that any testimonial or endorsement complies with the 
requirements of the rule, and (ii) a written agreement with any person 
giving a compensated testimonial or endorsement that describes the 
scope of the agreed upon activities and the terms of the compensation 
for those activities when the adviser is providing compensation for 
testimonials and endorsements that is above the de minimis 
threshold.\354\ The oversight requirement we are adopting is similar to 
the proposed oversight requirement and the current solicitation rule's 
oversight requirement, but differs in several respects to address 
commenters' concerns and to reflect the merger of the two rules.\355\
---------------------------------------------------------------------------

    \353\ Final rule 206(4)-1(b)(2) and (4).
    \354\ Final rule 206(4)-1(b)(2).
    \355\ See current rule 206(4)-3(a)(2)(iii)(C) (requiring that 
the investment adviser make a bona fide effort to ascertain whether 
the solicitor has complied with the agreement, and have a reasonable 
basis for believing that the solicitor has so complied.).
---------------------------------------------------------------------------

    First, the adviser oversight condition will require that the 
adviser have a reasonable basis for believing that the testimonial or 
endorsement complies with the requirements of the final rule, rather 
than the terms of a written agreement as proposed. The proposal would 
have replaced the solicitation rule's current requirement that the 
written agreement contain an undertaking by the solicitor to perform 
its duties under the agreement in a manner consistent with the 
provisions of the Act and the rules thereunder with the requirement 
that the solicitor agree to perform its solicitation activities in 
accordance with sections 206(1), (2), and (4) of the Act.\356\ We 
believe that explicitly requiring advisers to oversee third-party 
advertisements for compliance with the specific restrictions and 
requirements in the marketing rule, rather than the broader anti-fraud 
provisions, more appropriately and precisely addresses the risks posed 
by such advertisements.
---------------------------------------------------------------------------

    \356\ See rule 206(4)-3(a)(2)(iii)(C).
---------------------------------------------------------------------------

    The question of what would constitute a reasonable basis for 
believing that the testimonial or endorsement complies with the 
requirements of the final rule would depend upon the facts and 
circumstances. For instance, in the context of solicitation or referral 
activity, we believe that, as under the solicitation rule, a reasonable 
basis could involve periodically making inquiries of a sample of 
investors solicited or referred by the promoter in order to assess 
whether that promoter's statements comply with the rule.\357\ An 
adviser could implement policies and procedures to form a reasonable 
basis for believing the testimonial or endorsement complies with the 
rule. An adviser also could include terms in its written agreement with 
the promoter to help form such a reasonable belief. Such agreements 
could provide mechanisms, for example, to enable advisers to pre-review 
testimonials or endorsements, or otherwise impose limitations on the 
content of those statements.\358\
---------------------------------------------------------------------------

    \357\ 1979 Adopting Release, supra footnote 3, accompanying 
nn.14 and 15.
    \358\ However, the oversight requirement contains two prongs 
with separate obligations. Although certain mechanisms in the 
written agreement, if implemented, could lead the adviser to have a 
reasonable basis for believing that any testimonial or endorsement 
complies with the requirements of the rule, having a written 
agreement by itself would not satisfy the first prong of the 
oversight requirement.
---------------------------------------------------------------------------

    Second, the final rule will require that an adviser pay any 
compensation over

[[Page 13054]]

the de minimis threshold for a testimonial or endorsement pursuant to a 
written agreement with the person (aside from certain affiliates) 
giving the testimonial or endorsement. As proposed, the final rule will 
require that the written agreement describe the scope of the agreed 
upon activities and the terms of the compensation for those activities. 
Also as proposed, the final rule will not require that the written 
agreement require the promoter to deliver the adviser's brochure. We 
continue to believe that this requirement is duplicative of an 
adviser's delivery obligation under rule 204-3, the Act's brochure 
rule.
    The final rule, however, will not require that the written 
agreement require the promoter to deliver a separate written disclosure 
document as proposed (and as required under the current solicitation 
rule).\359\ Instead we are requiring advertisements that include 
testimonials or endorsements to provide certain disclosures at the time 
they are disseminated. Thus, we do not believe the rule should also 
prescribe in the written agreement that these disclosures are delivered 
in a separate document.\360\ In many cases, we believe the adviser 
itself will be providing the disclosures. Therefore, this approach will 
provide the adviser with flexibility in determining whether and how to 
address these disclosures in its written agreement with a promoter.
---------------------------------------------------------------------------

    \359\ See rule 206(4)-3(a)(2)(iii); see proposed rule 206(4)-
3(a)(1).
    \360\ See supra section II.C.2.f.
---------------------------------------------------------------------------

    Consistent with the final rule's principles-based approach, this 
streamlined requirement provides more flexibility for an adviser to 
determine how to tailor its written agreement with its promoters.\361\ 
We believe that advisers are better situated to tailor their oversight 
approach based on the types of testimonials and endorsements used and 
the risks in their particular arrangements. For the same reasons, as 
proposed, the final rule will not incorporate the current solicitation 
rule's requirement for the adviser to obtain a signed and dated 
acknowledgment from the client that the client has received the 
required disclosure.\362\ This principles-based approach is consistent 
with the Act's compliance rule, which requires advisers to adopt and 
implement compliance policies and procedures, but does not mandate 
specific elements of such policies and procedures.\363\
---------------------------------------------------------------------------

    \361\ For example, the written agreement requirement could be 
met through a written private placement agreement that describes the 
scope of the agreed upon activities and the terms of the 
compensation for those activities.
    \362\ See rule 206(4)-3(a)(2)(iii)(B).
    \363\ Under the compliance rule, each adviser that is registered 
or required to be registered under the Act is required to adopt and 
implement written policies and procedures reasonably designed to 
prevent the adviser and its supervised persons from violating the 
Advisers Act and the rules thereunder. Rule 206(4)-7. See 2019 
Proposing Release, supra footnote 7, at section II.B.6. Advisers 
should address their marketing practices in their policies and 
procedures under the compliance rule.
---------------------------------------------------------------------------

    One commenter supported a flexible and principles-based approach to 
adviser oversight.\364\ Several commenters supported our proposed 
approach to streamline the required provisions of the written 
agreement, such as by removing the provision requiring the solicitor to 
deliver the adviser's brochure.\365\ Another commenter opposed the 
proposed requirement that the written agreement require the adviser to 
oversee the solicitor for compliance with the Act's anti-fraud 
provisions, arguing that this is a regulatory function, not an advisory 
function.\366\ Some commenters also specifically supported removing the 
current rule's requirement that an adviser obtain a signed and dated 
acknowledgment.\367\ Two commenters, however, opposed the proposed 
oversight requirement, arguing that it would be burdensome and 
overbroad to require the adviser to oversee compliance with a written 
agreement.\368\ One commenter argued that it would impose a new 
monitoring cost on advisers, which they will ultimately pass along to 
investors.\369\ Another commenter claimed that requiring advisers to 
contact a sample of clients to ascertain whether solicitors were 
complying with the written solicitation agreement would be awkward and 
burdensome.\370\
---------------------------------------------------------------------------

    \364\ MFA/AIMA Comment Letter I.
    \365\ Mercer Comment Letter; SIFMA AMG Comment Letter II; Nesler 
Comment Letter; IAA Comment Letter.
    \366\ Mercer Comment Letter.
    \367\ MFA/AIMA Commenter Letter I; SIFMA AMG Comment Letter II.
    \368\ Mercer Comment Letter; SIFMA AMG Comment Letter II.
    \369\ SIFMA AMG Comment Letter II.
    \370\ Mercer Comment Letter.
---------------------------------------------------------------------------

    We believe the modifications to the adviser oversight condition 
discussed above address commenters' concerns. These changes are 
consistent with our overall approach to shift to a principles-based 
rule and leverage the Act's existing compliance rule.\371\ We disagree 
with commenters' assertion that this oversight requirement imposes a 
novel burden on advisers or is not an advisory function, considering 
the current solicitation rule's oversight provision and the Advisers 
Act compliance rule. We continue to believe that the oversight 
provision will protect investors' interests by requiring advisers to 
monitor third-party statements that constitute adviser advertisements 
(whether compensated or uncompensated) for compliance with the rule's 
requirements, especially when the adviser does not disseminate the 
testimonials or endorsements directly.\372\
---------------------------------------------------------------------------

    \371\ Rule 206(4)-7. See Compliance Programs of Investment 
Companies and Investment Advisers, Release No. IA-2204 (Dec. 17, 
2003) [68 FR 74714 (Dec. 24, 2003)] (``Compliance Program Adopting 
Release'').
    \372\ In addition, any endorsements and testimonials by third 
parties that are advertisements, or are part of an advertisement, 
will be subject to the recordkeeping obligations of rule 204-2, as 
discussed below. See infra section II.I.
---------------------------------------------------------------------------

4. Disqualification for Persons Who Have Engaged in Misconduct
    The final marketing rule prohibits an adviser from compensating a 
person, directly or indirectly, for a testimonial or endorsement if the 
adviser knows, or in the exercise of reasonable care should know, that 
the person giving the testimonial or endorsement is an ineligible 
person at the time the testimonial or endorsement is disseminated.\373\ 
Under the final rule, an ``ineligible person'' is a person who is 
subject either to a ``disqualifying Commission action'' or to any 
``disqualifying event,'' \374\ and, as discussed below, certain of that 
person's employees and other persons associated with an ineligible 
person.
---------------------------------------------------------------------------

    \373\ Final rule 206(4)-1(b)(3).
    \374\ Final rule 206(4)-1(e)(9). See final rule 206(4)-1(e)(3) 
and (4) for the defined terms ``disqualifying Commission action'' 
and ``disqualifying event.''
---------------------------------------------------------------------------

    The final marketing rule's disqualification provisions follow a 
structure similar to the proposed solicitation rule's disqualification 
provisions, with the following changes. First, to reflect the 
incorporation of solicitation and referral activities into the final 
marketing rule's definitions of endorsements and testimonials, the 
final rule applies the disqualification provisions to persons providing 
compensated testimonials and endorsements (i.e., compensated 
promoters). Second, under the final rule, certain Commission cease and 
desist orders will be disqualifying events (rather than disqualifying 
Commission actions, as proposed), and compensated promoters subject 
thereto may be eligible for the final rule's conditional carve-out 
applicable to disqualifying events. Third, the final rule conforms the 
proposed ten-year lookback period across all disqualifying events, 
aligning to advisers' disciplinary

[[Page 13055]]

disclosure reporting on Form ADV Part 1A.\375\ Fourth, the final rule's 
definition of ineligible person will not apply to certain control 
affiliates of the ineligible person. Fifth, the final rule will exempt 
from the disqualification provisions compensated promoters that are 
broker-dealers registered with the Commission in accordance with 
section 15(b) of the Exchange Act, provided that they are not subject 
to statutory disqualification as defined in the Exchange Act. It will 
also exempt any person covered by rule 506(d) of Regulation D with 
respect to a rule 506 securities offering, provided the person's 
involvement would not disqualify the offering under that rule.\376\
---------------------------------------------------------------------------

    \375\ Commenters' requests for not applying the proposed rule to 
certain existing solicitation arrangements are addressed in a 
separate section, below.
    \376\ See rule 506(d) of Regulation D under the Securities Act 
(``rule 506(d) of Regulation D''). Consistent with the approach 
discussed below, the final rule's disqualification provision, 
paragraph (b)(3), will not disqualify any broker-dealer or any 
covered person for purposes of the final rule for any matter(s) that 
occurred prior to the effective date of the rule, if such matter(s) 
would not have disqualified such person under rule 206(4)-
3(a)(1)(ii), as in effect prior to the effective date of the rule. 
See infra section II.C.4.f.
---------------------------------------------------------------------------

    Commenters generally supported the disqualification of compensated 
promoters that are ``bad actors,'' noting the importance of protecting 
investors from their influence in soliciting clients or investors for 
investment advisers.\377\ We believe compensated testimonials and 
endorsements raise the same concerns about misleading investors as 
compensated solicitations, and the final rule treats solicitations 
within the scope of the terms testimonial and endorsement. We are 
therefore adopting a final rule that prohibits advisers from 
compensating bad actors for testimonials and endorsements, including 
solicitations.
---------------------------------------------------------------------------

    \377\ See NAPFA Comment Letter; NRS Comment Letter; MFA/AIMA 
Comment Letter I; IAA Comment Letter; SIFMA AMG Comment Letter I; 
MMI Comment Letter; Consumer Federation Comment Letter. Some 
commenters, however, disagreed with particular aspects of the 
proposed disqualification provisions, discussed below.
---------------------------------------------------------------------------

    We did not propose, and we are not adopting, disqualification 
provisions for providers of uncompensated testimonials and 
endorsements. It has been, and continues to be, our view that the 
disqualification provisions are needed most where there are financial 
incentives for a promoter to engage in fraudulent conduct to persuade 
an investor to hire an investment adviser or invest in an investment 
adviser's private fund.\378\ For testimonials and endorsements that 
lack financial incentives, we believe the burden of assessing whether a 
promoter is disqualified would likely not be justified by the risk that 
the promoter would engage in fraudulent conduct. We believe that the 
final rule's other provisions applicable to testimonials and 
endorsements (i.e., required disclosures and adviser oversight and 
compliance), in combination with the final marketing rule's general 
prohibitions, are sufficient to address the risks that uncompensated 
testimonials and endorsements may present in misleading investors.
---------------------------------------------------------------------------

    \378\ See 2019 Proposing Release, supra footnote 7, at text 
accompanying nn.26-27.
---------------------------------------------------------------------------

    Some commenters recommended that the proposed solicitation rule 
exempt registered broker-dealers altogether, stating that applying the 
rule to broker-dealers would result in duplicative regulation.\379\ 
Some also recommended that the Commission conform the final rule to the 
disqualifying events set forth in rule 506(d) of Regulation D under the 
Securities Act \380\ for solicitors of investors in private funds who 
would be newly subject to the solicitation rule, or that we provide an 
exemption from the final rule's disqualification provisions for persons 
that are subject to rule 506 of Regulation D.\381\ They stated that 
having one set of disqualifying events for solicitors that are subject 
to both the final solicitation rule and rule 506 of Regulation D would 
streamline compliance processes for such solicitors.
---------------------------------------------------------------------------

    \379\ See e.g., MFA/AIMA Comment Letter I; Sidley Austin Comment 
Letter; SIFMA AMG Comment Letter I. See also infra section II.C.5, 
which discusses commenters' concerns about overlapping requirements 
for broker-dealers, particularly with respect to disclosures. One 
commenter stated that most solicitors who place private fund 
interests are broker-dealers already subject to the statutory 
disqualifications in section 3(a)(39) of the Exchange Act, but did 
not comment on the comparability of the statutory disqualification 
provisions. See IAA Comment Letter.
    \380\ See rule 506(d) of Regulation D.
    \381\ See MMI Comment Letter; SIFMA AMG Comment Letter I & III; 
FSI Comment Letter; Credit Suisse Comment Letter. Another 
alternative that commenters suggested was codification of existing 
no-action letters for broker-dealers and other solicitors. See infra 
section II.C.4.e (discussing the final rule's conditional exception 
from the definition of disqualifying event).
---------------------------------------------------------------------------

    As discussed below, we agree that registered broker-dealers acting 
as compensated promoters need not be subject to the disqualification 
provisions of both the Advisers Act marketing rule and the Exchange 
Act.\382\ Accordingly, the final rule contains an exemption from the 
disqualification provisions for registered broker-dealers, provided 
they are not subject to a statutory disqualification under the Exchange 
Act's disqualification provisions. We similarly agree that persons 
covered by rule 506(d) of Regulation D with respect to a rule 506 
securities offering need not be subject to both the disqualification 
provisions of the Advisers Act marketing rule and the bad actor 
disqualification provisions of rule 506 of Regulation D with respect to 
their participation in the offering.\383\ Accordingly, the final rule 
also contains an exemption from the disqualification provisions for any 
person that is covered by rule 506(d) of Regulation D with respect to a 
rule 506 securities offering, provided the person's involvement would 
not disqualify the offering under that rule.\384\ This exemption 
applies to persons covered by rule 506(d) of Regulation D only to the 
extent they are acting thereunder in a rule 506 securities offering. 
For example, a broker-dealer acting as a placement agent for a private 
fund in a rule 506 securities offering that is covered by this 
exemption will only be covered with respect to the broker-dealer's 
testimonials and endorsements made in its capacity under rule 506(d) of 
Regulation D as part of the offering.
---------------------------------------------------------------------------

    \382\ See infra section II.C.5.c. (discussing that broker-
dealers are subject to disqualification for a variety of misconduct 
under the Exchange Act section 3(a)(39), that the Exchange Act is 
particularized to broker-dealer activity, and that we believe such 
disqualification provisions will serve the same policy goal as the 
disqualification provisions under this rule).
    \383\ See id. (discussing that these covered persons are subject 
to disqualification for a variety of misconduct under rule 506(d) of 
Regulation D, that rule 506(d) of Regulation D is particularized to 
activities in connection with certain securities offerings, and that 
we believe such disqualification provisions will serve the same 
policy goal as the disqualification provisions under this rule).
    \384\ Final rule 206(4)-1(b)(4)(iv). See rule 506(d)(1) of 
Regulation D. See also infra section II.C.5.
---------------------------------------------------------------------------

    While we believe these exemptions will avoid regulatory overlap 
that would yield little benefit, we recognize that each 
disqualification regime is unique and will apply differently to 
compensated promoters regulated thereunder.\385\ Because each

[[Page 13056]]

disqualification regime is particularized to the activity thereunder, 
our final rule's exemptions defer to these other disqualification 
provisions where applicable.
---------------------------------------------------------------------------

    \385\ For example, the final rule's disqualification provisions 
and rule 506 of Regulation D apply to certain Commission orders that 
restrict a person's activities (e.g., supervisory or compliance bars 
or suspensions), whereas the Exchange Act's disqualification 
provisions do not. See, e.g., final rule 206(4)-1(e)(3); rule 
506(d)(1)(ii); section 3(a)(39) of the Exchange Act. In addition, 
the Exchange Act disqualification provisions are triggered by 
activities of employees and other associated persons, similar to the 
final rule's application to ``ineligible persons,'' but rule 506 of 
Regulation D is triggered by events involving partners, directors, 
and certain officers, but not other employees or associated persons. 
See final rule 206(4)-1(e)(9)(i)(A); rule 506(d)(1); section 
3(a)(39)(E) of the Exchange Act. As another example, while the look-
back periods under the final rule and the Exchange Act's statutory 
disqualification extend for ten years, some of the look-back periods 
under rule 506 of Regulation D extend for ten years, and others 
extend only for five years. See, e.g., final rule 206(4)-1(e)(4); 
rule 506(d)(1)(i) and (ii); section 3(a)(39)(F) of the Exchange Act.
---------------------------------------------------------------------------

a. Knowledge or Reasonable Care Standard
    No commenters objected to the proposed solicitation rule's 
introduction of a knowledge or reasonable care standard for the 
disqualification provisions, which we proposed to replace the current 
solicitation rule's strict liability standard.\386\ One commenter 
specifically supported the proposed standard.\387\ Others commented on 
the proposal's requirement that an adviser make the assessment about a 
solicitor's eligibility status ``at the time of solicitation.'' \388\ 
One commenter supported this timing,\389\ while another commenter 
stated that this timing would present an undue burden on advisers that 
may interpret the provision as requiring continuous monitoring of their 
solicitors.\390\ Another commenter agreed with the Commission's 
approach in the proposal to not prescribe the level, method, or 
frequency of required due diligence.\391\
---------------------------------------------------------------------------

    \386\ See 2019 Proposing Release, supra footnote 7, at text 
accompanying n.456. Under the proposed solicitation rule, an adviser 
could not compensate a solicitor, directly or indirectly, for any 
solicitation activity if the adviser knows, or, in the exercise of 
reasonable care, should have known, that the solicitor is an 
ineligible solicitor. See proposed rule 206(4)-3(a)(3).
    \387\ See NRS Comment Letter.
    \388\ See NAPFA Comment Letter; FSI Comment Letter; MFA/AIMA 
Comment Letter I. Under the proposed solicitation rule, the 
definition of ``ineligible solicitor'' meant, in part, ``[a] person 
who at the time of the solicitation is subject to a disqualifying 
Commission action or is subject to any disqualifying event.'' 
Proposed rule 206(4)-3(a)(3)(ii)(A).
    \389\ See NAPFA Comment Letter.
    \390\ See MFA/AIMA Comment Letter I (stating that a requirement 
to make an assessment at the time of solicitation would exceed the 
``reasonable care'' standard).
    \391\ See FSI Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that including a reasonable care standard 
preserves the benefits of a disqualification provision, while reducing 
the likelihood that advisers will inadvertently violate the provision 
(i.e., due to disqualifying events that they would not, even in the 
exercise of reasonable care, have known existed). Our final marketing 
rule generally maintains the proposed solicitation rule's knowledge or 
reasonable care standard with one modification to reflect its 
application to compensated testimonials and endorsements.\392\ Instead 
of tying the standard to the ``time of solicitation,'' the final 
marketing rule ties it to the time the compensated endorsement or 
testimonial is disseminated.\393\ We believe this timing is appropriate 
because it mirrors the timing of the final marketing rule's required 
disclosures for testimonials and endorsements.\394\ Furthermore, we 
believe that the time of dissemination is often when a compensated 
testimonial or endorsement by a bad actor could mislead a client or 
investor. For example, if a person provides a compensated testimonial 
or endorsement of an adviser in a face-to-face meeting with a potential 
advisory client, the time of dissemination (i.e., the meeting) is the 
point at which the client could be misled.
---------------------------------------------------------------------------

    \392\ The proposed solicitation rule defined ``ineligible 
solicitor'', in part, as a person who ``at the time of the 
solicitation'' is subject to a disqualifying Commission action or is 
subject to any disqualifying event. See proposed rule 206(4)-
3(a)(3)(ii)(A).
    \393\ See final rule 206(4)-1(b)(3). The final marketing rule 
also moves the timing of the reasonable care requirement to the 
operative disqualification provision, instead of including it within 
the definition of ``ineligible person.'' See id.
    \394\ Final rule 206(4)-1(b)(1). See supra section II.C.2.
---------------------------------------------------------------------------

    In some instances, an adviser may be obligated to compensate the 
promoter for a period after the dissemination of a testimonial or 
endorsement. For example, a promoter may continue to receive trailing 
compensation as a percentage of a client's assets under management with 
the adviser for the duration of time that client continues to use the 
adviser. If a compensated promoter was subject to a disqualifying event 
or disqualifying Commission action at the time of dissemination, but 
the adviser did not know, or have reason to know, of such event, then 
the adviser may make trailing payments resulting from such 
dissemination.\395\
---------------------------------------------------------------------------

    \395\ Under the final marketing rule, an adviser may pay 
trailing compensation for solicitations that were made prior to the 
marketing rule's effective date, provided the adviser complied with 
rule 206(4)-3 as in effect at the time. For example, if a solicitor 
was not disqualified under rule 206(4)-3 at the time of a 
solicitation, but the solicitor would have been an ineligible person 
at the time of solicitation under the final marketing rule solely 
because of a change in the scope of events that trigger 
disqualification, the adviser may provide trailing compensation. 
Commenters advocated for this approach. See IAA Comment Letter; MMI 
Comment Letter.
---------------------------------------------------------------------------

    The final marketing rule will not require an adviser to monitor the 
eligibility of compensated promoters on a continuous basis, as one 
commenter suggested. The frequency with which an adviser must monitor 
eligibility and the steps an adviser must take in making this 
assessment will vary depending on what constitutes the exercise of 
reasonable care in a particular set of facts and circumstances. 
Advisers could likely take a similar approach to monitoring promoters 
as they take in monitoring their own supervised persons, though 
advisers may assess the eligibility of their supervised persons more 
frequently in light of their obligations to report promptly certain 
disciplinary events on Form ADV.\396\
---------------------------------------------------------------------------

    \396\ Registered investment advisers ascertain their supervised 
persons' disciplinary history in order to report disciplinary events 
on Form ADV, which advisers must update by filing additional 
amendments promptly if the disciplinary information becomes 
inaccurate in any way. See Form ADV: General Instructions. 
Instruction 4. Certain registered investment advisers are also 
required to deliver to retail investors a relationship summary 
disclosing information about the firm. See rule 204-5. Form ADV, 
Part 3 requires that an adviser state ``Yes'' if it or any of its 
financial professionals currently disclose, or are required to 
disclose, disciplinary information in its Form ADV, and that the 
adviser take certain steps to update its relationship summary and 
inform the Commission and its retail investors whenever any 
information in the relationship summary becomes materially 
inaccurate. See Form ADV, Part 3: Instructions to Form CRS, General 
Instruction 8 and Item 4. In addition, if a person is subject to 
certain disciplinary events and the Commission has issued an order 
that, for example, censures or places limitations on the activities 
of that person, it is unlawful for any investment adviser to permit 
such a person to become, or remain, a person associated with the 
investment adviser without the consent of the Commission, if such 
investment adviser knew, or in the exercise of reasonable care, 
should have known, of such order. See section 203(f) of the Act.
---------------------------------------------------------------------------

    The frequency of inquiry could vary depending upon, for example, 
the risk that a person could become an ineligible person and the impact 
of other screening and compliance mechanisms already in place.\397\ In 
some cases where an endorsement or testimonial is posted on a public 
website and disseminated over a long period, it may not be practical 
for an adviser to update its inquiry continuously. In this case, we 
would expect an adviser to update its inquiry into the compensated 
promoter's eligibility at least annually while the endorsement or 
testimonial is available to clients and investors in order to 
demonstrate that it did not know, or have reason to know, that the 
promoter was ineligible at the time of dissemination.\398\ If the 
adviser has reason to believe that the compensated promoter is an 
ineligible person, then the exercise of reasonable care would require 
the adviser to inquire promptly

[[Page 13057]]

into the promoter's eligibility under the rule.\399\
---------------------------------------------------------------------------

    \397\ Advisers should address such methods in their policies and 
procedures under the Act's compliance rule. See rule 206(4)-7.
    \398\ However, this adviser would have to conduct its inquiry 
more often than annually if there is information or other indicators 
suggesting changes in circumstance that would be disqualifying under 
the rule.
    \399\ If a promoter notifies an adviser that it is subject to a 
disqualifying event or disqualifying Commission action, the adviser 
would have knowledge of the promoter's status as an ineligible 
person and the final rule would prohibit the adviser from 
compensating the promoter.
---------------------------------------------------------------------------

    Like the proposed solicitation rule, the final marketing rule will 
require that an adviser inquire into the relevant facts; however, it 
does not specify what method or level of due diligence or other inquiry 
is sufficient to exercise reasonable care. For example, advisers 
generally have an in-depth knowledge of their own personnel gained 
through the hiring process and in the course of the employment 
relationship. In such circumstances, further steps generally would not 
be required in connection with a compensated endorsement or testimonial 
by such personnel. Factual inquiry by means of questionnaires or 
certifications, perhaps accompanied by contractual representations, 
covenants and undertakings, may be sufficient in other circumstances, 
particularly if there is no information or other indicators suggesting 
bad actor involvement.
b. Ineligible Person
    Like the proposed solicitation rule, the final marketing rule 
applies the definition of ineligible person not only to the person 
subject to the disqualifying event or disqualifying Commission action, 
as both terms are discussed below, but also to certain persons 
associated with an ineligible person.\400\ An ineligible person 
includes a person who is subject to a disqualifying Commission action 
or is subject to any disqualifying event. It also includes any 
employee, officer, or director of an ineligible person and any other 
individuals with similar status or functions within the scope of 
association with an ineligible person. If the ineligible person is a 
partnership, the definition includes all general partners. If the 
ineligible person is a limited liability company managed by elected 
managers, the definition includes all elected managers. Unlike the 
proposed rule, the definition does not include persons that directly or 
indirectly control, or are controlled by, an ineligible person.
---------------------------------------------------------------------------

    \400\ See final rule 206(4)-1(e)(9). See also proposed rule 
206(4)-3(a)(3)(ii).
---------------------------------------------------------------------------

    One commenter supported the proposed definition of ineligible 
solicitor.\401\ Some commenters, however, expressed concern that the 
proposed solicitation rule would disqualify solicitors solely because 
their affiliates are ineligible solicitors, when their affiliates are 
not involved with or connected to the solicitation.\402\ These 
commenters stated that such potential disqualification would 
disadvantage larger, more established solicitors that have multiple 
affiliated entities, and that smaller standalone solicitors would 
therefore have a competitive advantage. They also stated that 
disqualification by affiliation, as proposed, would disadvantage 
investors through lack of choice.
---------------------------------------------------------------------------

    \401\ See NAPFA Comment Letter.
    \402\ See Credit Suisse Comment Letter; MFA/AIMA Comment Letter 
I; IAA Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we agree that the final rule should not 
apply to a disqualified person's control affiliates. These affiliates 
may operate independently from the person providing the compensated 
testimonial or endorsement, and may be uninvolved with an adviser's 
arrangement to compensate that person for the testimonial or 
endorsement. However, any compensation arrangement structured to avoid 
the final rule's restrictions, depending on the facts and 
circumstances, would violate section 208(d) of the Act's general 
prohibitions against doing anything indirectly which would be 
prohibited if done directly.\403\
---------------------------------------------------------------------------

    \403\ Section 208(d) of the Act.
---------------------------------------------------------------------------

    Under the final rule's definition of ineligible person, an entity 
that is not an ineligible person will not become an ineligible person 
solely because its employee, officer, or director (or an individual 
with a similar status or functions) is an ineligible person. However, 
any employee, officer, director, or person with similar status or 
functions that is an ineligible person may not directly or indirectly 
receive compensation for a testimonial or endorsement (e.g., by receipt 
of a share of profits the entity receives from the testimonial or 
endorsement, or as a bonus tied to the entity's overall profits without 
setting aside revenue from testimonials and endorsements).\404\
---------------------------------------------------------------------------

    \404\ See final rule 206(4)-1(b)(3). This principle also applies 
if the entity is a partnership, to all general partners; and if the 
entity is a limited liability company managed by elected managers, 
to all elected managers.
---------------------------------------------------------------------------

    In addition, we are clarifying that, in the case of an entity that 
is an ineligible person, the final rule's definition of ineligible 
person will apply to that entity's employees, officers, and directors 
(and persons with similar status or functions) associated with the 
ineligible person, but only within the scope of that association.\405\ 
In some cases, for example, an employee may be associated with two 
different firms, one of which is an ineligible person and the other is 
not. Under the final rule, if the employee is not herself an ineligible 
person, she may conduct compensated testimonial and endorsement 
activity on behalf of the firm that is not an ineligible person, 
because she would not be conducting that activity within the scope of 
her association with the ineligible person.
---------------------------------------------------------------------------

    \405\ Final rule 206(4)-1(e)(9) (defining ineligible person, in 
part, as ``[a] person who is subject to a disqualifying Commission 
action or is subject to any disqualifying event,'' and ``[a]ny 
employee, officer, or director of the ineligible person and any 
other individuals with similar status or functions within the scope 
of association with the ineligible person.'')
---------------------------------------------------------------------------

    The final marketing rule adopts, without change from the proposal, 
the provisions of the definition applying to general partners and 
elected managers of a partnership and limited liability company, 
respectively.\406\ Commenters did not respond to these aspects of the 
definition.
---------------------------------------------------------------------------

    \406\ Final rule 206(4)-1(e)(9). See also proposed rule 206(4)-
3(a)(3)(ii).
---------------------------------------------------------------------------

c. Disqualifying Commission Action
    Under the final rule, like the proposed rule, a disqualifying 
Commission action is any Commission opinion or order barring, 
suspending, or prohibiting a person from acting in any capacity under 
the Federal securities laws.\407\ Commenters stated that advisers have 
historically engaged solicitors that are subject to Commission actions 
or orders that address disqualifying events under the cash solicitation 
rule, but that do not bar, suspend, or prohibit the solicitor from 
acting in any capacity under the Federal securities laws.\408\ These 
commenters requested that we continue to permit advisers to engage 
solicitors subject to these types of Commission actions to avoid 
disturbing the existing

[[Page 13058]]

balance between protecting investors and aiding market efficiency.
---------------------------------------------------------------------------

    \407\ Final rule 206(4)-1(e)(3). The imposition of a bar, 
suspension, or prohibition may appear in an opinion of the 
Commission or in an administrative law judge initial decision that 
has become final pursuant to a Commission order. In both cases, such 
a bar, suspension, or prohibition is a disqualifying Commission 
action under the final rule. In addition to associational bars or 
suspensions, these include, for example, officer and director bars 
imposed in Commission cease and desist orders, limitations on 
activities imposed under section 203(e) or 203(f) of the Advisers 
Act that prevent persons from acting in certain capacities, penny 
stock bars imposed under section 15(b) of the Exchange Act, and 
investment company prohibitions imposed under section 9(b) of the 
Investment Company Act. In addition, under the final rule, if the 
Commission prohibits or suspends an individual from acting in a 
specific capacity under the Federal securities laws (e.g., as a 
supervisor or compliance officer), such prohibition will be a 
disqualifying Commission action, even if the Commission has not 
barred or suspended the individual from association with an 
investment adviser, broker-dealer or other registrant.
    \408\ See Mercer Comment Letter; Credit Suisse Comment Letter. 
See infra section II.C.4.e (discussing the final marketing rule's 
conditional carve-out).
---------------------------------------------------------------------------

    We agree with commenters that the final rule should permit advisers 
to engage compensated solicitors and other compensated promoters that 
are subject to certain Commission orders, provided that the Commission 
has not barred, suspended, or prohibited the compensated promoter from 
acting in any capacity under the Federal securities laws, and subject 
to conditions under the final rule. We are therefore relocating within 
the rule--from the definition of disqualifying Commission action, as 
proposed, to the definition of disqualifying event--Commission cease 
and desist orders from committing or causing a violation or future 
violation of any scienter-based anti-fraud provision of the Federal 
securities laws, and Section 5 of the Securities Act.\409\ This change 
will subject these orders to the final rule's conditional carve-out, if 
available, which aligns the rule's treatment of these orders with the 
final rule's other disqualifying events. We believe that these cease 
and desist orders could call into question a person's trustworthiness 
or ability to act as a compensated promoter,\410\ and that the final 
rule's conditional carve-out, discussed below, will address the risks 
of compensating a promoter subject to such an order. No one commented 
specifically on the proposed inclusion of this provision.\411\
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    \409\ See final rule 206(4)-1(e)(4)(v). See also proposed rule 
206(4)-3(a)(3)(iii)(A)(1).
    \410\ See 2019 Proposing Release, supra footnote 7, at text 
accompanying n.467.
    \411\ But see supra footnote 381 (discussing that some 
commenters advocated for conforming the rule's disciplinary 
provision with rule 506 of Regulation D under the Securities Act, 
which includes similar cease and desist orders, in connection with 
the proposed rule's new application to broker-dealers soliciting 
investors in private funds).
---------------------------------------------------------------------------

d. Disqualifying Event
    The final rule's disqualifying events are substantially similar to 
what we proposed, except for conforming the look-back period across all 
disqualifying events to ten years prior to the time the person 
disseminates the testimonial or endorsement. In addition, as noted 
above, we are including Commission cease and desist orders from 
committing or causing a violation or future violation of any scienter-
based anti-fraud provision of the Federal securities laws, and Section 
5 of the Securities Act as disqualifying events (rather than 
disqualifying Commission actions). Under the final marketing rule, 
therefore, a disqualifying event generally includes a finding, order, 
or conviction by a United States court or certain regulatory agencies 
that a person has engaged in any act or omission referenced in one or 
more of the provision's five prongs.
    A disqualifying event is any of five categories of events that 
occurred within ten years prior to the person disseminating an 
endorsement or testimonial.\412\ The first is a conviction by court of 
competent jurisdiction within the United States of any felony or 
misdemeanor involving conduct described in paragraph (2)(A) through (D) 
of section 203(e) of the Act.\413\ The second is a conviction by a 
court of competent jurisdiction within the United States of engaging 
in, any of the conduct specified in paragraphs (1), (5), or (6) of 
section 203(e) of the Act.\414\ The third is the entry of any final 
order by any entity described in paragraph (9) section 203(e) of the 
Act,\415\ or by the U.S. Commodity Futures Trading Commission or a 
self-regulatory organization (as defined in the Form ADV Glossary of 
Terms), of the type described in paragraph (9) of section 203(e) of the 
Act. The fourth is the entry of an order, judgment or decree that is 
described in paragraph (4) of section 203(e) of the Act, and that is in 
effect at the time of such dissemination by any court of competent 
jurisdiction within the United States.\416\ The fifth is a Commission 
order that a person cease and desist from committing or causing a 
violation or future violation of (i) any scienter-based anti-fraud 
provision of the Federal securities laws, including without limitation 
section 17(a)(1) of the Securities Act, section 10(b) of the Exchange 
Act, section 15(c)(1) of the Exchange Act, and section 206(1) of the 
Act, or any other rule or regulation thereunder, or (ii) Section 5 of 
the Securities Act.\417\ A disqualifying event does not include any of 
these events with respect to a person that is also subject to: An order 
pursuant to section 9(c) of the Investment Company Act with respect to 
such event; or a Commission opinion or order with respect to such event 
that is not a disqualifying Commission action, provided in each case 
that certain conditions are met.\418\
---------------------------------------------------------------------------

    \412\ Final rule 206(4)-1(e)(4).
    \413\ Final rule 206(4)-1(e)(4)(i).
    \414\ Final rule 206(4)-1(e)(4)(ii).
    \415\ Final rule 206(4)-1(e)(4)(iii). We made a non-substantive 
change from the proposal to cross reference the Advisers Act 
statutory provision rather than repeat the wording of the statutory 
provision in the final rule.
    \416\ Final rule 206(4)-1(e)(4)(iv).
    \417\ Rule 206(4)-1(e)(4)(v).
    \418\ Rule 206(4)-1(e)(4)(vi).
---------------------------------------------------------------------------

    The disqualifying events in the final rule incorporate a familiar 
framework for advisers evaluating promoters. As proposed, the rule's 
disqualifying events are drawn from section 203(e) of the Act, which is 
a basis for Commission action to censure, place limitations on the 
activities, or revoke the registration of any investment adviser or its 
associated persons.\419\ The final rule also includes actions of two 
types of regulatory entities not referenced in section 203(e) of the 
Act--specifically, the Commodity Futures Trading Commission (CFTC) and 
self-regulatory organizations--as we had proposed. Certain disciplinary 
actions by these organizations are included in Form ADV Part 1A's 
disciplinary history disclosures,\420\ which all registered investment 
advisers must complete for themselves and for their advisory 
affiliates.\421\ Only one commenter commented specifically on the 
addition of disciplinary actions by the CFTC, and supported it.\422\ No 
one commented specifically on the inclusion of disciplinary events by 
self-regulatory organizations. However, the final rule refers to self-
regulatory organization as defined in the Form ADV Glossary of Terms, 
rather than the term defined in the Exchange Act, as proposed.\423\ We 
believe that compensated promoters that are advisers must be familiar 
with the Form ADV definition,\424\ which is the same as the Exchange 
Act definition except that the Form ADV definition includes commodities 
exchanges and excludes the Municipal Securities Rulemaking Board.\425\ 
The inclusion of commodities exchanges also aligns with the final 
rule's inclusion of the CFTC in the disciplinary events provisions.
---------------------------------------------------------------------------

    \419\ See section 203(e) and (f) of the Act.
    \420\ See Form ADV Part 1A, Item 11 (requiring disclosure of 
certain actions related to the Commodity Futures Trading Commission 
(CFTC) and self-regulatory organizations).
    \421\ The term advisory affiliates is defined in the Form ADV 
Glossary of Terms, in part, as (1) all of your officers, partners, 
or directors (or any person performing similar functions); (2) all 
persons directly or indirectly controlling or controlled by you; and 
(3) all of your current employees (other than employees performing 
only clerical, administrative, support or similar functions). Form 
ADV Part 2 also requires information about the disciplinary history 
of the adviser and its personnel. See e.g., Form ADV Part 2A, Item 
9.
    \422\ See Consumer Federation Comment Letter.
    \423\ See proposed rule 206(4)-3(a)(3)(iii)(B)(3).
    \424\ See the Form ADV Glossary of Terms (defining Self-
Regulatory Organization as ``[a]ny national securities or 
commodities exchange, registered securities association, or 
registered clearing agency.'').
    \425\ See Exchange Act section 3(26). The Form ADV definition 
also aligns with the definition of self-regulatory organization used 
in Form BD for broker-dealers. See Form BD, Explanation of Terms.
---------------------------------------------------------------------------

    As discussed above, we are including in this definition a 
Commission cease and desist order from committing or

[[Page 13059]]

causing a violation or future violation of scienter-based anti-fraud 
provision of the Federal securities laws or of Section 5 of the 
Securities Act, which we had proposed to be disqualifying Commission 
actions. We continue to believe that including violations or future 
violations of these provisions protects investors from compensated 
promoters' bad acts that are likely to have the most effect on 
investors' review of a promoter's compensated testimonial or 
endorsement.
    Like those in the proposed rule, the final marketing rule's 
``disqualifying events'' are limited to actions of courts of competent 
jurisdiction within the United States, and of certain regulatory and 
self-regulatory organizations within the United States. Only one 
commenter commented on this aspect of the proposed rule, and supported 
it.\426\
---------------------------------------------------------------------------

    \426\ See NRS Comment Letter. A person subject to a regulatory 
action by a foreign court or regulatory or self-regulatory 
organization may become be an ineligible person under the final 
rule, to the extent that the Commission uses its authority to bar, 
suspend, or prohibit that person from acting in any capacity under 
the Federal securities laws. See the final rule's definition of 
disqualifying Commission action.
---------------------------------------------------------------------------

    In a change from the proposed rule, the final rule's look-back 
period will apply to all of the rule's ``disqualifying events,'' rather 
than only to some. We received no comments on the proposed look-back 
period, but we are conforming the period across the definition to ease 
advisers' compliance with the rule by providing a consistent framework 
for compliance. A ten-year look-back period is included in section 
203(e) of the Advisers Act.\427\ Advisers also apply this look-back 
period when reporting to the Commission their disciplinary history and 
the disciplinary history of all of their advisory affiliates.\428\ In 
addition, we are making a change to the fourth prong of the definition 
of disqualifying event to specify that this prong applies only to any 
order, judgment, or decree described therein that is in effect at the 
time the testimonial or endorsement is disseminated. This change aligns 
this prong of the definition of disciplinary event with the provision 
of the Advisers Act that it references.\429\
---------------------------------------------------------------------------

    \427\ Sections 203(e)(2) and (3) of the Act (containing a ten-
year look-back period for convictions for certain felonies and 
misdemeanors).
    \428\ Form ADV Part 1A, Item 11.
    \429\ See section 203(e)(4) of the Act.
---------------------------------------------------------------------------

    In addition, we are making a change from the proposed solicitation 
rule's look-back period to tie it to the time the testimonial or 
endorsement is disseminated, rather than to the time of solicitation. 
As discussed above, this change in timing will not result in a 
substantive change in timing for solicitations delivered orally, for 
which the time of solicitation and the time of dissemination are 
generally the same. This change conforms the look-back period to other 
aspects of the final marketing rule.\430\ Specifically, we believe that 
the same rationale for tying the final rule's reasonable care knowledge 
requirement to the dissemination of a compensated testimonial or 
endorsement applies here. Therefore, a disqualifying event is any of 
the final rule's enumerated disciplinary events that occurred within 
ten years prior to dissemination of an endorsement or testimonial.
---------------------------------------------------------------------------

    \430\ See supra sections II.C.2 (discussing the disclosure 
requirements for testimonials and endorsements) and II.C.4.a 
(discussing the reasonable care knowledge standard).
---------------------------------------------------------------------------

e. Conditional Exception From Definition of ``Disqualifying Event''
    The final rule provides a conditional carve-out from the definition 
of disqualifying event, adapted from the proposed solicitation rule. 
The carve-out permits an adviser to compensate a promoter that is 
subject to certain disqualifying actions, when the Commission has 
issued an opinion or order with respect to the promoter's disqualifying 
action, but not barred or suspended the promoter or prohibited the 
promoter from acting in any capacity under the Federal securities laws, 
subject to conditions. Specifically, the carve-out applies to a person 
that is subject to (A) an order pursuant to section 9(c) of the 
Investment Company Act with respect to a disciplinary action that would 
otherwise be a disciplinary event; or (B) a Commission opinion or order 
with respect to such action that is not a disqualifying Commission 
action, provided that, for each type of order or opinion described 
therein, certain conditions are met.\431\ The conditions are that: (1) 
The person is in compliance with the terms of the order or opinion 
including, but not limited to, the payment of disgorgement, prejudgment 
interest, civil or administrative penalties, and fines; and (2) for a 
period of ten years following the date of each order or opinion, the 
advertisement containing the testimonial or endorsement must include a 
statement that the person providing the testimonial or endorsement is 
subject to a Commission order or opinion regarding one or more 
disciplinary action(s), and include the order or opinion or a link to 
the order or opinion on the Commission's website.\432\
---------------------------------------------------------------------------

    \431\ Final rule 206(4)-1(e)(4)(vi). The conditions apply to 
each applicable type of order, and opinion or order, described in 
paragraphs (A) and (B) therein. See final rule 206(4)-1(e)(4)(vi).
    \432\ Id.
---------------------------------------------------------------------------

    This conditional carve-out is substantively similar to the proposed 
solicitation rule's carve-out from the definition of ineligible 
solicitor, with two changes The first change is that the final rule 
requires that the promoter be ``in compliance with,'' rather than, as 
proposed, that a solicitor ``has complied with,'' the terms of the 
order or opinion. The final rule will therefore permit a compensated 
promoter to apply the conditional carve-out if the promoter has 
complied with all of the terms of the applicable opinion or order that 
are required to be completed at the time the testimonial or endorsement 
is disseminated, even if there are additional terms of the applicable 
order or opinion that are, at that time, not yet required to be 
completed. We believe that the carve-out should not benefit promoters 
that are not in good standing under the terms of their Commission 
opinion or order.
    Second, we revised the disclosure requirement of the conditional 
carve-out. The final rule's disclosure condition is designed to provide 
investors with notice that the promoter has disciplinary action(s) and 
direct the investor to additional information. We revised the 
disclosure condition to reflect that the final rule does not require a 
separate solicitor disclosure, as proposed for compensated 
solicitations. It also reflects that the final rule's disqualification 
provisions apply to a broader population of promoters than solicitors 
and that advisers may advertise compensated testimonials and 
endorsements through space-constrained media. Accordingly, because 
there is no longer a separate solicitor disclosure requirement, the 
final rule requires the disclosure about disciplinary action(s) as part 
of the advertisement, rather than included in a separate solicitor 
disclosure. Further, because a testimonial or endorsement may appear in 
space-constrained media, the required disclosure is more concise than 
proposed. Instead of requiring a separate description of the acts or 
omissions that are the subject of, and the terms of, the opinion or 
order, the advertisement containing the testimonial or endorsement 
under the final rule must include a statement that the promoter is 
subject to a Commission opinion or order regarding one or more 
disciplinary action(s), and include the order or opinion or a link to 
the order or opinion on the Commission's

[[Page 13060]]

website.\433\ We believe the final rule's disclosure will make salient 
the fact that the promoter is subject to disciplinary action(s), while 
directing the investor to the facts and circumstance in the Commission 
opinion or order. An advertisement containing testimonial or 
endorsement disseminated electronically should include the opinion or 
order or an electronic link directly to the opinion or order on the 
Commission's website.
---------------------------------------------------------------------------

    \433\ Id. See also proposed rule 206(4)-3(a)(3)(iii)(C)(2)(ii).
---------------------------------------------------------------------------

    Some commenters requested we adopt a carve-out that aligns with 
advisers' long-established practice of engaging solicitors subject to 
Commission actions where the Commission order or opinion does not bar, 
suspend, or prohibit a person from acting in any capacity under the 
Federal securities laws.\434\ One commenter did not oppose the proposed 
carve-out, but urged the Commission to use its authority to issue non-
disqualifying Commission actions only in the most exceptional of 
circumstances.\435\
---------------------------------------------------------------------------

    \434\ See Credit Suisse Comment Letter; Mercer Comment Letter. 
See also Dougherty & Co., LLC, SEC Staff No-Action Letter (Mar. 21, 
2003), revised by Dougherty & Co., LLC, SEC Staff No-Action Letter 
(July 3, 2003) (collectively, the ``Dougherty Letter''). In the 
Dougherty Letter, Commission staff stated that it would not 
recommend enforcement action under section 206(4) and rule 206(4)-3 
if an investment adviser pays cash solicitation fees to a solicitor 
who is subject to an order issued by the Commission under section 
203(f) of the Advisers Act, or who is subject to a ``Rule 206(4)-3 
Disqualifying Order,'' based on certain representations. The staff 
described a Rule 206(4)-3 Disqualifying Order as an order issued by 
the Commission in which the Commission has found that the solicitor: 
(a) Has been convicted of any felony or misdemeanor involving 
conduct described in section 203(e)(2)(A) through (D) of the 
Advisers Act; (b) has engaged, or has been convicted of engaging, in 
any of the conduct specified in paragraphs (1), (5), or (6) of 
section 203(e) of the Advisers Act; or (c) was subject to an order, 
judgment, or decree described in section 203(e)(4) of the Advisers 
Act. Representations included that no Rule 206(4)-3 Disqualifying 
Order bars or suspends the solicitor from acting in any capacity 
under the Federal securities laws, and that, for a period of ten 
years following the date of each Rule 206(4)-3 Disqualifying Order, 
the solicitor or the investment adviser with which it has a 
solicitation arrangement subject to the cash solicitation rule 
discloses the order to each person whom the solicitor solicits.
    \435\ See Consumer Federation Comment Letter.
---------------------------------------------------------------------------

    We believe that when the Commission has issued an opinion or order 
with respect to a person's disqualifying conduct but not barred or 
suspended the person or prohibited the person from acting in any 
capacity under the Federal securities laws, it is appropriate to 
likewise permit such person to engage in activities related to 
compensated testimonials and endorsements. This approach obviates the 
need for the Commission to consider how to treat under the final rule a 
person with these disciplinary events. However, in the event that the 
Commission has not previously evaluated the disqualifying event and 
neither the promoter nor any person on its behalf has previously sought 
a waiver under the Investment Company Act with respect to the 
disqualifying event, such person may contact the Commission to seek 
relief.
    Commenters that addressed this provision generally supported it, 
noting the appropriateness of disclosure as a remedy for solicitors 
subject to non-disqualifying Commission actions.\436\ One commenter, 
however, stated that the ten-year disclosure period is overly punitive, 
and requested that we reduce the disclosure period to five years.\437\ 
We are adopting a ten-year look-back, however, because that period is 
consistent with the look-back period for the rule's disqualifying 
events, which is based on the look-back in the certain of the Act's 
statutory disqualification provisions and the rules for reporting to 
the Commission disciplinary history of advisers and their advisory 
affiliates.\438\ We believe that this period provides for a sufficient 
period after the disqualifying event that the past actions of the 
ineligible person may no longer pose as significant a risk.
---------------------------------------------------------------------------

    \436\ See Credit Suisse Comment Letter; SIFMA AMG Comment 
Letter; Mercer Comment Letter.
    \437\ See SIFMA AMG Comment Letter I (``The ten year time period 
is significant, and may have the effect of forcing such persons out 
of business rather than making them come into compliance.'').
    \438\ See supra footnotes 427 and 428 (discussing the ten-year 
lookback).
---------------------------------------------------------------------------

f. Application to Existing Events
    The final rule will not apply to pre-effective date conduct that 
would otherwise trigger the disqualification provisions, as we 
proposed.\439\ The final rule's disqualification provision, paragraph 
(b)(3), will not disqualify any person for purposes of the final rule 
for any matter(s), that occurred prior to the effective date of the 
rule, if such matter(s) would not have disqualified such person under 
rule 206(4)-3(a)(1)(ii), as in effect prior to the effective date of 
the rule.\440\ As discussed above, the final rule's disqualifying 
events are slightly broader than those under the current solicitation 
rule. For example, the solicitation rule's disqualification provisions 
do not include the entry of a final order of the CFTC or a self-
regulatory organization, whereas the final rule includes such 
conduct.\441\ We agree with commenters that it would be inappropriate 
to apply the final rule's broader disqualification provisions 
retroactively to prior conduct--such as a pre-effective date CFTC 
order--when such conduct had not disqualified that solicitor under the 
solicitation rule.\442\ In this case, the rule will not disqualify a 
person for prior conduct that did not cause disqualification at that 
time under the solicitation rule.
---------------------------------------------------------------------------

    \439\ As discussed below, the staff is also stating its view 
that it will not object if certain third parties that have been 
operating in a manner consistent with certain staff no-action 
letters under the existing cash solicitation rule, which will be 
nullified due to the rescission of the solicitation rule, provide 
compensated testimonials and endorsements under the new rule 
notwithstanding otherwise disqualifying events. See infra section 
II.J.
    \440\ Final rule 206(4)-1(b)(3). Such a person will not be an 
``ineligible person'' due to that conduct.
    \441\ Compare current rule 206(4)-3(a)(1)(ii), with final rule 
206(4)-1(e)(5)(iii).
    \442\ See IAA Comment Letter; Credit Suisse Comment Letter.
---------------------------------------------------------------------------

    However, we disagree with some commenters who requested that we 
grandfather all ongoing solicitation arrangements entered into prior to 
the final rule's effective date. Commenters argued that without a broad 
grandfathering provision, the final rule would require firms to 
renegotiate agreements with solicitors that had not been subject to the 
current rule when executed.\443\ Commenters' approach would effectively 
provide a blanket exemption that permits solicitation activities to 
continue indefinitely without complying with the final rule, if a 
solicitor performs such activity pursuant to a pre-effective date 
solicitation arrangement.\444\ Unlike the scenario discussed above, we 
believe this would exempt post-effective date solicitation activity 
that we explicitly intend to capture in the final rule.
---------------------------------------------------------------------------

    \443\ See, e.g., FSI Comment Letter; IAA Comment Letter.
    \444\ However, see supra footnote 395 and accompanying text for 
a discussion of trailing compensation.
---------------------------------------------------------------------------

5. Exemptions
    Under the final rule, we are adopting exemptions from certain 
conditions for compensated testimonials and endorsements by an 
adviser's affiliated personnel and for de minimis compensation.\445\ We 
are also adopting a partial exemption from certain conditions for 
testimonials and endorsements by a registered broker-dealer. The final 
rule will not exempt testimonials and endorsements related to the 
provision of impersonal investment advice or nonprofit

[[Page 13061]]

programs.\446\ Although some commenters suggested that we adopt 
additional exemptions for participants in refer-a-friend programs,\447\ 
publishers (e.g., bloggers),\448\ and those who refer clients from 
networking relationships,\449\ we do not believe general exemptions for 
these categories are appropriate. We believe that the final exemptions 
appropriately balance the risks of the use of compensated testimonials 
and endorsements with the benefits and protections of the final rule.
---------------------------------------------------------------------------

    \445\ The proposed rule would have provided four exemptions 
under the solicitation rule for: (1) Impersonal investment advice; 
(2) advisers' in-house solicitors and other affiliated solicitors; 
(3) de minimis compensation; and (4) nonprofit programs. Proposed 
rule 206(4)-3(b).
    \446\ See final rule 206(4)-1(b).
    \447\ See IAA Comment Letter.
    \448\ See IAA Comment Letter.
    \449\ MMI Comment Letter.
---------------------------------------------------------------------------

a. Affiliated Personnel
    Similar to the proposed solicitation rule, the final rule will 
partially exempt a testimonial or endorsement by an adviser's partners, 
officers, directors, or employees, or a person that controls, is 
controlled by, or is under common control with the investment adviser, 
or is a partner, officer, director or employee of such a person.\450\ 
For this exemption to apply, the affiliation between the investment 
adviser and such person must be readily apparent to or disclosed to the 
client or investor at the time the testimonial or endorsement is 
disseminated and the investment adviser must document such person's 
status at the time the testimonial or endorsement is disseminated.\451\ 
This is a partial exemption because the testimonial or endorsement will 
be exempt from the final rule's disclosure requirements, but it still 
will be necessary to comply with the adviser oversight and 
disqualification provisions.\452\ Commenters were generally supportive 
of retaining this current partial exemption under the solicitation 
rule.\453\
---------------------------------------------------------------------------

    \450\ For ease of reference, we refer to these persons in the 
release as ``affiliated persons'' or ``affiliated personnel.''
    \451\ Final rule 206(4)-1(b). The proposed solicitation rule 
would have provided a partial exemption for an adviser's in-house 
solicitors and other affiliated solicitors. See proposed rule 
206(4)-3(b)(2).
    \452\ However, an adviser's affiliated persons will not be 
required to comply with the written agreement requirement under the 
adviser oversight and compliance provision. See final rule 206(4)-
1(b)(4)(ii). See also proposed rule 206(4)-3(b)(2). The proposed 
rule would have created an exemption from the disclosure 
requirements by virtue of the exemption from the written agreement 
requirement.
    \453\ See, e.g., SIFMA AMG Comment Letter I; Proskauer Comment 
Letter.
---------------------------------------------------------------------------

    As proposed under the solicitation rule, we are modifying the 
current rule to permit an adviser to rely on the exemption not only 
when the affiliated status is disclosed to the investor, but also when 
such relationship is readily apparent to the investor.\454\ We continue 
to believe that, in such cases, a requirement to disclose a person's 
status as an affiliated person would not result in a benefit to the 
investor, and would create compliance burdens for the adviser and 
person giving the testimonial or endorsement. Commenters generally 
agreed with our approach, noting that disclosures regarding status are 
unnecessary because of the obvious and close relationship of some 
affiliates.\455\ However, commenters also suggested more guidance on 
the meaning of ``readily apparent.'' \456\
---------------------------------------------------------------------------

    \454\ Final rule 206(4)-1(b)(4)(ii).
    \455\ See, e.g., SIFMA AMG Comment Letter I; Proskauer Comment 
Letter; Mercer Comment Letter.
    \456\ SIFMA AMG Comment Letter I; Fidelity Comment Letter.
---------------------------------------------------------------------------

    What constitutes ``readily apparent'' will depend on the facts and 
circumstances. The relationship between an affiliated person and the 
adviser may be readily apparent to an investor, such as when an in-
house solicitor shares the same name as the advisory firm or a person 
operates under the same name brand as the adviser. An affiliated 
relationship also may be readily apparent when a person is clearly 
identified as related to the adviser in its communications with the 
investor at the time the testimonial or endorsement is disseminated. 
For example, the person's affiliation would be readily apparent if a 
business card distributed to investors at the time the testimonial or 
endorsement is disseminated clearly and prominently states that the 
person is a representative of the adviser. There may be other 
situations where the relationship between the adviser and its 
affiliated personnel is well known.
    One commenter suggested that there be a presumption that an adviser 
and its affiliated person's relationship is readily apparent to an 
investor if the adviser has disclosed the affiliation in its Form ADV 
brochure.\457\ However, we are not adopting such a presumption because 
the client may not have read the Form ADV brochure at the time the 
testimonial or endorsement is disseminated.
---------------------------------------------------------------------------

    \457\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    In certain situations, the adviser's relationship with an 
affiliated person is not readily apparent, such as when the person is a 
representative of the adviser but operates its marketing activities 
through its own DBA name or brand, and the name of the adviser is 
omitted or less prominent.\458\ If an adviser's and its affiliated 
person's relationship is not readily apparent, the adviser or 
affiliated person must disclose the affiliation in order to avail 
itself of the rule's partial exemption.
---------------------------------------------------------------------------

    \458\ Such persons could be employees or independent 
contractors.
---------------------------------------------------------------------------

    As proposed under the solicitation rule, we are expanding the 
current partial exemption for affiliated persons to cover any person 
that controls, is controlled by, or is under common control with, the 
investment adviser that is compensating the person pursuant to the 
final rule.\459\ One commenter explicitly supported this 
expansion.\460\ We continue to believe that the rule should treat a 
person that controls, is controlled by, or is under common control 
with, the investment adviser, similarly to any partners, officers, 
directors or employees of such affiliated person.
---------------------------------------------------------------------------

    \459\ Final rule 206(4)-1(b)(4)(ii).
    \460\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    One commenter suggested that we include an adviser's independent 
contractors under this partial exemption.\461\ However, another 
suggested that we limit the exemption to an adviser's supervised 
persons.\462\ We believe that the supervision and control an adviser 
exercises over an endorsing independent contractor may vary among 
different advisers and independent contractors. If the adviser 
exercises substantially the same level of supervision and control over 
an independent contractor as the adviser exercises over its own 
employees with respect to its marketing activities, the partial 
exemption would be available.
---------------------------------------------------------------------------

    \461\ SIFMA AMG Comment Letter I. We requested comment on 
whether we should define ``employee'' to include an adviser's 
independent contractors or provide that this partial exemption for 
in-house personnel applies to an adviser's independent contractors. 
2019 Proposing Release, supra footnote 7, at section II.B.7.
    \462\ See Mercer Comment Letter.
---------------------------------------------------------------------------

    We continue to believe, and commenters generally agreed, that when 
an investor is aware that a person endorsing the adviser is affiliated 
with the adviser, disclosures are not necessary to inform the investor 
of the person's bias in recommending such adviser. \463\ An investor is 
on notice that an in-house solicitor has a stake in soliciting the 
investor for its own firm. In these instances, the policy goals 
underlying the disclosure element of the final rule would already be 
satisfied.
---------------------------------------------------------------------------

    \463\ See SIFMA AMG Comment Letter I; Proskauer Comment Letter; 
Mercer Comment Letter.
---------------------------------------------------------------------------

    As proposed under the solicitation rule, the final rule's 
disqualification provisions will apply to affiliated personnel.\464\ 
One commenter expressed

[[Page 13062]]

concern that this approach would be overly restrictive and suggested 
that the rule also should exempt certain affiliated personnel from the 
disqualification provisions.\465\ This commenter stated that there is 
greater control and opportunity to train and rehabilitate affiliated 
personnel. We do not believe that the availability of training 
justifies exempting affiliated personnel from the disqualification 
provisions, and in other circumstances under the Federal securities 
laws the availability of such training does not affect affiliated 
personnel's disqualification.
---------------------------------------------------------------------------

    \464\ See final rule 206(4)-1(b)(3). See also proposed rule 
206(4)-3(b)(2).
    \465\ SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

    Some affiliated persons with disciplinary events under the final 
rule will be disqualified from association with an investment adviser 
independent of the final rule, if the Commission has barred or 
suspended those persons from association with an investment adviser 
under section 203(f) of the Act. However, other affiliated persons with 
such disciplinary events may not be subject to such Commission action 
and, absent the application of the rule's disqualification provisions, 
would be permitted to endorse an adviser as an affiliated person, 
notwithstanding their disqualifying event. After considering comments, 
including those from our Investor Feedback Flyers, we believe that the 
disqualification provisions should apply to compensated testimonials 
and endorsements, regardless of whether the marketing activity is 
conducted by a person affiliated or unaffiliated with the adviser.\466\
---------------------------------------------------------------------------

    \466\ See Investment Adviser Marketing Feedback Form. Question 
15 asks ``How important is it to know the following information 
about a paid salesperson's referral?'' and lists among other things, 
``Whether the solicitor has been disciplined for financial-related 
misconduct.'' Commenters were given the option to answer on a scale 
of 1-5, with 1 meaning ``Very Important'' and 5 meaning ``Not 
Important.'' There was also an option to answer ``Don't Know.'' More 
than two-thirds of the respondents indicated that this disciplinary 
information was ``Very Important.''
---------------------------------------------------------------------------

    Unlike the proposed solicitation rule, however, the final rule will 
subject affiliated persons to a part of the adviser oversight and 
compliance provision, which will require that the investment adviser 
have a reasonable basis for believing that the testimonial or 
endorsement complies with the requirements of the rule.\467\ We believe 
that this part of the oversight and compliance provision will help 
reduce the risk that any testimonials or endorsements do not comply 
with the final rule, particularly with respect to certain affiliates 
that may not be subject to the adviser's compliance policies and 
procedures. However, similar to the proposed solicitation rule, the 
final rule will not subject affiliated personnel to the written 
agreement requirement under the adviser oversight and compliance 
provision.\468\ Although we did not receive any comments on this 
particular modification under the proposed in-house and other 
affiliated personnel exemption, we continue to believe that advisers 
should not be required to enter into written agreements with their own 
affiliated persons in order to avail themselves of this partial 
exemption. We also continue to believe that such a requirement under 
the current rule creates additional compliance obligations for the 
adviser and its affiliated persons that are not justified by any 
corresponding benefit.
---------------------------------------------------------------------------

    \467\ See final rule 206(4)-1(b)(2)(i)).
    \468\ See final rule 206(4)-1(b)(4)(ii).
---------------------------------------------------------------------------

    Finally, we are adopting a new requirement, largely as proposed 
under the solicitation rule, that in order to avail itself of this 
partial exemption, an adviser must document an affiliated person's 
status contemporaneously with disseminating the testimonial or 
endorsement.\469\ One commenter criticized this requirement as 
unnecessary and unduly burdensome, stating that the Commission should 
either remove it or clarify the form and type of documentation 
expected.\470\ We are not requiring a specific form of documentation to 
record an affiliated person's status. We continue to believe that this 
approach affords advisers the flexibility to develop their own policies 
and procedures or use existing records to document such status.
---------------------------------------------------------------------------

    \469\ Final rule 206(4)-1(e)(2). The proposed solicitation rule 
would have required that ``the adviser documents such solicitor's 
status at the time the adviser enters into the solicitation 
arrangement.'' Proposed rule 206(4)-3(b)(2)(ii) (emphasis added).
    \470\ MMI Comment Letter.
---------------------------------------------------------------------------

    Advisers may wish to document this status through various means. 
For example, an adviser's policies and procedures regarding affiliated 
personnel may require that the adviser document a person's status on an 
internal form at the time that the adviser or affiliated person 
disseminates the testimonial or endorsement. However, an adviser does 
not need to create a new form of separate documentation to satisfy this 
requirement. For example, to the extent that an affiliated person's 
status is notated through corporate records, employee payroll records, 
Central Registration Depository (``CRD''), or any other similar records 
and licensing for investment adviser representatives, then such records 
would suffice so long as such records are kept current.
    Similar to our approach under the disqualification provisions 
applicable to testimonials and endorsements, we believe that the time 
of dissemination is the most appropriate time for an adviser to know 
about, or exercise reasonable care to determine, whether personnel is 
affiliated. The rule does not require an adviser to monitor the 
affiliated status of a person on a continuous basis. Instead, an 
adviser could conduct periodic inquiries to confirm that any 
testimonials or endorsements provided in reliance on this exemption are 
by affiliated personnel.
b. De Minimis Compensation
    The final rule will have a partial exemption for the use of 
testimonials or endorsements that are for zero or de minimis 
compensation.\471\ Specifically, a testimonial or endorsement that is 
disseminated for no compensation or de minimis compensation will not be 
subject to the disqualification provisions or the written agreement 
requirement, but must comply with the disclosure and oversight 
provisions.\472\ The proposed solicitation rule would have provided a 
full exemption for solicitation activities performed for de minimis 
compensation, which we proposed as $100 or less.\473\
---------------------------------------------------------------------------

    \471\ Final rule 206(4)-1(b)(4)(i).
    \472\ See supra footnote 123 (stating that a testimonial or 
endorsement for which an adviser provides de minimis compensation 
will be an advertisement under the second prong of the definition of 
advertisement).
    \473\ Proposed rule 206(4)-3(b)(3). Under the proposed de 
minimis compensation exemption, the solicitation rule would not have 
applied if the solicitor complied with certain conditions.
---------------------------------------------------------------------------

    Commenters generally supported the proposed de minimis exemption. 
However, commenters also suggested modifications to increase the 
utility of the exemption.\474\ For example, some commenters suggested 
raising the proposed de minimis threshold amount, arguing that $100 
would be too low.\475\ One commenter, while generally supporting the 
idea of a de minimis exemption, stated that tracking the exemption 
would be difficult in certain situations where advisers may make 
donations on behalf of clients who refer new prospective clients.\476\ 
Another commenter stated that the exemption would only offer a 
superficial benefit

[[Page 13063]]

because compensation paid to a solicitor would trigger required 
disclosure under the advertising rule since solicitor referrals often 
involve testimonials or endorsements.\477\ One commenter suggested 
eliminating the exemption altogether, arguing that small dollar values 
still create conflicts between a solicitor and the solicited 
investor.\478\
---------------------------------------------------------------------------

    \474\ See, e.g., Comment Letter of Wealthfront Corp. (Mar. 3, 
2020); SIFMA AMG Comment Letter I; MMI Comment Letter; and Flexible 
Plan Investments Comment Letter I.
    \475\ See, e.g., Comment Letter of MarketCounsel (Feb. 10, 2020) 
(``MarketCounsel Comment Letter''); SIFMA AMG Comment Letter I; IAA 
Comment Letter.
    \476\ NAPFA Comment Letter.
    \477\ SBIA Comment Letter.
    \478\ NASAA Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we believe a partial exemption is 
necessary because it could be overly burdensome for advisers and 
persons providing testimonials or endorsements for de minimis 
compensation to comply with the rule's disqualification provisions. We 
do not believe the same level of incentive or risk to defraud investors 
exists when a de minimis fee is involved.\479\ In supporting our 
proposed de minimis exemption, commenters agreed that a solicitor's 
incentives are reduced significantly when receiving de minimis 
compensation and that the need for heightened safeguards is likewise 
reduced.\480\ We also believe that many solicitation and referral 
programs would benefit from this exemption. Commenters confirmed our 
observation that there is a recent trend towards the use of programs 
that involve de minimis compensation, such as refer-a-friend 
programs.\481\
---------------------------------------------------------------------------

    \479\ We stated in our proposal that we recognize that the 
solicitor disqualification may pose major challenges, especially for 
smaller advisers. See 2019 Proposing Release, supra footnote 7, at 
section II.B.7.
    \480\ See, e.g., IAA Comment Letter (``This will help alleviate 
the compliance burden on investment advisers where incentives are 
inherently limited, and thus risks to prospective clients are 
low.''); Mercer Comment Letter.
    \481\ See, e.g., MarketCounsel Comment Letter; SIFMA AMG Comment 
Letter I.
---------------------------------------------------------------------------

    However, we agree with commenters to both the proposed advertising 
rule and solicitation rule who expressed concern that minimal 
compensation may still create conflicts.\482\ We believe disclosure of 
any conflicts is paramount to mitigate the risks that an investor would 
mistakenly view the promoter as unbiased and rely on a testimonial or 
endorsement more than the investor otherwise would have if the investor 
knew of any incentive or conflict. Even when there is no compensation 
involved, we believe these conflicts of interest create an incentive or 
bias on the part of the promoter. For instance, if the adviser and the 
promoter are participants in a referral network, it is important that 
these investors fully understand that the provider expects to benefit 
from its endorsement of or testimonial about the adviser. Although this 
will create some burden for promoters who are not already subject to 
the existing cash solicitation rule, we believe that the benefits of 
fully informing and protecting investors justify any such burden. 
Moreover, with respect to advisers, providing such disclosures is 
consistent with an adviser's duty to disclose all conflicts of interest 
and thus will not be unduly burdensome for advisers. In addition, we 
believe that subjecting testimonials and endorsements that are for no 
or de minimis compensation to the adviser oversight requirement is a 
reasonable benefit that justifies any burdens. Accordingly, unlike the 
proposed de minimis exemption under the solicitation rule, the final 
marketing rule will subject testimonials and endorsements for zero or 
de minimis compensation to the required disclosure and adviser 
oversight provisions and exempt such testimonials and endorsements only 
from the disqualification provisions.\483\
---------------------------------------------------------------------------

    \482\ See NASAA Comment Letter (arguing against the proposed de 
minimis exemption under the solicitation rule); Prof. Jacobson 
Comment Letter (supporting no de minimis exemption for testimonials 
and endorsements from the proposed advertising rule's disclosure 
requirements).
    \483\ See final rule 206(4)-1(b)(4)(i). However, testimonials 
and endorsements for zero or de minimis compensation will not be 
required to have a written agreement under the adviser oversight 
provision. See id. See also section II.C.3. (discussing the written 
agreement requirement under the adviser oversight and compliance 
provision).
---------------------------------------------------------------------------

    We also believe the exemption from the disqualification provisions 
will help ease the burden of compliance in many situations where the 
testimonials or endorsements are limited in scope, such as in refer-a-
friend programs. To illustrate, if the disqualification provisions were 
to apply, one commenter stated that firms with ``thousands of retail 
clients,'' not knowing who will participate in the refer-a-friend 
programs, would have to inquire into each client's disciplinary 
history.\484\ We agree that such an undertaking would be a major 
compliance challenge that is disproportionate to the limited scope and 
magnitude of such non-professional refer-a-friend programs. We 
accordingly believe that our approach appropriately balances the need 
for protections of the final rule with the burdens placed on the 
advisers complying with the rule.
---------------------------------------------------------------------------

    \484\ IAA Comment Letter.
---------------------------------------------------------------------------

    After considering comments and various thresholds, however, we are 
increasing the proposed de minimis threshold amount to $1,000.\485\ 
Accordingly, the disqualification provisions will not apply if an 
investment adviser provides compensation to a promoter of a total of 
$1,000 or less (or the equivalent value in non-cash compensation) 
during the preceding twelve months. We consider $1,000 to more 
appropriately capture referrals from both professional and non-
professional types of testimonials and endorsements than the $100 
amount we proposed. We also continue to believe that adopting an 
aggregate limit over a trailing 12-month period is consistent with our 
goal of providing an exception for small or nominal payments.\486\ One 
commenter supported our approach in requiring a trailing period, 
agreeing that it would not overly burden advisers because adviser 
should be keeping records of such payments.\487\
---------------------------------------------------------------------------

    \485\ Final rule 206(4)-1(e)(2).
    \486\ We would measure the initial date of the 12-month period 
to begin at the time that a promoter's testimonial or endorsement is 
initially disseminated.
    \487\ MarketCounsel Comment Letter.
---------------------------------------------------------------------------

c. Registered Broker-Dealers
    Under the final rule, we are providing an exemption from the rule's 
disqualification provisions for promoters that are brokers or dealers 
registered with the Commission in accordance with section 15(b) of the 
Exchange Act, provided they are not subject to statutory 
disqualification under the Exchange Act.\488\ In addition, we are 
providing an exemption from the rule's disclosure provisions when a 
broker-dealer is providing a testimonial or endorsement to a retail 
customer that is a recommendation subject to Regulation BI.\489\ 
Finally, we are providing an exemption from certain disclosure 
requirements when a broker-dealer provides a testimonial or endorsement 
to an investor who is not a retail customer as defined in Regulation 
BI.\490\
---------------------------------------------------------------------------

    \488\ Final rule 206(4)-1(b)(4)(iii)(C).
    \489\ Final rule 206(4)-1(b)(4)(iii)(A).
    \490\ Final rule 206(4)-1(b)(4)(iii)(B).
---------------------------------------------------------------------------

    While the proposed amendments to the solicitation rule would have 
applied the rule to all broker-dealer solicitations, we had 
contemplated whether to exempt certain advertisements or solicitation 
activities in some fashion from each of the proposed rules because we 
recognized some overlap in requirements applicable to broker-
dealers.\491\ We received several comments suggesting that we eliminate 
the application of the

[[Page 13064]]

proposed advertising rule to advertisements related to potential 
investors in pooled investment vehicles, and that we exempt registered 
broker-dealers that solicit private fund investors from the proposed 
solicitation rule.\492\ These commenters expressed concern that the 
proposed amendments would result in unnecessary and overlapping layers 
of regulation, including with respect to disclosures provided to 
investors, when a registered broker-dealer is involved in the sale of 
interests in a pooled investment vehicle.\493\ One commenter also 
stated that broker-dealers already are subject to the statutory 
disqualifications in section 3(a)(39) of the Exchange Act.\494\
---------------------------------------------------------------------------

    \491\ 2019 Proposing Release, supra footnote 7, at 38 and 211. 
We also considered the recently proposed exemption for certain 
``finders'' involved in exempt offerings. See Notice of Proposed 
Exemptive Order Granting Conditional Exemption from the Broker 
Registration Requirements of Section 15(a) of the Securities 
Exchange Act of 1934 for Certain Activities of Finders, Release No. 
34-90112 (Oct. 7, 2020) [85 FR 64542 (Oct. 13, 2020)].
    \492\ See, e.g., Wellington Comment Letter; Fidelity Comment 
Letter; MFA/AIMA Comment Letter I; IAA Comment Letter; Credit Suisse 
Comment Letter: SIFMA AMG Comment Letter I.
    \493\ Id.
    \494\ IAA Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that certain provisions of the final rule, 
such as the general prohibitions and performance provisions, should 
apply to all advertisements, regardless of whether the advertisement is 
provided to potential clients of an investment adviser or potential 
investors in a private fund.\495\ However, we recognize that regulatory 
overlap would yield little benefit. Specifically, we agree with 
commenters that certain statutory or regulatory requirements applicable 
to registered broker-dealers will satisfy the policy goals of some of 
the conditions.\496\ Broker-dealers are subject to disqualification for 
a variety of misconduct under the Exchange Act, many of which we 
believe are sufficiently similar to the misconduct that would trigger a 
disqualification under the marketing rule, but the Exchange Act is 
particularized to broker-dealer activity.\497\ We are confident these 
disqualification provisions will serve the same policy goal as the 
disqualification provisions under this rule.\498\ As a result, the 
final rule will exempt from the disqualification provisions any 
testimonial or endorsement by a broker-dealer registered with the 
Commission under section 15(b) of the Exchange Act, if the broker-
dealer is not subject to statutory disqualification under section 
3(a)(39) of the Exchange Act.\499\
---------------------------------------------------------------------------

    \495\ As stated in the proposal, we recognize that there may be 
some overlap between the prohibition in rule 206(4)-8 and the final 
rule. However, the final rule provides more specificity regarding 
what we believe to be false or misleading statements that advisers 
to private funds must avoid in their advertisements. We also 
continue to believe that any additional costs to advisers to private 
funds as a result of potential overlap between the final rule and 
rule 206(4)-8 with respect to advertisements will be minimal, as an 
advertisement that would raise issues under rule 206(4)-8 might also 
raise issues under a specific provision of the final rule as well as 
other anti-fraud provisions of the Federal securities laws. See 2019 
Proposing Release, supra footnote 7, at 35-36.
    \496\ See, e.g., MFA/AIMA Comment Letter I; Sidley Austin 
Comment Letter; SIFMA Comment Letter I.
    \497\ See section 3(a)(39) of the Exchange Act. Among other 
things, a person is subject to ``statutory disqualification'' under 
the Exchange Act if such person (i) is subject to an order of the 
Commission denying, suspending for a period not exceeding 12 months, 
or revoking the person's registration as a broker or dealer or 
barring or suspending for a period not exceeding 12 months the 
person's being associated with a broker or dealer; (ii) is subject 
to an order of the CFTC denying, suspending, or revoking his 
registration under the Commodity Exchange Act; and (iii) has been 
convicted of any specified offense or other felony within 10 years 
of the date of filing of an application for membership of a self-
regulatory organization. See also final rule 206(4)-1(e)(4).
    \498\ In this case, we agree with commenters that certain 
statutory or regulatory requirements applicable to registered 
broker-dealers will satisfy the policy goals of some of the 
conditions. See, e.g., MFA/AIMA Comment Letter I; Sidley Austin 
Comment Letter; SIFMA AMG Comment Letter I.
    \499\ Final rule 206(4)-1(b)(4)(iii)(C). See also supra section 
II.C.4.f. (discussing grandfathering for broker-dealers and covered 
persons with respect to the disqualification provisions). Advisers 
must have a reasonable basis for believing that the broker-dealer is 
not subject to such statutory disqualification, consistent with the 
adviser oversight and compliance provision applicable to 
testimonials and endorsements. Final rule 206(4)-1(b)(2)(i).
---------------------------------------------------------------------------

    Likewise, we recognize that the requirements under Regulation BI 
include conflicts of interest and compensation disclosures.\500\ For 
instance, under the Regulation BI Disclosure Obligation, when making a 
recommendation to a retail customer, a broker-dealer must disclose all 
material facts about the scope and terms of its relationship with the 
retail customer, such as the material fees and costs the customer will 
incur, as well as all material facts relating to its conflicts of 
interest associated with the recommendation, including third-party 
payments and compensation arrangements.\501\ In addition, all of the 
other Regulation BI obligations would apply when the broker-dealer is 
making a recommendation to a retail customer. Accordingly, we believe 
that the robust, protective framework of Regulation BI renders the 
disclosure requirements of the final marketing rule unnecessary when a 
broker-dealer provides a testimonial or endorsement to a retail 
customer that is a recommendation subject to Regulation BI.\502\
---------------------------------------------------------------------------

    \500\ Although Regulation BI does not explicitly require 
disclosure related to whether or not the broker-dealer is a current 
client or investor of the adviser, the Disclosure Obligation under 
Regulation BI requires the broker-dealer firm or representative to 
disclose that it is acting in a broker-dealer capacity, which we 
believe investors will generally understand to imply that the 
broker-dealer is not a client or investor of the adviser. Given 
this, we do not believe we need to separately require such a broker-
dealer to disclose its status as a client or non-client.
    \501\ See Regulation Best Interest Release, supra footnote 146, 
at 14. Regulation BI applies when a broker-dealer makes a 
recommendation to a ``retail customer.'' See id.
    \502\ Final rule 206(4)-1(b)(4)(iii)(A).
---------------------------------------------------------------------------

    In addition, we are providing a partial exemption in cases where a 
registered broker-dealer provides a testimonial or endorsement to an 
investor who is not a retail customer as defined in Regulation BI.\503\ 
Specifically, under the final rule, a broker-dealer that provides a 
testimonial or endorsement to such an investor will not be required to 
disclose the material terms of any compensation arrangement or a 
description of any material conflicts of interest.\504\ We believe that 
the clear and prominent disclosures such a broker-dealer will be 
required to provide under our final rule are sufficient to alert an 
investor that is not a retail customer that a testimonial or 
endorsement is a paid solicitation.\505\ We also believe that these 
investors will be able to request from the broker-dealer other 
information about the solicitation.
---------------------------------------------------------------------------

    \503\ Final rule 206(4)-1(b)(4)(iii)(B).
    \504\ Id. However, the broker-dealer must clearly and 
prominently disclose: (A) That the testimonial was given by a 
current client or investor, or the endorsement was given by a person 
other than a current client or investor; (B) that cash or non-cash 
compensation was provided for the testimonial or endorsement, if 
applicable; and (C) a brief statement of any material conflicts of 
interest on the part of the person giving the testimonial or 
endorsement resulting from the investment adviser's relationship 
with such person. See final rule 206(4)-1(b)(1)(i).
    \505\ See final rule 206(4)-1(b)(1)(i).
---------------------------------------------------------------------------

    Aside from this partial exemption from the disclosure provisions, 
the disclosure obligations of the final marketing rule will apply when 
a broker-dealer provides a testimonial or endorsement that is not a 
recommendation subject to Regulation BI. While registered broker-
dealers may be subject to other disclosure obligations in these 
circumstances, these obligations generally do not align with the 
disclosure obligations for testimonials and endorsements under our 
final rule.\506\ In addition, although broker-dealers must comply with 
FINRA rule 2210, we do not believe that FINRA rule 2210 requires the 
same substantive disclosures that we require under the final rule.\507\ 
Moreover, communications for purposes of FINRA rule 2210 are 
``written'' communications, whereas our final rule would apply to 
written and oral advertisements.\508\ Accordingly,

[[Page 13065]]

absent any exemption under the final rule, the rule will require the 
disclosures of compensation arrangements and material conflicts of 
interest associated with a testimonial or endorsement.\509\
---------------------------------------------------------------------------

    \506\ See, e.g., Exchange Act section 10(b) and rules 10b-5, 
10b-10(a)(2), 12b-20, 15c1-5, and 15c1-6 as well as FINRA rules 
2010, 2020, 2262, 2269, and 5123.
    \507\ See, e.g., FINRA rule 2210(d)(6).
    \508\ See FINRA rule 2210(a)(1). Although FINRA rule 2210(f) 
separately covers public appearances, ``communications'' consist of 
``correspondence, retail communications, and institutional 
communications,'' all of which are defined as written 
communications. See FINRA rule 2210(a)(2), (3), and (5).
    \509\ See final rule 206(4)-1(b)(1).
---------------------------------------------------------------------------

    The final rule does not provide an exemption for registered broker-
dealers from the adviser oversight and compliance condition applicable 
to testimonials and endorsements, including the written agreement 
requirement. We continue to believe that advisers should reasonably 
ensure that a registered broker-dealer providing a testimonial or 
endorsement for the adviser is complying with the rule's applicable 
conditions. We believe that many advisers would already have an 
incentive to oversee any broker-dealers operating as their promoters 
and accordingly believe that this provision will provide an additional 
benefit to investors without being unduly burdensome. As noted above, 
in the context of private placements of private fund shares, we believe 
that a written private placement agreement would meet the final rule's 
written agreement requirement, further reducing the compliance burdens 
associated with this aspect of the rule.\510\
---------------------------------------------------------------------------

    \510\ See supra footnote 361 and accompanying text.
---------------------------------------------------------------------------

d. ``Covered Persons''
    Under the final rule, similar to the partial exemption for 
registered broker-dealers, we are providing an exemption from the 
rule's disqualification provisions for ``covered persons'' under rule 
506(d) of Regulation D with respect to a rule 506 securities offering, 
provided the person's involvement would not disqualify the offering 
under that rule.\511\ With respect to rule 506 of Regulation D, 
``covered persons'' include the issuer, its predecessors and affiliated 
issuers; directors, general partners, and managing members of the 
issuer; executive officers of the issuer, and other officers of the 
issuer that participate in the offering; beneficial owners of 20 
percent or more of the issuer's outstanding voting equity securities, 
calculated on the basis of voting power; promoters connected to the 
issuer in any capacity at the time of sale; for pooled investment fund 
issuers, the fund's investment manager and any general partner, 
managing member, director, executive officer or other officer 
participating in the offering of any such investment manager; and 
persons compensated for soliciting investors, including any general 
partner, managing member, director, executive officer or other officer 
participating in the offering of any such solicitor.\512\
---------------------------------------------------------------------------

    \511\ See final rule 206(4)-1(b)(4)(iv).
    \512\ See rule 506(d)(1) under the Securities Act.
---------------------------------------------------------------------------

    Commenters expressed concern that issuers and solicitors conducting 
private fund offerings in reliance on Regulation D would face increased 
compliance burdens in observing two sets of overlapping 
disqualification regulations.\513\ Stating that a majority of private 
placements are carried out under rule 506, these commenters suggested 
we conform the rule's disqualification provisions to the provisions 
under rule 506 of Regulation D for solicitors of investors in private 
funds who would be newly subject to the solicitation rule, or that we 
provide an exemption from the final rule's disqualification provisions 
for persons that are subject to rule 506 of Regulation D.\514\
---------------------------------------------------------------------------

    \513\ See, e.g., Credit Suisse Comment Letter; SIFMA AMG Comment 
Letter I; MMI Comment Letter.
    \514\ Id.
---------------------------------------------------------------------------

    We agree with commenters that having one set of disqualifying 
events for promoters with respect to offerings conducted in reliance on 
rule 506 of Regulation D would streamline compliance processes and 
reduce the burden for such promoters. Additionally, similar to the 
statutory disqualification provisions under the Exchange Act, we 
believe that the disqualification provisions, or ``bad actor'' 
provisions, under Regulation D will serve the same policy goal as our 
final rule's disqualification provisions.\515\ While we recognize that 
the two sets of disqualification provisions are not identical and that 
there are certain categories of disqualifying events that do not 
overlap, we do not believe that the differences justify having more 
than one set of disqualification provisions for compliance. Moreover, 
this exemption is narrowly limited to testimonials and endorsements 
that are in connection with a sale of securities under rule 506 of the 
Securities Act. Accordingly, in cases where a covered person's activity 
with respect to a rule 506 securities offering would be considered a 
testimonial or endorsement under our final rule, such covered person 
will not be subject to the disqualification provisions under our final 
rule so long as his or her involvement would not disqualify the 
offering under rule 506(d) under the Securities Act.\516\
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    \515\ We believe that the two sets of provisions are 
sufficiently similar to help realize our policy goal of reducing the 
risk that certain ineligible persons should not be acting as 
promoters. For example, an offering is disqualified under rule 
506(d) if a covered person is subject to any order of the Commission 
entered within five years before such sale that, at the time of such 
sale, orders the person to cease and desist from committing or 
causing a violation or future violation of: (i) Any scienter-based 
anti-fraud provision of the Federal securities laws; or (ii) section 
5 of the Securities Act. See section 506(d)(1)(v) of the Securities 
Act. See also final rule 206(4)-1(e)(4)(v).
    \516\ Final rule 206(4)-1(b)(4)(iv).
---------------------------------------------------------------------------

    Given that Regulation D does not have any similar provisions that 
are sufficient to replace our final rule's disclosure or adviser 
oversight and compliance provisions, covered persons under rule 506(d) 
of Regulation D will not be exempt from our rule's disclosure and 
adviser oversight and compliance obligations for testimonials and 
endorsements. Accordingly, similar to the exemption for registered 
broker-dealers, persons covered by rule 506(d) of Regulation D with 
respect to a rule 506 offering will still be subject to all other 
provisions of the final rule, to the extent that their activity falls 
within the scope of the rule, including the general prohibitions, 
performance provisions, and conditions applicable to testimonials and 
endorsements except the disqualification provisions.
e. No Exemptions for Impersonal Investment Advice and Nonprofit 
Programs
i. Impersonal Investment Advice
    The proposed solicitation rule would have provided a partial 
exemption for solicitation activities for investment advisory services 
that do not purport to meet the objectives or needs of specific 
individuals or accounts.\517\ The proposed advertising rule did not 
provide any similar exemption. As a result of the merger of the two 
rules, the final rule will not have an exemption for promoters that 
refer investors for the provision of impersonal investment advice.\518\
---------------------------------------------------------------------------

    \517\ Proposed rule 206(4)-3(b)(1). Specifically, such 
solicitors would not have had to enter into a written agreement and 
provide the solicitor disclosure and would not have been subject to 
the adviser oversight and compliance provision. However, such 
solicitors would have been subject to the disqualification 
provisions under the proposed rule.
    \518\ Final rule 206(4)-1(b).
---------------------------------------------------------------------------

    One commenter supported our proposal to retain and modify the 
current exemption under the solicitation rule for solicitation 
activities related to the provision of impersonal investment 
advice.\519\ This commenter stated that the exemption is a ``long-
standing feature of the regime covering solicitation,'' and that our 
proposed

[[Page 13066]]

modifications such as removing the requirement to enter into a written 
agreement would improve aspects of the exemption. However, in the 
context of advertising, and testimonials and endorsements in 
particular, we do not believe that there should be any distinction made 
between personal and impersonal investment advice.\520\ Many 
testimonials and endorsements, by their nature, will be used to promote 
and advertise an adviser's services, without taking into account a 
particular investor's objectives or needs. Accordingly, in such cases, 
we believe that investors should be afforded all protections of the 
final rule. A testimonial or endorsement serving as an advertisement 
for an adviser should not be exempt from providing disclosures when 
there is a material conflict of interest simply because the 
advertisement is related to the provision of impersonal investment 
advice instead of personal investment advice.
---------------------------------------------------------------------------

    \519\ SIFMA AMG Comment Letter I.
    \520\ See current rule 206(4)-1. The current advertising rule 
does not have any exemptions for advertisements related to 
impersonal investment advice.
---------------------------------------------------------------------------

    We stated in the proposal that the current and proposed 
solicitation rule provided a partial exemption for impersonal advisory 
services because we understood that ``prospective clients normally 
would be aware that a person selling such services was a salesman who 
was paid to do so.'' However, with respect to the proposed advertising 
rule, one commenter argued against regulations built on any underlying 
assumption that consumers are skilled at evaluating testimonials.\521\ 
Other commenters argued against permitting testimonials and 
endorsements, raising concerns about investor confusion and inadvertent 
investor harm.\522\ Although we continue to recognize that a potential 
investor may be aware of a promoter's incentive to sell, after 
considering comments, we believe that any use of testimonials or 
endorsements, subject to the final exemptions, needs certain 
protections. Accordingly, notwithstanding the fact that an adviser may 
offer impersonalized services, if an adviser's advertisement includes a 
testimonial or endorsement, then such advertisement will be subject to 
the final rule's provisions.
---------------------------------------------------------------------------

    \521\ See TINA Comment Letter.
    \522\ See Mercer Comment Letter; NAPFA Comment Letter.
---------------------------------------------------------------------------

ii. Nonprofit Programs Exemption
    The proposed solicitation rule would have exempted certain types of 
nonprofit programs from the substantive requirements of the rule, 
codifying the positions taken in previous staff no-action letters.\523\ 
The proposed advertising rule provided no such exemption for 
testimonials or endorsements. The final marketing rule will not have an 
exemption for nonprofit programs.\524\
---------------------------------------------------------------------------

    \523\ Some solicitors have, from time to time, requested that 
the staff not recommend enforcement action under the cash 
solicitation rule for referral programs with some, or all, of these 
features. See National Football League Players Association, SEC 
Staff No-Action Letter (Jan. 25, 2002) (``NFLPA Letter''); 
Excellence in Advertising, Limited, SEC Staff No-Action Letter (Nov. 
13, 1986) (``EIA Letter''); International Association for Financial 
Planning, SEC Staff No-Action Letter (June 1, 1998) (``IAFP 
Letter''). These staff no-action letters will be nullified following 
the rescission of the solicitation rule.
    \524\ See final rule 206(4)-1(b). The proposed solicitation rule 
would not have applied to an adviser's participation in a program 
when the adviser had a reasonable basis for believing that the 
solicitor is a nonprofit program, participating advisers compensated 
the solicitor only for the costs reasonably incurred in operating 
the program, and the solicitor provided clients a list, based on 
non-qualitative criteria, of at least two advisers. See proposed 
rule 206(4)-3(b)(4). There is no special exception made for 
nonprofit programs under the current advertising rule.
---------------------------------------------------------------------------

    We proposed this exemption because we believed that the potential 
for the solicitor to demonstrate bias towards one adviser or another 
when there is no profit motive made the protections of the solicitation 
rule unnecessary.\525\ One commenter supported the proposed exemption 
and suggested that the same type of approach could be helpful for for-
profit entities that provide matching of investors and advisers based 
on objective criteria.\526\ However, given the merger of the 
advertising and solicitation rules and our final rule's requirements, 
we no longer believe that an exemption for nonprofit programs would be 
appropriate or necessary. Instead, we believe the requirements of the 
final rule are important for investors even when the advertisement take 
the form of a testimonial or endorsement by a nonprofit program.
---------------------------------------------------------------------------

    \525\ 2019 Proposing Release, supra footnote 7, at section 
II.B.7.
    \526\ SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

    Among other things, our proposed solicitation rule would have 
required a separate solicitor disclosure that provided investors with 
certain information including the terms of compensation, and a written 
agreement between the adviser and solicitor describing the solicitation 
activities and requiring solicitor compliance with section 206 of the 
Act.\527\ The proposed nonprofit programs exemption would have exempted 
advisers and solicitors from the requirements of the proposed 
solicitation rule including the written agreement and disclosure 
requirements, provided that the adviser and solicitor still met a 
number of conditions including some advisory oversight and different 
disclosures.\528\
---------------------------------------------------------------------------

    \527\ See proposed rule 206(4)-3(a)(1).
    \528\ See proposed rule 206(4)-3(b)(4), which would have 
required that: (i) The adviser have a ``reasonable basis for 
believing'' that among other things, the solicitor is a nonprofit 
program and that the solicitor (or adviser) ``prominently discloses 
to the client, at the time of any solicitation activities,'' certain 
information; and (ii) solicitor or adviser disclose: (1) The 
criteria for inclusion on the list of investment advisers; and (2) 
that investment advisers reimburse the solicitor for the costs 
reasonably incurred in operating the program.
---------------------------------------------------------------------------

    Under the final rule, though we are not providing an exemption for 
nonprofit programs per se, we took into account that, if there is no or 
minimal compensation involved, the nonprofit program would fall under 
the de minimis exemption. As a result, many nonprofit programs may 
effectively be subject to the required disclosures and a part of the 
adviser oversight provision under the final rule, similar to the 
proposed exemption under the solicitation rule.\529\ Under the final 
rule, the nonprofit program would need to disclose that it is not a 
current client of the adviser, the material terms of compensation, 
which, if any, would be similar to the disclosure under the proposed 
exemption,\530\ and any material conflicts of interest. With respect to 
the adviser oversight provision, if the nonprofit program falls under 
the de minimis exemption,\531\ advisers would only need to have a 
reasonable basis for believing that the nonprofit program complies with 
the final rule, rather than a number of specific items as proposed 
under the solicitation rule.\532\
---------------------------------------------------------------------------

    \529\ See final rule 206(4)-1(b)(4)(i). The proposed nonprofit 
program exemption would have required that the client receive 
certain disclosures. See proposed rule 206(4)-3(b)(4)(ii). The 
exemption would have also had a ``reasonable basis'' standard for 
the adviser's reliance on the exemption. See proposed rule 206(4)-
3(b)(4)(i). As with the de minimis exemption, nonprofit programs 
would not have been subject to the disqualification provisions under 
the proposed rule. See proposed rule 206(4)-3(b)(4). Since a person 
or program would be unlikely to demonstrate bias in referring one 
adviser over another when neither adviser provides compensation 
based on the number of referrals made or any other indicator of the 
potential to earn the adviser profit, we believed, and continue to 
believe, that an exemption from the disqualification provisions in 
such cases is appropriate.
    \530\ The proposed exemption would have required that the 
solicitor or adviser disclose to the client that investment advisers 
reimburse the solicitor for the costs reasonably incurred in 
operating the client. Proposed rule 206(4)-3(b)(4)(ii)(B).
    \531\ Such a program within the de minimis exemption will not be 
subject to the written agreement requirement under the adviser 
oversight and compliance provision. Final rule 206(4)-1(b)(2)(ii) 
and (b)(4)(i).
    \532\ See proposed rule 206(4)-3(b)(4)(i).
---------------------------------------------------------------------------

    We believe that the disclosure and advisory oversight requirements 
under

[[Page 13067]]

the final rule are more appropriate than, and preferable to, the more 
tailored disclosures and conditions that were proposed under the 
nonprofit program exemption. Accordingly, we believe eliminating the 
proposed nonprofit program exemption is appropriate, and the final rule 
will subject advisers participating in any referral program, whether 
nonprofit or for profit, to the rule in order to provide investors with 
sufficient and necessary information when presented with a testimonial 
or endorsement of an adviser by such a program. Absent the de minimis 
or other exemption, the rule will subject all referral programs that 
provide testimonials or endorsements to the required disclosures, 
adviser oversight and disqualification provisions.

D. Third-Party Ratings

    As proposed, the final rule will prohibit including third-party 
ratings in an advertisement, unless they comply with the rule's general 
prohibitions and additional conditions. An investment adviser may not 
include a third-party rating in its advertisement unless the adviser 
has a reasonable basis for believing that any questionnaire or survey 
used in the preparation of the third-party rating meets certain 
criteria and provides certain disclosures. Several commenters supported 
the proposed rule's approach of expressly permitting the inclusion of 
third-party ratings in advertisements.\533\ However, one commenter 
requested that we prohibit third-party ratings in retail 
advertisements, arguing that advisers will be incentivized to purchase 
only positive third-party ratings and aggressively market them to 
mislead investors.\534\ We believe that the final rule's conditions for 
including third-party ratings in an advertisement, discussed in more 
detail below, in conjunction with the rule's general prohibitions, 
mitigate any such incentives and safeguard investors from misleading 
third-party ratings.
---------------------------------------------------------------------------

    \533\ See, e.g., Blackrock Comment Letter; IAA Comment Letter.
    \534\ See NASAA Comment Letter.
---------------------------------------------------------------------------

    The final rule will, as proposed, define ``third-party rating'' as 
a ``rating or ranking of an investment adviser provided by a person who 
is not a related person (as defined in the Form ADV Glossary of Terms), 
and such person provides such ratings or rankings in the ordinary 
course of its business.'' \535\ This definition is intended to permit 
advisers to use third-party ratings, subject to conditions, when the 
ratings are conducted in the ordinary course of business. We continue 
to believe that the ordinary course of business requirement would 
largely correspond to persons with the experience to develop and 
promote ratings based on relevant criteria. It would also distinguish 
third-party ratings from testimonials and endorsements that resemble 
third-party ratings, but that are not made by persons who are in the 
business of providing ratings or rankings. The requirement that the 
provider not be an adviser's related person will avoid the risk that 
certain affiliations could result in a biased rating.
---------------------------------------------------------------------------

    \535\ Rule 206(4)-1(e)(17). An adviser's ``related person'' is 
defined in Form ADV's Glossary of Terms as ``[a]ny advisory 
affiliate and any person that is under common control with your 
firm.'' Italicized terms are defined in the Form ADV Glossary. We 
believe that a rating by a person under common control with the 
adviser could present the same bias towards the adviser as a rating 
by an adviser's other advisory affiliates.
---------------------------------------------------------------------------

    The final rule also will subject advertisements that include third-
party ratings to additional tailored conditions, as proposed. For such 
advertisements, the final rule will require that the investment adviser 
have a reasonable basis to believe that any questionnaire or survey 
used in the preparation of the third-party rating is structured to make 
it equally easy for a participant to provide favorable and unfavorable 
responses, and is not designed or prepared to produce any predetermined 
result (the ``due diligence requirement'').\536\ The final rule also 
will require that an investment adviser clearly and prominently 
disclose, or the investment adviser reasonably believes that the third-
party rating clearly and prominently discloses: (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 directly or indirectly by the adviser in connection with 
obtaining or using the third-party rating (the ``disclosure 
requirement'').\537\ In order to be clear and prominent, the disclosure 
must be at least as prominent as the third-party rating.\538\ While we 
are adopting the conditions required for including any third-party 
rating in an advertisement largely as proposed, we are providing 
additional clarification on how advisers can comply with such 
conditions.
---------------------------------------------------------------------------

    \536\ See final rule 206(4)-1(c).
    \537\ See id.
    \538\ Commenters claimed that a ``clearly and prominently'' 
disclosure standard would pose challenges for certain 
advertisements, including advertisements on certain social media or 
internet platforms, if hyperlinking is not permitted. See, e.g., 
Fidelity Comment Letter; LinkedIn Comment Letter; MMI Comment 
Letter. As discussed above, we continue to believe that it would not 
be consistent with the clear and prominent standard to use a 
hyperlink to include the disclosures required under the final rule. 
See supra section II.C.2.a. Instead, such required disclosures 
should be included within the advertisement.
---------------------------------------------------------------------------

    Several commenters requested guidance on how an adviser can satisfy 
the due diligence requirement.\539\ We continue to believe that an 
adviser could satisfy the requirement by accessing the questionnaire or 
survey that was used in the preparation of the rating. We are persuaded 
by commenters' concerns, however, that third-party rating agencies may 
be reluctant to share proprietary survey or questionnaire information 
to advisers, such as their calculation methodology.\540\ Accordingly, 
we are clarifying that obtaining the questionnaire or survey used in 
the preparation of the rating is not the only means to satisfy this 
requirement. We also do not believe that this condition requires an 
adviser to obtain complete information about how the third-party rating 
agency collects underlying data or calculates a rating, as one 
commenter suggested.\541\ Nevertheless, we continue to believe that an 
adviser relying solely on the results of a survey or questionnaire--
i.e., the rating itself--without conducting some due diligence into the 
underlying methodology and structure, could give rise to advertisements 
that include misleading ratings. To satisfy the due diligence 
requirement, an adviser could seek representations from the third-party 
rating agency regarding general aspects of how the survey or 
questionnaire is designed, structured, and administered. Alternatively, 
a third-party rating provider may publicly disclose similar information 
about its survey or questionnaire methodology. In either case, the 
adviser could obtain sufficient information to formulate a reasonable 
belief as required by the due diligence requirement without obtaining 
proprietary data of third-party rating agencies.
---------------------------------------------------------------------------

    \539\ See, e.g., Blackrock Comment Letter (suggesting that firms 
might not be willing to provide proprietary survey methodology 
information to advisers); MFA/AIMA Comment Letter I; IAA Comment 
Letter; AIC Comment Letter.
    \540\ See, e.g., Blackrock Comment Letter; AIC Comment Letter.
    \541\ See IAA Comment Letter.
---------------------------------------------------------------------------

    The first provision of the disclosure requirement--the date on 
which the rating was given and the period of time upon which the rating 
was based--will assist investors in evaluating the relevance of the 
rating. Ratings from an earlier date, or that are based on information 
from an earlier period, may not reflect the current state of an

[[Page 13068]]

investment adviser's business. An advertisement that includes an older 
rating would be misleading without clear and prominent disclosure of 
the rating's date.\542\
---------------------------------------------------------------------------

    \542\ In addition, an adviser would be required to provide 
contextual disclosures of subsequent, less-favorable performance in 
the rating, if applicable. See final rule 206(4)-1(a).
---------------------------------------------------------------------------

    The second provision of the disclosure requirement--the identity of 
the third party that created the rating--is important because it will 
provide investors with the opportunity to assess the qualifications and 
credibility of the rating provider. Investors can look up a third party 
by name and find relevant information, if available, about the third 
party's qualifications and can form their own opinions about 
credibility.
    The final provision of the disclosure requirement--that 
compensation has been provided directly or indirectly by the adviser in 
connection with obtaining or using the third-party rating--provides 
consumers with important context for weighing the relevance of the 
statement in light of the compensation incentive.\543\ Although the 
final rule uses the term ``compensation,'' this term continues to refer 
to cash and non-cash compensation, as proposed. Similarly, the final 
rule replaces the phrase ``by or on behalf'' with ``directly or 
indirectly.'' As discussed above, this reflects a non-substantive 
change to use a phrase that we believe is commonly understood in the 
industry.\544\
---------------------------------------------------------------------------

    \543\ In many cases, third-party ratings are developed by 
relying significantly on questionnaires or client surveys and 
involve different compensation models. For example, some investment 
advisers compensate the third-party ratings firm for the right to 
include the ratings or rankings that are calculated as a result of 
the survey in their advertisements. Other investment advisers 
compensate the third-party ratings firm to be included in the 
initial pool of advisers from which the rating or ranking is 
determined.
    \544\ See supra section II.A.
---------------------------------------------------------------------------

    While the final rule explicitly requires these three disclosures, 
they would not cure a rating that could otherwise be false or 
misleading under the final rule's general prohibitions or under the 
general anti-fraud provisions of the Federal securities laws. For 
example, where an adviser's advertisement references a recent rating 
and discloses the date, but the rating is based upon on an aspect of 
the adviser's business that has since materially changed, the 
advertisement would be misleading. Likewise, an adviser's advertisement 
would be misleading if it indicates that the adviser is rated highly 
without disclosing that the rating is based solely on a criterion, such 
as assets under management, that may not relate to the quality of the 
investment advice.`

E. Performance Advertising

    The final rule's general prohibitions apply to advertisements that 
include performance results (``performance advertising''), as proposed. 
We are adopting specific requirements and restrictions for performance 
advertising, with some changes from the proposal as described below. We 
continue to believe that performance advertising raises special 
concerns that warrant additional requirements and restrictions under 
the final marketing rule.\545\ In particular, the presentation of 
performance could lead reasonable investors to unwarranted assumptions 
and thus would result in a misleading advertisement.\546\ Some 
commenters objected to the proposed rule's specific performance 
advertising provisions, favoring relying only on the rule's general 
prohibitions for non-retail investors.\547\ However, commenters 
generally did not advocate for the removal of the performance 
advertising provisions as a whole. After considering comments, we 
remain convinced that additional protections should apply to 
advertisements that include performance results.
---------------------------------------------------------------------------

    \545\ See 2019 Proposing Release, supra footnote 7, at text 
accompanying n. 181.
    \546\ For example, investors may rely particularly heavily on 
advertised performance results in choosing whether to hire or retain 
an investment adviser or invest in a private fund managed by the 
adviser. This reliance may be misplaced to the extent that an 
investor considers past performance achieved by an investment 
adviser to be predictive of the results that the investment adviser 
will achieve for the investor.
    \547\ See, e.g., MFA/AIMA Comment Letter I; AIC Comment Letter 
I.
---------------------------------------------------------------------------

    We proposed several requirements for all advertisements that 
include performance advertising. Specifically, under our proposal, an 
advertisement could not: (i) Include gross performance, unless the 
advertisement provided or offered to provide a schedule of fees and 
expenses deducted to calculate net performance (the ``proposed schedule 
of fees requirement''); (ii) contain any statement that the performance 
results have been approved or reviewed by the Commission (the 
``Commission approval requirement''); and (iii) provide related, 
extracted, or hypothetical performance without meeting specific 
conditions.\548\ For Retail Advertisements,\549\ our proposal also 
would have required that: (i) Any presentation of gross performance 
also include net performance, subject to conditions (the ``net 
performance requirement''); and (ii) any performance results of a 
portfolio or composite aggregation of related portfolios include 
performance results for one-, five-, and ten-year periods, subject to 
conditions (the ``time period requirement'').\550\ As discussed in more 
detail below, the final rule substantially adopts the proposed rule's 
requirements, and applies them to all advertisements that include 
performance advertising. Unlike the proposed rule, the final rule does 
not provide separate requirements for performance advertising in Retail 
Advertisements and Non-Retail Advertisements and will not include the 
proposed schedule of fees requirement.
---------------------------------------------------------------------------

    \548\ Proposed rule 206(4)-1(c)(1).
    \549\ We proposed to define clients and investors that are 
``qualified purchasers'' or ``knowledgeable employees'' as ``Non-
Retail Persons'' and to define all other clients and investors as 
``Retail Persons.'' See proposed rule 206(4)-1(e)(8) and (14). 
Similarly, the proposed rule distinguished between advertisements 
for which an adviser has adopted and implemented policies and 
procedures reasonably designed to ensure that the advertisements are 
disseminated solely to Non-Retail Persons as ``Non-Retail 
Advertisements'' and all other advertisements as ``Retail 
Advertisements.'' See proposed rule 206(4)-1(e)(7) and (13).
    \550\ Proposed rule 206(4)-1(c)(2).
---------------------------------------------------------------------------

1. Net Performance Requirement; Elimination of Proposed Schedule of 
Fees Requirement
    The final rule will prohibit any presentation of gross performance 
in an advertisement unless the advertisement also presents net 
performance (i) with at least equal prominence to, and in a format 
designed to facilitate comparison with, the gross performance; and (ii) 
calculated over the same time period, and using the same type of return 
and methodology as, the gross performance.\551\ The final rule applies 
the net performance requirement to all advertisements, not only to 
Retail Advertisements and, in turn, eliminates the proposed schedule of 
fees requirement.\552\ We discuss below the benefits of expanding the 
net performance requirement to all performance advertisements in light 
of the removal of the proposed schedule of fees requirement, and the 
anticipated effects on advisers.
---------------------------------------------------------------------------

    \551\ Final rule 206(4)-1(d)(1).
    \552\ Id.
---------------------------------------------------------------------------

    Some commenters supported our proposal to require advisers that 
present gross performance in Retail Advertisements to present net 
performance.\553\ They agreed that presentations of net performance 
help demonstrate the effect that fees and expenses will have on future 
performance. One commenter also stated that providing net performance 
information to Non-Retail Persons alerts

[[Page 13069]]

them to the fact that fees and expenses may significantly reduce 
performance.\554\
---------------------------------------------------------------------------

    \553\ See Consumer Federation Comment Letter; CFA Institute 
Comment Letter; Proskauer Comment Letter. The majority of commenters 
who responded via the Investor Feedback Flyer marked net performance 
results as ``Very Important.''
    \554\ See NYC Bar Comment Letter (expressing this idea in the 
context of its overall argument that the rule should not require an 
adviser to provide (or offer to provide) a schedule of fees and 
expenses to Non-Retail Persons when also presenting net 
performance).
---------------------------------------------------------------------------

    Some commenters also supported our proposal to allow advisers to 
exclude net performance in Non-Retail Advertisements, stating that Non-
Retail Persons are often not at risk of being misled by gross 
performance.\555\ However, another commenter stated that many Non-
Retail Persons investing in private funds prefer to receive both net 
and gross performance results in advertisements because it provides an 
opportunity to cross check the investors' net performance calculations 
against advisers' calculations.\556\
---------------------------------------------------------------------------

    \555\ See, e.g., IAA Comment Letter; Proskauer Comment Letter 
(stating that for Non-Retail Persons, disclosure that gross 
performance is gross and not net is sufficient); CFA Institute 
Comment Letter; MFA/AIMA Comment Letter I; Blackrock Comment Letter.
    \556\ See ILPA Comment Letter.
---------------------------------------------------------------------------

    In addition, while some commenters supported permitting different 
performance presentations in Retail and Non-Retail Advertisements,\557\ 
other commenters stated that it could create operational, 
administrative, and compliance burdens for advisers, and significant 
potential for errors.\558\ Some commenters stated that advisers would 
face difficulties in controlling the distribution of Non-Retail 
Advertisements pursuant to policies and procedures that would be 
required under the proposal.\559\ A few commenters also raised concerns 
that in some cases Retail and Non-Retail Persons may invest in the same 
fund, but may receive different types or levels of information because 
of the proposed rule's bifurcated approach.\560\
---------------------------------------------------------------------------

    \557\ See, e.g., CFA Institute Comment Letter; Consumer 
Federation Comment Letter.
    \558\ See, e.g., NYC Bar Comment Letter; NSCP Comment Letter; 
AIC Comment Letter I; NAPFA Comment Letter; ACG Comment Letter.
    \559\ See, e.g., NSCP Comment Letter; IAA Comment Letter 
(stating that prospective investors typically do not provide 
information about their retail or non-retail status at the marketing 
stage, and stating that in the case of non-U.S. investors, this 
information is generally not gathered at any stage).
    \560\ See Ropes & Gray Comment Letter; Association for Corporate 
Growth Comment Letter. For example, a private fund that relies on 
section 3(c)(1) of the Investment Company Act may have investors 
that qualify as Retail and Non-Retail Persons under the proposed 
amendments to the advertising rule. Retail Persons would receive 
different disclosures under the proposal, raising the possibility of 
unequal treatment and potential questions about fair disclosure. See 
proposed rule 206(4)-1(c)(1) and (2).
---------------------------------------------------------------------------

    After considering comments, we believe that the net performance 
requirement is reasonably designed to prevent all types of prospective 
clients and private fund investors from being misled by the 
presentation of gross performance in an advertisement. Presenting gross 
performance alone in this context may imply that investors received the 
full amount of the presented returns, when the fees and expenses paid 
in connection with the investment adviser's investment advisory 
services would reduce the returns to investors. Presenting gross 
performance alone also may be misleading to the extent that amounts 
paid in fees and expenses are not deducted and thus not compounded in 
calculating the returns. In addition, we believe that presenting net 
performance in all advertisements will help illustrate for investors 
the effect of fees and expenses on the advertised performance results 
and allow all investors to compare the adviser's performance 
presentation with their own calculations, if applicable. We do not 
believe the burden will be considerable given that many advisers 
already present net performance.\561\
---------------------------------------------------------------------------

    \561\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    Given the operational complexity and challenges that commenters 
noted, as well as changes we are making to the final rule to streamline 
the performance presentation requirements for all advisers, we are 
persuaded that the rule should no longer provide different flexibility 
for advertisements to Non-Retail Persons. Accordingly, the final rule 
implements changes from the proposed rule that we believe, when viewed 
as a whole, simplify the rule's compliance for all advisers, while 
preserving and promoting protection for all investors. In particular, 
we are eliminating the proposed schedule of fees requirement. 
Commenters stated that this requirement could be overly burdensome for 
advisers and may not provide relevant information to investors.\562\ 
Some commenters also stated that Non-Retail Persons are in a position 
to negotiate for appropriately tailored disclosures based on their 
particular needs.\563\ While one commenter disagreed, arguing that 
investors in private funds (including Non-Retail Persons) sometimes 
have difficulty obtaining information regarding fees and expenses for 
complex products,\564\ we believe requiring net performance for all 
advertisements with appropriate disclosures will alert investors to the 
effect of fees on an adviser's performance results.
---------------------------------------------------------------------------

    \562\ See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter; 
CFA Institute Comment Letter (stating that they do not believe it is 
feasible for an adviser that presents gross returns to provide the 
proposed fee schedule, but that advisers should disclose certain 
information about fees a client will pay).
    \563\ See MFA/AIMA Comment Letter I; NYC Bar Comment Letter.
    \564\ See ILPA Comment Letter.
---------------------------------------------------------------------------

    As proposed, the final rule will not prescribe disclosure 
requirements for net and gross performance presentations. Instead, an 
adviser would need to comply with the final rule's general 
prohibitions. Comments were mixed on this aspect of the proposal.\565\ 
We continue to believe, however, that advisers should evaluate the 
particular facts and circumstances that may be relevant to investors, 
including the assumptions, factors, and conditions that contributed to 
the performance, and include appropriate disclosures or other 
information such that the advertisement does not violate the 
prohibitions in paragraph (a) of the final rule or other applicable 
law. Depending on the facts and circumstances, disclosures may include: 
(1) The material conditions, objectives, and investment strategies used 
to obtain the results portrayed; (2) whether and to what extent the 
results portrayed reflect the reinvestment of dividends and other 
earnings; (3) the effect of material market or economic conditions on 
the results portrayed; (4) the possibility of loss; and (5) the 
material facts relevant to any comparison made to the results of an 
index or other benchmark.\566\
---------------------------------------------------------------------------

    \565\ See, e.g., NAPFA Comment Letter (opposing additional 
disclosure requirements); NRS Comment Letter (supporting additional 
disclosure requirements). See also ILPA Comment Letter (requesting 
that the Commission incorporate specific disclosures for non-retail 
investors reviewing private equity fund performance advertising).
    \566\ See 2019 Proposing Release, supra footnote 7, at nn.191-
195.
---------------------------------------------------------------------------

a. Definition of Gross Performance
    Similar to the proposal, both ``gross performance'' and ``net 
performance'' will be defined by reference to a ``portfolio,'' which is 
defined as ``a group of investments managed by the investment adviser'' 
and can include ``an account or private fund.'' \567\ Under the final 
rule, ``gross performance'' is defined to mean the performance results 
of a portfolio (or portions of a portfolio that are included in 
extracted performance, if applicable) before the deduction of all fees 
and expenses that a client or investor has paid or would have paid in 
connection with the investment adviser's investment advisory services 
to the relevant

[[Page 13070]]

portfolio.\568\ We are adopting the definition of gross performance as 
proposed, with one change to require, as a commenter requested, that 
advisers that show extracted performance in accordance with the final 
marketing rule must show net and gross performance for the applicable 
subset of investments extracted from a portfolio.\569\ This change 
clarifies that gross performance applies not only to an entire 
portfolio but also to a portion of a portfolio that is included in 
extracted performance.
---------------------------------------------------------------------------

    \567\ Final rule 206(4)-1(e)(11). See also proposed rule 206(4)-
1(e)(10).
    \568\ Final rule 206(4)-1(e)(7).
    \569\ See CFA Institute Comment Letter. See infra section II.E.5 
(discussing extracted performance).
---------------------------------------------------------------------------

    Gross performance does not show the impact of all fees and expenses 
that the adviser's existing investors have borne or that prospective 
investors would bear, which can be relevant to an evaluation of the 
investment experience of the adviser's advisory clients and/or 
investors in private funds advised by the investment adviser.\570\ 
While commenters generally supported the proposed definition of gross 
performance, some requested that we clarify the types of fees and 
expenses advisers must deduct in calculating gross performance.\571\ 
For example, some commenters requested we specify that gross returns 
should reflect the deduction of transaction costs, if any exist.\572\ 
One of these commenters also requested that we add a definition for 
``pure gross returns'' (i.e., returns that do not reflect the deduction 
of any transaction costs), and require advisers to make additional 
disclosures when presenting pure gross returns in advertisements.\573\ 
The same commenter requested that we clarify that advisory fees paid to 
underlying investment vehicles must be deducted from gross performance.
---------------------------------------------------------------------------

    \570\ See 2019 Proposing Release, supra footnote 7, at text 
accompanying nn.235-236.
    \571\ See, e.g., IAA Comment Letter; CFA Institute Comment 
Letter.
    \572\ See IAA Comment Letter (recommending for all cases where 
an investment adviser has discretion and is responsible for the 
execution of client transactions); CFA Institute Comment Letter 
(recommending for all presentations of gross returns other than 
those the adviser describes as ``pure gross returns'').
    \573\ CFA Institute Comment Letter (``Pure gross returns are 
commonly used when transaction costs are bundled with investment 
management fees, such as in a wrap fee arrangement.''). This 
commenter also requested that we clarify whether returns of accounts 
that pay zero commissions are gross returns or pure gross returns.
---------------------------------------------------------------------------

    Like the proposed rule, the final rule does not prescribe any 
particular calculation of gross performance. For example, many private 
funds use money-weighted returns instead of time-weighted returns.\574\ 
Under the final rule, advisers may use the type of returns appropriate 
for their strategies provided that the usage does not violate the 
rule's general prohibitions, and, if applicable, subject to the 
requirements discussed below.\575\ We continue to believe that, because 
of the variation among types of advisers and investments, prescribing 
the calculation could unduly limit the ability of advisers to present 
performance information that they believe would be most relevant and 
useful to an advertisement's audience. However, if an investment 
adviser calculates the performance of a portfolio in part by deducting 
transaction fees and expenses, but deducts no other fees or expenses, 
then such performance would be ``gross performance.'' If an investment 
adviser's calculation of performance reflects the deduction of advisory 
fees paid to an underlying investment vehicle before the deduction of 
all fees and expenses that a client or investor has paid or would have 
paid in connection with the investment adviser's investment advisory 
services to the relevant portfolio, then such performance would be 
``gross performance.''
---------------------------------------------------------------------------

    \574\ See, e.g., CFA Institute Comment Letter.
    \575\ See, e.g., supra section II.B; infra section II.E.
---------------------------------------------------------------------------

    It would be misleading to present gross performance information 
without providing appropriate disclosure about gross performance, 
taking into account the particular facts and circumstances of the 
advertised performance. Advisers generally should describe the type of 
performance return presented in the advertisement. For example, an 
advertisement may or may not present the performance of a portfolio 
using a return that accounts for the cash flows into and out of the 
portfolio. In either case, under the final rule, an adviser generally 
should disclose what elements are included in the return presented so 
that the audience can understand, for example, how it reflects cash 
flow and other relevant factors. Similarly, if an adviser's 
presentation of gross performance does not reflect the deduction of 
transaction fees and expenses, an adviser should disclose that fact to 
avoid being misleading, if it would not be clear to the investor from 
the context of the advertisement.\576\
---------------------------------------------------------------------------

    \576\ Even though we are not adopting a definition of ``pure 
gross performance,'' as one commenter suggested, we believe that any 
adviser that presents such performance results in addition to gross 
performance and net performance should identify pure gross returns 
and disclose that pure gross returns do not reflect the deduction of 
transaction costs, to avoid misleading recipients of the 
advertisement.
---------------------------------------------------------------------------

b. Definition of Net Performance
    We are adopting the definition of net performance as proposed, with 
some modifications. First, as with gross performance and for the same 
reasons, the final rule provides that net performance applies not only 
to an entire portfolio but also to a portion of a portfolio that is 
included in extracted performance. Second, we are specifying when 
advisers may exclude certain custodian fees paid to third parties. 
Third, we are prescribing some aspects of the calculation of net 
performance using model fees.
    The final rule defines ``net performance'' to mean, in part, the 
performance results of a portfolio (or portions of a portfolio that are 
included in extracted performance, if applicable) after the deduction 
of all fees and expenses that a client or investor has paid or would 
have paid in connection with the investment adviser's investment 
advisory services to the relevant portfolio.\577\ Once an adviser 
establishes the ``portfolio'' for which performance results are 
presented, the adviser must determine the fees and expenses borne by 
the owner of the portfolio and then deduct those to establish the ``net 
performance.''
---------------------------------------------------------------------------

    \577\ Final rule 206(4)-1(e)(10).
---------------------------------------------------------------------------

    The final rule includes a non-exhaustive list of the types of fees 
and expenses to be considered in preparing net performance that is 
identical to the proposal.\578\ This list includes, if applicable, 
advisory fees, advisory fees paid to underlying investment vehicles, 
and payments by the investment adviser for which the client or investor 
reimburses the investment adviser. It illustrates fees and expenses 
that clients or investors bear in connection with the services they 
receive. In addition, ``net performance'' may exclude custodian fees 
paid to a bank or other third-party organization for safekeeping funds 
and securities. Finally, the final rule permits the use of a model fee 
in calculating net performance in an advertisement, subject to 
conditions.
---------------------------------------------------------------------------

    \578\ See proposed rule 206(4)-1(e)(6).
---------------------------------------------------------------------------

    A few commenters supported the proposed definition of net 
performance.\579\ Some commenters, however, requested we prescribe 
additional requirements for net performance calculations, including 
specific requirements for certain private funds.\580\ For example, one 
commenter

[[Page 13071]]

recommended that, when clients cannot ``opt out'' of custody or other 
administrative costs, the rule should expressly require the adviser to 
deduct these fees and costs when presenting net returns of a specific 
pooled investment vehicle.\581\ This commenter requested that we 
clarify that when presenting net performance of a specific pooled fund, 
advisers must deduct administrative fees, as required when complying 
with the CFA Institute's Global Investment Performance Standards 
(``GIPS standards''). Some commenters supported our proposal not to 
prescribe specific calculations, stating that there is no single 
correct way to calculate returns.\582\ Some of these commenters also 
requested we clarify that net performance calculations in 
advertisements must reflect the deduction of any transaction costs and 
investment advisory fees (including any performance-based fees or 
carried interest). One commenter requested clarification that net 
performance fees exclude taxes on gains generated in a portfolio.\583\
---------------------------------------------------------------------------

    \579\ See IAA Comment Letter; MFA/AIMA Comment Letter I; NRS 
Comment Letter.
    \580\ See Consumer Federation Comment Letter (stating that the 
Commission should require advisers to comply with a uniform set of 
principles when calculating performance). See also CFA Institute 
Comment Letter; ILPA Comment Letter (both letters discussing 
particular concerns regarding private equity funds).
    \581\ See CFA Institute Comment Letter.
    \582\ See, e.g., IAA Comment Letter; NRS Comment Letter.
    \583\ See Resolute Comment Letter.
---------------------------------------------------------------------------

    As proposed, the final rule does not prescribe any particular 
calculation of net performance. We believe that prescribing the 
calculation of net performance could unduly limit the ability of 
advisers to present performance information that they believe would be 
most relevant and useful to an advertisement's audience. Therefore, the 
final rule's definition continues to include a non-exhaustive list of 
the types of fees and expenses to be considered in preparing net 
performance. We decline, however, to enumerate all potential private 
fund fees and expenses, as one commenter suggested.\584\ Instead, the 
final rule's definition of net performance requires the deduction of 
private fund fees and expenses that the investor has paid or would have 
paid in connection with the investment adviser's investment advisory 
services to the relevant fund.
---------------------------------------------------------------------------

    \584\ See ILPA Comment Letter.
---------------------------------------------------------------------------

    However, we are clarifying in response to some commenters that any 
adviser that deducts applicable transaction fees and expenses, or 
advisory fees paid to an underlying investment vehicle, when 
calculating gross performance should also do so for net performance. We 
are also clarifying that, under the final rule's definition of net 
performance, advisory fees include performance-based fees and 
performance allocations that a client or investor has paid or would 
have paid in connection with the investment adviser's investment 
advisory services to the relevant portfolio. With respect to 
administrative fees and expenses that a commenter raised, whether a 
client or investor pays them in connection with the investment 
adviser's advisory services (and therefore they must be deducted) 
depends on the facts and circumstances. For example, if an adviser 
agrees to bear certain administrative fees as a result of negotiations 
with investors in the private fund, or if an investor agrees to 
directly bear them, we do not believe that those fees should be 
included in the calculation of net performance. In response to a 
commenter discussed above, we believe that capital gains taxes paid 
outside of the portfolio are not fees and expenses that a client or 
investor has paid or would have paid in connection with the investment 
adviser's investment advisory services (and are therefore not required 
to be deducted in the calculation of net performance).\585\
---------------------------------------------------------------------------

    \585\ See Resolute Comment Letter.
---------------------------------------------------------------------------

    In addition, as proposed, the definition of net performance refers 
to the deduction of all fees that an investor ``has paid or would have 
paid'' in connection with the services provided. That is, where 
hypothetical performance is permissibly advertised under the final 
rule, net performance should reflect the fees and expenses that ``would 
have'' been paid if the hypothetical performance had been achieved by 
an actual portfolio.\586\
---------------------------------------------------------------------------

    \586\ Final rule 206(4)-1(e)(10).
---------------------------------------------------------------------------

c. Deduction of Custodian Fees Paid to a Bank or Other Third-Party 
Organization
    Under the final rule, presentation of ``net performance'' in an 
advertisement may exclude custodian fees paid to a bank or other third-
party organization for safekeeping funds and securities, as 
proposed.\587\ We understand that advisory clients commonly select and 
directly pay custodians, and in such cases, advisers may not have 
knowledge of the amount of such custodian fees to deduct for purposes 
of establishing net performance.
---------------------------------------------------------------------------

    \587\ Final rule 206(4)-1(e)(10)(i). See proposed rule 206(4)-
1(e)(6)(iii).
---------------------------------------------------------------------------

    One commenter supported this treatment for non-pooled investment 
vehicles, stating that the rule should not require an adviser to 
reflect the deduction of custodian fees when clients select their 
custodians.\588\ However, this commenter also recommended that the rule 
expressly require custody fee deduction if a client cannot ``opt-out'' 
of paying those fees.
---------------------------------------------------------------------------

    \588\ See CFA Institute Comment Letter. See also IAA Comment 
Letter (supporting permitting the exclusion of custodian fees, 
generally).
---------------------------------------------------------------------------

    After considering comments, we continue to believe that the final 
rule should allow an adviser to exclude custodian fees paid to third 
parties given a client may control custodian selection (and 
accompanying fees). We believe that this approach is appropriate even 
where advisers know the amount of custodian fees--e.g., where the 
adviser recommended the custodian. However, to the extent a client or 
investor pays an adviser, rather than a third party, for custodial 
services, then the adviser must deduct the custodial fee in calculating 
net performance for purposes of the advertisement. This will be the 
case, for example, when an adviser provides custodial services with 
respect to funds or securities for which the performance is presented 
and charges a separate fee for those services, or when custodial fees 
are included in a single fee paid to the adviser, such as if they are 
included in wrap fee programs. This would also be the case when a 
client or investor reimburses the investment adviser for third-party 
custodian fees.
d. Deduction of Model Fees
    Under the final rule, presentation of ``net performance'' in 
advertisements may reflect the deduction of a model fee when doing so 
would result in performance figures that are no higher than if the 
actual fee had been deducted, as proposed.\589\ This will result in 
performance that is no higher than if the adviser deducted actual fees. 
For example, in a private fund with multiple series or classes where 
each series or class has different fees, an adviser may display the 
performance of the highest fee class. We did not receive any comments 
on this aspect of the proposal. Advisers may choose this modification 
to ease calculating net performance. When an adviser advertises net 
performance that is no higher than if deducting actual fees, there 
appears to be little chance of misleading the audience into believing 
that investors received better returns than they actually did.\590\
---------------------------------------------------------------------------

    \589\ Final rule 206(4)-1(e)(10)(ii)(A).
    \590\ If the fee to be charged to the intended audience is 
anticipated to be higher than the actual fees charged, the adviser 
must use a model fee that reflects the anticipated fee to be charged 
in order not to violate the rule's general prohibitions. See id. See 
also final rule 206(4)-1(a).

---------------------------------------------------------------------------

[[Page 13072]]

    The rule also will allow net performance to reflect the deduction 
of a model fee that is equal to the highest fee charged to the intended 
audience to whom the advertisement is disseminated, similar to as 
proposed.\591\ We continue to believe that allowing advisers to present 
net performance that reflects the deduction of this type of model fee 
may be useful for advisers who manage a particular strategy for 
different types of investors. For example, under the final rule, an 
adviser managing several accounts, each using the same investment 
strategy, could present in an advertisement the gross and net 
performance of all such accounts. For net performance, the adviser may 
deduct a model fee equal to the highest fee charged to retail investors 
(assuming an intended retail audience). This provision of the 
definition of net performance does not permit net performance that 
reflects a model fee that is not available to the intended audience. 
One commenter requested that we permit advisers to deduct model fees 
that reflect either the highest fee that was charged historically or 
the highest potential fee that it will charge the investors or clients 
receiving the particular advertisement, provided the performance is 
accompanied by appropriate disclosure.\592\ Under the final rule, an 
adviser does not have discretion to choose the model fee to use in 
calculating net performance--it must use the higher of these two model 
fees.\593\
---------------------------------------------------------------------------

    \591\ Final rule 206(4)-1(e)(10)(ii)(B). The final rule reflects 
one change from the proposal, in response to a commenter that 
requested that we conform the phrase ``relevant audience'' in the 
proposed rule's model fee provision, to other parts of the rule. See 
CFA Institute Comment Letter. We agree, and have revised the 
provision to refer to the ``intended audience to whom the 
advertisement is disseminated.''
    \592\ See MMI Comment Letter.
    \593\ See supra footnote 590 (discussing the final rule's first 
model fee provision and the general prohibitions). As discussed 
above, net performance that reflects a model fee that is not 
available to the intended audience is not permitted under the final 
rule's second model fee provision.
---------------------------------------------------------------------------

    Another commenter supported this provision, but stated that where 
an adviser has not yet managed an actual account for clients or 
investors similar to the relevant audience, the rule should permit the 
adviser to deduct a model fee that is equal to the highest fee to be 
charged to relevant audience.\594\ We agree, and the final rule 
requires the use of such a model fee.\595\
---------------------------------------------------------------------------

    \594\ See CFA Institute Comment Letter.
    \595\ See final rule 206(4)-1(e)(10) (referring, in the 
definition of net performance, to the deduction of all fees and 
expenses that a client or investor ``would have paid''). An adviser 
could use such a model fee pursuant to the second model fee 
provision. Final rule 206(4)-1(e)(10)(ii)(B).
---------------------------------------------------------------------------

    Another commenter expressed concern that the proposed rule would 
require an adviser to overstate its normal fee, when deducting a model 
fee, because the adviser had previously charged a client a higher fee 
for unique relationship servicing requirements.\596\ If an adviser 
charged a higher fee for unique services that it does not intend to 
provide in the future to the intended audience for the advertisement, 
the portfolio may be outside of the scope of the adviser's performance 
calculation. For example, it may not meet the criteria for a related 
portfolio and, in that case, should not be included in the calculation 
of related performance.
---------------------------------------------------------------------------

    \596\ See Wellington Comment Letter.
---------------------------------------------------------------------------

    Similarly, one commenter stated that the rule should not require an 
adviser to deduct a model fee when presenting performance of a 
portfolio of a non-fee paying client.\597\ This commenter requested 
that we instead permit such adviser to calculate net performance 
returns using actual investment management fees (i.e., zero fees) and 
disclose the percentage of assets under management represented by non-
fee paying portfolios. Further, this commenter stated that the GIPS 
standards do not require the application of a model fee to non-fee-
paying portfolios to calculate net returns, and that requiring it in 
the final rule may result in many advisers being required to restate 
historical performance. We believe this presentation could mislead 
investors to believe that they could receive returns as high as non-fee 
paying clients, even with the commenter's proposed disclosure. In the 
2019 Proposing Release, we expressed similar concerns with presenting 
related performance of accounts with fee waivers or reduced rates 
unavailable to unaffiliated clients of the adviser.\598\ Accordingly, 
to satisfy the final rule's general prohibitions, an adviser generally 
should apply a model fee that reflects either the highest fee that was 
charged historically or the highest potential fee that it will charge 
the investors or clients receiving the particular advertisement.
---------------------------------------------------------------------------

    \597\ See CFA Institute Comment Letter.
    \598\ See 2019 Proposing Release, supra footnote 7, at text 
following footnote 288.
---------------------------------------------------------------------------

    One commenter requested clarification that model fees also may 
exclude custodian fees that would be paid to a bank or other third-
party organization.\599\ We agree that an adviser that uses a model fee 
in accordance with the final rule may also exclude custodian fees if 
otherwise permitted under the final rule.
---------------------------------------------------------------------------

    \599\ See IAA Comment Letter.
---------------------------------------------------------------------------

e. Conditions for Presentation
    As proposed, the final rule will require that net performance be 
presented in the advertisement with at least equal prominence to, and 
in a format designed to facilitate comparison with, the gross 
performance, and calculated over the same time period, and using the 
same type of return and methodology as, the gross performance.\600\ 
These conditions are designed to help ensure that net performance 
effectively conveys to the audience information about the effect of 
fees and expenses on the relevant performance. A calculation of net 
performance over a different time period or using a different type of 
return or methodology would not necessarily provide information about 
the effect of fees and expenses. Only one commenter discussed this 
condition and recommended that the Commission encourage advisers to be 
certain that the layout of the information presented is not 
misleading.\601\ As described above, advertisements containing any 
performance presentation will be subject to the rule's general 
prohibitions.
---------------------------------------------------------------------------

    \600\ Final rule 206(4)-1(d)(1)(i) and (ii).
    \601\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

2. Prescribed Time Periods
    Our final rule also adopts the proposed one-, five-, and ten-year 
time period requirement for the presentation of performance results in 
an advertisement, with some modifications from the proposed rule. 
First, the final rule applies the time period requirement to all 
advertisements (with a new exception for private funds), rather than 
only to Retail Advertisements, as proposed.\602\ Second, prescribed 
time periods must end on a date that is no less recent than the most 
recent calendar year-end, rather than the most recent practicable date, 
as proposed.\603\ As proposed, this time period requirement will apply 
to all performance results, including gross and net performance, and 
including any composite aggregation of related portfolios. Also, as 
proposed, if the relevant portfolio did not exist for a particular 
prescribed period, then an adviser must present performance information 
for the life of the portfolio.\604\ For example, if a portfolio has 
been in existence for seven years, then the adviser must show

[[Page 13073]]

performance results for one- and five-year periods, as well as for the 
seven-year period. An investment adviser is free to include performance 
results for other periods as long as the advertisement also presents 
results for the prescribed time periods, and otherwise complies with 
the requirements of the final rule.\605\
---------------------------------------------------------------------------

    \602\ Final rule 206(4)-1(d)(2). See proposed rule 206(4)-
1(c)(2)(ii).
    \603\ See id.
    \604\ See id.
    \605\ For example, an adviser may present performance results 
for three-year periods, which is a requirement for advisers that 
claim compliance with the GIPS standards. See, e.g., CFA Institute 
Comment Letter. We are not requiring a three-year period, however, 
because we believe the time periods required under the final rule 
already provide investors with sufficient information regarding 
performance over varying time periods.
---------------------------------------------------------------------------

    The final rule also adopts the proposed requirement that the 
prescribed time periods be presented with equal prominence in the 
advertisement, so that an investor can observe the history of the 
adviser's performance on a short-term and long-term basis.\606\ An 
adviser may not highlight the single one-, five-, or ten-year period 
that shows the best performance, instead of showing them in relation to 
each other.
---------------------------------------------------------------------------

    \606\ Final rule 206(4)-1(d)(2).
---------------------------------------------------------------------------

    We believe this standardized presentation provides the audience 
with insight into the experience of the investment adviser over set 
periods that are likely to reflect how the advertised portfolio(s) 
performed during different market or economic conditions. For 
portfolios in existence for at least ten years, performance for that 
period could provide investors with more complete information than only 
performance over the most recent year. That performance may prompt 
investors to seek additional information from advisers regarding the 
causes of significant changes in performance over longer periods. Some 
commenters supported this aspect of the proposal for this reason.\607\ 
These commenters also stated that this information would aid investors 
in comparing different performance advertisements and reduce the risk 
that advisers would present performance based on cherry-picked periods.
---------------------------------------------------------------------------

    \607\ See Consumer Federation Comment Letter; CFA Institute 
Comment Letter; Fried Frank Comment Letter.
---------------------------------------------------------------------------

    Several commenters stated that the proposed time period requirement 
for closed-end private funds, however, would be inappropriate and 
confusing for investors, in part, because such performance (especially 
five- and ten-year periods) may not exist for the fund advertised, 
since private funds are often advertised to investors at early 
stages.\608\ In addition, commenters stated that the performance of 
private equity funds can vary substantially over the term of the fund 
(with early years often negatively affected by organizational expenses 
of the ``J-curve''), and that the presentation of performance over 
prescribed time periods is therefore not useful to investors.\609\ 
Similarly, commenters noted that the presentation of performance using 
an internal rate of return, as is typical with private equity funds, is 
often not meaningful in the early years of the fund because the fund is 
not fully invested, no investments have been harvested, and the new 
investments likely have not changed in value.\610\
---------------------------------------------------------------------------

    \608\ See AIC Comment Letter I; Fried Frank Comment Letter; MFA/
AIMA Comment Letter I; IAA Comment Letter; Ropes & Gray Comment 
Letter; NYC Bar Comment Letter.
    \609\ See, e.g., AIC Comment Letter; Fried Frank Comment Letter; 
Ropes & Gray Comment Letter; IAA Comment Letter.
    \610\ See Fried Frank Comment Letter; MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

    In light of our decision not to distinguish the treatment of Retail 
and Non-Retail Advertisements, and after considering comments, we agree 
that requiring advisers to provide performance results of private funds 
over one-, five-, and ten-year periods in advertisements will not 
provide investors with useful insight into how the advertised 
portfolio(s) performed during different market or economic conditions. 
Our final rule therefore applies the time period requirement to all 
performance advertisements, except for performance of a private 
fund.\611\ An adviser may rely on this exception when displaying 
performance advertising of any type of private fund, rather than only 
when displaying performance advertising of private equity funds or 
other closed-end private funds. We believe that it is appropriate to 
except any private fund because there may be additional types of 
private funds than those identified by commenters for which displaying 
this information could be misleading. We decline to allow only certain 
defined types of private funds to rely on this exception, given the 
varied limitations that private funds may place on redemptions now and 
in the future. We also do not believe the benefit of having advisers 
parse the rule's requirements based on specific fund types would 
justify the complexity. Further, although we are not mandating 
presentation of performance for any specific time periods for these 
funds, presentations of private fund performance are subject to the 
general anti-fraud provisions of the Federal securities laws and the 
general prohibitions in the final rule, including the prohibition of 
including or excluding performance results, or presenting performance 
time periods, in a manner that is not fair and balanced.\612\
---------------------------------------------------------------------------

    \611\ Final rule 206(4)-1(d)(2). See also final rule 206(4)-
1(e)(13) (defining private fund).
    \612\ See Fried Frank Comment Letter; Ropes & Gray Comment 
Letter (discussing that when not using time-based performance, there 
is a potential for investment advisers to cherry-pick only recent 
performance results or strong performance years, or otherwise 
mislead investors by using ``not meaningful'' to show performance 
information).
---------------------------------------------------------------------------

    Other commenters stated that our proposal would create operational 
difficulties for advisers that present annual returns as of the most 
recent calendar year-end.\613\ A commenter stated that, for these 
advisers, the proposal's requirement to present one-, five-, and ten-
year returns as of the ``most recent practicable date'' would require 
that they continuously update their performance presentations 
throughout the year.\614\ This commenter requested we permit annual 
returns presented through the most recent calendar year-end. This 
commenter also requested that the final rule align with the GIPS 
standards by allowing advisers to present annual returns for the past 
ten years (or since inception if the track record exists for less than 
ten years) as of the most recent calendar year end, instead of one-, 
five-, and ten-year annualized returns.
---------------------------------------------------------------------------

    \613\ See CFA Institute Comment Letter; IAA Comment Letter.
    \614\ CFA Institute Comment Letter. Cf. MMI Comment Letter 
(requesting that our final rule permit advisers to present quarterly 
performance results).
---------------------------------------------------------------------------

    We understand that, for some advisers, the most recent calendar 
year-end may be the most recent practicable date. Our final rule 
therefore requires that the prescribed time period end on a date that 
is no less recent than the most recent calendar year-end. In selecting 
time periods for purposes of an advertisement, an adviser may not 
select the periods that show only the most favorable performance--e.g., 
presenting a five-year period ending on a particular date because that 
five-year period showed growth while presenting a ten-year period 
ending on a different date because that ten-year period showed growth. 
Depending on the facts and circumstances, an adviser may be required to 
present performance results as of a more recent date than the most 
recent calendar year-end to comply with the rule's general 
prohibitions.\615\ For example, it could be misleading for an adviser 
to present performance returns as of the most recent calendar year-end 
if more timely quarter-end performance is available and events have 
occurred

[[Page 13074]]

since that time that would have a significant negative effect on the 
adviser's performance. If more recent quarter-end performance data is 
not available, the adviser should include appropriate disclosure about 
the performance presented in the advertisement.
---------------------------------------------------------------------------

    \615\ See, e.g., final rule 206(4)-1(a)(6) (an advertisement may 
not include or exclude performance results, or present performance 
time periods, in a manner that is not fair and balanced).
---------------------------------------------------------------------------

    We are also clarifying that, for an adviser that provides 
performance results in advertisements for periods other than one, five, 
and ten years, the adviser is free to include such results as long as 
the advertisement presents results for the final rule's required time 
periods. Thus, an adviser that complies with the GIPS standards may 
present annual returns for the past ten years (or since inception if 
the track record exists for less than ten years) as of the most recent 
calendar year end, in addition to performance results for the final 
rule's required periods.
3. Statements About Commission Approval
    As proposed, the final rule prohibits any statement, express or 
implied, that the calculation or presentation of performance results in 
the advertisement has been approved or reviewed by the Commission in 
any advertisement containing performance results.\616\ This approval 
prohibition is intended to prevent advisers from representing that the 
Commission has approved or reviewed the performance results, even when 
the adviser is presenting performance results in accordance with the 
rule. Furthermore, the final rule's general prohibitions have the 
effect of prohibiting an adviser from stating or implying that any part 
of an advertisement, and the advertisement as a whole, has been 
approved or reviewed by the Commission.\617\ Our final rule prescribes 
this condition specifically for advertisements containing performance 
results because of the particular weight an investor would likely give 
to performance results that it believes the Commission has reviewed or 
vetted.
---------------------------------------------------------------------------

    \616\ Final rule 206(4)-1(d)(3).
    \617\ Final rule 206(4)-1(a)(3).
---------------------------------------------------------------------------

    We received few comments on this aspect of the proposed rule, with 
one commenter supporting it and the other requesting clarification as 
to whether this provision would prohibit advertisements that combine 
performance results with summary information about an adviser's recent 
SEC examination.\618\ We continue to believe that performance results 
may lead to a heightened risk of creating unrealistic expectations in 
an advertisement's audience. An express or implied statement that the 
Commission has reviewed or approved the performance results could 
advance such unrealistic expectations. For example, while potentially 
true, a statement that ``performance results are prepared in compliance 
with the Commission's requirements on performance presentations in 
advertisements'' may mislead an investor into thinking that the 
Commission has approved the results portrayed.\619\ Such a statement 
could also be misleading to the extent it suggests that the Commission 
has reviewed or approved more generally the investment adviser, its 
services, its personnel, its competence or experience, or its 
investment strategies and methods. Therefore, under the final rule, 
advisers may not represent that the Commission has approved or reviewed 
the performance results.\620\
---------------------------------------------------------------------------

    \618\ See, e.g., Mercer Comment Letter (supporting this aspect 
of the proposed rule).
    \619\ Similarly, section 208(a) of the Act, states that it is 
unlawful for a registered investment adviser to represent or imply 
in any manner whatsoever that it has been sponsored, recommended, or 
approved, or that his abilities or qualifications have in any 
respect been passed upon by the United States or any agency or any 
officer thereof.
    \620\ See also section 208(a) of the Act.
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4. Related Performance
    The final rule will condition the use of ``related performance'' in 
adviser advertisements, on the inclusion of all ``related portfolios.'' 
\621\ Under the final rule, however, an adviser may exclude related 
portfolios if the advertised performance results are not materially 
higher than if all related portfolios had been included, and the 
exclusion does not alter the presentation of any applicable prescribed 
time period. The final rule defines ``related performance'' as ``the 
performance results of one or more related portfolios, either on a 
portfolio-by-portfolio basis or as a composite aggregation of all 
portfolios falling within stated criteria.'' \622\ It defines 
``portfolio'' as ``a group of investments managed by the investment 
adviser,'' and includes in the definition that ``[a] portfolio may be 
an account or a private fund.'' \623\ It defines ``related portfolio'' 
as ``a portfolio with substantially similar investment policies, 
objectives, and strategies as those of the services being offered in 
the advertisement.'' \624\ The final rule's treatment of related 
performance, including the conditions and definitions, is largely the 
same as the proposal. We discuss the few differences from the proposal 
below.
---------------------------------------------------------------------------

    \621\ Final rule 206(4)-1(d)(4). The presentation must also 
comply with the rule's general prohibitions. See final rule 206(4)-
1(a).
    \622\ Final rule 206(4)-1(e)(14).
    \623\ Final rule 206(4)-1(e)(11). A portfolio also includes, but 
is not limited to, a portfolio for the account of the investment 
adviser or its advisory affiliate (as defined in the Form ADV 
Glossary of Terms). See id.
    \624\ Final rule 206(4)-1(e)(15).
---------------------------------------------------------------------------

    Commenters broadly supported allowing advisers to present related 
performance in adviser advertisements.\625\ They generally agreed that 
related performance can be a valuable tool to assist an investor in 
evaluating a particular investment adviser or investment strategy, and 
that its use is consistent with industry practice. A few commenters 
also generally supported the proposed rule's conditions for the 
presentation of related performance.\626\ Others, however, described 
the proposed conditions as overly prescriptive and stated that we 
should address cherry-picking related portfolios solely through the 
rule's general prohibitions, such as the ``fair and balanced'' 
provision.\627\ Another commenter stated that we should remove the 
conditions and permit advisers to identify (and document) objective 
criteria that they can apply on a consistent basis to exclude certain 
types of accounts.\628\ Conversely, one commenter said we should 
require composite performance without any exclusions of related 
portfolios because allowing exclusions from composites would be 
different from the GIPS standards that require composites to include 
all portfolios that are managed in the composite's strategy.\629\
---------------------------------------------------------------------------

    \625\ See, e.g., MFA/AIMA Comment Letter I; Proskauer Comment 
Letter; Comment Letter of Loan Syndications and Trading Association 
(Feb. 10, 2020) (``LSTA Comment Letter''); MMI Comment Letter.
    \626\ See MFA/AIMA Comment Letter I (supporting the conditions 
generally, but requesting that we also permit advisers to present 
representative accounts that would not meet the proposed rule's 
conditions); LSTA Comment Letter.
    \627\ See IAA Comment Letter; SIFMA AMG Comment Letter II; Ropes 
& Gray Comment Letter.
    \628\ See SIFMA AMG Comment Letter II.
    \629\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that conditioning the presentation of 
related performance in advertisements on the presentation of all 
related portfolios (with limited exceptions) is necessary to prevent 
investment advisers from including only related portfolios that have 
favorable performance results or otherwise ``cherry-picking.'' We 
believe our approach will provide advisers some flexibility in 
presenting related portfolios, without permitting exclusion because of 
poor performance. We believe this approach strikes the right balance 
between commenters that advocated for relying solely on the rule's 
general prohibition (and/or an adviser's own objective criteria), on 
the

[[Page 13075]]

one hand, and requiring advisers to present all related performance, on 
the other hand. Under the final rule, although we are permitting an 
adviser to exclude related portfolios subject to conditions in the 
final rule, an adviser may nonetheless present performance without the 
exclusion of any related portfolios to comply with both the GIPS 
standards and the final marketing rule.
    In a change from the proposed rule, the final rule will allow an 
investment adviser to exclude from the presentation of related 
performance in the advertisement one or more related portfolios so long 
as the advertised performance results are ``not materially higher 
than''--rather than ``no higher than''--if all related portfolios had 
been included. One commenter recommended this change, stating that it 
will not necessarily be clear whether performance is ``no higher'' 
because performance results may vary based on the time period 
presented.\630\ Another commenter cautioned that, even with such 
conditions, an adviser would have difficulty demonstrating compliance 
for each period in its track record.\631\ Furthermore, this commenter 
stated that an adviser would incur the burden of calculating 
performance including all related portfolios in order to show that the 
performance presented was ``no higher than'' or ``not materially higher 
than'' if all related portfolios had been included.
---------------------------------------------------------------------------

    \630\ See IAA Comment Letter (``A firm may seek to exclude an 
account that has a superior five-year return, but a poor one-year 
return, or present the performance of a representative account that 
has a superior one-year return, but a poor five-year return. In this 
scenario, the advertised performance over five and ten years would 
be lower, but the 1-year return would be higher. This practice may 
be prohibited by the proposed rule because the 1-year return does 
not satisfy the rule's requirements, even though the longer term 
returns do satisfy the rule's requirements.''). See also CFA 
Institute Comment Letter (noting the same issue but making a 
different recommendation).
    \631\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    We understand that an adviser will likely be required to calculate 
the performance of all related portfolios to ensure that the exclusion 
of certain portfolios from the advertisement meets the rule's 
conditions. Because of the special concerns that performance 
advertising raises, however, we believe that this burden is warranted 
to prevent related performance advertising from misleading investors. 
We believe that the modified condition we are adopting will achieve the 
same policy goal as our proposed rule, but give advisers additional 
flexibility to present related performance when there may be immaterial 
differences in performance results depending on the methods of 
calculation of returns or as between the different prescribed time 
periods.\632\ Under the final rule, an adviser may meet this condition 
if the results for one prescribed time period are no higher than if all 
related portfolios had been included for that time period, and the 
results for another prescribed time period are higher, but not 
materially higher, than if all related portfolios had been included for 
that time period. It may also meet this condition if the results for 
any and all prescribed time periods are not materially higher than if 
all related portfolios had been included for each time period.
---------------------------------------------------------------------------

    \632\ We are not prescribing a specific numerical or percentage 
threshold for materiality or immateriality as part of this 
requirement. Instead, based on the facts and circumstances, if the 
results of excluding the related portfolio would be material to a 
reasonable client or investor, the portfolio should not be excluded.
---------------------------------------------------------------------------

    As proposed, the exclusion for related portfolios is also subject 
to the final rule's time period requirement for the presentation of 
performance in advertisements.\633\ We did not receive any comments on 
this condition. Related performance therefore cannot exclude any 
related portfolio if doing so would alter the presentation of the 
proposed rule's prescribed time periods.
---------------------------------------------------------------------------

    \633\ See final rule 206(4)-1(d)(4)(ii).
---------------------------------------------------------------------------

    Some commenters recommended that we permit advisers to advertise 
one ``representative account,'' such as a flagship fund, without any 
prescribed conditions or in addition to providing the performance 
results of all related portfolios.\634\ Commenters generally describe 
representative accounts as those that most closely resemble, or are 
most representative of, the advertised portfolio's specific 
strategy.\635\ A few commenters stated that permitting representative 
accounts would provide flexibility to advisers that manage separate 
accounts and may not maintain composites that cover all portfolios 
managed to a specific strategy, and to smaller advisers that do not 
have the resources to calculate the performance of a composite that 
includes all those portfolios.\636\ One such commenter stated that 
smaller advisers would therefore face challenges under the proposed 
rule in demonstrating that the performance of a representative account 
is no higher than if all related portfolios had been included.\637\ 
Others stated that permitting representative accounts would provide 
investors with more pertinent information than under our proposed rule, 
because they believe that prospective fund investors are generally less 
interested in the results of the ancillary funds around that flagship 
fund, and could find the additional information to be confusing.\638\
---------------------------------------------------------------------------

    \634\ See, e.g., IAA Comment Letter; Wellington Comment Letter; 
MFA/AIMA Comment Letter I; CFA Institute Comment Letter.
    \635\ See Wellington Comment Letter; CFA Institute Comment 
Letter. See also MFA/AIMA Comment Letter I (discussing their view 
that ``investment advisers need some flexibility to recognize a 
`flagship' fund for a given strategy and to treat that `flagship' 
fund as the sole related portfolio in many instances.'').
    \636\ See IAA Comment Letter; CFA Institute Comment Letter.
    \637\ See IAA Comment Letter.
    \638\ See MFA/AIMA Comment Letter I; Wellington Comment Letter; 
SIFMA AMG Comment Letter II.
---------------------------------------------------------------------------

    We are not convinced that the benefits of an adviser presenting in 
an advertisement a single representative account that is not subject to 
prescribed conditions would justify the risks of cherry-picking related 
portfolios with higher-than-usual returns.\639\ We also believe the 
materiality standard we are adopting helps to alleviate the burden on 
advisers to present all related performance (subject to a conditional 
exception). We therefore decline to make this suggested change to the 
rule.
---------------------------------------------------------------------------

    \639\ Under our final rule, advisers may include performance 
returns of a single portfolio (without also providing the 
performance of other related portfolios) if the performance is not 
materially higher than if all related portfolios had been included, 
and the performance does not violate the rule's general 
prohibitions.
---------------------------------------------------------------------------

    An adviser, however, may present the results of a single 
representative account (such as a flagship fund) or a subset of related 
portfolios alongside the required related performance so long as the 
advertisement would otherwise comply with the general 
prohibitions.\640\ In these circumstances, where the required related 
performance is also presented in the advertisement, we believe the 
concerns regarding cherry-picking a particular portfolio are mitigated. 
In addition, as proposed, advisers may present related performance on a 
portfolio-by-portfolio basis under the final rule. Advisers that manage 
a small number of related portfolios may find a portfolio-by-portfolio 
presentation to be the clearest way of demonstrating related 
performance in their advertisements. Presenting related performance on 
a portfolio-by-portfolio basis may illustrate for the audience the 
differences in performance achieved by the investment adviser in 
managing portfolios having substantially similar investment policies, 
objectives, and strategies. A portfolio-by-portfolio presentation also 
may best illustrate the differences in performance between a flagship 
fund and other related portfolios in some cases.
---------------------------------------------------------------------------

    \640\ See Wellington Comment Letter.
---------------------------------------------------------------------------

    As in the proposal, presenting related performance on a portfolio-
by-portfolio

[[Page 13076]]

basis will be subject to the general prohibitions, including the 
prohibition on omitting material facts necessary to make the 
presentation, in light of the circumstances under which it was made, 
not misleading. For example, an advertisement presenting related 
performance on a portfolio-by-portfolio basis could be potentially 
misleading if it does not disclose the size of the portfolios and the 
basis on which the adviser selected the portfolios. The alternative for 
presenting related performance, also as proposed, is as a composite 
aggregation of all portfolios falling within stated criteria, which we 
discuss below.
a. Related Portfolio
    Regarding presentations of related portfolios in advertisements, 
the final rule is similar to the proposal in that it does not identify 
or prescribe particular requirements for determining whether portfolios 
are ``related'' beyond whether there are ``substantially similar'' 
investment policies, objectives, and strategies as those of the 
services being offered in the advertisement. Some commenters also 
requested clarification that ``related portfolio'' does not include the 
performance results of the separately managed account or pooled 
investment vehicle being offered.\641\ We agree that the offered 
portfolio is not included in the definition of ``related portfolio.'' 
\642\
---------------------------------------------------------------------------

    \641\ See SIFMA AMG Comment Letter II; AIC Comment Letter; CFA 
Institute Comment Letter.
    \642\ A portfolio with substantially similar investment 
policies, objectives, and strategies as those of the services being 
offered in the advertisement is a related portfolio. See final rule 
206(4)-1(e)(15). Any performance presented in the advertisement, 
whether or not related, must not violate the final rule's general 
prohibitions, and the applicable requirements for the presentation 
of performance. See final rule 206(4)-1(a) and (d).
---------------------------------------------------------------------------

    One commenter requested that we permit advisers to present 
performance results of a private fund both with and without the effect 
of any side pockets.\643\ Whether a side pocket should be considered 
part of a portfolio or a separate portfolio and/or a related portfolio 
subject to the final rule's conditions for presenting related 
performance will be subject to the final rule's conditions for the 
presentation of performance and the rule's general prohibitions.\644\
---------------------------------------------------------------------------

    \643\ See CFA Institute Comment Letter.
    \644\ See final rule 206(4)-1(a).
---------------------------------------------------------------------------

    A commenter also requested that we permit an adviser to exclude a 
separately managed account that has similar investment policies, 
objectives, and strategies to a private fund that the investment 
adviser is offering, but is customized to reflect a client's investment 
objectives and desired restrictions, and has fees and expenses that may 
not be comparable to the private fund.\645\ Another commenter, however, 
noted that each adviser should determine for itself whether portfolios 
having client-specific constraints are ``substantially similar.'' \646\
---------------------------------------------------------------------------

    \645\ See AIC Comment Letter I.
    \646\ See Consumer Federation Comment Letter.
---------------------------------------------------------------------------

    Whether a portfolio is a ``related portfolio'' under the rule 
requires a facts and circumstances analysis. An adviser may determine 
that a portfolio with material client constraints or other material 
differences, for example, does not have substantially similar 
investment policies, objectives, and strategies and should not be 
included as a related portfolio. On the other hand, different fees and 
expenses alone would not allow an adviser to exclude a portfolio that 
has a substantially similar investment policy, objective, and strategy 
as those of the services offered.
    Two commenters also requested that the rule permit an adviser that 
has advised multiple private funds over time to exclude earlier private 
funds that the adviser determines are no longer relevant to investors, 
even if these funds have substantially similar investment policies, 
objectives, and strategies (and are therefore related portfolios).\647\ 
They stated that the performance of prior funds may not be relevant 
because the successor fund is larger than previous funds and capable of 
different types of investments, and that there may have been changed 
market conditions and/or investment professional turnover. Under the 
final rule, if the relevant financial markets or investment advisory 
personnel have changed over time such that the investment policies, 
objectives, and strategies of an adviser's earlier private funds are no 
longer substantially similar to those of the fund being marketed, the 
adviser would not be required to include the earlier private funds in 
its related performance.
---------------------------------------------------------------------------

    \647\ See AIC Comment Letter I; Ropes & Gray Comment Letter.
---------------------------------------------------------------------------

    In a change from the proposal, the final rule refers to 
presentation of related performance as ``a composite aggregation''--
rather than ``one or more composite aggregations''--``of all portfolios 
within stated criteria.'' \648\ An adviser may use the same criteria to 
construct any composites to meet the GIPS standards in order to satisfy 
the ``substantially similar'' requirement of the final rule's 
definition of ``related portfolio.'' \649\ However, in response to a 
comment from the organization that developed and administers the GIPS 
standards, our final rule clarifies that an adviser may only have one 
composite aggregation for each stated set of criteria. We agree with 
this commenter that the rule should not permit advisers to create more 
than one composite aggregation of all portfolios falling within a 
stated set of criteria.\650\ In addition, similar to the proposal, the 
final rule does not prescribe specific criteria to define the relevant 
portfolios but requires that once the criteria are established, all 
related portfolios meeting the criteria are included in the composite.
---------------------------------------------------------------------------

    \648\ One commenter requested that we add a definition of 
``composite'' that matches a commonly accepted industry term. See 
CFA Institute Comment Letter. The final rule does not include a 
definition for composite, because we understand that many investment 
advisers already have criteria governing their creation and 
presentation of composites.
    \649\ See 2019 Proposing Release, supra footnote 7, at n.280 
(discussing that, for GIPS purposes, a composite is an aggregation 
of portfolios managed according to a similar investment mandate, 
objective, or strategy).
    \650\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    As with the presentation of related performance on a portfolio-by-
portfolio basis in an advertisement, any presentation as a composite is 
subject to the general prohibitions, including the prohibition on 
omitting material facts necessary to make the presentation, in light of 
the circumstances under which it was made, not misleading. For example, 
an advertisement presenting related performance in a composite would be 
false or misleading where the composite is represented as including all 
portfolios in the strategy being advertised but excludes some 
portfolios falling within the stated criteria or is otherwise 
manipulated by the adviser. We also believe that omitting the criteria 
the adviser used in defining the related portfolios and crafting the 
composite could result in an advertisement presenting related 
performance that is misleading.
    Finally, the final rule's definition of ``portfolio'' includes a 
portfolio for the account of the investment adviser or its advisory 
affiliate. This is substantially the same as the proposed 
definition.\651\ The only commenter that addressed this aspect of 
``related performance'' generally agreed with our proposed 
approach.\652\
---------------------------------------------------------------------------

    \651\ To simplify the definitions, the final rule includes this 
wording within the definition of ``portfolio,'' rather than within 
the definition of ``related portfolio,'' as proposed.
    \652\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

5. Extracted Performance
    The final rule prohibits an adviser from presenting extracted 
performance in an advertisement unless the advertisement provides, or 
offers to provide promptly, the performance

[[Page 13077]]

results of the total portfolio from which the performance was 
extracted.\653\ ``Extracted performance'' means ``the performance 
results of a subset of investments extracted from a portfolio.'' \654\ 
We are adopting this provision substantially as proposed, though we are 
requiring the adviser provide, or offer to provide, the results of the 
``total portfolio,'' instead of the results of ``all investments in the 
portfolio,'' at the request of a commenter that recommended we clarify 
an adviser does not have to highlight individual positions.\655\
---------------------------------------------------------------------------

    \653\ Final rule 206(4)-1(d)(5).
    \654\ Final rule 206(4)-1(e)(6).
    \655\ See MFA/AIMA Comment Letter II. Final rule 206(4)-1(d)(5).
---------------------------------------------------------------------------

    Commenters supported permitting extracted performance in 
advertisements, although they differed on what constitutes extracted 
performance.\656\ Some commenters agreed that an adviser's extracted 
performance can provide useful information to investors, who often 
request such information to assist them in evaluating a particular 
investment adviser or investment strategy.\657\ They noted that this is 
especially true for new or modified investment strategies, or new 
investment vehicles using a new or modified investment strategy.
---------------------------------------------------------------------------

    \656\ See MFA/AIMA Comment Letter I; LSTA Comment Letter; 
Proskauer Comment Letter; IAA Comment Letter; CFA Institute Comment 
Letter.
    \657\ See MFA/AIMA Comment Letter I; LSTA Comment Letter. These 
commenters did not object to the proposed rule's conditions for 
presenting extracted performance.
---------------------------------------------------------------------------

    However, two commenters requested clarification about the 
definition of extracted performance and objected to the proposed 
conditions.\658\ One questioned whether the proposed definition 
includes composites of performance extracted from multiple portfolios, 
stating that the proposed conditions would be onerous in this 
case.\659\ This commenter recommended eliminating the conditions and 
instead relying on the general prohibitions to ensure advertisements 
with extracted performance are fair and balanced and not misleading. 
The other stated that the final rule should distinguish between 
performance that is extracted from a single portfolio (e.g., such as 
segment returns), and a standalone strategy presented as a composite of 
extracts from multiple portfolios.\660\ This commenter stated that 
advisers typically present standalone composites and the final rule 
should permit them, subject to similar conditions as under the GIPS 
standards.\661\ This commenter further agreed with the proposed 
requirement to provide, or offer to provide promptly, the performance 
results of the entire portfolio along with the extract when extracted 
performance is not advertised as a standalone strategy.
---------------------------------------------------------------------------

    \658\ See IAA Comment Letter; CFA Institute Comment Letter.
    \659\ See IAA Comment Letter (stating that advisers that present 
composite performance that includes extracted performance would need 
to present the performance of each of the total portfolios from 
which the carve-out segments were extracted under the proposed 
rule).
    \660\ See CFA Institute Comment Letter.
    \661\ See CFA Institute Comment Letter. CFA Institute agreed 
that for advisers presenting segment returns, or attribution, of a 
total portfolio, the condition to present performance of the total 
portfolio would be relevant.
---------------------------------------------------------------------------

    Like the proposed rule, our final rule's provision for extracted 
performance addresses the performance results of a subset of 
investments extracted from a single portfolio. For example, an 
investment adviser seeking to manage a new portfolio of only fixed-
income investments may wish to advertise its performance results from 
managing fixed-income investments within a multi-strategy portfolio. If 
a prospective investor already has investments in fixed-income assets, 
it may want to use the extracted performance to consider the effect of 
an additional fixed-income investment on the prospective investor's 
overall portfolio. The prospective investor may also use the 
presentation of extracted performance from several investment advisers 
as a means of comparing investment advisers' management capabilities in 
that specific strategy.
    We continue to believe that extracted performance can provide 
important information to investors about performance actually achieved 
within a portfolio. It can also provide investors with information 
about performance attribution within a portfolio.\662\ Moreover, we 
expect that conditioning the presentation of extracted performance on 
presenting (or offering to provide promptly) the performance results of 
the entire portfolio from which the performance was extracted will 
prevent investment advisers from cherry-picking certain performance 
results and provide investors necessary context for evaluating the 
extract.\663\ Requiring advisers to provide (or offer to provide 
promptly) this information mitigates the risk of extracted performance 
misleading investors. Furthermore, any differences between the 
performance of the entire portfolio and the extracted performance might 
be a basis for additional discussions between the investor and the 
adviser, which would assist the investor in deciding whether to hire or 
retain the adviser.
---------------------------------------------------------------------------

    \662\ See CFA Institute Comment Letter (requesting guidance on 
whether the proposed rule's ``extracted performance'' covers 
attribution).
    \663\ This context should include any particular differences in 
performance results between the entire portfolio and the extract. It 
may include assumptions underlying the extracted performance if 
necessary to prevent the performance results from being misleading. 
We received no comments on the ``or offer to provide'' aspect of the 
proposal's provision to permit an adviser to provide, or offer to 
promptly provide the performance results of the entire portfolio 
from which the extract was extracted (italics added). Therefore, we 
adopted this aspect of the proposed rule.
---------------------------------------------------------------------------

    On the other hand, performance that is extracted from a composite 
from multiple portfolios is not extracted performance as defined in the 
final rule because it is not a subset of investments extracted from a 
portfolio. We believe that such a performance presentation carries a 
greater risk of misleading investors than an extract from a single 
portfolio because an adviser could cherry-pick holdings from across the 
composite and deem those holdings part of a particular strategy. In 
addition, similar to hypothetical performance, this type of composite 
performance presentation may not reflect the holdings of any actual 
investor. As a result, the final rule does not prohibit an adviser from 
presenting a composite of extracts in an advertisement, including 
composite performance that complies with the GIPS standards, but this 
performance information is subject to the additional protections that 
apply to advertisements containing hypothetical performance, as 
discussed below. While these additional protections may result in 
additional burdens for advisers that typically present extracted 
performance from multiple portfolios as a composite, we believe that 
the investor protection gained from applying the hypothetical 
performance restrictions to the presentation of this type of 
performance, which reflects a hypothetical portfolio, justifies such 
burden.\664\
---------------------------------------------------------------------------

    \664\ The general prohibitions also will apply to any 
presentation of extracted performance. For example, we view it as 
misleading for an adviser to present extracted performance without 
disclosing that it represents a subset of a portfolio's investments 
(an omission of a material fact). Similarly, we would view it as 
misleading to include or exclude performance results, or present 
performance time periods, in a manner that is not fair and balanced, 
and able to be substantiated in accordance with the general 
prohibitions. In addition, an extract would likely be false or 
misleading where it excludes investments that fall within the 
represented selection criteria.
---------------------------------------------------------------------------

    One commenter recommended that we provide advisers with the option 
to either disclose assumptions underlying extracted performance, or 
provide them upon request, stating that detailed information about the 
selection criteria and assumptions used by the adviser could be 
overwhelming for a retail

[[Page 13078]]

audience.\665\ The final rule does not require an adviser to provide 
detailed information regarding the selection criteria and assumptions 
underlying extracted performance unless the absence of such 
disclosures, based on the facts and circumstances, would result in 
performance information that is misleading or otherwise violates one of 
the general prohibitions. As discussed above, an adviser should take 
into account the audience for the extracted performance in crafting 
disclosures.
---------------------------------------------------------------------------

    \665\ See CFA Institute Comment Letter (discussing presentations 
of performance for standalone strategies).
---------------------------------------------------------------------------

    Finally, as proposed, the final rule does not prescribe any 
particular treatment for a cash allocation with respect to extracted 
performance. One commenter recommended that we require such an 
allocation when presenting extracted performance advertised as a 
standalone strategy.\666\ This commenter also stated that including an 
allocation of cash is not necessary when showing a segment of a 
strategy that is not used to advertise a standalone strategy. We 
believe that, depending on the facts and circumstances, presenting 
extracted performance without accounting for the allocation of cash 
could imply that the allocation of cash had no effect on the extracted 
performance and would be misleading.\667\ In other cases, however, 
allocating cash to extracted performance may not be appropriate, such 
as when cash allocation decisions were made separately from the 
management of the extracted investments and the extracted performance 
is not presented as a standalone strategy. We, therefore, believe that 
it is appropriate to provide advisers with flexibility here since the 
appropriateness of allocating cash will be based on the facts and 
circumstances. Regardless, we would view it as misleading under the 
final rule to present extracted performance in an advertisement without 
disclosing whether it reflects an allocation of the cash held by the 
entire portfolio and the effect of such cash allocation, or of the 
absence of such an allocation, on the results portrayed.
---------------------------------------------------------------------------

    \666\ See CFA Institute Comment Letter.
    \667\ For example, it would be misleading to present extracted 
performance without allocating cash when the allocation of cash was 
part of the portfolio management for the subset of investments 
extracted from a portfolio, and such allocation would have 
materially reduced the extracted performance returns.
---------------------------------------------------------------------------

6. Hypothetical Performance
    The final rule will prohibit an adviser from providing hypothetical 
performance in an advertisement, unless the adviser takes certain steps 
to address its potentially misleading nature. Largely as proposed, the 
final rule will condition the presentation of hypothetical performance 
in advertisements on the adviser adopting policies and procedures 
reasonably designed to ensure that the hypothetical performance 
information is relevant to the likely financial situation and 
investment objectives of the advertisement's intended audience. We 
intend for advertisements including hypothetical performance 
information to only be distributed to investors who have access to the 
resources to independently analyze this information and who have the 
financial expertise to understand the risks and limitations of these 
types of presentations (referred to herein collectively as ``investors 
who have the resources and financial expertise'').\668\ An adviser also 
must provide additional information about the hypothetical performance 
that is tailored to the audience receiving the advertisement, such that 
the intended audience has sufficient information to understand the 
criteria, assumptions, risks, and limitations.
---------------------------------------------------------------------------

    \668\ We would not view the mere fact that an investor would be 
interested in high returns as satisfying the requirement that the 
hypothetical performance is relevant to the likely financial 
situation and investment objectives of the intended audience.
---------------------------------------------------------------------------

    While commenters requested additional flexibility with regard to 
some of the conditions, they generally supported our proposed treatment 
of hypothetical performance.\669\ However, one commenter stated that we 
should not allow the presentation of hypothetical performance in 
advertisements.\670\
---------------------------------------------------------------------------

    \669\ See, e.g., Wellington Comment Letter; Comment Letter of 
Withers Bergman LLP (Feb. 10, 2020) (``Withers Bergman Comment 
Letter''); MMI Comment Letter; NAPFA Comment Letter.
    \670\ See Mercer Comment Letter (stating that the restrictions 
imposed on hypothetical performance by the proposed general 
prohibitions would not be sufficient to prevent advisers from 
displaying hypothetical performance in a materially misleading 
manner).
---------------------------------------------------------------------------

    We are adopting the hypothetical performance provisions of the rule 
largely as proposed because we believe that such presentations in 
advertisements pose a high risk of misleading investors since, in many 
cases, they may be readily optimized through hindsight. Moreover, the 
absence of an actual investor or, in some cases, actual money 
underlying hypothetical performance raises the risk of a misleading 
advertisement, because such performance does not reflect actual losses 
or other real-world consequences if an adviser makes a bad investment 
or takes on excessive risk. However, we understand that other 
information that may demonstrate the adviser's investment process as 
well as hypothetical performance may be useful to prospective investors 
who have the resources and financial expertise. When subjected to this 
analysis, the information may allow an investor to evaluate an 
adviser's investment process over a wide range of periods and market 
environments or form reasonable expectations about how the investment 
process might perform under different conditions. We believe the three 
conditions discussed below, as well as our changes to the definition of 
``hypothetical performance,'' will make it more likely that the 
dissemination of advertisements containing hypothetical performance 
information will be limited to investors who have the resources and 
financial expertise to appropriately consider such information.
    Certain commenters suggested that we only allow advisers to present 
hypothetical performance to Non-Retail Persons,\671\ while others 
advocated for a more nuanced approach (rather than categorical 
exclusions) that would allow the dissemination of hypothetical 
performance based on facts and circumstances.\672\ As noted above, the 
final rule will not include different provisions for Retail and Non-
Retail Persons and we believe that the rule is sufficiently flexible to 
facilitate the application of the hypothetical performance conditions 
based on facts and circumstances.
---------------------------------------------------------------------------

    \671\ See, e.g., NASAA Comment Letter; Prof. Jacobson Comment 
Letter; Mercer Comment Letter.
    \672\ See, e.g., MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

    Like the proposed rule, the final rule applies to communications 
containing hypothetical performance that otherwise fall within the 
definition of ``advertisement'' because we believe that there is a 
significant risk that such performance could mislead investors.\673\ 
Some commenters stated that we should not impose the hypothetical 
performance conditions to one-on-one communications as such an approach 
would inhibit communications between an adviser and prospective or 
current investors.\674\ As discussed above, communications are excluded 
from the

[[Page 13079]]

scope of the final rule as long as they are provided in response to 
unsolicited investor requests; provided to a private fund investor in a 
one-on-one communication; or occur extemporaneously, live, and 
orally.\675\
---------------------------------------------------------------------------

    \673\ See proposed rule 206(4)-1(e)(1). The proposed rule 
included one-on-one communications in the definition of 
advertisement. While the proposed rule excluded responses to 
unsolicited requests from the definition of advertisement, the 
exclusion did not cover hypothetical performance even if such 
performance was included in a one-on-one communication. As a result, 
under our proposed rule, hypothetical performance would have been 
subject to the specific conditions of the proposed rule (subsection 
(c)).
    \674\ See, e.g., MFA/AIMA Comment Letter I; IAA Comment Letter.
    \675\ See final rule 206(4)-1(e)(1)(i)(A) and (C). The 
conditions also will not apply if hypothetical performance is 
included in a regulatory notice. Final rule 206(4)-1(e)(1)(i)(B).
---------------------------------------------------------------------------

    While the final rule allows advisers to provide certain performance 
presentations in advertisements that would otherwise be considered 
hypothetical performance (i.e., interactive tools and educational 
materials), we believe there are adequate protections to address this 
risk in part because the anti-fraud provisions of the Advisers Act 
would apply.\676\
---------------------------------------------------------------------------

    \676\ In connection with the marketing of private funds, the 
anti-fraud provisions of the Securities Act and Exchange Act would 
also apply.
---------------------------------------------------------------------------

    We also made the following changes to the treatment of hypothetical 
performance advertising under the rule in response to commenters' 
concerns: (1) Added more flexibility to the policies and procedures 
requirement of the final rule to allow advisers to consider the likely 
financial situation and investment objectives of the intended audience; 
(2) added more flexibility to allow advisers to consider each of the 
three hypothetical performance conditions with respect to the intended 
audience of the advertisement (as opposed to the specific person 
receiving the advertisement containing hypothetical performance 
information); (3) broadened the requirement for advisers to provide 
sufficient information to all investors (and not only Retail Persons) 
to enable them to understand the risks and limitations of using 
hypothetical performance advertising, except for private fund 
investors; and (4) revised the definition of hypothetical performance 
by: (a) Broadening the types of model portfolios whose performance is 
considered hypothetical performance; (b) excluding the performance of 
proprietary portfolios and seed capital portfolios; (c) including data 
from prior periods (and not just ``market data'' as proposed) for 
certain backtested performance; and (d) excluding interactive analysis 
tools and predecessor performance. The final rule also makes clear that 
an adviser need not comply with certain conditions on the presentation 
of performance in advertisements, namely the requirements to present 
specific time periods, and the particular conditions applicable to 
presenting related or extracted performance.\677\
---------------------------------------------------------------------------

    \677\ See final rule 206(4)-1(d)(6)(iii).
---------------------------------------------------------------------------

a. Types of Hypothetical Performance
    The final rule defines ``hypothetical performance'' as 
``performance results that were not actually achieved by any portfolio 
of the investment adviser'' and explicitly includes, but is not limited 
to, model performance, backtested performance, and targeted or 
projected performance returns.\678\ The proposed definition of 
hypothetical performance would have included ``performance results that 
were not actually achieved by any portfolio of any client of the 
investment adviser'' (emphasis added).\679\ In response to one 
commenter's concerns,\680\ we removed the ``of any client'' qualifier 
in order to clarify that the actual performance of the adviser's 
proprietary portfolios and seed capital portfolios is not hypothetical 
performance. However, advisers should not invest a nominal amount of 
assets in a portfolio in an effort to avoid the ``hypothetical 
performance'' designation. Instead, to show that the results are those 
of an actual portfolio, an adviser must invest an amount of seed 
capital that is sufficient to demonstrate that the adviser is not 
attempting to do indirectly what it is prohibited from doing 
directly,\681\ or otherwise be able to demonstrate that the strategy is 
reasonably intended to be offered to investors.
---------------------------------------------------------------------------

    \678\ Final rule 206(4)-1(e)(8).
    \679\ See proposed rule 206(4)-1(e)(5).
    \680\ See, e.g., CFA Institute Comment Letter.
    \681\ See section 208(d) of the Act.
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    In a change from the proposal, we also narrowed the definition of 
hypothetical performance under the rule to exclude interactive analysis 
tools and predecessor performance. While we proposed to exclude certain 
financial tools from the hypothetical performance provisions, below we 
clarify the treatment of such tools in response to commenters' 
concerns. We excluded predecessor performance because we are adopting 
specific rule text on the presentation of predecessor performance.
    We discuss each type of hypothetical performance in the following 
sections.
    Model Performance. The proposal referred to, but did not define, 
``representative performance'' and discussed model performance as a 
type of representative performance.\682\ In response to commenters' 
concerns,\683\ we are no longer using the term ``representative 
performance'' and are treating all ``model performance'' as 
hypothetical performance.\684\ We did not intend to limit the 
definition of hypothetical performance to only performance generated by 
the models described in the Clover no-action letter. Rather, we 
proposed this definition to make clear that the rule would apply in the 
context of a common industry practice that has evolved around prior 
staff letters.\685\ But, as one commenter noted, the discussion of 
model portfolios in staff letters reflects only the specific 
circumstances of the adviser seeking a staff letter, and advisers 
currently employ model portfolios in a variety of circumstances.\686\ 
Instead of limiting the discussion of model portfolios to those managed 
alongside portfolios managed for actual investors,\687\ the final rule 
will broaden the definition. Model performance will include, but not be 
limited to, performance generated by the following types of models: (i) 
Those described in the Clover no-action letter where the adviser 
applies the same investment strategy to actual investor accounts, but 
where the adviser makes slight adjustments to the model (e.g., 
allocation and weighting) to accommodate different investor investment 
objectives; (ii) computer generated models; and (iii) those the adviser 
creates or purchases from model providers that are not used for actual 
investors. After considering comments, we believe it is appropriate for 
the final rule to accommodate the use of these variations while 
ensuring that advisers consider whether this information is relevant to 
the intended audience.\688\
---------------------------------------------------------------------------

    \682\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.5 (describing representative performance as including 
performance generated by models that adhered to the same investment 
strategy as that used by the adviser for actual clients).
    \683\ See, e.g., CFA Institute Comment Letter; IAA Comment 
Letter.
    \684\ See final rule 206(4)-1(e)(8)(i). Model performance would 
include, among other things, the type of ``model performance'' 
described in the Clover Letter: Performance results generated by a 
``model'' portfolio managed with the same investment philosophy used 
by the adviser for actual client accounts and ``consist[ing] of the 
same securities'' recommended by the adviser to its clients during 
the same time period, ``with variances in specific client objectives 
being addressed via the asset allocation process (i.e., the relative 
weighting of stocks, bonds, and cash equivalents in each account).'' 
See Clover Letter. The rule will treat this as hypothetical 
performance because, although the ``model'' consists of the same 
securities held by several portfolios, the asset allocation process 
would result in performance results that were not actually achieved 
by any portfolio.
    \685\ See Clover Letter.
    \686\ See SIFMA AMG Comment Letter II; IAA Comment Letter 
(discussing ``other types of `model' performance that do not reflect 
investment advice actually provided to clients'').
    \687\ See proposed rule 206(4)-1(e)(5).
    \688\ See, e.g., SIFMA AMG Comment Letter II (suggesting that 
the Commission recognize that model portfolios are not limited to 
the type discussed in the Clover Letter); IAA Comment Letter.

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[[Page 13080]]

    One commenter supported treating model performance as hypothetical 
performance,\689\ while some commenters objected because model 
performance could reflect the actual performance of a strategy that is 
managed in real time.\690\ We understand that model portfolios can be 
(but are not always) managed alongside portfolios with investor or 
adviser assets and that many investors find model performance helpful. 
For instance, model performance may present a nuanced view of how an 
adviser would construct a portfolio without the impact of certain 
factors, such as the timing of cash flows or investor-specific 
restrictions, which may not be relevant to the particular investor. 
Model performance also can help an investor assess the adviser's 
investment style for new strategies that have not yet been widely 
adopted (or adopted at all) by the adviser's investors.
---------------------------------------------------------------------------

    \689\ See CFA Institute Comment Letter (stating that ``paper 
portfolios'' should be treated as hypothetical performance).
    \690\ See, e.g., SIFMA AMG Comment Letter II; MMI Comment 
Letter.
---------------------------------------------------------------------------

    However, we believe that model performance is appropriately treated 
as hypothetical performance because such performance was not achieved 
by the actual performance of a portfolio and could mislead investors. 
For example, advances in computer technologies have enabled an adviser 
to generate hundreds or thousands of potential model portfolios in 
addition to the ones it actually offers or manages. An adviser that 
generates a large number of model portfolios has an incentive to 
advertise only the results of the highest performing models and ignore 
others. The adviser could run numerous variations of its investment 
strategy, select the most attractive results, and then present those 
results as evidence of how well the strategy would have performed under 
prior market conditions. Even in cases where an adviser generates only 
a single model portfolio, neither investor nor sufficient adviser 
assets are at risk, so the adviser can manage that portfolio in a 
significantly different manner than if such risk existed. For these 
reasons, we believe it is more likely for an investor to be misled 
where the investor does not have the resources to scrutinize such 
performance and the underlying assumptions used to generate model 
portfolio performance. We believe treating model performance as 
hypothetical performance under the rule guards against the investor 
protection concerns addressed above.
    Some commenters suggested that we consider more flexible treatment 
of model performance given that performance generated by certain types 
of model portfolios would be less likely to mislead investors.\691\ We 
believe that the conditions described below are sufficiently flexible 
to allow advisers to tailor their approach based on the intended 
audience of the advertisement and the type of hypothetical performance, 
including performance generated for different types of model 
portfolios. For example, if an adviser believes that model performance 
is less likely to mislead the intended audience, the adviser may decide 
that less-stringent policies and procedures are required under the 
first condition, and that the required disclosures may differ and be 
more limited than those required for backtested performance. In 
contrast, if an adviser believes that model performance is highly 
likely to mislead a particular audience (e.g., it is difficult to 
provide disclosure that is sufficiently specific but also 
understandable), the adviser could adopt policies and procedures that 
eliminate the presentation of that type of model performance to this 
investor type in its advertisements or modify the presentation to 
satisfy the requirements of the final rule. An adviser would need to 
consider the intended audience of the advertisement and the type of 
hypothetical performance in order to satisfy the conditions.
---------------------------------------------------------------------------

    \691\ See, e.g., NYC Bar Comment Letter; NRS Comment Letter; 
MFA/AIMA Comment Letter I (stating that ``the Commission should 
modify the Proposed Advertising Rule to allow investment advisers to 
scale the scope of disclosures to the risk profile of the type of 
`hypothetical performance' information.'').
---------------------------------------------------------------------------

    Commenters suggested that we consider the impact of this 
characterization of hypothetical performance on model providers to wrap 
fee accounts and advisers that provide models to other, end-user 
advisers for implementation.\692\ We understand that model providers 
may not have access to the actual performance data generated after the 
end-user adviser implements the model and that the performance data 
they have access to may reflect another adviser's fees or adjustments. 
Even if model providers had access to such actual performance data, we 
believe they would still be subject to the hypothetical performance 
provisions because the performance generated would be the performance 
of a portfolio managed by the end-user adviser, not the model provider. 
However, we believe that model providers would not have difficulty 
satisfying the three hypothetical performance provisions. For example, 
we anticipate the intended audience for model provider advertisements 
often will be end-user advisers or wrap fee program sponsors. Model 
providers therefore could adopt simple policies and procedures because 
the model provider reasonably believes that the intended audience is 
sophisticated and should have the analytical resources and tools 
necessary to interpret this type of hypothetical performance. The model 
provider could similarly satisfy the rule's disclosure requirements for 
hypothetical performance based on the end-user's profile since the 
model providers would know that the end-user adviser is a well-informed 
investor with analytical tools at his/her disposal.
---------------------------------------------------------------------------

    \692\ See, e.g., SIFMA AMG Comment Letter II; MMI Comment Letter 
(stating that model performance is not hypothetical because it 
``reflects actual performance of an investment strategy in real-
time''); IAA Comment Letter (stating that ``[m]any advisers serve as 
model providers to wrap accounts and other advisers. Such model 
providers would not necessarily have the data on the actual 
performance of the accounts managed to their models, as they are not 
acting directly as advisers to the underlying accounts.''); NYC Bar 
Comment Letter.
---------------------------------------------------------------------------

    Backtested Performance. As proposed, the final rule will treat 
backtested performance as a type of hypothetical performance. We 
proposed to include ``[p]erformance that is backtested by the 
application of a strategy to market data from prior periods when the 
strategy was not actually used during those periods.'' \693\
---------------------------------------------------------------------------

    \693\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.5.c.iv.
---------------------------------------------------------------------------

    One commenter supported broadening the types of backtested 
performance that would be subject to the hypothetical performance 
provisions.\694\ Other commenters said that we should not treat 
backtested performance as a type of hypothetical performance.\695\
---------------------------------------------------------------------------

    \694\ See CFA Institute Comment Letter (stating that proposed 
definition of backtested performance would not include ``strategies 
that take data from other portfolios managed by the Adviser or 
someone else and backtest an asset allocation strategy.'').
    \695\ See, e.g., NYC Bar Comment Letter (stating ``backtested 
returns are a conditional analysis of prior data'' and advisers use 
this information to stress test investment methodologies that the 
advisers intend to use in the future); MMI Comment Letter (stating 
``backtested performance figures are not purely hypothetical, but 
rather reflect an analysis of actual investment performance based on 
certain assumptions'' and that such illustrations ``analyze 
historical data'').
---------------------------------------------------------------------------

    We acknowledge that backtested performance may help investors 
understand how an investment strategy may have performed in the past if 
the strategy had existed or had been applied at that time. In addition, 
this type of

[[Page 13081]]

performance information may demonstrate how the adviser adjusted its 
model to reflect new or changed data sources. While we understand the 
potential value of such data to investors, backtested performance 
information also has the potential to mislead investors. Because this 
performance is calculated after the end of the relevant period, it 
allows an adviser to claim credit for investment decisions that may 
have been optimized through hindsight, rather than on a forward-looking 
application of stated investment methods or criteria and with 
investment decisions made in real time and with actual financial risk. 
For example, an investment adviser is able to modify its investment 
strategy or choice of parameters and assumptions until it can generate 
attractive results and then present those as evidence of how its 
strategy would have performed in the past.\696\
---------------------------------------------------------------------------

    \696\ See, e.g., David H. Bailey, Jonathan M. Borwein, Marcos 
L[oacute]pez de Prado, and Qiji Jim Zhu, Pseudo-Mathematics and 
Financial Charlatanism: The Effects of Backtest Overfitting on Out-
of-Sample Performance, 61(5) Notices of the Am. Mathematical 
Society, 458, 466 (May 2014), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2308659 (describing the potential to 
overfit an investment strategy so that it performs well in-sample 
(the simulation over the sample used in the design of the strategy) 
but performs poorly out-of-sample (the simulation over a sample not 
used in the design of the strategy)).
---------------------------------------------------------------------------

    We believe that backtested performance included in an advertisement 
is more likely to be misleading to the extent that the intended 
audience does not have the resources and financial expertise to assess 
the hypothetical performance presentation. The conditions that the 
final rule will impose on displays of hypothetical performance in 
advertisements are designed to ensure that advisers present backtested 
performance in a manner that is appropriate for the advertisement's 
intended audience.
    In response to a commenter's suggestion,\697\ the final rule will 
apply to advertisements including presentations of performance that is 
backtested by the application of a strategy to data from prior time 
periods when the strategy was not actually used during those time 
periods, instead of applying only to application of the strategy to 
``market'' data from a prior time period. Accordingly, the hypothetical 
performance provisions will apply to presentations of both market and 
non-market data in advertisements. This change will account for 
scenarios where an adviser could backtest performance based on non-
market data (e.g., data from other portfolios managed by the adviser). 
We are otherwise adopting this provision as proposed.
---------------------------------------------------------------------------

    \697\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    Another commenter asked that we address which disclosures must 
accompany specific displays of backtested performance.\698\ In the 
spirit of our principles-based approach, we decline to prescribe the 
exact disclosure language that should accompany displays of backtested 
performance in advertisements.
---------------------------------------------------------------------------

    \698\ See NRS Comment Letter.
---------------------------------------------------------------------------

    Targets and Projections. As proposed, the final rule will treat 
presentations of targeted and projected returns in advertisements as 
presentations of hypothetical performance. Targeted returns reflect an 
investment adviser's aspirational performance goals. Projected returns 
reflect an investment adviser's performance estimate, which is often 
based on historical data and assumptions. Projected returns are 
commonly established through mathematical modeling.\699\
---------------------------------------------------------------------------

    \699\ The final rule does not define ``targeted return'' or 
``projected return.'' We believe that these terms have commonly 
understood meanings, and we do not intend to narrow or expand 
inadvertently the wide variety of returns that may be considered 
targets or projections. We generally would consider a target or 
projection to be any type of performance that an advertisement 
presents as results that could be achieved, are likely to be 
achieved, or may be achieved in the future by the investment adviser 
with respect to an investor.
---------------------------------------------------------------------------

    Most commenters that addressed this topic opposed the 
characterization of targeted returns as hypothetical performance on the 
grounds that targeted returns indicate expectations about how a product 
or strategy is intended to perform (e.g., how aggressively a strategy 
will be managed) as opposed to predictions of performance.\700\ Several 
of these commenters agreed that the Commission should continue to treat 
projected returns as hypothetical performance.\701\
---------------------------------------------------------------------------

    \700\ See, e.g., Wellington Comment Letter (agreeing that 
projected returns have a heightened ability to mislead investors, 
but stating that targeted returns can provide useful information 
about the risk profile of an investment strategy); Fidelity Comment 
Letter; MMI Comment Letter (stating that targeted returns ``are 
performance goals that an adviser seeks to achieve with a particular 
strategy or product'' while hypothetical returns ``represent a 
projection of what returns will or could be based on a series of 
assumptions'').
    \701\ See, e.g., CFA Institute Comment Letter; AIC Comment 
Letter.
---------------------------------------------------------------------------

    Targets and projections could potentially be presented in such a 
manner to raise unrealistic expectations of an advertisement's audience 
and thus be misleading, particularly if they use assumptions that are 
not reasonably achievable. For example, an advertisement may present 
unwarranted claims based on assumptions that are virtually impossible 
to occur, such as an assumption that three or four specific industries 
will experience decades of uninterrupted growth.
    We recognize, however, that there are some differences between 
targeted and projected returns. Targeted returns are aspirational and 
may be used as a benchmark or to describe an investment strategy or 
objective to measure the success of the strategy.\702\ Projected 
returns, on the other hand, use historical data and assumptions to 
predict a likely return.\703\ Therefore, targeted returns may not 
involve all (or any) of the assumptions and criteria applied to 
generate a projection. Still, we do not believe that the difference 
between targeted and projected returns is always readily apparent to 
recipients of an advertisement. We believe that the presentation of 
targeted returns in such context could result in unrealistic 
expectations. We continue to believe, therefore, that the presentation 
of targets and projections in advertisements should be subject to the 
rule's hypothetical performance conditions. The conditions we are 
adopting with respect to the use of hypothetical performance are 
principles-based, allowing the adviser to tailor the disclosure to the 
type of performance used in the advertisement. For example, in the case 
of an advertisement that presents targeted returns, which are generally 
aspirational in nature and not necessarily based on ``criteria and 
assumptions,'' to meet this disclosure requirement an adviser's 
disclosure could state that criteria and assumptions were not used.
---------------------------------------------------------------------------

    \702\ See, e.g., CFA Institute Comment Letter.
    \703\ Id.
---------------------------------------------------------------------------

    We believe that providing hypothetical performance in 
advertisements only to those investors with the resources and financial 
expertise to assess targets or projections will help avoid scenarios 
where an investor might be misled into thinking that such performance 
is guaranteed. We recognize that some investors want to consider 
targeted returns and projected returns (along with these underlying 
assumptions) when evaluating investment products, strategies, and 
services. For example, based on our staff's outreach and experience, we 
understand that financially sophisticated investors in particular may 
have specific return targets that they seek to achieve, and their 
planning processes may necessarily include reviewing and analyzing the 
targets advertised by investment advisers and the information

[[Page 13082]]

underlying those targets. Specifically, an analysis of these targets or 
projections can inform an investor about an adviser's risk tolerance 
when managing a particular strategy. We understand that information 
about an adviser's targets or projections also can be useful to an 
investor when assessing how the adviser's strategy fits within the 
investor's overall portfolio, but advisers must consider the intended 
audience when making such presentations in advertisements.
    The rule will apply only to targeted or projected performance 
returns ``with respect to any portfolio or to the investment advisory 
services with regard to securities offered in the advertisement.'' 
\704\ This means that projections of general market performance or 
economic conditions in an advertisement are not targeted or projected 
performance returns subject to the provision on presentation of 
hypothetical performance.
---------------------------------------------------------------------------

    \704\ Final rule 206(4)-1(e)(8)(iii).
---------------------------------------------------------------------------

    We did not propose to exclude from the definition of ``hypothetical 
performance'' the performance generated by interactive analysis tools. 
However, in the proposal, we noted that FINRA permits investment 
analysis tools as a limited exception from FINRA's general prohibition 
of projections of performance, subject to certain conditions and 
disclosures, and we requested comment on whether we should consider 
FINRA's approach.\705\ Commenters generally supported an exclusion for 
such tools and for adopting FINRA's approach.\706\
---------------------------------------------------------------------------

    \705\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.5.c.iv.
    \706\ See, e.g., SIFMA AMG Comment Letter II (stating that 
``[i]n the retail setting it is common to use projections that are 
based on statistically valid methodologies (e.g., Monte Carlo 
simulations) to assist clients and investors in understanding 
whether the investment of their current assets will allow them to 
meet future goals''); BlackRock Comment Letter (stating that the 
rule should provide a safe harbor from the hypothetical performance 
provisions for investment analysis tools that comply with FINRA rule 
2214); IAA Comment Letter; T. Rowe Price Comment Letter.
---------------------------------------------------------------------------

    As a result, the final rule will exclude the performance generated 
by investment analysis tools from the definition of hypothetical 
performance and will import a definition of ``investment analysis 
tool'' from FINRA Rule 2214 with slight modifications.\707\ FINRA Rule 
2214 defines an ``investment analysis tool'' as ``an interactive 
technological tool that produces simulations and statistical analyses 
that present the likelihood of various investment outcomes if certain 
investments are made or certain investment strategies or styles are 
undertaken, thereby serving as an additional resource to investors in 
the evaluation of the potential risks and returns of investment 
choices.'' We will adopt this definition, but will require that a 
current or prospective investor must use the tool (i.e., input 
information into the tool or provide information to the adviser to 
input into the tool).
---------------------------------------------------------------------------

    \707\ FINRA rule 2214 provides a limited exception from FINRA 
rule 2210's prohibition on communications that predict or project 
performance. While FINRA rule 2210 applies differently to 
communications directed to retail versus institutional investors, 
our final rule does not have such a bifurcated approach.
---------------------------------------------------------------------------

    Despite the fact that an investment analysis tool is often a 
computer-generated model that does not reflect the results of an actual 
account, the rule will allow an adviser to present these tools in 
advertisements without complying with the conditions applicable to 
hypothetical performance.\708\ We do not view these tools as presenting 
the same investor risks that model portfolios do because they typically 
present information about various investment outcomes based on the 
investor's situation and require the investor to interface directly 
with the tool. In providing an interactive analysis tool, an adviser 
should consider which disclosures are necessary in order to comply with 
the general prohibitions of the final marketing rule. For example, to 
comply with the first general prohibition, the adviser should neither 
imply nor state that the interactive tool, alone, can determine which 
securities to buy or sell.
---------------------------------------------------------------------------

    \708\ Under the final rule, general educational communications 
that rely on public information and do not reference specific 
advisory products or services offered by the adviser would not 
qualify as advertisements. See supra section II.A.2.a.v. Educational 
presentations of performance that reflect an allocation of assets by 
type or class, which we understand investment advisers may use to 
inform investors and to educate them about historical trends 
regarding asset classes would not be treated as advertisements and 
would not be subject to the rule's conditions on the use of 
hypothetical performance. For example, the following would not be 
considered hypothetical performance under the final rule: A 
presentation of performance that illustrates how a portfolio 
allocated 60% to equities and 40% to bonds would have performed over 
the past 50 years as compared to a portfolio composed of 40% 
equities and 60% bonds. Our approach regarding educational 
presentations of performance would apply even if the investment 
adviser used one of the allocations in managing a strategy being 
advertised or illustrated such allocations by reference to relevant 
indices or other benchmarks.
---------------------------------------------------------------------------

    The final rule will allow advisers to use interactive analysis 
tools, provided that the investment adviser: (1) Provides a description 
of the criteria and methodology used, including the investment analysis 
tool's limitations and key assumptions; (2) explains that the results 
may vary with each use and over time; (3) if applicable, describes the 
universe of investments considered in the analysis, explains how the 
tool determines which investments to select, discloses if the tool 
favors certain investments and, if so, explains the reason for the 
selectivity, and states that other investments not considered may have 
characteristics similar or superior to those being analyzed; and (4) 
discloses that the tool generates outcomes that are hypothetical in 
nature.\709\ The fact that an interactive tool uses the same underlying 
assumptions does not mean that outputs the tool generates are 
advertisements (because the adviser or investor inputs investor-
specific information). We believe that there are adequate investor 
protection guardrails in place to allow advisers to provide interactive 
analysis tools.\710\
---------------------------------------------------------------------------

    \709\ See final rule 206(4)-1(e)(8)(iv)(A)(4). Such disclosure 
could state, for example: ``IMPORTANT: The projections or other 
information generated by [name of investment analysis tool] 
regarding the likelihood of various investment outcomes are 
hypothetical in nature, do not reflect actual investment results and 
are not guarantees of future results.''
    \710\ See section 206 of the Advisers Act. See also section 
17(a) of the Securities Act, section 10(b) of the Exchange Act (and 
rule 10b-5 thereunder), and rule 206(4)-8 under the Advisers Act.
---------------------------------------------------------------------------

    Commenters suggested that we clarify the treatment of broad market 
or index-based performance data.\711\ We agree that the use of index-
based data can be informative to investors as a benchmarking tool.\712\ 
For example, in a scenario where an actual portfolio tracks an index, 
information regarding the index's performance can provide useful 
information regarding tracking error, sector allocation, and 
performance attribution. Accordingly, we believe that an index used as 
a performance benchmark in an advertisement would not be hypothetical 
performance, unless it is presented as performance that could be 
achieved by a portfolio.\713\
---------------------------------------------------------------------------

    \711\ See IAA Comment Letter; CFA Institute Comment Letter 
(stating that ``indexes created by the Adviser should be considered 
hypothetical performance when the Adviser backtests the index to see 
how it would have performed. Other than this case, we do not believe 
that benchmarks should be considered hypothetical performance.'').
    \712\ See e.g., IAA Comment Letter; CFA Institute Comment 
Letter.
    \713\ See final rule 206(4)-1(e)(8) (defining ``hypothetical 
performance'' as ``performance results that were not actually 
achieved by any portfolio of the investment adviser''). Although we 
would not expect an adviser to comply with the conditions applicable 
to hypothetical performance, we would expect the adviser to comply 
with the general prohibitions, for instance, by disclosing that the 
volatility of the index is materially different from that of the 
model or actual performance results with which the index is 
compared. Most of the other provisions of the rule would be 
irrelevant. For instance, although the conditions on the 
presentation of performance would apply, the requirement to show net 
performance would be inapplicable because there are no fees or 
expenses to deduct from an index. Index information that is provided 
for general educational purposes and not, for instance, as a 
comparison to the adviser's performance presentation, would not be 
considered an advertisement. See supra section II.A.2.a.v.

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[[Page 13083]]

b. Conditions on Presentation of Hypothetical Performance
    Largely as proposed, the final rule will prohibit the presentation 
of hypothetical performance in advertisements except under certain 
conditions designed to address the potential for hypothetical 
performance to mislead investors. First, the adviser must adopt and 
implement policies and procedures reasonably designed to ensure that 
the hypothetical performance information is relevant to the likely 
financial situation and investment objectives of the intended audience 
of the advertisement. Second, the adviser must provide sufficient 
information to enable the intended audience to understand the criteria 
used and assumptions made in calculating such hypothetical performance 
(the ``criteria and assumptions''). Third, the adviser must provide 
(or, if the intended audience is a private fund investor, provide, or 
offer to provide promptly) sufficient information to enable the 
intended audience to understand the risks and limitations of using 
hypothetical performance in making investment decisions (the ``risk 
information'').\714\ For purposes of this discussion, we refer to the 
criteria and assumptions and the risk information collectively as the 
``underlying information.'' Finally, the final rule does not require an 
investment adviser to comply with several conditions applicable to the 
presentation of performance information in advertisements, specifically 
the requirement to present specific time periods, and the requirements 
related to the presentation of related performance, and extracted 
performance.\715\
---------------------------------------------------------------------------

    \714\ See final rule 206(4)-1(d)(6)(iii).
    \715\ See id.
---------------------------------------------------------------------------

    Policies and Procedures. In a modification from the proposal, under 
the first condition for displaying hypothetical performance information 
in advertisements, advisers must adopt and implement policies and 
procedures ``reasonably designed to ensure that the hypothetical 
performance is relevant to the likely financial situation and 
investment objectives'' of the intended audience.\716\ The proposed 
condition would have required a higher degree of certainty of the 
financial situation and investment objectives of the person to whom the 
advertisement is disseminated. Under the final rule, reasonably 
designed policies and procedures need not address each recipient's 
particular circumstances; rather, the adviser must make a reasonable 
judgement about the likely investment objectives and financial 
situation of the advertisement's intended audience.
---------------------------------------------------------------------------

    \716\ Final rule 206(4)-1(d)(6)(i).
---------------------------------------------------------------------------

    The final rule will not prescribe the ways in which an adviser may 
seek to satisfy the policies and procedures requirement, including how 
the adviser will establish that the policies and procedures are 
reasonably designed to ensure that the hypothetical performance is 
relevant to the likely financial situation and investment objectives of 
the intended audience. We have previously used policies and procedures 
to establish a defined audience.\717\ We believe that this approach 
will provide investment advisers with the flexibility to develop 
policies and procedures that best suit their investor base and 
operations.
---------------------------------------------------------------------------

    \717\ We have defined ``retail money market fund'' to mean ``a 
money market fund that has policies and procedures reasonably 
designed to limit all beneficial owners of the fund to natural 
persons.'' See 17 CFR 270.2a-7(a)(21); see also Money Market Fund 
Reform; Amendments to Form PF, Release No. IA-3879 (July 23, 2014) 
[79 FR 47736 (Aug. 14, 2014)], at nn.715-716 and accompanying text.
---------------------------------------------------------------------------

    While one commenter supported the proposed condition,\718\ several 
commenters suggested that we eliminate it because it is too subjective 
and difficult to implement.\719\ One commenter suggested that the 
condition not apply to institutional investors,\720\ while another 
commenter stated that the condition imposes a standard so high that an 
adviser could not satisfy the standard for retail investors.\721\ 
Another commenter suggested that we clarify that the proposed condition 
would not require an adviser to have knowledge of the specific 
individual circumstances or financial condition of each investor 
receiving hypothetical performance from the adviser.\722\
---------------------------------------------------------------------------

    \718\ See Consumer Federation Comment Letter.
    \719\ See, e.g., MMI Comment Letter (stating this condition 
would be difficult, if not impossible, to satisfy for an 
advertisement that would be disseminated to a large number of 
people); SIFMA AMG Comment Letter II; Wellington Comment Letter.
    \720\ See Credit Suisse Comment Letter.
    \721\ See CFA Institute Comment Letter.
    \722\ See Comment Letter of Flexible Plan Investments, Ltd. on 
proposed advertising rule (Feb. 10, 2020) (``Flexible Plan 
Investments Comment Letter II'') (noting that the relevancy 
requirement would be difficult to administer because ``[i]t will be 
dependent on knowing in many cases the exact person to whom the use 
of (sic) hypothetical performance is being delivered.'').
---------------------------------------------------------------------------

    We continue to believe that this condition, as modified, will 
ensure that advisers provide advertisements containing relevant 
hypothetical performance to the appropriate audience without creating 
unnecessary compliance burdens. In response to commenters' concerns, 
however, the final rule will specify that the policies and procedures 
must be reasonably designed to ensure that hypothetical performance is 
relevant to the likely financial situation and investment objectives of 
the intended audience. We added the qualifier ``likely'' to clarify 
that an adviser is not required to know the actual financial situation 
or investment objectives of each investor that receives hypothetical 
performance. We also replaced the word ``person'' with ``intended 
audience'' to clarify that advisers can comply with this condition, as 
well as the other conditions related to hypothetical performance, by 
grouping investors into categories or types, and to emphasize that an 
investor might not be a natural person. We believe that these changes 
will ease the compliance burdens commenters identified.
    This condition is designed to help ensure that an adviser provides 
advertisements containing hypothetical performance information only to 
those investors with the resources and financial expertise. 
Hypothetical performance may not be relevant to the likely financial 
situation and investment objectives of and may be misleading for 
investors that do not have the resources and financial expertise. For 
example, analysis of hypothetical performance may require tools and/or 
other data to assess the impact of assumptions driving hypothetical 
performance, such as factor or other performance attribution, fee 
compounding, or the probability of various outcomes. Without being able 
to subject hypothetical performance to additional analysis, this 
information could tell an investor little about an investment adviser's 
process or other information relevant to a decision to hire the 
adviser. Instead, providing hypothetical performance to an investor 
that does not have access to the resources and financial expertise 
needed to assess the hypothetical performance and underlying 
information could mislead the investor to believe something about the 
adviser's experience or ability that is unwarranted. We believe that 
advisers generally would not be able to include hypothetical 
performance in advertisements directed to a mass audience or intended 
for general circulation. In that case, because the advertisement would 
be available to mass audiences, an adviser generally could not form any 
expectations about

[[Page 13084]]

their financial situation or investment objectives.
    The adviser's past experiences with particular types of investors 
should lead the adviser to design reasonable policies and procedures 
that distinguish among investor types and whether hypothetical 
performance is relevant to the likely financial situation and 
investment objectives of an audience composed of that type. Such 
policies and procedures could distinguish investor types on the basis 
of criteria, such as previous investments with the adviser, net worth 
or investing experience if that information is available to the 
adviser, certain regulatory defined categories (e.g., qualified 
purchasers or qualified clients), or whether the intended audience 
includes only natural persons or only institutions.
    An adviser could determine that certain hypothetical performance 
presentations are relevant to the likely financial situation and 
investment objectives of certain types of investors based on routine 
requests from those types of investors in the past. For example, an 
adviser, based on its past experience, might be able to reasonably 
conclude that hypothetical performance would be relevant to investors 
who meet certain financial sophistication standards such as qualified 
client \723\ or qualified purchaser.\724\ The adviser could explain in 
its policies and procedures why it believes that hypothetical 
performance is relevant for this intended audience. In addition, an 
adviser's policies and procedures should address how the adviser's 
dissemination of the advertisement would seek to be limited to that 
audience. As discussed above, hypothetical performance directed to mass 
audiences generally will not be able to meet this standard.
---------------------------------------------------------------------------

    \723\ See rule 205-3(d)(1) under the Act.
    \724\ See section 2(a)(51) of the Investment Company Act.
---------------------------------------------------------------------------

    One commenter expressed concerns that this condition would pose a 
compliance challenge for advisers to private funds because they do not 
have insight into potential investors, especially prior to the time 
when subscription documents are disseminated.\725\ Because an adviser's 
policies and procedures should be informed by its prior experience with 
certain investor types, an adviser that plans to advise a private fund 
can develop policies and procedures that take into account its 
experience advising a prior private fund for which it raised money from 
investors. That experience might indicate that investors in the vehicle 
valued a particular type of hypothetical performance because, for 
example, the investors used it to assess the adviser's strategy and 
investment process. Similarly, an adviser could determine, based on its 
experience, that hypothetical performance is not relevant to the likely 
financial situation and investment objectives of certain investors and 
reflect such determination in its policies and procedures. New advisers 
that do not have prior client experiences to inform their determination 
of the intended audience can rely on other resources, including 
information they have gathered from potential investors (e.g., 
questionnaires, surveys, or conversations) and academic research, to 
help identify the intended audience in connection with the three 
hypothetical performance conditions.\726\
---------------------------------------------------------------------------

    \725\ See Ropes & Gray Comment Letter.
    \726\ Advisers may already be required to comply with similar 
provisions under other regulatory regimes that also require advisers 
to consider the recipient when disseminating communications. See, 
e.g., FINRA rule 2210(d)(1)(E) (``Members must consider the nature 
of the audience to which the communication will be directed and must 
provide details and explanations appropriate to the audience.''); 
Global Investment Performance Standards (GIPS) for Firms (2020), 
Provision 1.A.11; GIPS Standards Handbook for Firms (Nov. 2020), 
Discussion of Provision 1.A.11.
---------------------------------------------------------------------------

    One commenter expressed concern that this condition would 
effectively restrict hypothetical performance only to a sub-set of 
investors with the financial and analytical resources to analyze such 
performance even if an investor outside of this sub-set specifically 
requested the information.\727\ As noted above, we believe that it is 
appropriate to apply the hypothetical performance conditions to 
communications that otherwise meet the definition of advertisement, 
even if they take place in one-on-one settings due to the potential for 
such information to mislead investors. However, advisers would still be 
able to provide investors with interactive financial analysis tools 
without subjecting those tools to the hypothetical performance 
conditions.
---------------------------------------------------------------------------

    \727\ See CFA Institute Comment Letter (suggesting that ``an 
[a]dviser could consider hypothetical performance to be relevant to 
the financial situation and investment objectives of the person if 
the person has expressed interest in the strategy or the [a]dviser 
has determined it is an appropriate strategy for the investor based 
on their (sic) investment needs'').
---------------------------------------------------------------------------

    Criteria and Assumptions. The second condition for the presentation 
of hypothetical performance will require the adviser to provide 
sufficient information to enable the intended audience to understand 
the criteria used and assumptions made in calculating the hypothetical 
performance.\728\ The rule does not prescribe any particular 
methodology or calculation for the different categories of hypothetical 
performance, just as it does not prescribe methodologies or 
calculations for actual performance. Instead, advisers must provide the 
information about criteria and assumptions so that the intended 
audience can understand how the hypothetical performance was 
calculated. We are adopting the second condition largely as proposed, 
except that we are replacing the phrase ``such person'' with ``the 
intended audience'' for consistency with the first condition, as 
discussed above. In addition, and in response to one commenter's 
concerns,\729\ we are clarifying that the adviser is responsible for 
providing sufficient information as we agree that it would not be 
workable to require advisers to have a precise understanding of exactly 
what each investor needs in order to allow that investor to understand 
the calculations and assumptions underlying the hypothetical 
performance.\730\
---------------------------------------------------------------------------

    \728\ See final rule 206(4)-1(d)(6)(ii). We would consider any 
calculation information provided alongside the hypothetical 
performance to be a part of the advertisement and therefore subject 
to the books and records rule. See infra section II.I.
    \729\ See Flexible Plan Investments Comment Letter II.
    \730\ This obligation would be similar to an adviser's 
obligation to provide full and fair disclosure to its clients of all 
material facts relating to the advisory relationship and of 
conflicts of interest. See Fiduciary Interpretation, supra footnote 
8888, at n.70 (stating that institutional clients, as compared to 
retail clients, generally have a greater capacity and more resources 
to analyze and understand complex conflicts and their 
ramifications).
---------------------------------------------------------------------------

    Several commenters expressed concern that this condition would 
require advisers to disclose proprietary or confidential information 
\731\ due to the statement in the proposal that this condition may 
require advisers to provide the ``methodology used in calculating and 
generating the hypothetical performance.'' \732\ To clarify, we do not 
expect advisers to disclose proprietary or confidential information to 
satisfy this condition. We expect that a general description of the 
methodology used would be sufficient information for an investor to 
understand how it was generated.
---------------------------------------------------------------------------

    \731\ See, e.g., Withers Bergman Comment Letter; MFA/AIMA 
Comment Letter I; Resolute Comment Letter.
    \732\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.5.c.iv.
---------------------------------------------------------------------------

    Under the final rule, the condition will not require an adviser to 
provide information that would be necessary to allow the intended 
audience to replicate the performance (e.g., information that is 
confidential or proprietary). With

[[Page 13085]]

respect to assumptions, investment advisers should provide information 
that includes any assumptions on which the hypothetical performance 
rests--e.g., in the case of targeted or projected returns, the 
adviser's view of the likelihood of a given event occurring.
    Commenters suggested that we not require advisers to disclose the 
extent to which hypothetical performance is based on the likelihood of 
an event occurring because this would require advisers to make 
speculative statements.\733\ Yet, commenters agreed that an adviser 
should disclose the assumptions it has made.\734\
---------------------------------------------------------------------------

    \733\ See, e.g., NYC Bar Comment Letter; AIC Comment Letter.
    \734\ See, e.g., NYC Bar Comment Letter; AIC Comment Letter 
(stating that the requirements of the second condition are 
``consistent with market practice'' but that advisers should not be 
required to state the likelihood that a given event would occur).
---------------------------------------------------------------------------

    It is our view that assumptions underlying hypothetical performance 
should be interpreted to include assumptions that future events will 
occur. We believe that hypothetical performance, by its nature, 
contains a speculative element; therefore, requiring advisers to 
disclose the assumptions that informed a model aligns with the types of 
restrictions we seek to place on performance presentation that have a 
high potential to mislead investors. We believe advisers should provide 
this information so that the intended audience is able to determine, in 
part, how much value to attribute to the hypothetical performance. 
Without information regarding criteria and assumptions, we believe that 
such performance would be misleading even to an investor with the 
resources and financial expertise to evaluate it.
    Risk Information. The final rule will require the adviser to 
provide--or, if the intended audience is a private fund investor, to 
provide, or offer to provide promptly--sufficient information to enable 
the intended audience to understand the risks and limitations of using 
the hypothetical performance in the advertisement in making investment 
decisions.\735\
---------------------------------------------------------------------------

    \735\ See final rule 206(4)-1(d)(6)(iii).
---------------------------------------------------------------------------

    Commenters generally supported this condition.\736\ However, one 
commenter suggested that we add a reasonableness component in order to 
provide more flexibility, requiring advisers to provide reasonably 
sufficient information.\737\ We do not believe this change is necessary 
as we believe that advisers' consideration of the intended audience 
will provide advisers with flexibility and alleviate some of the 
burdens imposed by these conditions. In a change from the proposal, we 
replaced ``Non-Retail Person'' with ``an investor in a private fund'' 
in order to align with broader changes to the rule (i.e., to dispense 
with the distinction between Retail and Non-Retail Persons).\738\ As 
explained above, we also replaced references to ``such person'' with 
``the intended audience.'' After considering comments,\739\ the final 
rule will not require advisers to provide private fund investors with 
information on the risks and limitations of using the advertised 
hypothetical performance. Instead, advisers can merely offer to 
promptly provide such information.
---------------------------------------------------------------------------

    \736\ See CFA Institute Comment Letter; Withers Bergman Comment 
Letter.
    \737\ See Flexible Plan Investments Comment Letter II.
    \738\ See proposed rule 206(4)-1(c)(1)(v)(C) (requiring an 
adviser to ``[p]rovide[ ] (or, if such person is a non-retail 
person, provide[ ] or offer[ ] to provide promptly) sufficient 
information to enable such person to understand the risks and 
limitations of using such hypothetical performance in making 
investment decisions.'').
    \739\ See, e.g., Ropes & Gray Comment Letter; IAA Comment 
Letter; AIC Comment Letter.
---------------------------------------------------------------------------

    With respect to risks and limitations, investment advisers should 
provide information that would apply to both hypothetical performance 
generally and to the specific hypothetical performance presented--e.g., 
if applicable, that hypothetical performance reflects certain 
assumptions but that the adviser generated dozens of other, varying 
performance results applying different assumptions. Risk information 
should also include any known reasons why the hypothetical performance 
might differ from actual performance of a portfolio--e.g., that the 
hypothetical performance does not reflect cash flows into or out of the 
portfolio. This risk information will, in part, enable the intended 
audience to understand how much value to attribute to the hypothetical 
performance in deciding whether to hire or retain the investment 
adviser or invest in a private fund managed by the adviser. An adviser 
should tailor its risk information to its intended audience.
    In addition, any communication that is an advertisement under the 
first prong of the definition of advertisement, and that includes 
hypothetical performance, will be required to comply with the general 
prohibitions.\740\ As a result, the rule will prohibit advisers from 
presenting hypothetical performance in such advertisements in a 
materially misleading way. For example, we would view an advertisement 
as including an untrue statement of material fact if the advertised 
hypothetical performance reflected the application of rules, criteria, 
assumptions, or general methodologies that were materially different 
from those stated or applied in the underlying information of such 
hypothetical performance. Also, we would view it as materially 
misleading for an advertisement to present hypothetical performance 
that discusses any potential benefits resulting from the adviser's 
methods of operation without providing fair and balanced discussion of 
any associated material risks or material limitations associated with 
the potential benefits.\741\ Similarly, an adviser can meets its 
obligation with respect to an advertisement presenting hypothetical 
performance that includes an offer to promptly provide risk information 
to a private fund investor if the adviser makes reasonable efforts to 
promptly provide such information upon the investor's request.
---------------------------------------------------------------------------

    \740\ See supra section II.B.
    \741\ See final rule 206(4)-1(a)(4).
---------------------------------------------------------------------------

F. Portability of Performance, Testimonials, Endorsements, Third-Party 
Ratings, and Specific Investment Advice

    Among the performance results that an investment adviser may seek 
to advertise are those of groups of investments or accounts for which 
the adviser, its personnel, or its predecessor investment adviser firms 
have provided investment advice in the past as or at a different 
entity. In some cases, an investment adviser may seek to advertise the 
performance results of portfolios managed by the investment adviser 
before it was spun out from another adviser. Alternatively, an adviser 
may seek to advertise performance achieved by its investment personnel 
when they were employed by another investment adviser. This may occur, 
for example, when a portfolio management team leaves one advisory firm 
and joins another advisory firm or begins its own firm. Predecessor 
performance results may be directly relevant to an audience when the 
advertisement offers services to be provided by the personnel 
responsible for the predecessor performance, even when the personnel 
did not work for the adviser disseminating the advertisement (the 
``advertising adviser'') during the period for which performance is 
being advertised.\742\
---------------------------------------------------------------------------

    \742\ The term ``predecessor performance'' is defined in final 
rule 206(4)-1(e) and refers to all situations where an investment 
adviser presents investment performance achieved by a group of 
investments consisting of an account or a private fund that was not 
advised by the investment adviser at all times during the period 
shown.
---------------------------------------------------------------------------

    We believe that the presentation of predecessor performance can 
mislead

[[Page 13086]]

investors, especially, for example, when: (i) The team that was 
primarily responsible for the predecessor performance is different from 
the team whose advisory services are being offered in the 
advertisement, (ii) an individual who played a significant part in 
achieving the predecessor performance is not a member of the 
advertising adviser's investment team,\743\ (iii) the adviser that 
generated the performance underwent a restructuring, reorganization, or 
sale,\744\ or (iv) an advertising adviser does not clearly disclose 
that the performance was achieved at a different entity.
---------------------------------------------------------------------------

    \743\ See, e.g., Fiduciary Management Associates, Inc., SEC 
Staff No-Action Letter (Feb. 2, 1984) (``Fiduciary Management 
Letter'').
    \744\ See, e.g., South State Bank, SEC Staff No-Action Letter 
(May 8, 2018) (``South State Bank Letter'') (the staff stated that 
it would not recommend enforcement action based on representations 
designed to ensure advisory clients would not be misled if clients 
attributed the predecessor adviser's performance to the advertising 
adviser, including, for example, that it would operate in the same 
manner and under the same brand name as the predecessor adviser).
---------------------------------------------------------------------------

    We have previously identified characteristics of a restructuring, 
sale, or reorganization (collectively, ``reorganization'') that likely 
support a finding that an adviser's business continued to exist where: 
There was a substantial and direct business nexus between the successor 
and predecessor advisers; the reorganization was not designed to 
eliminate substantial liabilities and/or spin off personnel; and, if 
applicable, the successor adviser assumed substantially all of the 
assets and liabilities of the predecessor adviser.\745\ Under the final 
rule, we would consider similar factors when analyzing the extent to 
which an advertising adviser must treat a predecessor adviser's 
performance as predecessor performance. For example, we do not believe 
that a change of brand name, without additional differences between the 
advisory entity before and after the restructuring, would render its 
past performance as ``predecessor performance.'' Likewise, a mere 
change in the form of legal organization (e.g., from a corporation to 
limited liability company) or a change in ownership of the adviser 
would likely not raise the concerns described in this section.
---------------------------------------------------------------------------

    \745\ See Registration of Successors to Broker-Dealers and 
Investment Advisers, Release No. IA-1357 (Dec. 28, 1992) [58 FR 7-01 
(Jan. 4, 1993)].
---------------------------------------------------------------------------

    In the proposal, we considered whether applying the rule's general 
prohibitions and the more specific performance advertising restrictions 
would sufficiently alleviate our concerns,\746\ or whether specific 
rule provisions would more appropriately address those concerns.\747\ 
For example, we questioned whether the untrue or misleading implication 
general prohibition would prevent the display of predecessor 
performance containing an untrue or misleading implication about a 
material fact relating to the advertising adviser. As another example, 
we stated that, depending on the circumstances, predecessor performance 
results that exclude accounts managed in a substantially similar manner 
at the predecessor firm may be misleading and implicate the proposed 
general prohibitions in the rule. We stated that such presentations 
could result in the inclusion or exclusion of performance results in a 
manner that is neither accurate nor fair and balanced. Accordingly, we 
requested comment on whether the advertising rule should include 
additional provisions on the presentation of predecessor performance 
results, and we specifically asked about the approach our staff has 
taken in providing guidance on this issue under the current rule.\748\
---------------------------------------------------------------------------

    \746\ See proposed rule 206(4)-1(a) and (c).
    \747\ For the discussion that follows, see generally 2019 
Proposing Release, supra footnote 7, at section II.A.6.
    \748\ See Horizon Asset Management, LLC, SEC Staff No-Action 
Letter (Sept. 13, 1996) (``Horizon Letter''); Great Lakes Advisers, 
Inc., SEC Staff No-Action Letter (Apr. 3, 1992) (``Great Lakes 
Letter''); Fiduciary Management Letter; South State Bank Letter. We 
requested comment on a number of the issues raised by predecessor 
performance. See 2019 Proposing Release, supra footnote 7, at 
section II.A.6.
---------------------------------------------------------------------------

    Some commenters supported the addition of a provision on this 
topic, urging us to address predecessor performance in the final 
rule.\749\ Two commenters supported the approach our staff took in its 
no-action letters and suggested we adopt a rule that would draw from 
those requirements, with minor modifications.\750\ In light of these 
comments, we believe that placing explicit guardrails on displays of 
predecessor performance will increase investor protection, in addition 
to the general prohibitions. Moreover, we expect that clarifying our 
views on positions taken by our staff over the years will promote 
consistency of practices among advisory firms and thereby level the 
playing field.
---------------------------------------------------------------------------

    \749\ See IAA Comment Letter; CFA Institute Comment Letter 
(supporting specific provisions on predecessor performance, but 
suggesting compliance with GIPS standards); Fried Frank Comment 
Letter (stating that the final rule should explicitly address 
predecessor performance and supporting a ``principles-based, 
disclosure-driven approach'' that has a similar framework as the 
proposed approach to hypothetical performance); Comment Letter of 
SIFMA (Supplemental) (June 5, 2020) (``SIFMA Supplemental Comment 
Letter'').
    \750\ See IAA Comment Letter; SIFMA Supplemental Comment Letter.
---------------------------------------------------------------------------

    Investments advisers will be prohibited from displaying predecessor 
performance in an advertisement, unless the following requirements are 
satisfied:
    (A) The person or persons who were primarily responsible for 
achieving the prior performance results manage accounts at the 
advertising adviser;
    (B) the accounts managed at the predecessor investment adviser are 
sufficiently similar to the accounts managed at the advertising adviser 
that the performance results would provide relevant information to 
investors;
    (C) all accounts that were managed in a substantially similar 
manner are advertised unless the exclusion of any such account would 
not result in materially higher performance and the exclusion of any 
account does not alter the presentation of any prescribed time periods; 
and
    (D) the advertisement clearly and prominently includes all relevant 
disclosures, including that the performance results were from accounts 
managed at another entity.\751\
---------------------------------------------------------------------------

    \751\ See final rule 206(4)-1(d)(7)(iv); see also 2019 Proposing 
Release, supra footnote 7, at sections II.A.5.c.ii and II.A.6.
---------------------------------------------------------------------------

    In addition to applying these specific provisions, advisers should 
consider the extent to which other provisions of the advertising rule, 
such as the general prohibitions (including those pertaining to the 
fair and balanced presentation of information), apply to any display of 
predecessor performance.
    Primarily Responsible. In order to present predecessor performance 
in an advertisement, the person or persons who were primarily 
responsible for achieving the prior performance results while employed 
at the predecessor firm must manage accounts at the advertising 
adviser.\752\ We believe that the ``primarily responsible'' requirement 
will help place critical guardrails on the use of predecessor 
performance and will require advisers to focus on the role that the 
individual played in producing the performance (e.g., the extent of the 
person's decision-making authority or influence). Advisers should 
consider the substantive responsibilities of those who are responsible 
for generating the performance at issue and, where more than one 
individual is primarily

[[Page 13087]]

responsible for making investment decisions, whether a substantial 
identity of the group responsible for achieving the prior performance 
have moved over to the advertising adviser. We anticipate that this 
principles-based approach will address scenarios where a committee 
makes the investment decisions and where a single person is responsible 
for investment decisions. Where a committee managed the group of 
investments at the predecessor firm, a committee comprising a 
substantial identity of the membership must manage the portfolios at 
the advertising adviser.\753\
---------------------------------------------------------------------------

    \752\ See final rule 206(4)-1(d)(7)(i). Our staff has applied a 
similar principle when considering the presentation of predecessor 
performance. See Horizon Letter (stating that the staff would not 
find a display of predecessor performance to be in and of itself 
misleading based on several representations, including that ``the 
person or persons who manage accounts at the adviser were also those 
primarily responsible for achieving the prior performance 
results'').
    \753\ Our staff applied a similar principle when considering 
investment teams or committees. See Great Lakes Letter, at n.4 
(staff declined to take a no-action position where only one person 
from a three-person committee transferred from the predecessor 
adviser to the advertising adviser and where the other two 
individuals played a significant role stating that, ``at a minimum, 
there would have to be a substantial identity of personnel among the 
predecessor's and successor's committees.''); Horizon Letter (staff 
stated that it would not recommend enforcement action under rule 
206(4)-1 where one individual was primarily responsible for 
achieving performance results at the predecessor firm and, upon 
joining the advertising adviser, would be a member of a three-person 
committee. The individual would still have final decision-making 
authority and the other committee members would only advise the sole 
decision-maker.).
---------------------------------------------------------------------------

    A person or group of persons is ``primarily responsible'' for 
achieving prior performance results if the person makes or the group 
makes investment decisions.\754\ Where more than one person is involved 
in making investment decisions, advisers should consider the authority 
and influence that each person has in making investment decisions.\755\
---------------------------------------------------------------------------

    \754\ Commenters generally supported applying guardrails to 
displays of predecessor performance based on existing staff no-
action letters and industry best practices. See IAA Comment Letter 
(citing Horizon Letter, South State Bank Letter, Great Lakes Letter, 
Fiduciary Management Letter, and Conway Asset Management, Inc., SEC 
Staff No-Action Letter (Jan. 27, 1989)); Fried Frank Comment Letter; 
SIFMA Supplemental Comment Letter.
    \755\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.6. (stating that it may be difficult to attach relative 
significance to the role played by each group member where an 
adviser selects portfolio securities by consensus or committee 
decision-making). See also Great Lakes Letter; Horizon Letter. 
Commenters generally supported the positon our staff has taken in 
no-action letters on predecessor performance where a committee makes 
investment decisions. See, e.g., IAA Comment Letter (suggesting that 
the final rule require that ``substantially all of the investment 
decision-makers who manage accounts at the adviser are those 
primarily responsible for achieving the prior performance 
results'').
---------------------------------------------------------------------------

    Sufficiently similar accounts. Under the final rule, an advertising 
adviser may not present predecessor performance in an advertisement 
unless the accounts managed at the predecessor and advertising advisers 
are ``sufficiently similar'' in order to ensure the investor receives 
relevant information.\756\ Prior staff letters took no-action positions 
with accounts that were ``so similar'' to the advertised accounts.\757\ 
We believe that the language in the final rule provides advisers 
appropriate flexibility in displaying predecessor performance and would 
not result in investor confusion.
---------------------------------------------------------------------------

    \756\ See final rule 206(4)-1(d)(7)(ii). Our staff applied a 
similar principle when considering whether displays of predecessor 
performance would be relevant to investors. See Horizon Letter 
(stating that the staff would not find a display of predecessor 
performance to be in and of itself misleading based on several 
representations, including that ``the accounts managed at the 
predecessor entity are so similar to the accounts currently under 
management that the performance results would provide relevant 
information to prospective clients'').
    \757\ See IAA Comment Letter (suggesting that the Commission 
require the accounts to be ``sufficiently similar'' instead of ``so 
similar'').
---------------------------------------------------------------------------

    Managed in a substantially similar manner. Under the final rule, an 
investment adviser using predecessor performance in an advertisement 
will be required to display all accounts that were managed in a 
``substantially similar manner'' at the predecessor adviser, unless 
excluding any account would not result in materially higher performance 
and the exclusion of any account does not alter the presentation of any 
applicable time periods required by the rule.\758\ This condition 
mirrors the related performance provisions of the final rule, which 
requires investment advisers to include all related portfolios and only 
permits an adviser to exclude a related portfolio if performance would 
not be materially higher and if the exclusion of any related portfolio 
does not alter the presentation of any applicable time periods required 
by the rule.\759\ Accounts that are managed in a substantially similar 
manner are those with substantially similar investment policies, 
objectives, and strategies.\760\ As a result, advisers can use the same 
approach for determining the scope of the accounts that are managed in 
a substantially similar manner as they use to determine which accounts 
are related portfolios for purposes of displaying related performance.
---------------------------------------------------------------------------

    \758\ See final rule 206(4)-1(d)(7)(iii). Our staff applied a 
similar principle when considering whether displays of predecessor 
performance would be relevant to investors. See Horizon Letter 
(stating that the staff would not find a display of predecessor 
performance to be in and of itself misleading based on several 
representations, including that ``all accounts that were managed in 
a substantially similar manner are advertised unless the exclusion 
of any such account would not result in materially higher 
performance''); IAA Comment Letter (supporting this provision).
    \759\ See final rule 206(4)-1(d)(4); 2019 Proposing Release, 
supra footnote 7, at section II.A.5.c.ii, n.279.
    \760\ See final rule 206(4)-1(e)(15). Our staff has stated that 
it would not recommend enforcement action if advisers present 
predecessor performance where the adviser presents the composite 
performance of all of the predecessor firm's accounts that had the 
same investment objectives and were managed using the same 
investment strategies that the adviser will manage at the new firm. 
See Horizon Letter.
---------------------------------------------------------------------------

    An adviser that chooses to display predecessor performance 
information in an advertisement must consider the related performance 
requirements of the final rule. For example, if an adviser includes 
predecessor performance and the advertising adviser manages accounts 
that are related portfolios to those groups of investments depicted in 
the predecessor performance, then the advertising adviser must include 
these related portfolios in its performance display.\761\
---------------------------------------------------------------------------

    \761\ In presenting such performance, advisers should also 
consider the general prohibitions and other performance advertising 
provisions of the final rule.
---------------------------------------------------------------------------

    Relevant disclosures. The final rule will require an adviser to 
clearly and prominently include all relevant disclosures and indicate 
that the performance results were from accounts managed at another 
entity.\762\ While what disclosures are ``relevant'' will depend on the 
facts and circumstances, we agree with a commenter's suggestion that 
the fact that the performance was generated from accounts managed at 
another entity will always be relevant. Accordingly, the final rule 
will explicitly require this disclosure.\763\ Additionally, advisers 
should consider what disclosures would be appropriate to comply with 
the other provisions of the final rule, such as the general 
prohibitions.
---------------------------------------------------------------------------

    \762\ See final rule 206(4)-1(d)(7)(iv). Our staff applied a 
similar principle when considering whether displays of predecessor 
performance would be relevant to investors. See Horizon Letter 
(stating that the staff would not find a display of predecessor 
performance to be in and of itself misleading based on several 
representations, including that ``the advertisement includes all 
relevant disclosures, including that the performance results were 
from accounts managed at another entity.''). Disclosures that are 
subject to a clear and prominent standard under final rule 206(4)-1 
should be included within the advertisement. See supra footnote 286.
    \763\ See IAA Comment Letter (suggesting the addition of 
``including that the performance results were from accounts managed 
at another entity'' to the rule text).
---------------------------------------------------------------------------

    Our amendments to the books and records rule will require an 
adviser to retain records to support the performance presented.\764\ We 
believe that, in order to avoid misleading presentations of predecessor

[[Page 13088]]

performance, an adviser must have access to the books and records 
underlying the performance.\765\ We have applied this concept more 
generally under the final rule, which will also require that an adviser 
have a reasonable basis for believing that it will be able to 
substantiate (upon demand by the Commission) all material statements of 
fact contained in an advertisement.\766\
---------------------------------------------------------------------------

    \764\ See final rule 204-2(a)(16). See also Great Lakes Letter 
(stating that rule 204-2(a)(16) applies to a successor's use of a 
predecessor's performance data).
    \765\ Our staff took this approach in stating that it would not 
recommend enforcement action under section 206 of the Advisers Act 
or the current advertising rule if an advertising adviser presents 
performance results achieved at another firm based on several 
representations, including that the advertising adviser would keep 
the books and records of the predecessor firm that are necessary to 
substantiate the performance results in accordance with rule 204-
2(a)(16). See Horizon Letter; see also Great Lakes Letter, at n.3 
(stating that rule 204-2(a)(16) ``applies also to a successor's use 
of a predecessor's performance data''). We understand that 
investment advisers who consider this staff no-action letter 
currently keep copies of all advertisements containing performance 
data and all documents necessary to form the basis of those 
calculations.
    \766\ See final rule 206(4)-1(a)(2).
---------------------------------------------------------------------------

    Certain commenters that addressed this aspect of the proposal 
requested that we preserve flexibility for the types of records that 
support predecessor performance,\767\ while another commenter disagreed 
that flexibility was appropriate and suggested permitting predecessor 
performance only where the records required under rule 204-2 were 
available.\768\ Without supporting information, we are concerned about 
the accuracy of such performance displays and that such information 
could be misleading. We do not believe that an advertising adviser 
could recreate performance based on a sampling of investor statements 
and/or display performance from a prior firm because we are concerned 
that such an approach has a heightened risk of cherry picking 
performance. Allowing a sampling of information to support performance 
displays is inconsistent with our general approach to require advisers 
to display all applicable performance (e.g., related performance) to 
mitigate these cherry-picking concerns.
---------------------------------------------------------------------------

    \767\ See SIFMA AMG Comment Letter II; IAA Comment Letter 
(stating that an adviser should be permitted to substantiate 
performance using publicly available information and audit or 
verification statements); MarketCounsel Comment Letter (noting that 
the books and records of the predecessor firm are often unavailable 
due to contractual or privacy restrictions and suggesting that the 
Commission permit advertising advisers to recreate performance based 
on a sampling of client statements and/or display performance from a 
prior firm in a scenario where the advertising adviser has a copy of 
the advertisement and where the prior firm was subject to the books 
and records rule).
    \768\ See CFA Institute Comment Letter (stating that alternative 
books and records requirements should not be an option for 
predecessor performance because verification reports will not 
satisfy the books and records requirements in most cases, nor would 
performance information that has been subject to a financial 
statement audit).
---------------------------------------------------------------------------

    Because the final rule addresses the portability of adviser 
performance, our staff will withdraw several no-action letters our 
staff has issued on this topic.\769\ However, other related letters 
will not be withdrawn in connection with this rulemaking since they 
address different activity than the activity covered by our final rule 
text on predecessor performance. Those letters address topics including 
an adviser's use of performance generated by predecessor accounts 
(e.g., separate accounts or private funds) in RIC advertisements and 
filings \770\ and the establishment of pools in order to generate 
performance track records.\771\ These letters generally address the use 
of performance from predecessor accounts (i.e., where the same adviser 
uses performance generated by one investment vehicle in an 
advertisement for another product) rather than performance of a 
predecessor advisory firm.\772\
---------------------------------------------------------------------------

    \769\ See infra section II.J.
    \770\ See, e.g., MassMutual Institutional Funds, SEC Staff No-
Action Letter (Sept. 28, 1995); Nicholas-Applegate, SEC Staff No-
Action Letter (Aug. 6, 1996); Growth Stock Outlook Trust Inc., SEC 
Staff No-Action Letter (Apr. 15, 1986).
    \771\ See Dr. William Greene, SEC Staff No-Action Letter (Feb. 
3, 1997).
    \772\ See, e.g., Salomon Brothers Asset Management Inc., SEC 
Staff No-Action Letter (July 23, 1999). See also, Jennison 
Associates LLC, SEC Staff No-Action Letter (July 6, 2000).
---------------------------------------------------------------------------

    Although we requested comment on the portability of testimonials, 
endorsements, third-party ratings, and specific investment advice,\773\ 
commenters did not address these topics. To the extent that 
testimonials, endorsements, third-party ratings, and specific 
investment advice contain performance from a predecessor firm, the 
general prohibitions apply to such testimonials, endorsements, and 
third-party ratings. We do not believe we need to address their 
portability specifically as the general prohibitions, depending on the 
facts and circumstances, will have the effect of prohibiting advisers 
from presenting misleading information to investors by using outdated 
testimonials, endorsements, and third-party ratings.
---------------------------------------------------------------------------

    \773\ See 2019 Proposing Release, supra footnote 7, at section 
II.A.6.
---------------------------------------------------------------------------

G. Review and Approval of Advertisements

    The final rule will not require investment advisers to review and 
approve their advertisements prior to dissemination, unlike the 
proposal. The proposed advertising rule would have required an adviser 
to have an advertisement reviewed and approved for consistency with the 
requirements of the proposed rule by a designated employee before 
disseminating the advertisement, except in certain circumstances.\774\ 
We proposed this requirement because we believed it might reduce the 
likelihood of advisers violating the proposed rule. We believed it was 
important that investment advisers implement a process designed to 
promote compliance with the proposed rule's requirements. We also 
proposed to require that advisers create and maintain a written record 
of the review and approval of the advertisement, which would have 
allowed our examination staff to better review adviser compliance with 
the rule.
---------------------------------------------------------------------------

    \774\ See proposed rule 206(4)-1(d).
---------------------------------------------------------------------------

    Many commenters opposed this requirement or suggested modifications 
to it. Commenters expressed concern that it would impose a significant 
compliance burden on advisers, especially smaller firms.\775\ Many 
commenters also argued that such a requirement would be duplicative of 
the compliance rule, pointing out that most advisers already have 
implemented policies and procedures to review advertisements for 
accuracy prior to dissemination.\776\ Other commenters stated that an 
inflexible review and approval requirement covering nearly all 
advertisements would impair an adviser's ability to communicate timely 
with clients, resulting in poor client service or slow responses during 
periods of market volatility.\777\ Commenters claimed that the 
proposal, which did not exclude one-on-one communications from the 
definition of advertisement, would effectively require advisers to 
screen all communications to assess whether a communication would 
constitute an advertisement subject to the review and approval 
requirement, or met one of the requirement's exceptions.\778\ 
Consequently, some of these commenters suggested that if we adopt this 
requirement, the final rule should expand the exceptions to include, 
for example, responses to questions that contain pre-approved template 
language, advertisements to Non-Retail

[[Page 13089]]

Persons, and interactive social media content.\779\
---------------------------------------------------------------------------

    \775\ See, e.g., FPA Comment Letter; MFA/AIMA Comment Letter I.
    \776\ See, e.g., SBIA Commenter Letter; SIFMA AMG Comment Letter 
I.
    \777\ See, e.g., Commonwealth Comment Letter.
    \778\ See, e.g., NSCP Comment Letter; SIFMA AMG Comment Letter 
I.
    \779\ See, e.g., MFA/AIMA Comment Letter I; MMI Comment Letter; 
ICE Comment Letter.
---------------------------------------------------------------------------

    After considering these comments, we are not adopting the proposed 
internal review and approval requirement. Instead, we believe an 
adviser's existing obligations under the compliance rule will allow an 
adviser to tailor its compliance program to its own advertising 
practices to prevent violations from occurring, detect violations that 
have occurred, and correct promptly any violations that have 
occurred.\780\ In adopting the compliance rule, the Commission stated 
that investment advisers should adopt policies and procedures that 
address ``. . . the accuracy of disclosures made to investors, clients, 
and regulators, including account statements and advertisements.'' 
\781\ We believe for these compliance policies and procedures to be 
effective, they should include objective and testable means reasonably 
designed to prevent violations of the final rule in the advertisements 
the adviser disseminates.
---------------------------------------------------------------------------

    \780\ See Compliance Program Adopting Release, supra footnote 
371, at 74716. Rule 206(4)-7 makes it unlawful for an investment 
adviser to provide investment advice unless the adviser has adopted 
and implemented written policies and procedures reasonably designed 
to prevent violations of the Advisers Act and rules that the 
Commission has adopted under the Act, which will include final rule 
206(4)-1 and its specific requirements. See rule 206(4)-7(a). Rule 
206(4)-7 also requires investment advisers to review, no less than 
annually, the adequacy of the policies and procedures and the 
effectiveness of their implementation, and to designate who is 
responsible for administering the policies and procedures adopted 
under the rule. See id. at (b)-(c).
    \781\ See Compliance Program Adopting Release, supra footnote 
371, at 74716.
---------------------------------------------------------------------------

    Advisers can establish such an objective and testable compliance 
policies and procedures through a variety of tools. For example, 
internal pre-review and approval of advertisements could serve as an 
effective component of an adviser's compliance program. Other effective 
methods to prevent issues could include reviewing a sample of 
advertisements based on risk or pre-approving templates. Effective 
methods to detect and correct promptly violations and adjust practices 
to prevent future violations might include spot-checking advertisements 
and periodic reviews.\782\ Commenters confirmed our understanding that 
the internal policies and procedures of many advisers currently require 
some level of review for advertisements, although not pre-review of 
every advertisement.\783\ Advisers should also consider the extent to 
which reasonably designed policies and procedures should involve 
training on the requirements and prohibitions of the advertising rule 
for any employee(s) involved in the creation, review, or dissemination 
of adviser advertisements.
---------------------------------------------------------------------------

    \782\ See Compliance Program Adopting Release, supra footnote 
371, at 74716. If advisers indirectly market or solicit through 
third parties, they should consider how to tailor policies and 
procedures according to the risks posed by those third parties 
making statements that constitute advertisements under the rule. See 
supra section II.C.3.
    \783\ See, e.g., SBIA Comment Letter; SIFMA AMG Comment Letter I 
(stating that advisers' compliances programs currently include 
upfront reviews of templates, spot-checking or sampling 
advertisements after dissemination, or a risk-based approach 
depending on the type of advertisement).
---------------------------------------------------------------------------

    In addition, consistent with the Commission's examination 
authority, upon request, advisers must promptly provide information 
about their compliance policies and procedures and any records that 
document implementation of those policies and procedures to us and our 
staff.\784\ The Commission's ability to collect information in a timely 
fashion through its examination authority, and evaluate such 
information for compliance with the Federal securities laws, is 
essential to our mission of protecting investors and our securities 
markets.\785\ Indeed, the prompt production of records to the 
Commission is central to our mission of protecting investors, and is 
imperative to an effective and efficient examination program.\786\
---------------------------------------------------------------------------

    \784\ See 15 U.S.C. 80b-4 (section 204 of the Investment 
Advisers Act) (providing the Commission with examination authority 
over ``all records'' of an investment adviser); see rule 204-2(g)(2) 
(requiring prompt production of records); see rule 204-2(a)(17) 
(requiring investment advisers to make and keep records of their 
policies and procedures formulated pursuant to rule 206(4)-7).
    \785\ See, e.g., 15 U.S.C. 80b-4 (section 204 of the Investment 
Advisers Act) (providing the Commission with examination authority); 
see also 17 CFR 275.204-2 (rule 204-2 under the Investment Advisers 
Act) (Commission books and records rules).
    \786\ See, e.g., Electronic Recordkeeping by Investment 
Companies and Investment Advisers, Release No. IA-1945 (May 24, 
2001) [66 FR 29224 (May 30, 2001)] (explaining that the ``continuing 
accessibility and integrity of fund and adviser records are critical 
to the fulfillment of our oversight responsibilities,'' and noting 
the Commission's expectation that a fund or adviser would be 
permitted to delay furnishing electronically stored records for more 
than 24 hours only in ``unusual circumstances.'').
---------------------------------------------------------------------------

    In connection with the proposed review and approval requirement, we 
also proposed to require investment advisers to maintain a copy of all 
written approvals of advertisements by designated employees.\787\ As we 
are not adopting the proposed pre-use approval requirement, we are also 
not adopting this associated recordkeeping requirement.
---------------------------------------------------------------------------

    \787\ See proposed rule 204-2(a)(11)(iii).
---------------------------------------------------------------------------

H. Amendments to Form ADV

    We are adopting, largely as proposed, amendments to Item 5 of Form 
ADV Part 1A to improve information available to the Commission and the 
public about advisers' marketing practices. Item 5 currently requires 
an adviser to provide information about its advisory business.\788\ We 
proposed to add a subsection L (``Marketing Activities'') to require 
information about an adviser's use in its advertisements of performance 
results, testimonials, endorsements, third-party ratings, and 
references to its specific investment advice.
---------------------------------------------------------------------------

    \788\ Exempt reporting advisers (that are not also registering 
with any state securities authority) are not required to complete 
Item 5 of Part 1A. Accordingly, subsection L of Item 5 of Part 1A 
will not be required for such advisers. See, e.g., Instruction 3 to 
Form ADV: General Instructions (``How is Form ADV organized''). 
Exempt reporting advisers will not be subject to the final rule. See 
supra footnote 21.
---------------------------------------------------------------------------

    Several commenters supported the proposed additions to Form 
ADV,\789\ while others questioned their usefulness.\790\ Some 
commenters suggested removing the question regarding whether an 
adviser's performance results were verified, arguing that it could 
disadvantage smaller advisers or could provide investors with a false 
assurance of accuracy.\791\ Other commenters suggested that we include 
questions about an adviser's use of other types of performance, such as 
predecessor performance,\792\ or specific types of hypothetical 
performance.\793\ One commenter opposed including questions regarding 
the amount or range of compensation paid for testimonials, 
endorsements, or third-party ratings, arguing that this could be 
commercially sensitive information.\794\ Others suggested technical 
improvements to the proposed section. For example, one commenter 
requested that we clarify how frequently advisers must update responses 
to Item 5.L.\795\ Another commenter requested that we define 
advertisement and other relevant terms

[[Page 13090]]

of Item 5.L in the Form ADV Glossary.\796\
---------------------------------------------------------------------------

    \789\ See CFA Institute Comment Letter; NRS Comment Letter; 
NAPFA Comment Letter.
    \790\ See, e.g., SIFMA AMG Comment Letter I.
    \791\ See, e.g., JG Advisory Comment Letter; Pickard Djinis 
Comment Letter.
    \792\ See CFA Institute Comment Letter.
    \793\ See NRS Comment Letter (suggesting that Form ADV 
specifically request that an adviser disclose whether its 
advertisements include backtested performance or projected or 
targeted returns).
    \794\ See SIFMA AMG Comment Letter I.
    \795\ See NRS Comment Letter.
    \796\ See Pickard Djinis Comment Letter.
---------------------------------------------------------------------------

    After considering the comments, we are adopting new subsection L to 
Item 5 of Form ADV with slight modifications to the ordering and 
content of the subsection versus the proposal. We are also amending the 
Form ADV Glossary to incorporate the final rule's definitions for 
``advertisement,'' ``endorsement,'' ``hypothetical performance,'' 
``testimonial,'' ``third-party rating,'' and ``predecessor 
performance.'' Because new subsection L is included under Item 5 of 
Form ADV, advisers will be required to update responses to these 
questions in their annual updating amendment only.\797\ We continue to 
believe that this new information will be useful for staff in reviewing 
an adviser's compliance with the final rule, including the restrictions 
and conditions on advisers' use in advertisements of performance 
presentations and third-party statements.
---------------------------------------------------------------------------

    \797\ See Instruction 4 to Form ADV: General Instructions 
(``When am I required to update my Form ADV?'').
---------------------------------------------------------------------------

    First, we are combining several proposed questions into Item 
5.L(1), which will require an adviser to state whether any of its 
advertisements include performance results, a reference to specific 
investment advice, testimonials, endorsements, or third-party 
ratings.\798\ Unlike under the proposal, this item will require an 
adviser to address separately whether its advertisements include 
testimonials, endorsements, and third-party ratings. We believe that 
requiring advisers to address each separately will provide more 
specific and useful information to our staff regarding whether an 
adviser engages in these marketing practices. We are not including the 
proposed related question that would have asked whether the performance 
results in Item 5.L(1) were reviewed or verified, as proposed. We agree 
with commenters that ``verification'' may inappropriately suggest an 
assurance of accuracy to investors, and disadvantage smaller advisers 
that may not obtain third-party reviews of their performance 
results.\799\
---------------------------------------------------------------------------

    \798\ The question will exclude testimonials and endorsements 
given by certain affiliated persons of the adviser that satisfy rule 
206(4)-1(b)(4)(ii).
    \799\ See JG Advisory Comment Letter; CFA Institute Comment 
Letter.
---------------------------------------------------------------------------

    As proposed, we are requiring an adviser to state whether the 
adviser pays or otherwise provides cash or non-cash compensation, 
directly or indirectly, in connection with the use of testimonials, 
endorsements, or third-party ratings.\800\ This question will only 
require `yes' or `no' responses, and will not require additional 
information about the amount or range of compensation provided to avoid 
the disclosure of potentially sensitive information as suggested by one 
commenter.\801\
---------------------------------------------------------------------------

    \800\ This question will appear in Item 5.L(2), but had been 
proposed as Item 5.L(4).
    \801\ See SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

    Third, unlike under our proposal, we are adding items requiring an 
adviser to state whether any of its advertisements include hypothetical 
performance and predecessor performance, respectively. We agree with 
commenters' suggestions that this information could be useful for our 
staff preparing for examinations, especially considering that 
hypothetical performance can pose a heightened risk of misleading 
investors.\802\ Additionally, as explained above, the final rule 
specifically addresses when advisers can include predecessor 
performance in advertisements.\803\ Responses regarding predecessor 
performance will enable our examination staff to better assess 
compliance with this new provision of the rule.
---------------------------------------------------------------------------

    \802\ See, e.g., CFA Institute Comment Letter; NRS Comment 
Letter.
    \803\ See supra section II.F.
---------------------------------------------------------------------------

I. Recordkeeping

    We are adopting amendments to the books and records rule, largely 
as proposed, to reflect the final rule and to help further the 
Commission's inspection and enforcement capabilities. Investment 
advisers must make and keep records of all advertisements they 
disseminate, and certain alternative methods for complying with this 
provision are available for oral advertisements, including oral 
testimonials and oral endorsements.\804\ If an adviser provides an 
advertisement orally, the adviser may, instead of recording and 
retaining the advertisement, retain a copy of any written or recorded 
materials used by the adviser in connection with the oral 
advertisement.\805\ If an adviser's advertisement includes a 
compensated oral testimonial or endorsement, the adviser may, instead 
of recording and retaining the advertisement, make and keep a record of 
the disclosures provided to investors.\806\ Further, if an adviser's 
disclosures with respect to a testimonial or endorsement are not 
included in the advertisement, then the adviser must retain copies of 
such disclosures provided to investors.\807\
---------------------------------------------------------------------------

    \804\ See final rule 204-2(a)(11)(i)(A).
    \805\ See final rule 204-2(a)(11)(i)(A)(1).
    \806\ See final rule 204-2(a)(11)(i)(A)(2).
    \807\ See final rule 204-2(a)(11)(i)(A) and (15)(i).
---------------------------------------------------------------------------

    Commenters generally disagreed with this expansion of the books and 
records rule, which currently only requires advisers to retain 
advertisements sent to ten or more persons. According to commenters, 
advisory firms of all sizes would face compliance challenges, 
especially smaller advisers, if required to maintain all 
advertisements.\808\ We believe, however, that this change is necessary 
to conform the books and records rule to the definition of 
advertisement and is designed to ensure advisers comply with the 
requirements in the final rule.\809\ Our decision to narrow the 
proposed definition of advertisement by excluding one-on-one 
communications from the first prong of the definition (other than most 
communications that include hypothetical performance) will lessen any 
burden imposed by the associated recordkeeping obligations.
---------------------------------------------------------------------------

    \808\ See JG Advisory Comment Letter; NAPFA Comment Letter; FPA 
Comment Letter.
    \809\ See also NRS Comment Letter (stating that ``most advisers 
have developed procedures requiring the retention of all written 
communications, so that individuals within the firm do not have the 
discretion to determine whether or not a particular communication is 
required under rule 204-2(a)(7).''). As proposed, we are not 
changing the requirement that advisers keep a record of 
communications other than advertisements (e.g., notices, circulars, 
newspaper articles, investment letters, and bulletins) that the 
investment adviser disseminates, directly or indirectly, to ten or 
more persons.
---------------------------------------------------------------------------

    One commenter asked us to clarify that electronic mail (``email'') 
archives are an acceptable method of maintaining records of 
advertisements that are disseminated to investors, and we agree.\810\ 
The final rule does not prescribe or prohibit any particular method of 
maintaining records. Rather, it requires the adviser to maintain and 
preserve these records ``in an easily accessible place for a period of 
not less than five years, the first two years in an appropriate office 
of the investment adviser, from the end of the fiscal year during which 
the investment adviser last published or otherwise disseminated, 
directly or indirectly, the . . . advertisement.'' \811\ We believe it 
would be permissible for an adviser to store records using email 
archives (including in cloud storage or with a third-party vendor), 
provided that the adviser can promptly produce records in accordance 
with the recordkeeping rule \812\ and statements of the 
Commission.\813\
---------------------------------------------------------------------------

    \810\ See JG Advisory Comment Letter.
    \811\ Final rule 204-2(e)(3)(i). This provision has not been 
amended from the current rule.
    \812\ See final rule 204-2(g)(2)(ii). This provision has not 
been amended from the current rule.
    \813\ See Amendments to the Timing Requirements for Filing 
Reports on Form N-PORT, Release No. IC-33384 (Feb. 27, 2019) [84 FR 
7980 (Mar. 6, 2019)] (interim final rule), at n.44. See also JG 
Advisory Comment Letter (suggesting that the Commission clarify that 
email archives are an acceptable method of recordkeeping in certain 
contexts).

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[[Page 13091]]

    The current recordkeeping rule requires advisers to retain 
originals of all written communications received and copies sent by the 
adviser relating to the performance or rate of return of any or all 
managed accounts or securities recommendations.\814\ As proposed, the 
final rule will amend the current rule to also require advisers to 
maintain written communications relating to the performance or rate of 
return of any portfolios (as defined in the final marketing rule).\815\
---------------------------------------------------------------------------

    \814\ See current rule 204-2(a)(7)(iv).
    \815\ See final rule 204-2(a)(7)(iv).
---------------------------------------------------------------------------

    The current recordkeeping rule requires advisers to retain all 
accounts, books, internal working papers, and other documents necessary 
to form the basis for or demonstrate the calculation of the performance 
or rate of return of any or all managed accounts or securities 
recommendations in any advertisement.\816\ As proposed, the final rule 
will amend the current rule to also require advisers to maintain 
accounts, books, internal working papers, and other documents necessary 
to form the basis for or demonstrate the calculation of the performance 
or rate of return of any portfolios (as defined in the final marketing 
rule).\817\ In addition, the supporting records of investment advisers 
that display hypothetical performance must include copies of all 
information provided or offered pursuant to the hypothetical 
performance provisions of the final rule.\818\ These changes are 
designed to help to facilitate the Commission's inspection and 
enforcement capabilities.
---------------------------------------------------------------------------

    \816\ See current rule 204-2(a)(16).
    \817\ See final rule 204-2(a)(16). See also Recordkeeping by 
Investment Advisers, Release No. IA-1135 (Aug. 17, 1988) [53 FR 
32033 (Aug. 23, 1988)] (describing as ``supporting records'' the 
documents necessary to form the basis for performance information in 
advertisements that are required under rule 204-2(a)(16)).
    \818\ See final rule 206(4)-1(d)(6), which will prohibit 
hypothetical performance in an advertisement except under certain 
conditions, including a requirement that the investment adviser 
provides (or offers to provide promptly to a recipient that is a 
private fund investor) sufficient information to enable the intended 
audience to understand the risks and limitations of using such 
hypothetical performance in making investment decisions. Any such 
supplemental information that is required by final rule 206(4)-1 to 
be a part of the advertisement is subject to the books and records 
rule. See final rule 204-2(a)(16).
---------------------------------------------------------------------------

    In a change from the proposal, the final rule will require advisers 
to maintain documentation of communications relating to predecessor 
performance.\819\ This change complements the predecessor performance 
provisions of the final rule and will help ensure that advertising 
advisers retain appropriate documentation to substantiate displays of 
predecessor performance. One commenter noted that advisers often have 
difficulty complying with the books and records requirements in 
connection with predecessor performance.\820\ For the reasons discussed 
above, we decline to provide additional flexibility.\821\
---------------------------------------------------------------------------

    \819\ See proposed rule 204-2(a)(7)(iv). See also 2019 Proposing 
Release, supra footnote 7, at sections II.A.6. and II.C. (requesting 
comment about whether to amend the books and records rule to address 
the substantiation of performance results from a predecessor firm 
and whether the Commission should amend the rule to address 
specifically other provisions of the proposed advertising rule).
    \820\ See SIFMA AMG Comment Letter II.
    \821\ See supra section I.F.
---------------------------------------------------------------------------

    In a change from the proposal, we will require advisers to make and 
keep a record of who the ``intended audience'' is pursuant to the 
hypothetical performance and model fee provisions of the final 
marketing rule.\822\ Our examination staff may choose to review the 
adviser's policies and procedures (for displaying hypothetical 
performance) against the records retained in connection with this new 
recordkeeping provision when determining whether the adviser satisfied 
the hypothetical performance policies and procedures condition. Also, 
we believe this additional requirement will assist our examination 
staff in confirming that advisers are appropriately considering the 
target audience when preparing and disseminating net performance and 
hypothetical performance.
---------------------------------------------------------------------------

    \822\ See final rule 204-2(a)(19). See also final rule 206(4)-
1(d)(6) and (e)(10)(ii)(B).
---------------------------------------------------------------------------

    We proposed to require investment advisers to maintain a copy of 
all written approvals of advertisements by designated employees in 
order to track a corresponding proposed provision of the advertising 
rule relating to a review and approval process.\823\ Since we are not 
adopting the provision of the proposed advertising rule relating to 
review and approval, we are not adopting the corresponding proposed 
recordkeeping requirement. As discussed above, we are persuaded by 
commenters who asserted that an adviser's own policies and procedures 
would provide an effective compliance mechanism.\824\
---------------------------------------------------------------------------

    \823\ See proposed rule 204-2(a)(11)(iii).
    \824\ See, e.g., NRS Comment Letter.
---------------------------------------------------------------------------

    The combination of the current solicitation rule and current 
advertising rule into a single marketing rule resulted in additional 
changes to the books and records rule. We are adopting, as proposed, 
changes to the books and records rule in order to correspond to the 
marketing rule's provisions that address testimonials and endorsements. 
The rule will require investment advisers to make and keep any 
communication or other document related to the investment adviser's 
determination that it has a reasonable basis for believing that a 
testimonial or endorsement complies with rule 206(4)-1 and that a 
third-party rating complies with rule 206(4)-1(c)(1).\825\ We are not 
adopting amendments to the books and records rule that would 
specifically reference the adviser's obligation to retain the written 
agreements with promoters \826\ because such a provision would be 
duplicative of the current books and records rule.\827\
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    \825\ See final rule 204-2(a)(15)(ii).
    \826\ See final rule 206(4)-1(b)(2)(ii).
    \827\ Advisers are already required to retain the written 
agreement pursuant to current rule 204-2(a)(10).
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    We did not receive any comments on the proposed amendments to the 
recordkeeping rule provisions that corresponded to the proposed 
amendments to the solicitation rule. For the reasons discussed in the 
proposal regarding amendments to the solicitation rule, we are 
retaining the current recordkeeping rule's requirement for investment 
advisers to keep a record of the disclosures delivered to investors, 
which now apply to testimonials, endorsements, and third-party ratings. 
However, we are adjusting the wording to correspond to changes to the 
final marketing rule that permit either the investment adviser or the 
promoter to provide the disclosure. Further, in a change from the 
current solicitation rule, the final marketing rule will not require a 
promoter to provide an investor with the adviser's brochure. 
Accordingly, as proposed, we will remove the corresponding books and 
records requirement as no longer relevant or necessary.
    As discussed above, in a change from the proposed amendments to the 
solicitation rule, the final rule contains a partial exemption (from 
the disclosure requirements associated with testimonials and 
endorsements in the final rule) for an adviser's affiliated personnel. 
The amended recordkeeping rule will now contain a corresponding 
requirement for advisers that rely on the exemption to keep a record of 
the names of all affiliated personnel and document their affiliates' 
status at the time the

[[Page 13092]]

investment adviser disseminates the testimonial or endorsement.\828\
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    \828\ See final rule 204-2(a)(15)(iii).
---------------------------------------------------------------------------

    Finally, we are adopting, as proposed, the requirement that an 
adviser retain a copy of any questionnaire or survey used in the 
preparation of a third-party rating included or appearing in any 
advertisement.\829\ Commenters expressed concerns about not being able 
to obtain a copy of the questionnaire or survey.\830\ As discussed 
above, we recognize this concern and the rule will require an adviser 
to retain a copy of this material only in the event the adviser obtains 
a copy of the questionnaire or survey (i.e., an adviser would not be 
required to obtain a copy of the questionnaire or survey in order to 
comply with rule 206(4)-1 or rule 204-2).
---------------------------------------------------------------------------

    \829\ See final rule 204-2(a)(11)(ii).
    \830\ See, e.g., Blackrock Comment Letter; AIC Comment Letter.
---------------------------------------------------------------------------

J. Existing Staff No-Action Letters

    Staff in the Division of Investment Management reviewed certain of 
our staff's no-action letters that addresses the application of the 
advertising and solicitation rules to determine whether any such 
letters should be withdrawn in connection with the adoption of the 
marketing rule. Because we are rescinding the solicitation rule, the 
staff no-action letters that address that rule will be nullified.\831\ 
Additionally, pursuant to the staff's review, the staff will be 
withdrawing the staff's remaining no-action letters and other staff 
guidance, or portions thereof, as of the compliance date of the final 
rules.\832\ A few commenters supported this approach, suggesting that 
the final rule should either supersede or incorporate every 
letter.\833\ Other commenters requested that certain no-action letters 
not be withdrawn that were issued to solicitors who would otherwise be 
subject to the rule's disqualification provisions.\834\ These 
commenters alternatively requested that the Commission grandfather such 
solicitation arrangements if these letters are withdrawn.
---------------------------------------------------------------------------

    \831\ The order granting exemptive relief under rule 206(4)-3 is 
also terminated. See In the Matter of Blackrock, Investment Advisers 
Release Nos. 2971 (Jan. 4, 2010) [75 FR 1421 (Jan. 11, 2010)] 
(application) and 2988 (Feb. 26, 2010) (order) (stating that ``the 
Applicant will rely on the Order only for so long as the Cash 
Solicitation Rule in effect as of the date of the Order is 
operative.'').
    \832\ A list of the letters to be withdrawn will be available on 
the Commission's website.
    \833\ IAA Comment Letter; Mercer Comment Letter.
    \834\ See, e.g., SIFMA AMG Comment Letter II; Mercer Comment 
Letter; Stansberry Comment Letter.
---------------------------------------------------------------------------

    Based on the staff's review, we understand that some solicitors may 
continue to conduct solicitation activity consistent with the 
conditions stated in certain of the solicitor disqualification letters 
identified below.\835\ The majority of these letters, however, pertain 
to events that occurred more than ten years prior to the effective date 
of the marketing rule and thus would not be disqualifying events under 
the marketing rule.\836\ The nullification of these solicitation 
disqualification letters will not have an impact on the relevant 
solicitor's eligibility under the rule. For the minority of the 
solicitor disqualification letters that involve events that occurred 
within the rule's ten-year lookback period, however, nullification of 
these letters could trigger disqualification under the marketing rule 
for that underlying event. To avoid this result, we understand that the 
staff will take a no-action position with respect to the events in 
those letters to prevent those solicitors from being deemed 
disqualified under the marketing rule. This position is designed 
primarily to assist the phase-out of these letters as of the compliance 
date of the final rule.\837\
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    \835\ See also, Stansberry Comment Letter.
    \836\ See final rule 206(4)-1(e)(4).
    \837\ We believe that the need for this position will likely be 
temporary since the events covered by these letters, over time, will 
fall outside the ten-year lookback period for purposes of 
disqualification under the rule.
---------------------------------------------------------------------------

K. Transition Period and Compliance Date

    The final rule will provide an eighteen-month transition period 
between the effective date of the rule and the compliance date. While 
we had proposed a one-year transition period, two commenters requested 
a longer transition period to prepare for the new rule's 
requirements.\838\ One of these commenters argued that a two-year 
transition period would be more appropriate given the compliance burden 
of implementing the proposed review and approval requirement.\839\ We 
did not adopt the proposed pre-review and approval requirement; 
nevertheless, we appreciate commenters' concerns. Accordingly, the 
compliance date will be eighteen months following the effective date of 
the rules. Any advertisements disseminated on or after the compliance 
date by advisers registered or required to be registered with the 
Commission would be subject to the new marketing rule.
---------------------------------------------------------------------------

    \838\ See FPA Comment Letter; MFA/AIMA Comment Letter I.
    \839\ See MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

    The compliance date for the amended recordkeeping rule will also 
provide an eighteen-month transition date from the effective date of 
the rule. Advisers filing Form ADV after a similar eighteen-month 
transition period from the effective date of the rule will be required 
to complete the amended form. Importantly, Form ADV does not require an 
adviser to update responses to Item 5 promptly by filing an other-than-
annual amendment, and if an adviser submits an other-than-annual 
amendment, the adviser is not required to update its response to Item 5 
even if the response has become inaccurate.\840\ Therefore, each 
adviser is only responsible for filing an amended form that includes 
responses to the amended questions in Item 5 in its next annual 
updating amendment that is filed after the eighteen-month transition 
period.
---------------------------------------------------------------------------

    \840\ See Form ADV General Instruction 4.
---------------------------------------------------------------------------

L. Other Matters

    Pursuant to the Congressional Review Act,\841\ the Office of 
Information and Regulatory Affairs has designated this rule a ``major 
rule'' as defined by 5 U.S.C. 804(2). If any of the provisions of these 
rules, or the application thereof to any person or circumstance, is 
held to be invalid, such invalidity shall not affect other provisions 
or application of such provisions to other persons or circumstances 
that can be given effect without the invalid provision or application.
---------------------------------------------------------------------------

    \841\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

III. Economic Analysis

A. Introduction

    We are mindful of the costs imposed by, and the benefits obtained 
from, our rules. Whenever we engage in rulemaking and are required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, section 202(c) of the Advisers Act requires the 
Commission to consider, in addition to the protection of investors, 
whether the action would promote efficiency, competition, and capital 
formation. The following analysis considers, in detail, the potential 
economic effects that may result from the final rule, including the 
benefits and costs to market participants as well as the broader 
implications of the final rule for efficiency, competition, and capital 
formation. Where possible, the Commission quantifies the likely 
economic effects of the final rule; however, the Commission is unable 
to quantify certain economic effects because it lacks the information 
necessary to provide estimates or ranges. In some cases, quantification 
is particularly challenging due to the number of assumptions that would 
be

[[Page 13093]]

required to forecast how investment advisers would respond to the new 
conditions of the final rule, and how those responses would in turn 
affect the broader market for investment advice and the investors' 
participation in this market. Nevertheless, as described more fully 
below, the Commission is providing both a qualitative assessment and, 
where feasible, a quantified estimate of the economic effects.
    In large part, the scope of these costs and benefits is determined 
by the scope of the rule's definition of advertisement. The final 
rule's definition includes many of the types of communications subject 
to the current advertising rule. The final rule, however, will 
expressly apply the protections of the rule to investors in private 
funds, and advisers will now incur costs related to these 
communications, to the extent that their current practices differ from 
the final rule. In addition, the definition's scope has been expanded 
to include communications made by promoters, including cash-compensated 
promoters, who were previously subject to the cash solicitation rule, 
and non-cash-compensated promoters who were not. Some of these affected 
promoters whose communications will be newly defined as advertisements 
may also be registered broker-dealers whose communications may be 
subject to other regulatory requirements governing communications and 
advertisements, including those under the Exchange Act, the rules 
promulgated thereunder (including Regulation BI), and FINRA rules 
(including FINRA rule 2210). The final rule's application to promoters 
that are registered broker-dealers relating to endorsements to private 
fund investors may create some overlap in regulation to the extent 
regulatory requirements under the Exchange Act and FINRA rules apply to 
their promotional activities. This may create burdens on these 
promoters to the extent their compliance with these other regulatory 
requirements does not fully satisfy the final rule. However, both the 
costs and benefits of the testimonial and endorsement requirements will 
be mitigated by the exclusions from the endorsement requirements that 
will apply to these registered broker-dealers.
    Other aspects of the final rule will also yield costs and benefits, 
such as the final rule's general prohibitions on certain marketing 
practices. The impact of these changes are generally limited to the 
extent that communications are subject to similar restrictions under 
the current advertising rule, the current solicitation rule, and the 
general anti-fraud provisions of the securities laws, and the extent to 
which the final rule's prohibitions conform to current market 
practices. The impact is more pronounced with respect to communications 
newly subject to the definition of an advertisement and not previously 
subject to the solicitation rule--particularly to communications by 
solicitors who are not cash-compensated. In addition, the rules and 
rescission of existing no-action letters may increase certainty because 
advisers who choose to advertise will be able to follow the 
requirements of the final rules rather than various no-action letters, 
which could ultimately reduce compliance costs. Conversely, to the 
extent that the specificity of the rules prompts some advisers to 
devote greater resources to ensure compliance obligations under the 
final rules, the requirements of the rules may impose greater costs on 
such funds and advisers. Changes in costs of compliance for advisers 
ultimately could affect investors to the extent that any changes in 
costs would be passed down to them in the form of changed fund 
operating expenses or higher advisory fees.
    In addition, the rule will (i) permit investment advisers to use 
certain features in an advertisement, such as testimonials and 
endorsements, subject to certain conditions, such as disclosing 
information that would help investors evaluate the advertisement, and 
(ii) prohibit third-party ratings and investment adviser performance in 
advertisements unless they comply with certain conditions. The ability 
to use testimonials and endorsements will likely have a less pronounced 
impact on advisers that are currently complying with the solicitation 
rule because this aspect of the marketing rule is drawn from the 
current solicitation rule. The impact of restrictions in the marketing 
rule related to the use of performance advertising is likely similar on 
advisers currently subject to the advertising or solicitation rule 
because this aspect of the final rule permits certain activity that is 
not permissible under either current rule. If an adviser that is 
subject to the current advertising rule is implementing practices 
similar to those of the recipients of staff letters with respect to 
performance advertising, the impact of this new aspect of the final 
rule may be less pronounced for these advisers as compared to the 
impact on other advisers to the extent that there are some similarities 
between the final rule and the staff letters.
    The Commission is also adopting amendments to Form ADV that are 
designed to provide additional information regarding advisers' 
marketing practices, and amendments to the Advisers Act books and 
records rule to correspond to the features of the marketing rule. The 
final rule reflects market developments since 1961 and 1979, when rules 
206(4)-1 and 206(4)-3, respectively, were adopted, as well as practices 
addressed in staff no-action letters. These market developments include 
advances in communication technology and marketing practices that did 
not exist at the time the rules were adopted and may fall outside of 
the scope of the current rules.

B. Broad Economic Considerations

    While we discuss investment advisers' many diverse marketing 
methods and practices in detail later, here we discuss the broad 
economic considerations that frame our economic analysis of the final 
rule and describe the relevant structural features of the market for 
investment advice and its relationship to marketing of advisory 
services and private funds. Key to this framework is the problem that 
investors face when searching for an investment adviser; specifically 
the lack of information that investors may have about the ability and 
potential fit of an investment adviser for the investor's preferences. 
By setting up this economic framework, we can see how the 
characteristics of the market for investment advice and its 
participants can influence the costs and benefits of the final rule and 
its impact on efficiency, competition, and capital formation.
Information Usefulness
    The usefulness of the information in investment adviser 
advertisements is an important factor in determining how investors 
decide with which investment advisers to engage. For the purposes of 
the final rule, we use the term ``ability'' to refer to the usefulness 
of advice an investment adviser provides. The ``potential fit'' of an 
investment adviser refers to attributes that investors may have 
specific preferences for, such as communication style, investment 
style, or risk preference. For example, some investors would prefer an 
investment adviser that does not proactively provide advice or suggest 
investments, while others might prefer a more active communication and 
management style.
    While the effectiveness and usefulness of an investment adviser's 
advertisements can have direct effects on the quality of the matches 
that investors make with investment advisers--in terms of both fit and 
better returns from the investment--there may be important indirect 
effects as well. If the final rule provides additional methods for 
investment advisers to

[[Page 13094]]

credibly and truthfully advertise their ability and potential fit with 
investors, investment advisers may have a greater marginal incentive to 
invest more in the quality of their services, because advisers would 
have additional methods to communicate their ability and potential fit 
through advertisements. Additionally, because investors might be able 
to better observe the relative qualities of competing investment 
advisers, the final rule may also enhance competition among investment 
advisers. In summary, to the extent that the final rule improves the 
effectiveness and usefulness of investment adviser advertisements, the 
final rule could also have a secondary effect of increasing competition 
among investment advisers, and encourage investment in the quality of 
services.
Information Access
    Investors generally have access to a variety of sources of 
information on the ability and potential fit of an investment adviser. 
Advertisements, word of mouth referrals, and independent research are 
all ways in which investors acquire information about investment 
advisers as they search for them. During this search, investors trade 
off the benefits of finding a better investment adviser (in terms of 
ability and potential fit) against the costs of searching for and 
obtaining information about one. If the cost of searching is too high, 
investors may contract with lower quality investment advisers on 
average, because they cannot spend the resources to conduct a search 
that would yield an investment adviser with higher ability or better 
fit, or they might not be able to evaluate the quality of the 
investment adviser they have found. Thus, higher search costs can 
result in inefficiencies because the same expected quality of match 
requires an investor to incur higher search costs. Similarly, for a 
fixed amount of spending on a search, an investor is less able to find 
information about investment advisers, and finds a lower expected 
quality of match.
    Marketing can potentially mitigate inefficiencies associated with 
the costs of searching for good products or suitable services. To the 
extent that marketing provides accurate and useful information to 
investors about investment advisers at little or no cost to investors, 
marketing can reduce the search costs that investors bear to acquire 
information and improve the ability of investors to identify high 
quality investment advisers. Investors have a variety of preferences 
regarding investment adviser characteristics such as investment 
strategies or communication styles. Marketing can help communicate 
information about an investment adviser's ability, and that may aid an 
investor in selecting an investment adviser who is a good ``fit'' for 
the investor's preferences.
    While marketing by or on behalf of investment advisers may reduce 
search costs for potential investors, investment advisers' or 
promoters' incentives may not necessarily be aligned with those of 
potential investors. Such a misalignment could undercut the potential 
gains to efficiency. For example, investment advisers have incentives 
to structure their advertisements to gain potential investors, 
regardless of whether their advertisements accurately reflect their 
ability and indicate whether they offer a potential fit with an 
investor's preferences. One commenter suggested, for instance, that 
advisers may be incentivized to purchase positive testimonials or 
endorsements, or otherwise curate content.\842\
---------------------------------------------------------------------------

    \842\ See NASAA Comment Letter.
---------------------------------------------------------------------------

    In addition, advertisements might make claims that are costly for 
investors to verify or are inherently unverifiable. For example, 
evaluating a claim that an investment adviser's strategy generates 
``alpha'' or returns in excess of priced risk factors generally 
requires information about the strategy's returns and permitted 
holdings, as well as a model that attributes returns to risk factors. 
While some investors may have ready access to these resources or 
information, other investors may not. In some cases, an investor may be 
unable to assess the plausibility of an investment adviser's claims. An 
investment adviser might also state facts but omit the contextual 
details that an investor would need to properly evaluate these facts.
    Several economic models suggest that the ability to control or 
influence an investor's access to information can hamper the investor's 
ability to process information in an unbiased manner, even if the 
specific facts or information communicated to an investor are not 
false.\843\ For example, this type of control or influence on 
information can be as explicit as deletion or removal of unfavorable 
ratings or reviews,\844\ or as implicit as a reordering of the ratings 
or a suggestion of which ratings or reviews to read.\845\ Similarly, 
promoters may overstate the quality of the investment adviser they are 
promoting or their familiarity with the advisers' services, or hide 
negative details that would have aided an investor when choosing an 
investment adviser or private fund, given promoters' financial 
incentive to recommend the adviser to the investor.
---------------------------------------------------------------------------

    \843\ Luis Rayo and Ilya Segal, Optimal Information Disclosure, 
118 J. POL. ECON. 949 (2010); Emir Kamenica and Matthew Gentzkow, 
Bayesian Persuasion, 101 a.m. ECON. REV. 2590 (2011); Pak Hung Au 
and King King Li, Bayesian Persuasion and Reciprocity: Theory and 
Experiment, SSRN (June 5, 2018), available at https://ssrn.com/abstract=3191203; Jacob Glazer and Ariel Rubinstein, On Optimal 
Rules of Persuasion, 72 ECONOMETRICA 1715 (2004) (``Glazer'').
    \844\ See id. for Segal and Rayo 2010, Kamenica and Gentzkow 
2011, Au Li 2018.
    \845\ See Glazer, supra footnote 843.
---------------------------------------------------------------------------

Information Evaluation
    There are considerable differences among investors and potential 
investors in their ability to process and evaluate information 
communicated by investment advisers. Many investors and prospective 
investors may lack the financial literacy needed to evaluate and 
interpret the types of financial information contained in investment 
adviser advertisements. In 2010, the Dodd-Frank Act required the 
Commission to study the financial literacy among retail investors, 
including methods and efforts that could increase financial literacy 
among investors.\846\ The Commission contracted with the Federal 
Research Division at the Library of Congress to conduct a review of the 
quantitative studies on the financial literacy of retail investors in 
the United States.\847\ According to the Library of Congress Report, 
studies show consistently that many American retail investors \848\ 
lack important elements of financial literacy. For example, studies 
have found that many investors do not understand certain financial 
concepts, such as compound interest and inflation. Studies have also 
found that many investors do not understand other key

[[Page 13095]]

financial concepts, such as diversification or the differences between 
stocks and bonds, and are not fully aware of investment costs and their 
impact on investment returns.\849\ A 2016 FINRA survey found that 56 
percent of respondents correctly answered less than half of a set of 
financial literacy questions, and yet 65 percent of respondents 
assessed their own knowledge about investing as high (between five and 
seven on a seven-point scale).\850\ Moreover, the general lack of 
financial literacy among some investors makes it difficult for those 
investors to evaluate claims about financial services made in 
advertisements, which increases the risk that such investors are unable 
to effectively use the information in advertisements to find an 
investment adviser that has high ability and is a good fit.\851\
---------------------------------------------------------------------------

    \846\ U.S. Securities and Exchange Commission, Study Regarding 
Financial Literacy Among Investors As Required by Section 917 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Aug. 
2012), available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf. (``Financial Literacy Study'').
    \847\ See id. Although the report does not link American 
investors specifically to those who would become clients of SEC-
registered investment advisers or investors in private funds, we 
believe that the study may be indicative of the level of financial 
literacy for prospective investors.
    \848\ The financial literacy studies in the Library of Congress 
Report (2011) fall into three categories, depending on the 
population or special topic under investigation. Most studies survey 
the general population. For example, the FINRA Investor Education 
Foundation's 2009 National Financial Capability study, which was 
included in the Library of Congress Report, consisted of a national 
sample of 1488 respondents. Other research included in the report 
focus on particular subgroups, such as women, or specific age groups 
or minority groups. A third type of study deals specifically with 
investment fraud. These studies do not differentiate between 
qualified purchasers, knowledgeable employees, and other investors. 
Results from studies conducted on general populations may not apply 
to private fund investors.
    \849\ See Financial Literacy Study, supra footnote 846.
    \850\ FINRA Investor Education Foundation, Investors in the 
United States (2016).
    \851\ Annamaria Lusardi and Olivia S. Mitchell, The Economic 
Importance of Financial Literacy: Theory and Evidence, 52 J. ECON. 
LITERATURE 5 (2014).
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C. Baseline

1. Market for Investment Advisers for the Advertising Rule
a. Current Regulation
    The current rule 206(4)-1 imposes four broadly drawn limitations on 
the content of advertisements that are ``directly or indirectly'' 
published, circulated, or distributed by investment advisers. In 
addition to these specific prohibitions, the current rule prohibits any 
advertisement that contains any untrue statement of a material fact, or 
which is otherwise false or misleading. This prohibition operates more 
generally than the specific prohibitions to address advertisements that 
do not violate any of the specific prohibition but still may be 
fraudulent, deceptive, or manipulative and, accordingly, may risk 
misleading investors.
    For purposes of the advertising rule, the Commission currently 
defines ``advertisement'' to be ``any notice, circular, letter or 
written communication addressed to more than one person, or any notice 
or other announcement in any publication or by radio or television, 
which offers (1) any analysis, report, or publication concerning 
securities, or which is to be used in making any determination as to 
when to buy or sell any security, or which security to buy or sell, or 
(2) any graph, chart, formula, or other device to be used in making any 
determination as to when to buy or sell any security, or which security 
to buy or sell, or (3) any other investment advisory service with 
regard to securities.''
    Investment advisers owe a fiduciary duty under the Advisers Act, 
which is enforceable under the Act's anti-fraud provisions in section 
206.\852\ Section 206 of the Advisers Act prohibits misstatements or 
misleading omissions of material facts and other fraudulent acts and 
practices in connection with the conduct of an investment advisory 
business.\853\
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    \852\ See Fiduciary Interpretation, supra footnote 88, at 6-7.
    \853\ See also section 17(a) of the Securities Act, section 
10(b) of the Exchange Act and rule 10b-5 thereunder, and rule 
206(4)-8 under the Advisers Act.
---------------------------------------------------------------------------

b. Market Practice
    In addition to section 206 and rule 206(4)-1, investment advisers 
have considered staff no-action letters in their advertising practices. 
For example, the staff has issued no-action letters under rule 206(4)-
1(b), stating that, in general, the staff would not view a written 
communication by an adviser to an existing client or investor about the 
performance of the securities in the investor's account as an ``offer'' 
of investment advisory services but instead would view it as part of 
the adviser's advisory services (unless the context in which the 
performance or past specific recommendations are provided suggests 
otherwise), and that the staff would not view communications by an 
adviser in response to an unsolicited request by an investor, 
prospective client, or consultant for specified information as an 
advertisement.\854\
---------------------------------------------------------------------------

    \854\ See ICAA letter, supra footnote 95.
---------------------------------------------------------------------------

    The staff has also stated that it would not recommend enforcement 
action under section 206(4) and rule 206(4)-1 on issues relating to 
third-party ratings and testimonials. Specifically, the staff has 
stated that it would not recommend enforcement action if certain 
circumstances were present regarding the use of ratings or 
testimonials, such as: (i) References to independent third-party 
ratings that are developed by relying significantly on client surveys 
or clients' experiences more generally; \855\ (ii) the use of ``social 
plug-ins'' such as the ``like'' feature on an investment adviser's 
social media site; \856\ and (iii) references regarding, for example, 
an adviser's religious affiliation or moral character, trustworthiness, 
diligence or judgement, in addition to more typical testimonials that 
reference an adviser's technical competence or performance track 
record.\857\ The Commission has also stated that an investment adviser 
should consider the application of rule 206(4)-1, including the 
prohibition on testimonials, before including hyperlinks to third-party 
websites on its website or in its electronic communications.\858\ For 
example, staff has stated that it would not recommend enforcement 
action, under certain circumstances, when an adviser provided: (i) Full 
and partial client lists; \859\ and (ii) references to unbiased third-
party articles concerning the investment adviser's performance.\860\
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    \855\ See Investment Adviser Association, SEC Staff No-Action 
Letter (Dec. 2, 2005) (not recommending enforcement action if in 
determining whether a third-party rating is a testimonial, the 
adviser considers the criteria used by the third party when 
formulating the rating and the significance to the ratings 
formulation of criteria related to client evaluations of the 
adviser); DALBAR, Inc., SEC Staff No-Action Letter (Mar. 24, 1998) 
(not recommending enforcement action if an adviser used references 
to third-party ratings that reflect client experiences, based on 
certain representations and certain disclosures made, both of which 
designed to ensure that the rating is developed in a fair and 
unbiased manner and that disclosures provide investors with 
sufficient context to make informed decisions).
    \856\ See, e.g., National Examination Risk Alert, Office of 
Compliance, Inspections and Examinations (Jan. 4, 2012).
    \857\ See Gallagher and Associates, Ltd., SEC Staff No-Action 
Letter (July 10, 1995) (where the staff reiterated its view that 
rule 206(4)-1 prohibits testimonials of any kind concerning the 
investment adviser); see also IM Guidance Update No. 2014-04, at 
n.12 and accompanying text, in which staff partially withdrew its 
Gallagher position.
    \858\ See Interpretive Guidance on the Use of Company websites, 
Release No. IC-28351 (Aug. 1, 2008); see also Guidance on the 
Testimonial Rule and Social Media, IM Guidance Update No. 2014-04, 
at n.19 and accompanying text.
    \859\ See, e.g., Cambiar Investors, Inc., SEC Staff No-Action 
Letter (Aug. 28, 1997) (stating it would not recommend enforcement 
action when the adviser proposed to use partial client lists that do 
no more than identify certain clients of the adviser, the Commission 
staff stated its view that partial client lists would not be 
testimonials because they do not include statements of a client's 
experience with, or endorsement of, an investment adviser); see also 
Denver Investment Advisors, Inc., SEC Staff No-Action Letter (July 
30, 1993) (stating that partial client lists can be, but are not 
necessarily, considered false and misleading under 206(4)-1(a)(5)).
    \860\ See New York Investors Group, Inc., SEC Staff No-Action 
Letter (Sept. 7, 1982) (stating that in the staff's view an unbiased 
third-party article concerning an adviser's performance is not a 
testimonial unless the content includes a statement of a customer's 
experience with or endorsement of the adviser).
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    Staff no-action letters have also stated that the staff would not 
recommend enforcement action under rule 206(4)-1 for references to 
specific investment advice in an advertisement, notwithstanding the 
rule's general prohibition of the use of past specific recommendations. 
An adviser that acts consistently with a staff no-action letter may 
include past specific recommendations in an advertisement

[[Page 13096]]

provided the recommendations were selected using performance-based or 
objective, non-performance-based criteria, and in either case, the 
adviser's practices are consistent with a number of specific 
representations articulated in the no-action letters.\861\ For example, 
the staff stated that it would not recommend enforcement action if an 
adviser included in an advertisement a partial list of recommendations 
provided that, in general, the list: (i) Includes an equal number (at 
least five) of best and worst-performing holdings; (ii) takes into 
account consistently the weighting of each holding within the portfolio 
(or representative account) that contributed to the performance during 
the measurement period; (iii) is presented consistently from 
measurement period to measurement period; and (iv) discloses how to 
obtain the calculation methodology and an analysis showing every 
included holding's contribution to the portfolio's (or representative 
account's) overall performance.\862\
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    \861\ See, e.g., Scientific Market Analysis, SEC Staff No-Action 
Letter (Mar. 24, 1976) (the staff would not recommend enforcement 
action when an investment adviser offers a list of past specific 
recommendations, provided that the adviser offers to provide the 
list free of charge); and Kurtz Capital Management, SEC Staff No-
Action Letter (Jan. 18, 1988) (the staff would not recommend 
enforcement action relating to an adviser's distribution of past 
specific recommendations contained in third-party reports, provided 
that the adviser sends only bona-fide unbiased articles).
    \862\ See The TCW Letter (not recommending enforcement action 
based on certain representations such as presenting best and worst-
performing holdings on the same page with equal prominence; 
disclosing that the holdings identified do not represent all of the 
securities purchased, sold or recommended for the adviser's clients 
and that past performance does not guarantee future results; and 
maintaining certain records, including, for example, evidence 
supporting the selection criteria used and supporting data necessary 
to demonstrate the calculation of the chart or list's contribution 
analysis).
---------------------------------------------------------------------------

    The staff has also stated that it would not recommend enforcement 
action if an adviser includes in an advertisement a partial list of 
recommendations selected using objective, non-performance-based 
criteria, provided that, in general: (i) The same selection criteria 
are used consistently from measurement period to measurement period; 
(ii) there is no discussion of the profits or losses (realized or 
unrealized) of any specific securities; and (iii) the adviser maintains 
certain records, including, for example, records that evidence a 
complete list of securities recommended by the adviser in the preceding 
year for the specific investment category covered by the advertisement 
and the criteria used to select the specific securities listed in the 
advertisement.\863\
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    \863\ See Franklin Letter (not recommending enforcement action 
based on certain representations including that the adviser would 
disclose in the advertisement that the specific securities 
identified and described do not represent all of the securities 
purchased, sold, or recommended for advisory clients, and that the 
investor not assume that investments in the securities identified 
and discussed were or will be profitable); see also supra footnote 
204 (citing Clover Letter, Stalker Letter, and Eberstadt Letter 
regarding untrue or misleading implications).
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    Finally, the Commission has brought enforcement actions related to 
the presentation of performance results in advertisements. For example, 
we have alleged in settled enforcement actions that the performance 
information that certain advisers included in their advertisements 
failed to disclose all material facts, and thus created unwarranted 
implications or inferences.\864\ Our staff has also expressed its views 
as to the types of disclosures that would be necessary in order to make 
the presentation of certain performance information in advertisements 
not misleading.\865\ Our staff has taken the position that the failure 
to disclose how material market conditions, advisory fee expenses, 
brokerage commissions, and the reinvestment of dividends affect the 
performance results would be misleading.\866\ Our staff has also 
considered materially misleading the suggestion of potential profits 
without disclosure of the possibility of losses.\867\
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    \864\ See, e.g., In the Matter of Van Kampen Investment Advisory 
Corp., Release No. IA-1819 (Sept. 8, 1999) (settled order); In the 
Matter of Seaboard Investment Advisers, Inc., Release No. IA-1431 
(Aug. 3, 1994) (settled order).
    \865\ See, e.g., Clover Letter (not recommending enforcement 
action provided that certain disclosures about included performance 
results are made). Regarding mutual funds, our staff has stated that 
it would not recommend enforcement action if an advertisement 
included performance data from private accounts that are 
substantially similar in size and investment strategy to the fund in 
the fund's prospectus or sales literature if the prospectuses or 
advertisements: (i) Disclose that the performance results are not 
those of the fund and should be considered a substitute for such 
performance; (ii) include the fund's performance results if such 
results exist and; (iii) disclose all material differences between 
the institutional accounts and the fund. See Nicholas-Applegate 
Mutual Funds, SEC Staff No-Action Letter (Aug. 6, 1996); GE Funds, 
SEC Staff No-Action Letter (Feb. 7, 1997); ITT Hartford Mutual 
Funds, SEC Staff No-Action Letter (Feb. 7, 1997).
    \866\ See Clover Letter (not recommending enforcement action 
provided that if an adviser compares performance to that of an 
index, it would disclose all material factors affecting the 
comparison) See also Investment Company Institute, SEC Staff No-
Action Letter (May 5, 1988); Association for Investment Management 
and Research, SEC Staff No-Action Letter (Dec. 18, 1996) (not 
recommending enforcement action provided that gross performance 
results may be provided to clients so long as this information is 
presented on a one-on-one basis or alongside net performance with 
appropriate disclosure.) See Also Securities Industry Association, 
SEC Staff No-Action Letter (Nov. 27, 1989) (not recommending 
enforcement action provided that an adviser that advertises 
historical net performance using a model fee makes certain 
disclosures).
    \867\ See Clover Letter (stating staff's view that an adviser's 
advertisement that suggests or makes claims about the potential for 
profit without also disclosing the possibility of loss may be 
misleading for purposes of rule 206(4)-1(a)(5)).
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    Our staff has taken the position that prior performance results of 
accounts managed by a predecessor entity may be used so long as: (i) 
The person responsible for such results is still the adviser; (ii) the 
prior account and the present account are similar enough that the 
performance results would provide relevant information; (iii) all prior 
accounts that are being managed in a substantially similar fashion to 
the present account are being factored into the calculation; and (iv) 
the advertisement includes all relevant disclosures.\868\ More 
recently, our staff has taken the position that, based on certain 
representations, a surviving investment adviser following an internal 
restructuring may continue to use the performance track record of a 
predecessor advisory affiliate to the same extent as if the 
restructuring had not occurred.\869\
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    \868\ See Horizon Letter; see also Great Lakes Letter (not 
recommending enforcement action if a successor adviser, composed of 
less than 100 percent of the predecessor's committee, used the 
preceding performance information in their calculation when there 
was a substantial identification of personnel, and noting that 
without substantial identification of personnel in such a committee, 
use of the data would be misleading even with appropriate 
disclosure).
    \869\ See South State Bank Letter (the staff stated that it 
would not recommend enforcement action on representations including, 
for example, that the successor adviser would operate in the same 
manner and under the same brand name as the predecessor adviser).
---------------------------------------------------------------------------

    In addition, the Commission believes that many advisers currently 
prepare and present GIPS standard-compliant performance information, 
and also that many advisers currently prepare annual performance 
information for investors. The GIPS standards require advisers to 
provide certain reports to prospective clients at a specific time, and 
the standards provide guidance on how advisers can determine whether a 
potential investor qualifies as a ``prospective client.'' \870\
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    \870\ Global Investment Performance Standards (GIPS) for Firms 
(2020), Provision 1.A.11. (requiring the firm to ``make every 
reasonable effort to provide a GIPS Composite Report to all 
Prospective Clients when they initially become Prospective 
Clients''), and GIPS Standards Handbook for Firms (Nov. 2020), 
Discussion of Provision 1.A.11. (stating that ``[i]t is up to the 
firm to establish policies and procedures for determining who is 
considered to be a prospective client. These include policies and 
procedures for determining when an interested party becomes a 
prospective client. An interested party becomes a prospective client 
when two tests are met. First, the interested party must have 
expressed interest in a specific composite strategy or strategies. 
Second, the firm must have determined that the interested party 
qualifies to invest in the respective composite strategy'').

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[[Page 13097]]

    Regarding the use of model performance results, the staff has taken 
the position that such results are misleading under rule 206(4)-1(a)(5) 
if the investment adviser does not make certain disclosures.\871\ The 
Commission has also taken the position that the use of backtested 
performance data may be misleading unless accompanied by disclosure 
detailing the inherent limitations of data derived from the retroactive 
application of a model developed with the benefit of hindsight.\872\ 
Moreover, staff have taken the position that the rule 204-2(a)(16) 
requirement to keep records of documents necessary to form the basis 
for performance data provided in advertisements also applies to a 
successor's use of a predecessor's performance data.\873\
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    \871\ Id. See also In the Matter of LBS Capital Mgmt. Inc., 
Release No. IA-1644 (July 18, 1997) (settled order) (The Commission 
brought an enforcement action and stated its view that the marketing 
materials were misleading and that the Commission looks at 
``investment sophistication or acumen'' of the recipients of an 
advertisement will look into the identity of the intended recipient 
of advertisement when determining if the results were misleading.).
    \872\ See In the Matter of Market Timing Systems, Inc., et al., 
Release No. IA-2047 (Aug. 28, 2002) (settled order) (The Commission 
brought an enforcement action against, among others, a registered 
investment adviser, asserting that its advertising was misleading 
because it failed to disclose that performance results advertised 
were hypothetical and generated by the retroactive application of a 
model, and in other cases failed to disclose the relevant 
limitations inherent in hypothetical results and the reasons why 
actual results would differ); see also In the Matter of Leeb 
Investment Advisers, et al., Release No. IA-1545 (Jan. 16, 1996) 
(settled order) (The Commission brought an enforcement action 
against, among others, a registered investment adviser, asserting 
that advertising mutual fund performance using a market-timing 
program based on backtested performance was misleading because the 
program changed during the measurement period and certain trading 
strategies were not available at the beginning of the measurement 
period.). See also In the Matter of Schield Mgmt. Co., et al., 
Release No. IA-1872 (May 31, 2000) (settled order) (The Commission 
brought an enforcement action against, among others, a registered 
investment adviser, asserting that advertisements presenting 
backtested results were misleading in violation of section 206(2) 
and rule 206(4)-1 because, among other things, they failed to 
disclose or inadequately disclosed that the performance was 
backtested, and stating that labeling backtested returns 
``hypothetical'' did not fully convey the limitations of the 
performance.).
    \873\ Rule 204-2(a)(16); See Great Lakes Letter (not 
recommending enforcement action and stating the staff's view that 
the requirement in rule 204-2(a)(16) applies to a successor's use of 
a predecessor's performance data.)
---------------------------------------------------------------------------

    Certain investment advisers that must comply with the final rule 
are also subject to other regulatory regimes that govern communications 
and advertisements. For example, investment advisers that are also 
registered as broker-dealers must comply with FINRA's rules.\874\ FINRA 
rule 2210 governs broker-dealers' communications with the public, 
including communications with retail and institutional investors, and 
provides standards for the content, approval, recordkeeping, and filing 
of communications with FINRA. In particular, FINRA's rule 2210(d)(6) 
requires any retail communication or correspondence providing any 
testimonial concerning the investment advice or investment performance 
of a member or its products to prominently disclose: (i) The fact that 
the testimonial may not be representative of the experiences of other 
customers; (ii) the fact that the testimonial is no guarantee of future 
performance or success; and (iii) if more that $100 is paid for the 
testimonial, the fact that it is a paid testimonial. FINRA rule 
2210(d)(6) also requires that if a testimonial in any type of 
communication concerns a technical aspect of investing, the person 
making the testimonial must have the knowledge and experience to form a 
valid opinion. Regulation BI also applies to testimonials or 
endorsements by promoters that are registered broker-dealers to the 
extent such testimonials or endorsements are recommendations to retail 
customers under that regulation. Additionally, communications to 
investors in private funds are subject to various statutory and 
regulatory anti-fraud provisions, such as rule 206(4)-8 under the 
Advisers Act, section 17(a) of the Securities Act, section 10(b) of the 
Exchange Act and rule 10b-5 thereunder.
---------------------------------------------------------------------------

    \874\ Similarly, investment advisers registered with the 
Commission may also be registered with the National Futures 
Association and may be subject to additional compliance rules on 
sales practices and promotional material. See NFA Compliance Rules 
2-29 and 2-36. See also Municipal Securities Rulemaking Board rules 
G-21(a) and G-40.
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c. Data on Investment Advisers
    Based on Form ADV filings, as of August 1, 2020, 13,724 investment 
advisers were registered with the Commission. Of these registered 
investment advisers (``RIAs''), 11,653 reported that they were ``large 
advisory firms,'' with regulatory assets under management (``RAUM'') of 
at least $90 million. 512 reported that they were ``mid-sized advisory 
firms,'' with RAUM of between $25 million and $100 million, and 1,561 
did not report as either, which implies that they have regulatory 
assets under management of under $25 million.\875\
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    \875\ From Form ADV: A ``Large advisory firm'' either: (a) Has 
regulatory assets under management of $100 million or more or (b) 
has regulatory assets under management of $90 million or more at the 
time of filing its most recent annual updating amendment and is 
registered with the SEC; a ``mid-sized advisory firm'' has 
regulatory assets under management of $25 million or more but less 
than $100 million and either: (a) Not required to be registered as 
an adviser with the state securities authority of the state where 
they maintain their principal office and place of business or (b) 
not subject to examination by the state securities authority of the 
state where they maintain their principal office and place of 
business.
---------------------------------------------------------------------------

    Form ADV disclosures show $97.05 trillion in RAUM for all RIAs, 
with an average of $7.07 billion and a median of $350 million. These 
values show that the distribution of RAUM is skewed, with more RIAs 
managing assets below the average, than above. The majority of RIAs 
report that they provide portfolio management services for individuals 
and small businesses.\876\ In aggregate, RIAs have over $97 trillion in 
RAUM. A substantial percentage of RAUM at investment advisers is held 
by institutional investors, such as investment companies, pooled 
investment vehicles, and pension or profit-sharing plans.\877\ Based on 
staff analysis of Form ADV data, 8,134 (59 percent) of RIAs have some 
portion of their business dedicated to individual clients, including 
both high net worth and non-high net worth individual clients.\878\ In 
total, firms that have some portion of their business dedicated to high 
net worth clients have approximately $44 trillion of RAUM,\879\ of 
which $12 trillion is attributable to individual clients, including 
both non-

[[Page 13098]]

high net worth and high net worth clients. Approximately 7,115 RIAs (52 
percent) serve 35.4 million non-high net worth individual clients and 
have approximately $5.2 trillion in RAUM attributable to the non-high 
net worth clients, while nearly 7,694 RIAs (56 percent) serve 
approximately 4.9 million high net worth individual clients with $7.5 
trillion in RAUM attributable to the high-net worth clients. In 
addition, there are 3,517 broker dealers registered with FINRA, 442 
identify themselves as dually registered broker-dealers, and 2,394 
investment advisers (17%) report an affiliate that is a broker-dealer.
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    \876\ Of the 13,724 RIAs, 8,795 (64 percent) report in Item 
5.G.(2) of Form ADV that they provide portfolio management services 
for individuals and/or small businesses. In addition, there are 
approximately 17,932 state-registered investment advisers. 
Approximately 14,851 state-registered investment advisers are retail 
facing (see Item 5.D. of Form ADV).
    \877\ See Table 1.
    \878\ We use the responses to Items 5(D)(a)(1), 5(D)(a)(3), 
5(D)(b)(1), and 5(D)(b)(3) of Part 1A of Form ADV. If at least one 
of these responses was filled out as greater than 0, the firm is 
considered as providing business to retail investors. Form ADV Part 
1A. Of the 8,134 investment advisers serving individual clients, 356 
are also registered as broker-dealers. By high net worth (HNW) 
individual, we are referring to an individual who is a ``qualified 
client'' as defined in rule 205-3 under the Advisers Act. Generally, 
this means a natural person with at least $1,000,000 in assets under 
the management of an adviser, or whose net worth exceeds $2,100,000 
(excluding the value of his or her primary residence). See rule 205-
3(d)(1); Order Approving Adjustment for Inflation of the Dollar 
Amount Tests in Rule 205-3 under the Investment Advisers Act of 
1940, Release No. IA-4421 (June 14, 2016).
    \879\ The aggregate RAUM reported for these investment advisers 
that have retail investors includes both retail RAUM as well as any 
institutional RAUM also held at these advisers.
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2. Market for Solicitation Activity
a. Current Regulations
    The current solicitation rule makes paying a cash fee for referrals 
of advisory clients unlawful unless the solicitor and the adviser enter 
into a written agreement. A solicitor's written agreement with an 
advisor must also contain an undertaking by the solicitor to perform 
its duties under the agreement in a manner consistent with the 
instructions of the investment adviser and the provisions of the 
Advisers Act and the rules thereunder. In addition, among other 
provisions, it requires the solicitor to provide the client with a 
current copy of the investment adviser's Form ADV brochure and a 
separate written solicitor disclosure document at the time of 
solicitation.\880\ The solicitor disclosure must contain information 
highlighting the solicitor's financial interest in the investor's 
choice of an investment adviser.\881\ Further, advisers are required to 
have a reasonable belief that solicitors are complying with these 
contractual requirements.
---------------------------------------------------------------------------

    \880\ See rule 206(4)-3(a)(1)(ii).
    \881\ See rule 206(4)-3(b).
---------------------------------------------------------------------------

    In addition, the solicitation rule prescribes certain methods of 
compliance, such as requiring an adviser to receive a signed and dated 
acknowledgment of receipt of the required disclosures.\882\ The 
solicitation rule also prohibits advisers who have engaged in certain 
misconduct from acting as solicitors.\883\
---------------------------------------------------------------------------

    \882\ See rule 206(4)-3(a)(2)(iii)(B).
    \883\ See rule 206(4)-3(a)(1)(ii).
---------------------------------------------------------------------------

b. Data on Solicitors
    Given that there is no current registration requirement for 
solicitors of investment advisers based on their solicitation activity, 
our view on solicitation practices is through the disclosures made by 
RIAs in Form ADV. As of August 1, 2020, 27 percent of RIAs reported 
compensating any person besides an employee for client referrals.\884\ 
As shown in Figure [1], the share of RIAs that reported this type of 
arrangement has declined since 2009. However, this figure does not 
capture employees of an investment adviser that are compensated for 
client referrals, who are solicitors under the solicitation rule. The 
downward trend in Figure [1] may suggest that the use of solicitors is 
declining through an overall decline in client referral activity. 
Alternatively, the data presented in the figure is also consistent with 
employers shifting their solicitation activities in-house.
---------------------------------------------------------------------------

    \884\ Response to Item 8(h)(1) of Part 1A of Form ADV.
    [GRAPHIC] [TIFF OMITTED] TR05MR21.000
    
c. RIAs to Private Funds
---------------------------------------------------------------------------

    \885\ Based on responses to Item 8(h)(1) of Part 1A of Form ADV.
---------------------------------------------------------------------------

    Based on Form ADV data from August 1, 2020, 4,925 RIAs report that 
they are advisers to private funds, and 54 of these RIAs report that 
they are a small entity.\886\ Of the RIAs that advise private funds, 
1,641 RIAs report that they use the services of solicitors that are not 
their employees or themselves (``related marketers'' in Form ADV). 
Among the RIAs that hire solicitors, each RIA uses 3 solicitors on 
average, while the median number of solicitors reported is 1, and the 
maximum is 67. There are 343 RIAs that indicate that they have at least 
one related marketer, and 206 of them indicate that they only rely on 
related marketers. Among RIAs that report using a related marketer, the 
average number of related marketers reported is 1.5, while the median 
reported is 1 and the maximum is 24. 1,315 RIAs indicate that they have 
at least one marketer that is registered with the SEC: The average 
number of marketers, registered with the SEC as either IAs or BDs, 
employed by these RIAs is 3.1, while the median number reported is 2 
and the maximum is 67. Finally, 570 RIAs indicate that they have at 
least one non-US marketer: The average number of non-US marketers

[[Page 13099]]

reported among these RIAs is 3.1, while the median is 1 and the maximum 
is 60.\887\
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    \886\ Form ADV Item 5.F.2 and Item 12.A.
    \887\ Data on solicitors (marketers) hired by RIAs to private 
funds are collected from Form ADV Section 7.B(1) (28).
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3. RIA Clients
    RIAs are required to report their specific number of clients in 13 
different categories and a catch-all ``Other'' category.\888\ Based on 
Form ADV data collected as of August 1, 2020, RIAs report having a 
total of approximately 42 million clients, and $97 trillion in RAUM. 
Individual investors constitute the majority (95 percent) of the RIA 
client base. Columns 2 and 3 of Table 1 present the breakdown of the 
RIA client base, and column 4 shows the total RAUM from each investor 
category as of August 2020.
---------------------------------------------------------------------------

    \888\ Form ADV Item 5.D. of Part 1A.
---------------------------------------------------------------------------

    Non-high net worth (HNW) individuals comprise the largest group of 
advisory clients by client number--83 percent of total clients. The 
number of HNW individuals is only 12 percent of advisory clients, but 
RAUM from HNW individuals makes up almost 8 percent of the industry-
wide RAUM ($97 trillion) in 2018, while RAUM from non-HNW individuals 
accounts makes up about 5.4 percent.
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    \889\ Data taken from Form ADV data.

                        Table 1--Investor Categories by Clients, RAUM, and Advisers \889\
----------------------------------------------------------------------------------------------------------------
                                                                       RAUM
       Investor categories            Clients       Clients (%)     (billions)       RAUM (%)        Advisers
----------------------------------------------------------------------------------------------------------------
Non-HNW individuals.............      35,433,736          83.451       $5,228.92            5.39           7,115
HNW individuals.................       4,916,781          11.580        7,465.29            7.69           7,694
Other investment advisers.......         863,785           2.034        1,250.71            1.29             548
Corporations or other businesses         321,471           0.757        2,674.23            2.76           3,320
Pension and profit sharing plans         386,897           0.911        6,504.54            6.70           3,933
Other...........................         279,025           0.657          970.50            1.00             951
Pooled Investment Vehicles                83,942           0.198       25,883.53           26.68           5,354
 (PIVs)--Other..................
State/municipal entities........          24,761           0.058        3,565.01            3.67             970
Charities.......................          99,968           0.235        1,189.66            1.23           3,302
Banking or thrift institutions..           9,833           0.023          992.93            1.02             281
Insurance companies.............          12,070           0.028        6,257.69            6.45             711
PIVs--Investment companies......          26,520           0.062       33,362.03           34.39           1,583
Sovereign Wealth Funds and                 1,643           0.004        1,544.11            1.59             213
 Foreign official institutions..
PIVs--Business development                   159          0.0004          132.15            0.14              87
 companies......................
----------------------------------------------------------------------------------------------------------------

    A number of surveys show that individuals \890\ predominantly find 
their current financial firm or financial professional from personal 
referrals by family, friends, or colleagues, rather than through 
advertisements.\891\ For instance, a 2008 study conducted by RAND 
reported that 46 percent of survey respondents indicated that they 
located a financial professional from personal referral, although this 
percentage varied depending on the type of service provided (e.g., only 
35 percent of survey participants used personal referrals for brokerage 
services). After personal referrals, RAND 2008 survey participants 
ranked professional referrals (31 percent), print advertisements (4 
percent), direct mailings (3 percent), online advertisements (2 
percent), and television advertisements (1 percent), as their source of 
locating individual professionals. The RAND 2008 study separately 
inquired about locating a financial firm,\892\ in which a smaller group 
of respondents reported selecting a financial firm (of any type) based 
on: Referral from family or friends (29 percent), professional referral 
(18 percent), print advertisement (11 percent), online advertisements 
(8 percent), television advertisements (6 percent), direct mailings (2 
percent), with a general ``other'' category (36 percent).
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    \890\ The surveys generally use ``retail investors'' to refer to 
individuals that invest for their own personal accounts.
    \891\ See Angela A. Hung, et al., Investor and Industry 
Perspectives on Investment Advisers and Broker-Dealers, RAND 
Institute for Civil Justice Technical Report (2008), available at 
https://www.rand.org/content/dam/rand/pubs/technical_reports/2008/RAND_TR556.pdf (``RAND 2008''), which discusses a shift from 
transaction-based to fee-based brokerage accounts prior to certain 
regulatory changes at the time; see also Financial Literacy Study, 
supra footnote 846.
    \892\ Only one-third of the survey respondents that responded to 
``method to locate individual professionals'' also provided 
information regarding locating the financial firm.
---------------------------------------------------------------------------

    The Commission's 2012 Financial Literacy Study provides similar 
responses, although it allowed survey respondents to identify multiple 
sources from which they obtained information that facilitated the 
selection of the current financial firm or financial professional.\893\ 
In the 2012 Financial Literacy Study,\894\ 51 percent of survey 
participants received a referral from family, friends, or colleagues. 
Other sources of information or referrals came from: Referral from 
another financial professional (23 percent), online search (14 
percent), attendance at a financial professional-hosted investment 
seminar (13 percent), advertisement (e.g., television or newspaper) 
(11.5 percent), other (8 percent), while approximately 4 percent did 
not know or could not remember how they selected their financial firm 
or financial professional. Twenty-five percent of survey respondents 
indicated that the ``name or reputation of the financial firm or 
financial professional'' affected the selection decision.
---------------------------------------------------------------------------

    \893\ See Financial Literacy Study, supra footnote 846.
    \894\ The data used in the 917 Financial Literacy Study comes 
from the Siegel & Gale, Investor Research Report (July 26, 2012), 
available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part3.pdf.
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D. Costs and Benefits of the Final Rule and Form Amendments

    The Commission is adopting a final combined marketing rule by 
amending rule 206(4)-1, which is related to advertisements, and 
eliminating rule 206(4)-3, which deals with solicitation. The final 
rule changes the definition of advertisement and generally expands the 
set of permitted advertisements. It includes general prohibitions of 
certain advertising practices, and will (i) impose requirements of or 
restrictions on investment adviser performance in advertisements, and 
(ii) permit investment advisers to use certain features in an 
advertisement, such as testimonials, endorsements, and third-party 
ratings, subject to certain conditions, such as disclosing

[[Page 13100]]

information that would help investors evaluate the advertisement.
    The marketing rule, among other things, also applies disclosure, 
oversight, and disqualification requirements to compensated 
testimonials or endorsements, including those directed at prospective 
investors in private funds. The Commission is also adopting amendments 
to Form ADV that are designed to provide additional information 
regarding advisers' marketing practices and amendments to the Advisers 
Act books and records rule to correspond to the features of the 
marketing rule. The final rule reflects market developments since 1961 
and 1979, when rules 206(4)-1 and 206(4)-3, respectively, were adopted, 
as well as practices addressed in staff no-action letters. These market 
developments include advances in communication technology and marketing 
practices that did not exist at the time the rules were adopted and may 
fall outside of the scope of the current rules. As a result, the 
current rule is less effective at mitigating some information and 
search problems investors face when searching for investment advisers 
than when it was initially written.\895\
---------------------------------------------------------------------------

    \895\ See infra section III.B.
---------------------------------------------------------------------------

    Advertisements falling in the two categories of communications 
defined as advertisements in the final rule are currently subject to 
different regulatory baselines and market practices. We discuss the 
costs and benefits of specific provisions of the final rule, taking 
care to note whether a cost or benefit applies to the first or the 
second prong of advertisement, or both.
1. Quantitative Estimates of Costs and Benefits
    The economic effects of the final rule are generally difficult to 
quantify for several reasons. First, there is little to no direct data 
suggesting how investment advisers and promoters might alter their 
marketing practices as a result of the final rule or mitigate the 
compliance burdens related to the final rule, and commenters did not 
provide any. It is difficult to quantify the impact that specific 
provisions of the final rule will have on adviser behavior because the 
final rule may influence adviser behavior in opposing directions. For 
example, it might motivate advisers to provide more information to 
potential investors that helps such investors more accurately evaluate 
those advisers' abilities and potential fit with such investors' 
preferences. Alternatively, the rule may introduce compliance burdens 
that disincentivize the creation of communications that fall within the 
definition of advertisement. This could reduce the amount of 
information that advisers provide to potential investors through 
advertisements.
    Second, it is difficult to quantify the impact that the specific 
provisions of the final rule will have on investor behavior because the 
final rule may influence investor behavior in opposing directions. 
Disclosures might provide additional context for investors to make 
better decisions when choosing investment advisers; alternatively, they 
might not be used by investors, or might make them overconfident when 
making decisions.\896\ Without knowing the magnitude of these opposing 
effects, it is not possible to quantify the effects of specific 
provisions of the final rule.
---------------------------------------------------------------------------

    \896\ See infra section III.B.
---------------------------------------------------------------------------

    Finally, it is difficult to quantify the extent to which certain 
changes in adviser, promoter, and investor behavior enhance or diminish 
the welfare of specific market participants. For example, if investors 
increased the amount of advisers' RAUM as a result of the final rule, 
it is not clear to what extent investor welfare would have improved, 
without knowing the extent to which the final rule also affected the 
quality of investment advisers with whom investors chose to invest. 
Further, if RAUM increased as advisers increased their marketing and 
incurred higher marketing expenditures, a portion of these expenditures 
could be transferred to investors through fees offsetting, in part, any 
increase in investor welfare.
    Some commenters directly addressed the cost estimates in the 
proposal.\897\ Two of these commenters stated that the proposal 
underestimated the number of advertisements that investment advisers 
use under the current rule.\898\ One commenter stated that heavy 
advertisers would be expected to create new advertisements 50 times per 
year, and update their advertisements 250 times per year.\899\ One 
commenter broadly criticized the cost estimates as too low, and also 
specifically criticized the proposal's estimates of the number of 
advertisements that advisers would distribute.\900\ In response to 
commenters, we have adjusted our estimates of the annual number of 
advertisements that investment advisers will create.\901\
---------------------------------------------------------------------------

    \897\ See Fidelity, IAA, MFA/AIMA Comment Letters.
    \898\ See Fidelity, IAA Comment Letters.
    \899\ See Fidelity Comment Letter
    \900\ See IAA Letter Comment Letter.
    \901\ See infra section IV.B.
---------------------------------------------------------------------------

    One commenter made several critiques of the cost estimates.\902\ 
The commenter separated its expected costs into three categories--
implementation costs, ongoing costs, and management resource drain, 
arguing that the proposal failed to recognize whole types of costs. The 
commenter broadly criticized many of the quantitative estimates in the 
proposal as significantly underestimating the cost burden on investment 
advisers. The commenter specifically criticized the cost estimates for 
third-party rankings, hypothetical performance, and Form ADV changes, 
but did not provide additional estimates or data to use. Many of the 
quantitative estimates in the proposal were for the Paperwork Reduction 
Act (``PRA''), which are a subset of the total economic costs of the 
rule. Many of these total costs are difficult to quantify, for reasons 
mentioned above. However, given the commenter's feedback on the 
categories and types of costs that the rules will impose on investment 
advisers, we have updated our analysis of the costs of the rule, as 
well as our PRA-related quantitative cost estimates.
---------------------------------------------------------------------------

    \902\ See MFA/AIMA Comment Letter.
---------------------------------------------------------------------------

    In the following sections, we have quantified some elements of the 
overall cost of the general anti-fraud prohibitions as part of the 
Commission's Paperwork Reduction Act obligations. These are costs 
associated with the collection of information that are generated by the 
final rule, but do not represent the entire cost of each provision.
2. Definition of Advertisement
    The final rule's definition of advertisement contains two prongs. 
The first prong generally captures traditional advertising, and changes 
the scope of communications that fall within the scope of the final 
rule. The first prong includes, among other communications, 
communications made to investors and potential investors in private 
funds advised by the adviser. The second prong generally includes the 
cash-compensated solicitation activity that occurs currently under rule 
206(4)-3. In addition, the second prong will include non-cash 
compensated communications made by promoters and compensated 
solicitation activity for private fund investors.
    This definition of ``advertisement'' determines the scope of 
communications affected by the final rule, which determines, in part, 
the costs and benefits of the regulatory program set forth by the other 
components of the final rule (the ``programmatic effects''). For 
example, if

[[Page 13101]]

the definition of ``advertisement'' is not sufficiently broad and 
excludes communications that could serve as a substitute for 
advertisements and that raise similar investor protection concerns, 
investment advisers might use these alternative communications to avoid 
the costs associated with complying with the final rule. This would 
reduce the effect of changes to the substantive provisions to the 
advertising rule that would regulate advertisements. Conversely, if the 
scope of communications captured by the final rule is too broad and 
captures communications that do not aim to attract clients, the 
amendments may impose costs on investment advisers while yielding 
insubstantial benefits.
    In response to the final rule's definition of advertisement, 
investment advisers and promoters might modify their communication 
strategies in an effort to reduce the amount of communication that 
could be deemed to fall within the definition of ``advertisement.'' 
These strategic responses could, in turn, impose costs on some clients 
or investors, to the extent that they currently rely on communications 
by investment advisers or promoters that are advertisements to inform 
their decisions.\903\ If investment advisers or promoters respond by 
reducing the amount of such communications, both prospective and 
existing investors may need to search more intensively for information 
about investment advisers than they currently do or, alternatively, 
base their choice of financial professional on less information. This 
could result, for example, in inefficiencies to the extent that an 
existing client of an investment adviser is unaware of the breadth of 
services the investment adviser provided and incurs costs to open a new 
account with another investment adviser to obtain certain services. 
Similarly, a prospective client that receives less information from 
investment advisers and promoters might ultimately choose an investment 
adviser that is a poorer match for them or might be discouraged from 
seeking investment advice. These potential costs to investors depend on 
the extent to which the final rules cause investment advisers and 
promoters to reduce their advertisements.
---------------------------------------------------------------------------

    \903\ To the extent that broker-dealers and other third parties 
disseminate communications that are defined as advertisements under 
the final rule, including with respect to private funds, they may 
incur compliance costs associated with the final rule. These 
compliance obligations generally will be separate from any 
compliance obligations incurred under the requirements of the 
Exchange Act, the rules promulgated thereunder, and FINRA rules.
---------------------------------------------------------------------------

    As discussed above, some of the affected parties whose 
communications will be newly defined as advertisements under the final 
rule may also be registered broker-dealers whose communications are 
subject to other regulatory regimes that govern communications and 
advertisements, including those under FINRA rules and, in some cases, 
Regulation BI. As a result, these parties will incur new compliance 
obligations with respect to communications subject to the final rule, 
and may incur incremental costs similar to other parties whose 
communications are also newly-subject to the rule. In general, however, 
to the extent that these parties may leverage existing compliance 
methods similar to those that they currently use, the programmatic 
effects of including these communications within the final rule's 
definition of advertisement may be mitigated.
    Below, we address the costs and benefits associated with 
determining the scope of communications affected by the final rule 
through specific elements of the final rule's definition of an 
advertisement.\904\ We address the costs and benefits of the two prongs 
of the definition separately.
---------------------------------------------------------------------------

    \904\ The specific costs and benefits of the rule's changes to 
the substantive prohibitions and conditions applicable to 
advertisements are discussed in later sections. See infra section 
II.D.3-8.
---------------------------------------------------------------------------

a. Communications Other Than Compensated Testimonials or Endorsements
    The first prong includes within the definition of an advertisement 
any direct or indirect communication an investment adviser makes to 
more than one person, or to one or more persons if the communication 
includes hypothetical performance information, and that offers the 
investment adviser's investment advisory services with regard to 
securities to prospective clients or investors in a private fund 
advised by the investment adviser or offers new investment advisory 
services with regard to securities to current clients or investors in a 
private fund advised by the investment adviser. It also excludes (a) 
extemporaneous, live, oral communications, regardless of whether they 
are broadcast; (b) any information contained in a statutory or 
regulatory notice, filing, or other required communication, provided 
that such information is reasonably designed to satisfy the 
requirements of such notice, filing, or other required communication; 
and (c) a communication that includes hypothetical performance that is 
provided: (i) In response to an unsolicited investor request or (ii) to 
a private fund investor in a one-on-one communication.
i. Any Direct or Indirect Communication an Investment Adviser Makes
    The first prong includes communications directly or indirectly made 
by the adviser, regardless of whether they are prepared and 
disseminated by the adviser or by a third party. Prong one includes 
communications disseminated by an adviser that incorporate statements 
or content prepared by a third party, such as positive reviews from 
clients selectively picked by an adviser to be posted or attributed, 
materials an adviser helps draft to be distributed by third-party 
promoters, and endorsements organized by an adviser on social media. 
This provision (the phrase ``directly or indirectly'') does not differ 
from the current rule, and we therefore do not anticipate any 
significant costs or benefits to be generated directly by this 
provision.
    The first prong defines advertisements as communications made to 
more than one person, or to any number of persons if the communication 
includes hypothetical performance information that is not provided in 
response to an unsolicited investor request or to a private fund 
investor in a one-on-one communication. Because the definition's 
limitation to communications to more than one person does not differ 
from the current rule, we generally do not anticipate any significant 
costs or benefits to be generated directly by this part of the 
rule.\905\ However, the inclusion of one-on-one communications with 
hypothetical performance information (except for hypothetical 
performance information that is provided in response to an unsolicited 
investor request or to a private fund investor) in the definition of 
advertisement represents a change from the current rule.\906\ We expect 
that

[[Page 13102]]

this change could produce costs and benefits with respect to these one-
on-one communications that are similar to those described below that 
are associated with prong one's inclusion of communications that offer 
investment advisory services to prospective investors, including for 
review and monitoring of communications.
---------------------------------------------------------------------------

    \905\ The final rule does contain a related compliance and 
recordkeeping requirement that requires investment advisers to 
retain records of communications addressed to more than one person, 
which we discuss in further detail later. See infra section III.D.8.
    \906\ The rule excludes from the first prong of the 
advertisement definition a communication that includes hypothetical 
performance that is provided in response to an unsolicited investor 
request for such information or to a private fund investor in a one-
on-one communication. See rule 206(4)-1(e)(1)(i)(C). Because the 
current advertising rule excludes one-on-one communications from the 
definition of advertisement, we do not anticipate that this 
exclusion will result in significant costs or cost savings for 
advisers.
---------------------------------------------------------------------------

    While the current definition of advertisement includes 
communications directly or indirectly made by the adviser, it only 
explicitly covers written, radio, or television advertisements. As a 
result, the first prong of the definition could cover additional 
communications with prospective clients as compared to the current 
definition. This change will further extend the investor protection and 
benefits of the final rule.\907\ Investment advisers will also incur 
costs directly as a result of this change, which may include dedicating 
personnel time, or conducting training for personnel to determine the 
extent to which the substantive content of one of these newly-covered 
types of communication subjects it to the final rule.\908\
---------------------------------------------------------------------------

    \907\ See, e.g., infra sections III.D.3; III.D.4; III.D.5.
    \908\ See supra section III.D.1 and footnote 902.
---------------------------------------------------------------------------

    These costs may be mitigated to the extent that investment advisers 
may be able to leverage existing oversight methods similar to those 
that they currently use, including those used by dual-registrant 
advisers or promoters who are also broker-dealers in connection with 
compliance with FINRA's rules,\909\ for example, in communicating with 
prospective clients through intermediaries. Additionally, investment 
advisers might reduce certain types of communications to avoid having 
to bear these costs of complying with the final rule, which may 
mitigate the benefits of additional information in advertisements 
available to investors.\910\
---------------------------------------------------------------------------

    \909\ See supra section II.A.2.b.i.
    \910\ The final rule contains a related compliance and 
recordkeeping requirement that requires investment advisers to 
retain records of communications addressed to more than one person, 
which we discuss in further detail later. See infra section III.D.8.
---------------------------------------------------------------------------

ii. Offers the Investment Adviser's Investment Advisory Services With 
Regard to Securities to Prospective Clients or Investors in a Private 
Fund Advised by the Investment Adviser
    Prong one also includes communications that offer the investment 
adviser's investment advisory services with regard to securities to 
prospective clients or investors in a private fund advised by the 
investment adviser. This prong will expressly apply to communications 
to prospective investors in private funds. By including communications 
that offer the adviser's investment advisory services with regard to 
securities to private fund investors, the final rule will provide more 
specificity (and certainty) regarding what we believe to be untrue or 
misleading statements that advisers must avoid in their advertisements, 
which may reduce compliance costs for some investment advisers. On the 
other hand, to the extent that an adviser's current practices differ 
from the final rule, an investment adviser may incur some increased 
costs to review and monitor its communications with potential investors 
for general compliance purposes. An investment adviser may respond by 
reducing the number of these advertisements or the amount of 
information it distributes to potential investors. This could, in turn, 
reduce the amount of information available to potential investors in 
these private funds. An investment adviser to a private fund also may 
respond by not seeking potential investors likely to have less money to 
invest in the private fund, reducing investment opportunities for these 
investors.
iii. Offers New Investment Advisory Services With Regard to Securities 
to Current Clients or Investors in a Private Fund Advised by the 
Investment Adviser
    The final definition of advertisement under the first prong also 
includes communications that offer new investment advisory services 
with regard to securities to existing clients or investors in a private 
fund advised by the investment adviser. Investment advisers will incur 
costs similar to those described above that are associated with prong 
one's inclusion of communications that offer investment advisory 
services to prospective investors, including for review and monitoring 
of communications. However, to the extent that an adviser uses a single 
set of communications aimed at both new and existing clients, these 
costs may be mitigated because the adviser may incur only a single set 
of costs for both prospective and existing investors.
b. Compensated Testimonials and Endorsements
    The second prong of the final definition of advertisement includes 
testimonials or endorsements for which compensation is provided, 
excluding any information contained in a statutory or regulatory 
notice, filing, or other required communication, provided that such 
information is reasonably designed to satisfy the requirements of such 
notice, filing, or other required communication. The baseline for these 
advertisements is generally shaped by the current solicitation rule, 
which obligates advisers to enter into written agreements with 
solicitors to require them to act in a manner consistent with the 
Advisers Act and rules, including the current advertising rule.\911\ 
Under the current solicitation rule, investment advisers must have a 
reasonable belief that solicitors are complying with this written 
agreement. Furthermore, solicitations of private fund investors are not 
subject to the current solicitation rule.
---------------------------------------------------------------------------

    \911\ Under the cash solicitation rule, certain affiliated 
advisers are not required to satisfy all of the elements of the 
written agreement. See rule 206(4)-3(a)(2)(ii) and (iii).
---------------------------------------------------------------------------

    Prong two will scope in non-cash compensated testimonials and 
endorsements and compensated testimonials and endorsements to private 
fund investors, including communications from solicitors for impersonal 
advisory services, and, as a result, will extend the investor 
protection benefits of the final rule to the investors who receive 
these communications. Similarly, it will impose certain costs on 
advisers and persons who are solicitors under the current rule, 
including costs associated with oversight of these communications not 
currently subject to the rule, including endorsements to private fund 
investors.\912\ Advisers may respond by reducing the number of these 
advertisements or the amount of information they distribute to 
potential investors. Similarly, advisers to private funds also may 
respond by not seeking potential investors likely to have less money to 
invest in the private fund, reducing investment opportunities for these 
investors.
---------------------------------------------------------------------------

    \912\ See infra sections III.D.3-8 for discussion of the direct 
costs and benefits of the requirements of the rule.
---------------------------------------------------------------------------

    Prong two does not contain the same exclusion for one-on-one 
communications as prong one. Oversight of one-on-one communications 
will likely involve greater costs for investment advisers compared to 
those addressed to more than one person because one-on-one 
communications have the potential for more variety and volume in their 
content. However, one-on-one solicitations are subject to the current 
solicitation rule. Therefore, there will likely be incrementally 
greater costs for advisers overseeing promoters under the final rule. 
Of these incremental costs,

[[Page 13103]]

the increase in costs is attributable less to the inclusion of one-on-
one communications and more to the expansion in compensation type (from 
cash to non-cash) and the expanded types of persons who would be 
promoters under the final rule as compared to solicitors under the 
current solicitation rule.
    Extending the scope of the rule to communications made by 
solicitors who receive non-cash compensation may have further benefits 
for investors. Because solicitations provided in connection with non-
cash compensation that solicitors might receive generate nearly 
identical conflicts of interest to solicitations provided in connection 
with cash compensation, prong two may reduce the risk that investors 
might be unaware of such conflicts for a larger set of communications. 
For example, many advisers use brokerage--a form of non-cash 
compensation--to reward brokers that refer them to investors. This 
practice presents advisers with conflicts of interest as the brokers' 
interests may not be aligned with investors' interests. Including non-
cash compensated testimonials and endorsements in the definition of 
advertisement would also give cash and non-cash compensation more equal 
regulatory treatment for these purposes, which will enhance competition 
between promoters that accept non-cash compensation and those that 
accept cash compensation. Additionally, to the extent that investment 
advisers currently direct order flow to broker-dealers with lower 
execution quality, the final rule's inclusion of non-cash compensation 
into the definition of advertisement could potentially affect quality 
of execution. If the final rule's requirements for non-cash 
compensation impose regulatory burdens that reduce the usage of 
directed brokerage towards brokers with lower quality of execution, 
these investment advisers might instead choose brokers with higher 
execution quality, which could result in a benefit for their investors.
    The extent of additional benefits and costs attributed to prong two 
of the definition will be mitigated to the extent that solicitors 
previously entered into written agreements obliging them to act in a 
manner consistent with the Advisers Act and its rules, including the 
current advertising rule. As a result of such agreements, the 
additional costs and benefits of the final rule's substantive 
provisions for these solicitors will generally be limited to changes in 
the programmatic effects of the final rule as compared to the current 
advertising rule. Any solicitors making communications subject to the 
final rule who did not previously enter into such a contract will, 
however, incur these costs fully and also incur costs associated with 
the creation of written agreements. The benefits and costs attributed 
to prong two may also be mitigated to the extent that advisers and 
promoters were previously complying with the current solicitation rule 
with respect to endorsements to private fund investors and to the 
extent that some aspects of the final rule overlap with the scope of 
rule 206(4)-8 under the Advisers Act, section 17(a) of the Securities 
Act, or section 10(b) and rule 10b-5 under the Exchange Act.
c. Exclusions From the Definition of Advertisement
    The first prong of the definition of an advertisement excludes 
extemporaneous, live, oral communications. The current rule does not, 
however, include these communications unless they are broadcast by 
radio or television. As a result, to the extent that some 
extemporaneous, live, oral communications were previously transmitted 
by radio or television or otherwise subject to the current advertising 
rule, the first prong of the definition could cover fewer of these 
communications with investors than the current definition. While this 
change could reduce investor protection and benefits of the final rule 
to investors with respect to these communications, it may also reduce 
the costs associated with the fact that advisers might avoid making any 
extemporaneous communications because of the difficulties in ensuring 
that they comply with the requirements of the rule.
    Both prongs of the definition of advertisement contain an exception 
for any statutorily or regulatory required notice, filing, or 
communication, provided that such information is reasonably designed to 
satisfy the requirements of such notice, filing, or other required 
communication. These exceptions are designed to reduce the likelihood 
that the final rule imposes costs or burdens on communications 
unrelated to advertising, or adds costs or burdens for communications 
already regulated by the Commission. The current advertising rule does 
not exclude statutory or regulatory notices, so the final rule will 
entail a reduction in costs for investment advisers to the extent they 
currently bear costs to comply with the advertising rule for their 
statutory or regulatory notices. Advisers will, however, continue to 
incur potential liability for these statements under applicable anti-
fraud provisions.
3. General Prohibitions
    The final rule generally prohibits certain marketing practices as a 
means reasonably designed to prevent fraudulent, deceptive, or 
manipulative acts. In general, we anticipate that the introduction of 
these general prohibitions will generate new interpretive questions 
regarding whether a particular communication is prohibited, which will 
impose compliance costs on investment advisers, including costs of 
legal advice and managerial resources, on an initial and ongoing basis. 
In addition, promoters for investment advisers will bear similar 
compliance costs, such as for legal advice and managerial 
resources.\913\
---------------------------------------------------------------------------

    \913\ See supra section III.D.1 and footnote 902.
---------------------------------------------------------------------------

    Below, we analyze the costs and benefits of these general 
prohibitions.\914\ The baseline for analyzing different types of 
advertisements may, however, be different. While advertisements as 
defined under the final rule will be subject to a single set of 
prohibitions and requirements, under the baseline, the same 
advertisements as defined by the final rule may be subject to different 
regulatory requirements. For example, solicitors that receive cash 
compensation are currently subject to the solicitation rule and, 
because they have entered into written agreements that oblige them to 
act in a manner consistent with the Advisers Act and its rules, the 
advertising rule. However, some communications that meet the definition 
of an advertisement do not currently fall under the solicitation rule 
or the advertising rule. For example, non-cash compensated promoters, 
and promoters for an adviser's impersonal advisory services currently 
are not subject to the requirements of rule 206(4)-3, while under the 
final rule certain of their communications would be defined as 
advertisements and subject to the general prohibitions. Further, 
communications to prospective and current investors in private funds 
are currently subject to rule 206(4)-8, section 17(a) of the Securities 
Act,

[[Page 13104]]

section 10(b) of the Exchange Act, and rule 10b-5 thereunder.
---------------------------------------------------------------------------

    \914\ In addition to the general prohibitions discussed below, 
the final rule specifically prohibits (i) any untrue statement of a 
material fact, or omission to state a material fact necessary in 
order to make the statement made, in the light of the circumstances 
under which it was made, not misleading and (ii) otherwise 
materially misleading statements. These provisions prohibit 
statements that would be prohibited by the current advertising rule 
and rule 206(4)-8, for example, and as a result, we do not believe 
that these provisions will generate significant costs or benefits.
---------------------------------------------------------------------------

    We have quantified a subset of the costs associated with the 
general anti-fraud prohibition, specifically, the burden of information 
collection costs estimated for the purposes of the Paperwork Reduction 
Act. The general anti-fraud prohibitions do not create any collection 
of information burdens, with one exception. The prohibition on 
unsubstantiated statements of material fact might cause investment 
advisers to create records to substantiate statements either 
contemporaneously or after the fact, and we estimate the costs of this 
collection. We estimate these costs to be $657 for each investment 
adviser per year, for a total cost of $9,016,668 per year.\915\
---------------------------------------------------------------------------

    \915\ See infra section IV.B.1.
---------------------------------------------------------------------------

a. Unsubstantiated Material Statements of Fact
    The final rule contains a prohibition on material statements of 
fact that an investment adviser does not have a reasonable basis for 
believing that it will be able to provide substantiation on demand by 
the Commission. Investment advisers would need to gather materials 
needed to substantiate the material statements of fact made in 
advertisements only if requested by the Commission. Currently, there is 
no express prohibition of making statements in advertisements that the 
adviser does not have a reasonable basis for believing it will be able 
to substantiate on demand, in the current rule or the general anti-
fraud provisions.
    This prohibition will benefit current and prospective investors by 
reducing the likelihood that advisers will make material statements of 
fact in advertisements that are not able to be substantiated, a 
practice which could potentially mislead investors. Additionally, the 
prohibition could incentivize investment advisers to invest additional 
resources to substantiate material statements of fact. Some commenters 
noted that a substantiation requirement would be burdensome,\916\ and 
we recognize that there will be costs associated with this requirement 
for advisers. We note, however, that commenters raised these concerns 
about the proposed requirement, which was not limited to material 
statements of fact. Nonetheless, there may, for example, be costs to 
determine whether a statement is a material statement of fact, whether 
the adviser has a reasonable basis to believe that it will be able to 
substantiate the statement upon demand, or how statements or facts 
would be substantiated on demand. These costs could include, among 
other things, personnel time for review and documentation, as well as 
direct costs when demanded by the Commission, which might entail 
personnel time to prepare materials for the Commission. Further, while 
an adviser may choose to substantiate the material fact after it has 
received the demand from the Commission, we recognize that some 
advisers may choose to create such records contemporaneously with the 
advertisement for sake of efficiency or to manage their compliance 
risk, which will cause them to incur compliance costs.
---------------------------------------------------------------------------

    \916\ See, e.g., MFA/AIMA Comment Letter I; FPA Comment Letter; 
NVCA Comment Letter; Fried Frank Comment Letter.
---------------------------------------------------------------------------

    Compliance costs may, however, be mitigated to the extent that 
advisers currently retain records that effectively substantiate 
performance advertising \917\ and, upon inquiry by the staff or the 
Commission, demonstrate that the adviser's statements are not untrue 
statements of material fact, consistent with the Advisers Act and its 
rules. These costs may be further mitigated to the extent that advisers 
believe there are external sources that support the material statements 
of fact they make in advertisements, which they also believe will be 
available at the time of any subsequent demand by Commission staff. We 
expect that this may be the case for some of the material facts, and 
costs may be further mitigated to the extent that advisers do not 
prepare this support in advance of such demand.
---------------------------------------------------------------------------

    \917\ See supra footnote 221.
---------------------------------------------------------------------------

    We recognize that the costs associated with substantiation might 
induce some investment advisers to avoid making material statements of 
fact that are too costly to substantiate. This could yield benefits for 
clients or investors, to the extent that any such advertisement not 
made has an increased risk of being misleading. These decisions could, 
however, have costs to clients or investors to the extent that they 
would receive less information about an adviser, and costs to advisers 
to the extent that they forgo some communications to clients or 
investors.
b. Untrue or Misleading Implications or Inferences
    The final rule contains a prohibition on information that would 
reasonably be likely to cause an untrue or misleading implication or 
inference to be drawn concerning a material fact relating to the 
investment adviser. There is no provision in the current advertising 
rule that expressly prohibits this type of information, though in staff 
no-action letters, the staff has stated its view that in some 
circumstances an advertisement may be false or misleading if it 
implies, or a reader would infer from it, something false.\918\ 
Further, the current advertising rule and rule 206(4)-8 each generally 
prohibit misleading statements.
---------------------------------------------------------------------------

    \918\ See supra section II.B.2; III.C.1.b.
---------------------------------------------------------------------------

    To the extent that advisers or promoters do not already omit 
information that would reasonably be likely to cause an untrue or 
misleading implication or inference, this prohibition to be drawn 
concerning a material fact relating to the investment adviser will 
benefit current and prospective investors by removing this type of 
information from advertisements, which has the potential to mislead 
investors and impair their ability to find an investment adviser. In 
addition, because this prohibition will generally require the adviser 
to consider the context and totality of information presented such that 
it would not reasonably be likely to cause any misleading implication 
or inference to be drawn concerning a material fact relating to the 
investment adviser, the prohibition will entail compliance costs to 
investment advisers and promoters, including those related to 
interpretation of the application of the new rule. We expect, however, 
that the costs and benefits of the prohibition will likely be 
mitigated, to the extent that advisers and promoters currently exclude 
from their communications this type of information.
c. Failure To Provide Fair and Balanced Treatment of Material Risks or 
Other Limitations
    The final rule contains a prohibition on advertisements which 
discuss any potential benefits to clients or investors connected with 
or resulting from the investment adviser's services or methods of 
operation without providing fair and balanced treatment of any 
associated material risks or other limitations associated with the 
potential benefits. Currently, while Form ADV requires disclosure of 
certain material risks, there is no provision in the current 
advertising rule, rule 206(4)-8, the other rules under the Advisers 
Act, or in the Advisers Act itself that explicitly requires such 
treatment.
    This prohibition will benefit current and prospective investors by 
requiring material risks and other limitations to be presented in a 
fair and balanced manner included in advertisements. This could provide 
such investors with additional, higher quality, information about

[[Page 13105]]

investment advisers and additional context for the claims they make in 
their advertisements. This information would allow investors to find 
better matches with investment advisers, and would reduce the costs 
associated with the search for investment advisers.
    This prohibition, however, may cause advisers and promoters to 
incur costs associated with changes to compliance processes, and 
investment advisers might incur costs to adjust their advertising 
materials to discuss material risks and limitations in a fair and 
balanced manner, including changes in formatting and tailoring 
disclosures based on the form of the communication. To the extent that 
investment advisers already prepare similar disclosure in existing 
communications with investors or in connection with the preparation of 
Form ADV Part 2, we expect the costs of compliance to be mitigated.
    One commenter expressed concern that this prohibition would expand 
the amount of required disclosures and overwhelmingly lengthen 
advertisements.\919\ We recognize that this prohibition will have costs 
associated with changes to the formatting of advertisements associated 
with the additional information, including with respect to 
communications made to prospective and current investors in private 
funds advised by the investment adviser. Further, we recognize that the 
associated costs might induce some investment advisers and promoters to 
avoid making some types of claims to the extent that they will require 
extensive discussion of the associated material risks or other 
limitations. This could have costs to investors to the extent that they 
would receive less information about an adviser, and costs to advisers 
to the extent that they forgo some communications to investors. This 
could, however, yield benefits for investors, to the extent that any 
such advertisement not made has an increased risk of being misleading.
---------------------------------------------------------------------------

    \919\ See MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

d. Anti-Cherry Picking Provisions: References to Specific Investment 
Advice and Presentation of Performance Results
    The final rule contains two other provisions designed to address 
concerns about investment advisers presenting potentially cherry-picked 
information to investors in advertisements.
    The first prohibits reference to specific investment advice where 
such advice is not presented in a manner that is fair and balanced. 
Currently, there is a per se prohibition against past specific 
recommendations in the advertising rule, though the current rule allows 
reference to past specific recommendations in an advertisement where 
the advertisement offers to furnish a list of all recommendations made 
by such investment adviser in the last year. Further, the staff has 
indicated that it would not recommend enforcement action under rule 
206(4)-1 under certain circumstances.\920\
---------------------------------------------------------------------------

    \920\ See infra section II.C.1.b.
---------------------------------------------------------------------------

    The first provision replaces the current advertising rule's per se 
prohibition of past specific recommendations with a principles-based 
prohibition on presentations of specific investment advice that is not 
presented in a manner that is ``fair and balanced.'' We believe that 
this change will provide benefits to advisers and promoters by 
providing additional clarity on which market practices are prohibited. 
Further, it will provide benefits to current and prospective investors 
related to potentially expanding the circumstances under which advisers 
may provide information regarding past specific advice to investors. In 
addition, investors may be able to better evaluate presentations of 
past or current specific advice because of the rule's requirement for 
fair and balanced presentation. This shift in approach might impose 
costs on investment advisers and promoters related to compliance, who 
will need to devote personnel time to evaluate whether a potential 
presentation of specific investment advice is fair and balanced.\921\ 
These compliance costs may be mitigated to the extent that advisers 
currently present past or current specific recommendations in a ``fair 
and balanced'' manner. Further, these costs may also be mitigated to 
the extent that an adviser currently complies with FINRA's rule 2210, 
which requires that broker communications be ``fair and balanced.'' 
\922\
---------------------------------------------------------------------------

    \921\ See supra section III.D.1 and note 902.
    \922\ See supra section II.B.5.a.
---------------------------------------------------------------------------

    The second anti-cherry-picking provision prohibits presentations of 
performance results, or performance time periods that are not presented 
in a fair and balanced manner. Currently, there is no express provision 
in the advertising rule requiring presentation of performance results 
in this manner, though the staff has stated views regarding certain 
circumstances in which the staff may view a presentation of performance 
results as misleading, including, for example, where an adviser failed 
to disclose how material market conditions, advisory fee expenses, 
brokerage commissions, and reinvestment of dividends affect the 
performance results.\923\
---------------------------------------------------------------------------

    \923\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    This provision may yield benefits to current and prospective 
investors by reducing the likelihood that they are misled by 
advertisements, and requiring the provision of information to evaluate 
an investment adviser that is presented in a fair and balanced manner. 
We recognize, however, that the standard in this rule will impose costs 
on advisers and promoters. Two commenters, for example, indicated that 
the ``fair and balanced'' standard may be difficult in 
application.\924\ We recognize that this ``fair and balanced'' 
component for the second provision also represents a shift towards a 
principles-based approach, which could impose compliance costs on 
investment advisers, who might need to devote personnel time to update 
compliance processes.\925\
---------------------------------------------------------------------------

    \924\ Consumer Federation Comment Letter; NASAA Comment Letter.
    \925\ See supra section III.D.1 and infra section IV.A.
---------------------------------------------------------------------------

    These costs and benefits may be mitigated, however, to the extent 
that advisers already ensure that their advertisements are fair and 
balanced in presentation of performance results in order to ensure that 
they are not misleading under the current advertising rule or other 
applicable anti-fraud provisions.
    These costs might, however, induce some investment advisers to 
avoid presenting performance results altogether. This could have costs 
to investors to the extent that they would receive less information 
about an adviser's performance, and may make finding an investment 
adviser more difficult or costly for some investors. Additionally, this 
could impose costs on advisers to the extent that they forgo some 
communications to investors. This reduction in performance advertising, 
however, could yield benefits for investors, to the extent that any 
such advertisement not made has an increased risk of misleading 
investors.
4. Conditions Applicable to Testimonials and Endorsements, Including 
Solicitations
    The final rule prohibits the use of testimonials and endorsements 
unless they comply with certain disclosure, oversight, and 
disqualification requirements, substantially as originally proposed for 
solicitors. The costs and benefits of this provision of the final rule 
differ depending on whether the testimonial or endorsement is 
compensated or uncompensated.

[[Page 13106]]

    To clarify the change from the baseline for each type of 
advertisement, we analyze the costs and benefits of imposing these 
conditions on testimonials and endorsements that are not compensated. 
We then separately analyze the costs and benefits of these conditions 
for testimonials and endorsements that are compensated. As described 
above, the baseline for each type of advertisement is different, making 
the extent of the effects of the changes effected by the rule different 
for advisers, depending on whether they are complying with the current 
advertising rule and the current solicitation rule.\926\
---------------------------------------------------------------------------

    \926\ See supra section III.D.3.
---------------------------------------------------------------------------

    We have quantified a subset of the costs associated with 
requirements for testimonials and endorsements, specifically, the 
burden of information collection costs estimated for the purposes of 
the Paperwork Reduction Act.\927\ The disclosure and oversight 
provisions of the requirements for testimonials and endorsements will 
entail information collection costs, and investment advisers will incur 
initial implementation costs. We estimate that investment advisers will 
incur an initial implementation cost of $1,060 for each adviser, or 
$7,273,720 in total.\928\ We estimate that investment advisers will 
incur an ongoing internal cost of $5,729 per year per adviser, $500 
external cost for those advisers that deliver disclosures by postal 
service, and $39,998,598 in total.\929\ We therefore estimate a total 
industry cost in the first year of $47,272,318.\930\
---------------------------------------------------------------------------

    \927\ See infra section IV.B.2.
    \928\ Initial cost burden estimate of $1,060 from section 
IV.B.2. 13,724 x \1/2\ = 6,862 affected investment advisers. $1,060 
x 6,862 = $7,273,720.
    \929\ Ongoing cost estimate includes disclosure, oversight, and 
annual costs from section IV.B.2. $5,679 x 6,862 + $500 external 
cost x 6,862 advisers x 20% mail use = $39,998,598.
    \930\ This number is based on the following calculation: 
$7,273,720 + $39,998,598 = $47,272,318.
---------------------------------------------------------------------------

a. Communications Other Than Compensated Testimonials or Endorsements
    The current advertising rule prohibits, but does not define, 
testimonials and does not address endorsements. In contrast to the 
current advertising rule, the final rule prohibits advisers from using, 
or compensating promoters for testimonials and endorsements, unless 
certain requirements are met, and distinguishes statements made by 
investors from those made by non-investors.
    In general, we believe that the ability of advisers to advertise 
testimonials and endorsements will give investors additional 
information about the views of clients and non-clients with an 
investment adviser, which could improve the matches between investors 
and investment advisers. Additionally, the ability to use testimonials 
and endorsements in advertisements might incentivize investment 
advisers to further improve the quality of the services they provide, 
because investment advisers will be better able to advertise any 
improvements in their services. We discuss the costs and benefits of 
the requirements that must be met in order to include a testimonial or 
endorsement in an advertisement below.
i. Disclosures
    The final rules impose disclosure requirements on investment 
advisers that make use of testimonials and endorsements and on persons 
giving testimonials and endorsements, unless subject to an 
exemption.\931\ Under the final rule, an investment adviser must 
disclose, or reasonably believe that the person giving the testimonial 
or endorsement discloses, (i) clearly and prominently, (A) whether the 
person giving the testimonial or endorsement is a client or a non-
client, as applicable, (B) that cash or non-cash compensation was 
provided for the testimonial or endorsement, if applicable, and (C) a 
brief statement of any material conflicts of interests; (ii) the 
material terms of the person's compensation arrangement, if any, 
including a description of the compensation provided or to be provided 
to the person for the testimonial or endorsement; and (iii) a 
description of any material conflicts of interest the person may have 
that result from the investment adviser's relationship with such person 
and/or any compensation arrangement. These disclosures must be 
delivered at the time the testimonial or endorsement is disseminated.
---------------------------------------------------------------------------

    \931\ See supra section II.C.5 (discussing partial exemptions 
from disclosure requirements).
---------------------------------------------------------------------------

    These disclosures can aid investors by providing information and 
context with which to evaluate a promoter's claims. Investors may 
benefit from receiving information about the experiences of other 
investors or other people. In addition, the requirement that the 
advertisement clearly and prominently disclose the client status of the 
promoter, the fact of compensation, and a brief statement of material 
conflicts of interests will increase the salience of these disclosures, 
and increase the likelihood that they are incorporated into an 
investor's decisions. Testimonials and endorsements may benefit 
investment advisers by allowing them to show satisfied clients or other 
persons willing to support the investment adviser.
    However, the positivity of a testimonial or endorsement may not 
always reflect the investment adviser's ability or the adviser's 
potential ``fit'' for investors. The final rule may, therefore, lead 
investment advisers, regardless of ability, to inefficiently increase 
spending on testimonials or endorsements in advertisements to attract 
clients. In this case, the fees that result from higher advertising 
spending could mitigate the benefits that the additional information in 
testimonials and endorsements might provide to investors. Additionally, 
to the extent that market practices have developed in such a way that, 
under circumstances described in staff no-action letters, market 
participants already include information in advertisements that would 
be a testimonial under the final rule, the costs and benefits of the 
final rule's testimonials and endorsements provision will be decreased 
in magnitude relative to the baseline.
    The final rule's requirement for disclosure of client or non-client 
status of the promoter, material terms of compensation, and material 
conflicts of interest, will provide useful information to prospective 
clients about the potential credibility and incentives of the provider 
of the testimonial or endorsement. This provision might also yield 
benefits for investors if investment advisers or their promoters are 
incentivized to mitigate their conflicts of interest or otherwise 
improve the quality of their services as a result of the disclosures. 
This might improve the efficiency of the investment adviser search 
process by improving the quality of the matches between investors and 
investment advisers, both because of the additional information about 
promoters' incentives and because it may lead investment advisers to 
alter their arrangements to mitigate conflicts of interest.
    However, conflict of interest disclosures may not necessarily lead 
to optimal decisions by investors. For example, the Commission's 
Financial Literacy Study surveyed investors about their understanding 
of fees as disclosed in a typical brochure, finding that many 
respondents had difficulty interpreting certain disclosures that are 
relevant to evaluating conflicts of interest.\932\ These

[[Page 13107]]

findings are consistent with academic literature that describes 
investors' difficulty in understanding financial disclosure. For 
example, one study shows that, in an experimental setting, even when 
subjects were told of the bias of persons who were giving them advice, 
participants did not fully adjust their behavior to reflect the 
disclosed bias.\933\ In addition, these papers and others \934\ find 
that mandating disclosure from biased persons may have the unintended 
consequence of making these persons appear honest and increase trust in 
them. While the context of these studies is not specific to investment 
advisers, promoters, or in certain cases, of financial advice 
generally, they provide evidence that suggests that disclosures might 
not fully mitigate the incentive problems generated by conflicts of 
interest. Additionally, advisers or their promoters may incur legal and 
compliance costs in connection with reviewing existing disclosures and 
drafting new disclosures to comply with the final rule.
---------------------------------------------------------------------------

    \932\ ``For instance, they had difficulty calculating hourly 
fees and fees based on the value of their assets under management. 
They also had difficulty answering comprehension questions about 
investment adviser compensation involving the purchase of a mutual 
fund and identifying and computing different layers of fees based on 
the amount of assets under management. Moreover, many of the online 
survey respondents on the point-of-sale panel had similar 
difficulties identifying and understanding fee and compensation 
information described in a hypothetical point-of-sale disclosure and 
account statement that would be provided to them by broker-
dealers.'' See Financial Literacy Study, supra footnote 846.
    \933\ See Daylian M. Cain, et al., The Dirt on Coming Clean: 
Perverse Effects of Disclosing Conflicts of Interest, 34 J. L. Stud. 
1 (2005); George Loewenstein, et al., The Limits of Transparency: 
Pitfalls and Potential of Disclosing Conflicts of Interest, 101 Am. 
Econ. Rev. 423 (2011).
    \934\ See e.g., Steven Pearson, et al., A Trial of Disclosing 
Physicians' Financial Incentives to Patients, 166 Archives of 
Internal Medicine 623 (2006); Sunita Sah, George Loewenstein & 
Daylian M. Cain, The Burden of Disclosure: Increased Compliance With 
Distrusted Advice, 104 J. Personality & Soc. Psychol. 289 (2013).
---------------------------------------------------------------------------

ii. Oversight and Compliance
    The final rule has an oversight and compliance provision that 
requires the investment adviser to have a reasonable basis for 
believing that a testimonial or endorsement complies with the 
rule.\935\ This provision is designed to help ensure that 
communications made by promoters comply with the provisions of the 
final rule. This requirement will entail costs for both advisers and 
their promoters to devote staff and managerial resources, enter into 
new written agreements or amend existing written agreements, and update 
their processes to the extent necessary for oversight and compliance of 
testimonials and endorsements under the final rule.
---------------------------------------------------------------------------

    \935\ In addition, the final rule requires that an investment 
adviser have ``a written agreement with any person giving a 
compensated testimonial or endorsement that describes the scope of 
the agreed-upon activities and the terms of the compensation for 
those activities.'' However, the rule does not contain this 
requirement in the case of uncompensated testimonials and 
endorsements or where de minimis compensation is provided to the 
promoter. For example, promoters providing testimonials or 
endorsements in refer-a-friend programs might not be subject to 
these requirements depending on the amount of compensation provided 
in such programs.
---------------------------------------------------------------------------

b. Compensated Testimonials or Endorsements
    The current solicitation rule prohibits advisers from providing 
solicitors with cash compensation, unless certain requirements are 
satisfied. Among these requirements is a requirement that the adviser 
enter into a written agreement requiring the solicitor to act in a 
manner consistent with the Advisers Act and its rules. Non cash-
compensated solicitations are not subject to the solicitation rule, 
however. To the extent that non-cash compensated testimonials and 
endorsements are viewed as advertisements made directly or indirectly 
by an adviser, they may be subject to the current advertising rule, 
including its general prohibition on testimonials if applicable. 
Solicitations of private fund investors are not subject to the current 
solicitation rule, though they are subject to rule 206(4)-8 and are 
likely subject to restrictions applicable to private placements under 
the Federal securities laws. Persons who would be promoters under the 
final rule that are registered broker-dealers and FINRA members, such 
as those who transact in privately issued securities, are also subject 
to FINRA rules applicable to communications, including restrictions on 
the use of compensated testimonials, and may be subject to Regulation 
BI.
    We believe that the costs and benefits of the conditions on the use 
of testimonials and endorsements in an advertisement will have similar 
costs and benefits to those described above,\936\ though these effects 
will be mitigated to the extent that the adviser was complying with the 
current solicitation rule. To some extent these effects will also be 
mitigated to the extent the promoter is a registered broker-dealer and 
FINRA member; such a promoter could adapt existing compliance systems, 
for instance, but will need to modify for any differences under the two 
regulatory constructs.
---------------------------------------------------------------------------

    \936\ See supra section III.D.4.a.
---------------------------------------------------------------------------

i. Disclosures
    We expect similar costs and benefits of the disclosure requirements 
for compensated testimonials and endorsements as described above for 
non-compensated testimonials and endorsements. For example, we expect 
investors to benefit from new disclosures, as mitigated to the extent 
that, for example, conflict of interest disclosures may not necessarily 
lead to optimal decisions by investors. Further, disclosures may impose 
compliance costs on advisers and promoters similar to those described 
above, including costs to draft new disclosures in connection with, for 
example, advertisements by non-cash compensated promoters and in 
connection with compensated testimonials or endorsements made to 
prospective or current investors in private funds advised by the 
adviser.
    However, these costs and benefits may be mitigated with respect to 
compensated testimonials or endorsements for four reasons. First, these 
costs may be mitigated for communications made by cash-compensated 
solicitors, given the disclosure requirements under the current 
solicitation rule. Currently, cash compensated solicitors must provide 
disclosures to clients pursuant to rule 206(4)-3(b), as well as provide 
the investment adviser's Form ADV brochure and their disclosure 
statement to potential investors. As a result, we expect that these 
costs will be mitigated to the extent that this type of information is 
already known and accessible to the investment adviser and promoter, 
and to the extent that similar information is already provided under 
the current solicitation rule. Further, the final rule's requirement to 
provide disclosure at the time the testimonial or endorsement is 
disseminated is similar to the current solicitation rule's requirement 
to deliver disclosure at the time of any solicitation activities. 
Second, the final rule exempts from these disclosure requirements 
certain affiliates of the adviser, provided that the affiliation is 
readily apparent or disclosed to the client or investors at the time 
the testimonial or endorsement is disseminated.
    Third, the costs and benefits of this provision may be mitigated 
because the final rule includes exemptions from these disclosure 
requirements. First, there is an exemption from these requirements when 
a broker-dealer provides a testimonial or endorsement to a retail 
customer that is a recommendation subject to Regulation BI. Second, 
when a broker-dealer provides a testimonial or endorsement to an 
investor that is not a retail customer as defined by Regulation BI, 
there is an exemption from the requirements to disclose the material 
terms of any compensation arrangement and a description of any material

[[Page 13108]]

conflicts of interest. As a result, the extent of the effects of this 
exemption on investors will vary. Where the testimonial or endorsement 
is a recommendation to a retail customer subject to Regulation BI, 
broker-dealers, including those that are also registered as investment 
advisers, acc will have to comply with the Disclosure Obligation under 
Regulation BI and will not also be subject to disclosure requirements 
under the final rule. Although these investors will not receive the 
investor protection benefits of the marketing rule disclosures, the 
recommendation will be subject to Regulation BI requirements under the 
baseline. With respect to testimonials or endorsements by a broker-
dealer to investors that are not retail customers (as defined by 
Regulation BI), although we believe such investors will be able to 
request from the broker-dealer other information about the 
solicitation, some may not. These exemptions may, therefore, result in 
a reduction of costs and benefits of the disclosure provisions for 
testimonials and endorsements to these investors.
    These exemptions might also make advisers more likely to compensate 
a broker-dealer as a promoter rather than promoters that are not 
broker-dealers, which would give these broker-dealers a competitive 
advantage. Further, with respect to communications made by broker-
dealers that are not so exempted, costs for promoters who are broker-
dealers may also be mitigated to the extent that broker-dealers are 
already preparing similar disclosures in order to comply with other 
disclosure obligations.\937\
---------------------------------------------------------------------------

    \937\ See supra section II.C.2.
---------------------------------------------------------------------------

    Finally, because there is no Form ADV brochure delivery requirement 
under the final rule, as compared to the current solicitation rule, we 
anticipate a reduction in costs associated with cash-compensated 
promoters no longer being subject to this requirement. We expect that 
this will not result in a loss of benefits to clients, however, because 
they will still receive the brochure from advisers as a result of 
advisers' delivery obligations. We recognize, however, that investment 
advisers and persons who are currently cash-compensated solicitors will 
bear costs as a result of the replacement of the current rule's 
disclosure requirements with the final rule's disclosure requirements.
ii. Oversight and Compliance
    Investment advisers must have a reasonable belief that the 
solicitors comply with the provisions of the Advisers Act and rules 
under the current solicitation rule, and we therefore expect the 
magnitude of the costs and benefits from the application of the 
testimonials and endorsements requirements related to oversight and 
compliance to be relatively small for advisers complying with the 
current rule and for promoters that are cash solicitors under the 
current solicitation rule.
    Under the current solicitation rule, investment advisers must make 
a bona fide effort to ascertain whether the cash-compensated solicitor 
has complied with the provisions of its written agreement with the 
adviser and must have a reasonable basis for so believing. As described 
above, the final rule has an oversight and compliance provision that 
requires the investment adviser to have a reasonable basis for 
believing that a testimonial or endorsement complies with the rule, and 
as applicable here, the adviser must also have a written agreement with 
the person giving a testimonial or endorsement that describes the scope 
of the agreed upon activities when making payments for compensated 
testimonials and endorsements that are above the de minimis threshold. 
This provision will help ensure that communications made by promoters 
comply with the provisions of the final rule. Further, this requirement 
would entail costs for both advisers and their promoters to devote 
personnel time and managerial resources to enter into written 
agreements and update the processes necessary for oversight and 
compliance of testimonials and endorsements.
    These benefits and costs may, however, be mitigated for several 
reasons. First, to the extent that advisers with cash-compensated 
solicitors are already substantially performing this oversight in 
connection with their compliance with rule 206(4)-3's oversight 
requirements, the rule will not have these full effects. Second, for 
private placements of private fund shares, the written private 
placement agreement could meet the written agreement requirement. 
Third, the final rule includes certain exemptions from the requirement 
to enter into a written agreement with the adviser. The first such 
exemption applies where de minimis compensation is provided to the 
promoter. For example, promoters providing testimonials or endorsements 
in refer-a-friend programs will likely be eligible for this exemption. 
The second such exemption applies to certain affiliates of the adviser, 
provided that the affiliation is readily apparent or disclosed to the 
client or investors at the time the testimonial or endorsement is 
disseminated.
iii. Disqualification
    The final rule contains disqualification provisions which prohibit 
an adviser from compensating a person, directly or indirectly, for any 
testimonial or endorsement if the adviser knows, or, in the exercise of 
reasonable care, should have known, that the person is an ineligible 
person at the time the testimonial or endorsement is disseminated. The 
rule defines an ``ineligible person'' to mean a person, who is subject 
to a disqualifying Commission action or disqualifying event, and 
certain of that person's employees and other persons associated with an 
ineligible person. The definition further encompasses, as appropriate, 
all general partners or all elected managers of an ineligible person.
Ineligible Persons and Disqualifying Events
    Currently, the solicitation rule categorically bars advisers from 
making cash payments to certain disqualified persons. The final rule's 
disqualification provisions generally expand the set of ineligible 
persons by including certain disciplinary actions that are not part of 
the current solicitation rule. For example, under the final rule a 
disqualifying event is expanded to also include generally actions of 
the CFTC and self-regulatory organizations. It also newly includes 
Commission cease and desist orders from committing or causing a 
violation or future violation of any scienter-based anti-fraud 
provision of the Federal securities laws, and Section 5 of the 
Securities Act.
    The final rule's prohibition on compensating such ineligible 
persons could yield benefits for investors by prohibiting investment 
advisers from hiring promoters most likely to abuse investors' trust--
that is, promoters who have been subject to certain Commission opinions 
or orders, other regulatory actions, civil actions, or convictions for 
certain conduct. This prohibition could, however, also yield costs for 
advisers. For example, an adviser may not be able to hire a solicitor 
that the adviser otherwise feels to be best able to promote its 
service. This may reduce the number of persons available to advisers to 
serve as promoters, increase the cost of obtaining referrals for 
investment advisers, and impose costs on those promoters who are 
disqualified. The application of the final rule's definition of 
ineligible person could also impose additional compliance and search 
costs on investment advisers. For example, investment advisers will 
need to check that a promoter is not an ineligible

[[Page 13109]]

person. In addition, to the extent the disqualification provisions 
under the new rule result in an increase in the number of disqualified 
persons as compared to the current rule, the number of available 
potential promoters would fall, which could increase the difficulty of 
finding a promoter for an adviser.
    We expect that the benefits and costs of this provision may be 
mitigated for a number of reasons. First, to the extent a solicitor is 
currently cash-compensated and currently subject to the solicitation 
rule, the final disqualification provisions are not entirely new, and 
only those changes from the solicitation rule's disqualification 
provisions, including new bars on persons subject to CFTC and self-
regulatory organization orders, will have any economic effects.
    Second, the final rule includes certain exemptions from this 
requirement. The first such exemption is available for promoters who 
receive de minimis compensation. The second exemption is available for 
promoters that are brokers or dealers registered with the Commission in 
accordance with section 15(b) of the Exchange Act, provided they are 
not subject to statutory disqualification under the Exchange Act. 
Broker-dealers currently have similar provisions that protect investors 
by disqualifying certain individuals from acting as a broker-dealer. 
This exemption may further have the effect of making it more likely 
that an adviser will compensate a broker-dealer as a promoter. In 
addition, persons that are covered by rule 506(d) of Regulation D under 
the Securities Act with respect to a rule 506 securities offering and 
whose involvement would not disqualify the offering under that rule 
(such as persons acting as placement agents for a private fund) will 
also not be disqualified under this disqualification provision of the 
final rule, which could similarly encourage the use of such agents in 
connection with marketing activities for private funds.
    Finally, the final rule's disqualification provisions will not 
disqualify any promoter for any matter(s) that occurred prior to the 
effective date of the rule, if such matter would not have disqualified 
the promoter under rule 206(4)-3, as in effect prior to the effective 
date of the rule. We expect this will reduce the costs and benefits of 
the disqualification provisions when the rule initially goes into 
effect.
    The final rule also provides a conditional carve-out from the 
definition of disqualifying event, with respect to a person that is 
subject to certain Commission opinions or orders, provided certain 
requirements are met. The provisions of this conditional carve-out are 
similar to statements in staff no-action letters in which the staff 
stated that it would not recommend enforcement action to the Commission 
under section 206(4) and rule 206(4)-3 if the solicitor's practices 
were consistent with certain representations made in connection with 
those letters.
Diligence Standards
    In addition to changing what promoters are ineligible to be 
compensated by an adviser, the final rule changes the diligence 
standards of investment advisers when hiring promoters. It establishes 
a knowledge or reasonable care standard for the disqualification 
provisions, which replaces the current solicitation rule's absolute bar 
on paying cash for solicitation activities to a person with any 
disciplinary history enumerated in the rule.
    In general, we believe that the requirement to exercise reasonable 
care at the time of dissemination will yield indirect benefits for 
investors, because it will require advisers to help ensure that the 
protections of the rule's disqualification provisions are realized for 
investors. This standard will also generally impose costs on advisers 
related to the necessary investigation of the promoter and to ensuring 
that they remain in compliance.
    We expect that the benefits and costs of this provision may be 
mitigated to the extent a solicitor is cash-compensated and previously 
subject to the solicitation rule. The required diligence standard in 
the final rule is formally less burdensome than was required under the 
current solicitation rule, which could lower compliance costs for 
advisers, including by reducing the likelihood that advisers will 
inadvertently violate the provision due to disqualifying events that 
they would not, even in the exercise of reasonable care, have known 
existed. We do not, however, believe that this standard will 
significantly affect the client and investor protections of the 
disqualification provisions, because we do not believe that 
investigation beyond what is reasonable under the circumstances would 
yield substantial benefits. Under the final rule, an adviser will need 
to inquire into the relevant facts of an engagement, with the method or 
level of due diligence or other inquiry varying depending on the 
circumstances of the compensated promoter and its arrangement with the 
adviser.\938\ To the extent that an engagement presents greater risk, 
greater screening and compliance mechanisms would be required under the 
rule, which we believe would preserve these benefits. For example, to 
the extent that there are indicators suggesting bad actor involvement, 
increased levels of due diligence will be required. Further, we believe 
that advisers will generally use many of the same mechanisms that they 
use today to determine whether a disqualified person is an ineligible 
person under the final rule. To the extent that the mechanisms 
currently in use already resemble or satisfy the final rule's diligence 
standard, the cost burden of the new standard may be mitigated.
---------------------------------------------------------------------------

    \938\ See supra section II.C.4.a.
---------------------------------------------------------------------------

5. Third-Party Ratings
    The final rule will also restrict the use of third-party ratings in 
advertisements, subject to certain requirements about the structure of 
the rating, and clear and prominent disclosures about the date of the 
rating, the identity of the third party, and compensation provided for 
obtaining or using the rating. We analyze the costs and benefits of 
imposing restrictions on the use of third-party ratings on 
communications subject to these restrictions below.
    While the current advertising rule does not mention third-party 
ratings, it prohibits an advertisement that contains a third-party 
rating if it contains an untrue statement or a material fact or is 
otherwise false or misleading. Further, the current solicitation rule, 
like the current advertising rule, does not expressly mention third-
party ratings.
    The staff has taken the position that certain ratings may 
constitute testimonials and stated it would not recommend enforcement 
action under the prohibition of testimonials if an adviser made 
references in an advertisement to third-party ratings that reflect 
client experiences, based on certain representations.\939\ 
Specifically, no-action letters have stated the staff would consider 
the following when not recommending an enforcement action for 
potentially false or misleading ratings in an advertisement: Whether 
the advertisement disclosed the criteria on which the rating was based, 
whether favorable ratings were selectively disclosed, whether there 
were any untrue implications of being a top-rated adviser, the identity 
of who created and conducted the rating, and whether investors can 
expect similar

[[Page 13110]]

performance in the future from the investment adviser.\940\
---------------------------------------------------------------------------

    \939\ See DALBAR, Inc., SEC Staff No-Action Letter (Mar. 24, 
1998).
    \940\ See id.; see Investment Adviser Association, SEC Staff No-
Action Letter (Dec. 2, 2005).
---------------------------------------------------------------------------

    The disclosure requirements of the final rule will provide 
investors more information to judge the context of a third-party 
rating, which might reduce the likelihood that investors will be misled 
by an investment adviser's ratings.\941\ Additionally, the final rule 
requires that the adviser have a reasonable basis for believing that 
any questionnaire or survey used in the preparation of a third-party 
rating be structured to make it equally easy for a participant to 
provide favorable and unfavorable responses, and not designed or 
prepared to produce any predetermined result, which might also reduce 
the likelihood that investors will be misled. Investors will benefit 
from the disclosure requirements for third-party ratings, not only 
because the disclosures provide investors with additional context to 
evaluate the information provided in ratings, but also because the 
required disclosures may dissuade advisers from including misleading 
third-party ratings.
---------------------------------------------------------------------------

    \941\ See supra section III.B.
---------------------------------------------------------------------------

    The disclosures required by the final rule might reduce the 
incentives of investment advisers to include third-party ratings that 
might be stale or otherwise misleading. The requirement to create these 
disclosures could impose costs on advisers, including compliance costs 
related to drafting these disclosures and ensuring that they comply 
with the requirements of the final rule. In addition, the final rule 
requires that investment advisers make certain disclosures or 
reasonably believe that such disclosures have been made, which will 
impose additional costs on investment advisers. Investment advisers and 
the associated personnel that use third-party ratings in their 
advertisements will bear costs associated with compliance with this 
aspect of the final rule.\942\ These costs could entail the dedication 
of personnel time and managerial resources to draft disclosures and to 
satisfy due diligence requirements.
---------------------------------------------------------------------------

    \942\ Although the investment advisers bear the legal burden of 
complying with third-party ratings requirement, we expect that the 
costs of this requirement will be partially borne by other parties, 
such as persons communicating on behalf of an investment adviser.
---------------------------------------------------------------------------

    However, these costs and benefits may be mitigated because the 
third-party rating requirements of the final rule are similar to the 
representations made in staff letters in which it has previously stated 
that it would not recommend enforcement under section 206(4) and rule 
206(4)-1. As a result, advisers may only bear the incremental costs of 
modifying compliance systems to account for the differences of the 
final rule requirements, though these advisers would also bear the 
costs of evaluating those differences.
    We have quantified a subset of the costs associated with 
requirements for the use of third-party ratings in advertisements, 
specifically, the burden of information collection costs estimated for 
the purposes of the Paperwork Reduction Act.\943\ The disclosure 
provisions of the requirements for testimonials and endorsements will 
entail information collection costs, and investment advisers will incur 
initial implementation costs. We estimate that investment advisers will 
incur an initial implementation cost of $1,011 for each adviser, or 
$6,937,482 in total.\944\ We estimate that investment advisers will 
incur an ongoing cost of $252.74 per year per adviser, or $1,734,301.88 
total ongoing cost per year. We therefore estimate a total industry 
cost in the first year of $8,671,783.88.\945\
---------------------------------------------------------------------------

    \943\ See infra section IV.B.3.
    \944\ Initial cost burden estimate of $1,011 from section 
IV.B.3. 13,724 x \1/2\ = 6,862 affected investment advisers. $1,011 
x 6,862 = $6,937,482.
    \945\ Ongoing cost estimate includes disclosure, oversight, and 
annual costs from section IV.B.3. $252.74 x 6,862 = $1,734,301.88. 
For the total first year cost, $6,937,482 + $1,734,301.88 = 
$8,671,783.88.
---------------------------------------------------------------------------

6. Performance Advertising
    The final rule includes provisions that impose specific 
requirements and prohibitions on the inclusion of performance 
information in advertisements. These provisions include net performance 
requirements, prescribed time period requirements, prohibitions of 
statements expressing or implying Commission approval or review of the 
calculation or presentation of performance results in the 
advertisement, and requirements for related performance, extracted 
performance, hypothetical performance, and predecessor performance. We 
analyze the costs and benefits of imposing these specific requirements 
on the use of performance advertising in communications below.
    We have quantified a subset of the costs associated with the 
restrictions on the use of performance advertising in advertisements, 
specifically, the burden of information collection costs estimated for 
purposes of the Paperwork Reduction Act.\946\ The provisions of the 
requirements for performance advertising will entail information 
collection costs and modification of the presentation of performance. 
These collection of information costs primarily entail an initial cost 
to update performance calculations, and an ongoing annual cost for 
investment advisers. We estimate that investment advisers will incur a 
total initial implementation cost $394,998,740 \947\ and a total 
ongoing cost of $273,772,232 per year.\948\ We therefore estimate the

[[Page 13111]]

total cost in the first year to be $672,544,972.\949\
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    \946\ See infra section IV.B.4.
    \947\ These total cost estimates differ from those in section 
IV.B.4, because the estimates in those sections amortize the initial 
implementation costs over three years, while the cost estimates in 
this section do not. However, both estimates make identical 
assumptions about the resources required to comply with the rule. 
The initial burden associated with net performance is based on 15 
hours x $337 (compliance manager and compliance attorney, split 
evenly) = $5,055 for each of the 13,038 investment advisers expected 
to be affected, implying an initial cost of $65,907,090. The initial 
burden associated with performance time periods is based on 35 hours 
x $337 (compliance manager and compliance attorney, split evenly) = 
$11,795 for each of the 13,038 investment advisers expected to be 
affected, implying an initial cost of $153,783,210. The initial 
burden associated with related performance is based on 30 hours x 
$337 (compliance manager and compliance attorney, split evenly) = 
$10,110 for each of the 10,979 investment advisers expected to be 
affected, implying an initial cost of $110,997,690. The initial 
burden associated with extracted performance is based on 10 hours x 
$337 (compliance manager and compliance attorney, split evenly) = 
$3,370 for each of the 686 investment advisers expected to be 
affected, implying an initial cost of $2,311,820. The initial burden 
associated with hypothetical performance is based on 15 hours x $337 
(compliance manager and compliance attorney, split evenly) + 7 hours 
x $530 (compliance officer) = $8,765 for each of the 6,862 
investment advisers expected to be affected, implying an initial 
cost of $60,145,430. The initial burden associated with predecessor 
performance is based on 20 hours x $337 (compliance manager and 
compliance attorney, split evenly) = $6,740 for each of the 275 
investment advisers expected to be affected, implying an initial 
cost of $1,853,500. Therefore, the total initial industry burden 
associated with the final rule is $197,721,270 + $153,783,210 + 
$110,997,690 + $2,311,820 + $60,145,430 + $1,853,500 = $394,998,740. 
See infra section II.B.4.
    \948\ The ongoing burden associated with net performance is 
based on 10.5 hours x $337 (compliance manager and compliance 
attorney, split evenly) = $3,538.50 for each of the 13,038 
investment advisers expected to be affected, implying an ongoing 
cost of $46,134,963. The ongoing burden associated with performance 
time periods is based on 28 hours x $337 (compliance manager and 
compliance attorney, split evenly) = $9,436 for each of the 13,038 
investment advisers expected to be affected, implying an ongoing 
cost of $123,026,568. The ongoing burden associated with related 
performance is based on 17.5 hours x $337 (compliance manager and 
compliance attorney, split evenly) = $5,897.50 for each of the 
10,979 investment advisers expected to be affected, implying an 
ongoing cost of $64,748,652.50. The ongoing burden associated with 
extracted performance is based on 7 hours x $337 (compliance manager 
and compliance attorney, split evenly) = $2,359 for each of the 686 
investment advisers expected to be affected, implying an ongoing 
cost of $1,618,274. The ongoing burden associated with hypothetical 
performance is based on 10.5 hours x $337 (compliance manager and 
compliance attorney, split evenly) + 3.75 hours x $530 (compliance 
officer) = $5,526 for each of the 6,862 investment advisers expected 
to be affected, implying an ongoing cost of $37,919,412. The ongoing 
burden associated with predecessor performance is based on 3.5 hours 
x $337 (compliance manager and compliance attorney, split evenly) = 
$1,179.50 for each of the 275 investment advisers expected to be 
affected, implying an initial cost of $324,362.50. Therefore, the 
total initial industry burden associated with the final rule is 
$138,404,889 + $123,026,568 + $64,748,652.50 + $1,618,274 + 
$37,919,412 + $324,362.50 = $273,772,232. See infra section II.B.4.
    \949\ $394,998,740 (total initial cost) + $273,772,232 (total 
ongoing cost) + $3,774,000 (external cost) = $672,544,972 (total 
first year cost).
---------------------------------------------------------------------------

a. Net Performance Requirement
    The final rule will prohibit any presentation of gross performance 
unless the advertisement also presents net performance with at least 
equal prominence to the presentation of gross performance. In addition, 
the net performance must be calculated over the same time period, and 
using the same type of return and methodology as, the gross 
performance. While the current advertising rule does not mention 
performance advertising, it prohibits any untrue statement of a 
material fact and statements that are otherwise false or misleading, 
which includes statements made in the context of performance 
advertising. The staff has stated its views about the types of 
circumstances in which it may view the presentation of performance 
results as misleading, including, for example, where an adviser did not 
disclose how advisory fee expenses, commissions, and reinvestment of 
dividends affect the performance results.\950\
---------------------------------------------------------------------------

    \950\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    This provision will likely benefit investors by providing them with 
additional information about the performance generated by an investment 
adviser, including the effect of fees and expenses on that performance, 
and reducing the chance that they are misled by presentations of gross 
performance. To the extent that investment advisers' current practices 
differ from the requirements of this provision, these requirements may 
impose costs on advisers, including advisers that serve private funds, 
to compute and include net performance in their marketing 
communications, to the extent that advisers do not currently compute 
and include net performance. These costs could involve devoting 
personnel time, modifying marketing materials, and devoting managerial 
resources. In addition, some investors may be better able to make their 
own risk adjusted return assessments, and these investors may similarly 
derive fewer benefits from this requirement.
    However, these costs and benefits may be mitigated to the extent 
that this requirement is similar to the circumstances under which the 
staff has previously stated that it would not recommend enforcement 
under section 206(4) and rule 206(4)-1. Given that many investment 
advisers already provide this information in light of staff no-action 
letters, there are not likely to be significant costs or benefits to 
this provision.
b. Prescribed Time Periods
    The final rule prohibits the presentation of performance results of 
any portfolio or any composite aggregation of related portfolios, other 
than any private fund, in advertisements unless the results for one, 
five, and ten year periods are presented as well. Each of the required 
time periods must be presented with equal prominence and end on a date 
that is no less recent than the most recent calendar-year end.\951\ If 
the portfolio was not in existence for the full duration of any of 
these three periods, the lifetime of the portfolio can be substituted. 
Under the baseline for current advertisements, there is no such 
Commission requirement relating to performance advertising.
---------------------------------------------------------------------------

    \951\ See supra section II.E.2.
---------------------------------------------------------------------------

    Requiring advertisements to include one, five, and ten year period 
performance will benefit investors other than private fund investors by 
giving them standardized information about the performance and limiting 
the potential that an investor could be unintentionally misled about an 
investment adviser's performance through the investment adviser's 
selection of performance periods. The requirement will impose costs on 
investment advisers, who will need to compute the performance for the 
prescribed time periods, update their advertising materials, and devote 
personnel time to ensure compliance with the final rule. These costs 
may disincentivize the presentation of performance results of any 
portfolio or any composite aggregation of related portfolios.
    However, these benefits and costs may be mitigated to the extent 
that this requirement is similar to information currently collected and 
provided to clients in order to comply with GIPS standards to present 
performance information. In addition, to the extent that advisers 
already present, for example, performance information for these time 
periods, these costs and benefits may also be mitigated.
c. Statements of Commission Approval or Review
    The final rule prohibits any advertisement that includes a 
statement, whether express or implied, that the calculation or 
presentation of performance results has been reviewed or approved by 
the Commission. This prohibition will benefit investors by preventing 
misleading advertisements that could lead investors to draw false 
conclusions about the Commission's approval of a presentation or 
calculation of performance. Any such statement would be false, as the 
Commission does not review or approve of calculations or presentations 
of performance. The prohibition may likely impose costs associated with 
legal review of performance presentation, but these costs are likely to 
remain small. Further, such costs may be mitigated to the extent that 
advisers currently have procedures to ensure compliance with section 
208(a), which contains a similar prohibition from representing or 
implying that an adviser's abilities or qualifications have been passed 
upon by the United States or any agency thereof.
d. Related Performance
    The final rule will condition the presentation of ``related 
performance'' in all advertisements on the inclusion of all related 
portfolios. However, the final rule will allow related performance to 
exclude related portfolios as long as the advertised performance 
results are not materially higher than if all related portfolios had 
been included. This exclusion will be subject to the rule's requirement 
that the presentation of performance results of any portfolio include 
results for one-, five-, and ten-year periods. The final rule will 
allow related performance to be presented either on a portfolio-by-
portfolio basis or as a composite of all related portfolios. The 
inclusion of related performance in advertisements may give investment 
advisers flexibility in how they choose to advertise their performance, 
such as which aspects of their performance they can advertise, and 
might give investors additional information about how an investment 
adviser managed portfolios having substantially similar investment 
policies, objectives and strategies.
    The requirements for related performance may, however, impose costs 
on investment advisers related to the creation of composites to the 
extent that they do not currently create composites or create 
composites using the final rule's criteria for related portfolios. For 
example, the ``not materially higher than'' requirement for

[[Page 13112]]

excluding related portfolios may generate an additional need to 
recalculate performance to verify that the related performance 
satisfies the requirement. Further, as discussed above, we understand 
that an adviser will likely be required to calculate the performance of 
all related portfolios to ensure that any exclusion of certain 
portfolios meets the rule's conditions, which may be burdensome on 
advisers, particularly smaller advisers.\952\
---------------------------------------------------------------------------

    \952\ See IAA Comment Letter.
---------------------------------------------------------------------------

    However, we expect investment advisers to incur these calculation 
costs only if they expect sufficient benefits from inclusion of related 
performance. Further, we expect that these costs and benefits may be 
mitigated to the extent that advisers currently include related 
performance presentations in their advertisements that comply with the 
current rule.\953\ Commenters generally described the related 
performance definition that was originally proposed as being similar to 
industry practice.\954\ In addition, advisers that comply with GIPS 
standards are permitted to show related performance in advertisements, 
and presentations that meet the GIPS standard requirements to show all 
related performance will also satisfy the requirements of this 
provision to show all related performance.
---------------------------------------------------------------------------

    \953\ The use by investment advisers that are also broker-
dealers of certain forms of related performance in advertisements 
may be viewed by FINRA as inconsistent with the content standards in 
FINRA rule 2210.
    \954\ See MFA Comment Letter I; Proskauer Comment Letter.
---------------------------------------------------------------------------

e. Extracted Performance
    The final rule will condition the presentation of extracted 
performance in all advertisements on the advertisement providing, or 
offering to provide promptly, the performance results of the total 
portfolio from which the performance was extracted. ``Extracted 
performance'' means ``the performance results of a subset of 
investments extracted from a portfolio.'' \955\ While the current 
advertising rule does not mention extracted performance, it prohibits 
any untrue statement of a material fact and statements that are 
otherwise false or misleading, which includes statements made in the 
context of advertising extracted performance.
---------------------------------------------------------------------------

    \955\ Final rule 206(4)-1(e)(6).
---------------------------------------------------------------------------

    The use of extracted performance in advertisements will benefit 
investors by giving them information about performance results 
applicable to a particular subset of the adviser's investments, and the 
accompanying disclosures could help investors contextualize the claims 
of an investment adviser about its extracted performance, thereby 
reducing the risk that investors might be misled by such extracted 
performance.
    Investment advisers who use extracted performance in their 
advertisements will likely incur costs to prepare the performance 
results of the total portfolio from which the performance was 
extracted, to the extent that they do not do this already. The final 
rule does not prohibit an adviser from presenting a composite of 
extracts, including composite performance that complies with GIPS 
standards. However, any presentation of a composite of extracts is 
subject to the additional protections that apply to hypothetical 
performance, as discussed below, and as a result, these additional 
protections may result in additional burdens for advisers that 
typically present extracted performance from multiple portfolios as a 
composite, and potentially limit these types of presentations of 
performance to institutional investors.
    However, these benefits and costs may be mitigated to the extent 
that the restrictions imposed by this provision are similar to the 
manner in which advisers currently present extracted performance, 
including under GIPS standard requirements applicable to similar 
presentations of extracted performance, or other requirements.
f. Hypothetical Performance
    The rule also prohibits the use of hypothetical performance in 
advertisements unless (i) the investment adviser adopts and implements 
policies and procedures reasonably designed to ensure that the 
hypothetical performance is relevant to the likely financial situation 
and investment objectives of the intended audience of the 
advertisement; (ii) provides sufficient information to enable the 
intended audience to understand the criteria used and assumptions made 
in calculating such hypothetical performance; and (iii) provides, or if 
the intended audience is an investor in a private fund provides, or 
offers to provide promptly, sufficient information to enable the 
intended audience to understand the risks and limitations of using such 
hypothetical performance in making investment decisions. The rule 
defines several types of hypothetical performance--model performance, 
performance derived from model portfolios; backtested performance, 
performance that is backtested by the application of a strategy to data 
from prior time periods when the strategy was not actually used during 
those periods; and targeted or projected performance returns with 
respect to any portfolio or to the investment services offered in the 
advertisement.
    The current advertising rule does not explicitly address 
hypothetical performance. The Commission has, however, brought 
enforcement actions alleging that the presentation of performance 
results that were not actually achieved would be misleading where 
certain disclosures were not made, including disclosure that the 
performance results were hypothetical or disclosure of the relevant 
limitations inherent in hypothetical results and the reasons why actual 
results would differ.\956\
---------------------------------------------------------------------------

    \956\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    The final rule's imposes minimum standards for the presentation of 
hypothetical performance in advertisements, which could potentially 
increase the willingness of investment advisers to use hypothetical 
performance. If investment advisers increase their use of hypothetical 
performance in advertising, investors may benefit from the additional 
information provided by hypothetical performance advertising, together 
with information and context that may help investors to better 
understand it. This additional information could aid an investor in the 
choice of an investment adviser by helping investors find a better 
match or reducing costs associated with finding an investment adviser.
    To the extent that these requirements will help ensure that 
hypothetical performance is disseminated to the specific investors who 
have access to the resources to independently analyze this information 
and who have the financial expertise to understand the risks and 
limitations of these types of presentations, these requirements on the 
presentation of hypothetical performance will benefit investors. 
Although investors will not face any direct costs from the inclusion of 
hypothetical performance, they may face indirect costs associated with 
processing and interpreting this new information if investment advisers 
increase their use of hypothetical performance. Even if investors are 
provided with sufficient information to contextualize hypothetical 
performance, they may need time and expertise to interpret that 
contextual information. Some, investors might have difficulty 
interpreting the context of hypothetical performance because of a lack 
of resources of financial expertise, which could lead to poorer matches 
with investment advisers. However, the final

[[Page 13113]]

rule requires disclosures and contextual information for hypothetical 
performance that are sufficient for the intended audience, which should 
mitigate these costs to investors.
    Advisers may incur costs associated with complying with the three 
conditions described above, such as consulting with in-house counsel, 
time to draft these policies and procedures and disclosures, and 
requiring firms to pay outside counsel or consultants to draft or 
review these policies and procedures and disclosures. These 
requirements could also entail costs such as training of staff to 
comply with the policies and procedures, and demands on personnel time 
and counsel to draft and review advertisements and disclosures to 
ensure compliance with the policies and procedures and the rule's 
requirements. We recognize that investment advisers will need to 
evaluate their intended audiences, as well as ensure that the 
advertisement is tailored to the audience receiving it, which will 
cause advisers to incur costs. An adviser may make such evaluations 
based on past experiences with investor types, including, for example, 
routine requests from those types of investors in the past, or based on 
information they have gathered from potential investors (e.g., 
questionnaires, surveys, or conversations) or academic research.\957\ 
Investment advisers are, however, unlikely to incur these costs if they 
do not expect the benefits of hypothetical performance advertising to 
exceed the costs associated with screening.
---------------------------------------------------------------------------

    \957\ See supra section II.E.6.b.
---------------------------------------------------------------------------

    The costs and benefits associated with these restrictions may, 
however, be mitigated to the extent that advisers currently present 
information that meets the final rule's definition of ``hypothetical 
performance'' in circumstances consistent with the representations made 
in staff no-action letters. Additionally, to the extent that some 
investment advisers already maintain policies and procedures to screen 
prospective clients in order to comply with the GIPS standards, the net 
costs and benefits associated evaluating an ``intended audience'' for 
purposes of complying with this requirement may be mitigated. Under 
these circumstances, advisers may only bear the incremental costs of 
modifying compliance systems and disclosures to account for the 
differences of the final rule's requirements, though these advisers 
would also bear the costs of evaluating those differences.
g. Predecessor Performance
    The final rule subjects the presentation of predecessor performance 
to several requirements: (i) The person or persons who were primarily 
responsible for achieving the prior performance results manage accounts 
at the advertising adviser; (ii) the accounts managed at the 
predecessor investment adviser are sufficiently similar to the accounts 
managed at the advertising investment adviser that the performance 
results would provide relevant information to clients or investors; 
(iii) all accounts that were managed in a substantially similar manner 
are advertised unless the exclusion of any such account would not 
result in materially higher performance and the exclusion of any 
account does not alter the presentation of any applicable time periods 
required by the final rule; and (iv) the advertisement includes, 
clearly and prominently, all relevant disclosures, including that the 
performance results were from accounts managed at another entity.
    Under the current advertising rule, predecessor performance is not 
explicitly addressed; however, the staff has stated in no-action 
letters that it would not view advertisements that include predecessor 
performance as misleading under certain circumstances.\958\ These 
circumstances are similar to the requirements of the final rule, and 
costs and benefits may flow from the extent to which the rule imposes 
requirements for use of predecessor performance.
---------------------------------------------------------------------------

    \958\ See Horizon Letter.
---------------------------------------------------------------------------

    To the extent that the final rule's provisions permit the use of 
predecessor performance in advertisements, predecessor performance has 
the potential to provide additional information and context for 
investors. This information could improve investor decisions and reduce 
the costs associated with searching for an investment adviser. However, 
the rule has requirements that will impose costs on investment advisers 
that present predecessor performance. Determining the extent to which 
the personnel and the portfolios of a predecessor adviser are 
sufficiently similar under the rule can require resources, especially 
when portfolios are managed by multiple people, or have long or 
complicated performance histories. Additionally, investment advisers 
may bear additional costs to analyze any intellectual property issues 
or non-compete agreements between portfolio management personnel and 
their previous firms.
7. Amendments to Form ADV
    Under the final rule, Form ADV will include additional questions 
about investment advisers' advertising practices, including performance 
advertising, the use of testimonials and endorsements, and compensation 
for promoters. Current Form ADV does not contain any questions about 
advertising practices, and the changes to Form ADV will support the 
Commission's compliance oversight efforts, thus helping the Commission 
monitor market practices and the effects of its rules. For example, the 
changes to Form ADV will allow the Commission to understand the 
relative popularity of certain advertising practices and compensation 
practices for promoters. To the extent that these amendments do 
facilitate compliance oversight, these changes may benefit clients. 
These investors may also derive benefits from the information provided 
in the Form ADV, as amended, which may help them make better decisions 
with respect to which advisers' services to utilize. Additionally, it 
will enable the Commission to evaluate the final rule's requirements, 
and their impact on how investment advisers choose to advertise. 
Investment advisers that use advertisements will likely incur 
additional costs associated with collecting information to answer these 
questions, as investment advisers will need to accurately track the 
types of content in their advertisements.
    We have quantified a subset of the costs associated with changes to 
Form ADV, specifically the burden of information collection costs 
estimated for the purposes the Paperwork Reduction Act. The amendments 
to Form ADV will impose additional ongoing costs for investment 
advisers. We estimate the marginal increase in the aggregate cost 
burden of these changes to Form ADV will be $4,355,288 per year for 
RIAs not obligated to prepare and file relationship summaries, 
$3,429,942 per year for RIAs obligated to prepare and file relationship 
summaries, and $171,881 per year for exempt reporting advisers.\959\ We 
therefore estimate the total annual cost increase for all advisers to 
be $7,957,111 per year.\960\ However, we note that some portion of the 
increase in costs is due to an increase in the number of RIAs that will 
bear these costs, and not entirely

[[Page 13114]]

due to an increase in the cost burden for an individual RIA.
---------------------------------------------------------------------------

    \959\ The total cost increase for exempt reporting advisers 
reflects an increase in the number of exempt reporting advisers 
rather than a per adviser cost increase generated by the final rule.
    \960\ See infra section IV.E. Cost estimates were calculated by 
subtracting current Form ADV cost burdens from the new Form ADV cost 
burdens.
---------------------------------------------------------------------------

8. Recordkeeping
    The amendments to the recordkeeping rule will require investment 
advisers to make and keep records of all advertisements they 
disseminate. Generally, the amended recordkeeping rule will require 
additional retention of written or distributed communications of an 
investment adviser, including certain oral communications. For example, 
the current recordkeeping rule requires the retention of advertisements 
disseminated to ten or more individuals. In contrast, the amendments 
require that advisers retain all advertisements, with the two 
exceptions. First, for oral advertisements, the adviser may, instead of 
recording and retaining the advertisement, retain a copy of any written 
or recorded materials used by the adviser in connection with the oral 
advertisement.\961\ Second, if an adviser's advertisement includes a 
compensated oral testimonial or endorsement, the adviser may, instead 
of recording and retaining the advertisement, make and keep a record of 
the disclosures provided to investors.\962\ In addition, if the 
required disclosures with respect to a testimonial or endorsement are 
not included in the advertisement, then the adviser must retain copies 
of such disclosures provided to investors.\963\ The recordkeeping rule 
will continue to require that advisers keep a record of communications 
other than advertisements (for example, notices, circulars, newspaper 
articles, investment letters, and bulletins) that the investment 
adviser disseminates, directly or indirectly, to ten or more persons. 
Additionally, there are some types of newly required records that can 
be particularly costly to retain. For example, creating and retaining 
records of orally delivered disclosures will impose extra costs on 
investment advisers and promoters. These requirements may result in 
costs on investment advisers, such as dedicating personnel time to 
capture and retain these records.
---------------------------------------------------------------------------

    \961\ See final rule 204-2(a)(11)(i)(A)(1).
    \962\ See final rule 204-2(a)(11)(i)(A)(2).
    \963\ See final rule 204-2(a)(11)(i)(A) and (15)(i).
---------------------------------------------------------------------------

    The amendments to the recordkeeping rule will also require 
investment advisers to make and keep: (i) Documentation of 
communications relating to predecessor performance; (ii) documentation 
to support performance calculations; (iii) copies of any questionnaire 
or survey used in preparation of a third-party rating (in the event the 
adviser obtains a copy of the questionnaire or survey); (iv) if not 
included in an advertisement, a record of disclosures provided to the 
client; (v) documentation substantiating the adviser's reasonable basis 
for believing that a testimonial, endorsement, or third-party rating 
complies with the applicable tailored requirements of the marketing 
rule and copies of any written agreement made with promoters; (vi) a 
record of certain affiliated personnel of the adviser; and (vii) a 
record of who the ``intended audience'' is.
    These requirements will impose compliance costs on advisers related 
to the creation and retention of these records. These costs will be 
associated with additional personnel time to capture or retain these 
communications. Notably, retaining documents that form the basis of a 
calculation could be more expensive due to the requirement that 
advisers retain calculation information for portfolios (and not only 
for managed accounts and securities recommendations). However, we 
believe that there is overlap between accounts included in 
``portfolios'' and those ``managed accounts'' already captured by the 
current recordkeeping rule. Retaining these documents might require an 
investment adviser to evaluate which documents are relevant for a 
performance calculation, which could potentially generate costs for the 
investment adviser. Similarly, advisers will incur costs related to 
required records that are not communications, including a record of who 
an advertisement's ``intended audience'' is, for example. Creation of 
these records might involve research and collection of information 
about an investment adviser's intended audience. Furthermore, the 
recordkeeping rule requires advisers to retain documents that support 
the inclusion of predecessor performance in an advertisement, including 
a requirement to make and keep originals of all written communications 
received and copies of all written communications sent by an investment 
adviser relating to predecessor performance and the performance or rate 
of return of any portfolios. In contrast, this provision in the current 
recordkeeping rule only requires advisers to make and keep originals of 
all written communications received and copies of all written 
communications sent by an investment adviser relating to the 
performance or rate of return of any or all managed accounts or 
securities recommendations. The recordkeeping rule also requires that a 
list of certain affiliated personnel be retained, to parallel the 
exemption for certain affiliated personnel from the compensated 
testimonials and endorsements requirements. This requirement may 
generate costs for the investment adviser to retain and update this 
list. Some of these costs may ultimately be passed on to clients or 
investors through higher fees.
    These costs may, however, be mitigated to the extent that advisers 
are already retaining similar records. Under the current recordkeeping 
rule, for example, advisers are required to retain originals of 
documentation supporting the calculation of performance or rate of 
return of all managed accounts or securities recommendations. The 
amendments to the recordkeeping rule, in contrast, will also require 
documentation supporting the calculation of performance or the rate of 
return for any or all portfolios. As a result, the total costs of 
compliance for advisers with respect to communications previously 
included in the definition of an advertisement will be mitigated 
somewhat. Further, the staff has, for example, taken the position that 
rule 204-2(a)(16) also applies to a successor's use of a predecessor's 
performance data.\964\ As a result, retention of some documentation and 
written communications required to be retained under the recordkeeping 
rule will impose relatively minor costs on investment advisers with 
respect to communications currently subject to the existing 
recordkeeping requirements.
---------------------------------------------------------------------------

    \964\ See rule 204-2(a)(16); See Great Lakes Letter (not 
recommending enforcement action and stating the staff's view that 
the requirement in rule 204-2(a)(16) applies to a successor's use of 
a predecessor's performance data).
---------------------------------------------------------------------------

    Under the baseline, there are no recordkeeping requirements for the 
communications of solicitors, except for the disclosure documents that 
solicitors are required to provide to clients pursuant to the current 
solicitation rule. Investment advisers that currently use solicitors 
will incur additional costs associated with the substantive changes to 
the final recordkeeping requirements discussed in this section, as well 
as the expansion of the definition of advertisement to include 
testimonials and endorsements. In addition, given that the 
recordkeeping obligations fall upon investment advisers and not their 
promoters, we do not anticipate this provision will generate 
substantial costs or benefits for promoters.
    We have quantified a subset of the costs associated with the 
recordkeeping provisions, specifically, the burden of information 
collection costs estimated for the purposes of the Paperwork Reduction 
Act. The amendments to the recordkeeping requirements will cause

[[Page 13115]]

investment advisers to incur annual ongoing costs related to the 
creation and retention of records. We estimate these costs to have a 
total cost of $16,636,198 per year.\965\
---------------------------------------------------------------------------

    \965\ See infra section IV.D.
---------------------------------------------------------------------------

E. Efficiency, Competition, Capital Formation

    We believe the final amendments could have positive effects on 
efficiency, competition, and capital formation. As discussed below, we 
expect the amendments could improve efficiency by improving the 
quantity and quality of information in advertisements. Further, if 
investors are thereby able to make more informed decisions about 
investment advisers and more easily learn about the ability and 
potential fit of investment advisers, investment advisers might have a 
stronger incentive to invest in the quality of their services, which 
could promote increased competition among investment advisers. However, 
if advertisements attract customers for investment advisers in a manner 
unrelated to the quality of their services, competition among 
investment advertisers could result in an inefficient ``arms race.'' To 
the extent that the final rule results in improved matches in the 
market for investment advice, potential investors may be drawn to 
invest additional capital, which could promote capital formation.
1. Efficiency
    The final rules have the potential to improve the information in 
investment adviser advertisements by improving the quantity and quality 
of information available to investors. This in turn could improve the 
efficiency of the market for investment advice in two ways.
    First, the final rule could increase the overall amount of 
information in investment adviser advertisements by increasing the 
types of information that investment advisers include in their 
advertisements and prescribing requirements and restrictions on the 
presentation of certain kinds of information in adviser and private 
fund advertisements. This could either be directly through the 
provisions of the rule, or indirectly, through competition among 
investment advisers on how informative their advertisements are. For 
example, to the extent that the rules and rescission of existing no-
action letters increase certainty for advisers and thereby reduce 
compliance costs, advisers may increase their use of the types of 
marketing activities covered by the final rules. This may increase 
investor access to information regarding the ability and potential fit 
of investment advisers, which may improve the quality of the matches 
that investors make with investment advisers. In addition, 
advertisements can improve the efficiency of the investment adviser 
search process through the investor protections and disclosures that 
the final rule will provide. On the other hand, investment advisers, 
promoters, and related personnel may reduce the overall amount of 
information in these communications, because of the expanded definition 
of an advertisement and related costs imposed on communications newly 
brought within the definition, which could reduce the overall 
efficiency of an investor's investment adviser search.
    The information from testimonials, endorsements, performance data, 
and third-party ratings presented in accordance with the provisions of 
the rule can potentially provide valuable information for investors. 
Better informed investors could improve the efficiency of the market 
for investment advice by improving the matches between investors and 
investment advisers and reducing search costs, as they may be better 
able to evaluate investment advisers based on the information in their 
advertisements.\966\ To the extent that the rule improves the 
usefulness of the recommendations of non-cash compensated promoters, 
another programmatic benefit of the rule is that it may improve the 
efficiency of matches between investment advisers and investors.
---------------------------------------------------------------------------

    \966\ See supra section III.B.
---------------------------------------------------------------------------

    Although the final rule requires additional disclosures when 
investment advisers include certain elements in their advertisements, 
the value of these disclosures to investors depends on the extent to 
which investors are able to utilize the disclosures to better 
understand the context of an adviser's claims. By providing information 
to investors in the required disclosures to aid their evaluation of an 
adviser's advertisements, these disclosures could mitigate the 
potential that advertisements mislead investors, and improve their 
ability to find the right investment adviser for their needs.
    Second, the final rule could increase the overall quality of 
information about investment advisers. To the extent that the rules 
mitigate misleading or fraudulent advertising practices, investors may 
be more likely to believe the claims of investment adviser 
advertisements. Because information in advertisements is more likely to 
increase the number of investors interested in an investment adviser, 
advisers may include more information that will improve the choices of 
investors. One potential consequence of modifying the regulatory 
standards for advertisements provided by the final rule is that 
investment advisers may increase the amount of resources they allocate 
to advertising their services (including resources aimed to address 
compliance with the final rule). While additional spending on 
advertisements may facilitate matching between investment advisers and 
investors, under some circumstances, this additional spending may be 
inefficient if the benefits of better matches fall short of the 
resources required to facilitate better matches.
    The final rule also merges certain solicitation activity into the 
definitions of testimonials and endorsements and expands the scope by 
covering all forms of compensation. The rule also includes persons 
providing testimonials or endorsements to investors in a private fund. 
In addition, the rule will continue to require disclosures to make 
salient the nature of the relationship between a promoter and the 
investment advisers. These provisions could improve the efficiency of 
the market for promoters and their investment advisers by ensuring that 
the provisions for testimonials and endorsements apply to all forms of 
potential conflicts of interest. If investors are aware of these 
conflicts of interest through disclosures, they may be better able to 
interpret testimonials and endorsements and choose an investment 
adviser that is of higher quality, or a better match.
2. Competition
    As discussed earlier, the final rule might result in an increase in 
the efficiency of investment adviser advertisements, providing more 
useful information to investors about the abilities of an investment 
adviser than advertisements under the baseline, which would allow them 
to make better decisions about which investment advisers to 
choose.\967\ In this case, if investors make more informed decisions 
about investment advisers based on the content of their advertisements, 
investment advisers might have a stronger incentive to invest in the 
quality of their services, as the final rule will permit them more 
flexibility to communicate the higher quality of their services by 
providing additional information about their services. This could 
promote competition among investment advisers based on the

[[Page 13116]]

quality of their services, and result in a benefit for investors.
---------------------------------------------------------------------------

    \967\ See supra section III.B.
---------------------------------------------------------------------------

    However, the final rule might instead provide investment advisers 
with a stronger incentive to invest in the quality of their 
advertisements rather than the quality of their services. If investment 
advisers increase spending on advertisements in a way that does not 
improve the information quality in advertisements, but still attracts 
investors, the competition could potentially be inefficient. Although 
the direct costs of advertisements would be borne by the investment 
adviser, it is possible that some portion of the costs of advertisement 
will be indirectly borne by investors.\968\ As a result, investments in 
advertisements may result in higher fees for investors.
---------------------------------------------------------------------------

    \968\ Firms that face a change in costs will bear some portion 
of these costs directly, but will also pass a portion of the cost to 
their consumers through the price. In a competitive market, the 
portion of these costs that firms are able to pass on to consumers 
depends on the relative elasticities of supply and demand. For 
example, if demand for investment adviser services is elastic 
relative to supply of investment adviser services, investment 
advisers will be limited in their ability to pass through costs. For 
more, see Mankiw, Gregory, Principles of Economics (2017).
---------------------------------------------------------------------------

    The final rule has conditions that can affect market participants 
in different ways. For example, the final rule's restriction on the 
presentation of performance results unless results for one, five, and 
ten year periods are presented does not restrict the presentation of 
performance of private funds. This could give investment advisers that 
are able to advertise both private funds and general funds more options 
in how they advertise performance, and provide them a competitive 
advantage over investment advisers that only advertise non-fund 
performance. Further, to the extent that advisers increase their usage 
of compensated testimonials or endorsements as a result of the final 
rule, this could provide competitive advantages to advisers who are 
better able to pay fees for such testimonials or endorsements, or for 
larger firms who have larger audiences with which to leverage favorable 
testimonials and endorsements.\969\ In addition, provisions for 
different types of performance advertising can have a disparate impact 
on newer investment advisers versus older ones. Generally, newer 
investment advisers have fewer performance advertising options and 
shorter performance histories than older investment advisers, and might 
prefer to rely on hypothetical or related performance advertising. To 
the extent that the final rule's provisions place different 
requirements on these types of performance, newer investment advisers 
could face competitive disadvantages relative to older investment 
advisers.
---------------------------------------------------------------------------

    \969\ See NAPFA Comment Letter.
---------------------------------------------------------------------------

    In addition, the final rule affects current solicitors by including 
non-cash compensation in the scope of the rule's requirements for 
testimonials and endorsements. The final rule could improve competition 
among investment advisers and solicitors by subjecting all forms of 
compensation for testimonials and endorsements to the same 
requirements, and not imposing a higher regulatory burden on solicitors 
compensated in cash and their respective investment advisers do not 
receive a higher regulatory burden. Under the final rule, providers of 
testimonials or endorsements that prefer or accept cash compensation 
for their activities will not be subject to a higher burden relative to 
persons that prefer or accept non-cash compensation. In addition, non-
cash compensated promoters will bear additional costs associated with 
being scoped into the marketing rule. We expect that some portion of 
these costs will be passed onto investors through higher fees.
    Differences in the scope of disqualification between investment 
advisers subject to the disqualification provisions in this final rule, 
broker-dealers, and promoters of private funds under Regulation D may 
create competitive disparities in the personnel that are available to 
provide testimonials or endorsements. Investment advisers that operate 
as broker-dealers or advise private funds might have more flexibility 
to use personnel that might be disqualified from providing testimonials 
or endorsements under the final rule, but are not disqualified under 
section 3(a)(39) of the Exchange Act for broker-dealers or Regulation D 
for advisers of private funds. This flexibility could impose an uneven 
burden on investment advisers, as those that are also registered as 
broker-dealers or broker-dealer affiliates, or advise private funds, 
will potentially able to draw upon a larger pool of personnel to 
provide testimonials or endorsements.
3. Capital Formation
    To the extent that the final rule results in improved matches in 
the market for investment advice, potential investors may be drawn to 
invest additional capital, which could promote capital formation, to 
the extent that the additional capital does not reduce other forms of 
capital formation. However, the final rule could induce some investment 
advisers to increase their advertising such that the additional 
expenses of advertising may offset any gains to the quality of matches 
with investors.\970\ In this case, any benefits to capital formation as 
a result of the final rule could be reduced or eliminated.
---------------------------------------------------------------------------

    \970\ See supra sections III.E.1 and III.E.2.
---------------------------------------------------------------------------

    Similarly, if the costs associated with the disclosure, oversight, 
and recordkeeping requirements of the final rule result in a reduction 
of advertisements, the information available to investors might 
decrease. This could decrease the quality of matches between investors 
and investment advisers, leading investors to divert capital away from 
investment to other uses, hindering capital formation.
    The final rule's expansion of the types of compensation subject to 
solicitor regulation for providers of testimonials or endorsements 
might improve the efficiency of the ultimate choice of investment 
adviser that investors make. Improving the efficiency of the investment 
adviser selection process could improve the efficiency of the investing 
overall for investors, which may lead them to devote more capital 
towards investment. In addition, the final rule expands the set of 
disqualifying events that would bar an adviser from compensating an 
individual to provide a testimonial or endorsement, which may improve 
an investor's confidence in a testimonial or endorsement's 
recommendation of an investment adviser, which, in turn, could lead 
investors to allocate more of their resources towards investment, thus 
promoting capital formation.

F. Reasonable Alternatives

1. Reduce or Eliminate Specific Limitations on Investment Adviser 
Advertisements
    We could change the degree to which the marketing rule relies on 
specific limitations on investment adviser marketing. One alternative 
to the marketing rule would be reducing or eliminating specific 
limitations on investment adviser advertising, and instead relying on 
general prohibitions to achieve the programmatic benefits of the rule. 
For example, such an alternative might include reducing or eliminating 
the specific limitations on the different types of hypothetical 
performance or testimonials and endorsements. The specific prohibitions 
of the final rule are prophylactic in nature, and many of the 
advertising practices described in the specific prohibitions would also 
be prohibited under the general prohibition on fraud

[[Page 13117]]

and deceit in section 206 of the Act, among other provisions.\971\
---------------------------------------------------------------------------

    \971\ For anti-fraud provisions applicable to the marketing of 
private funds, see Section 17(a) of the Securities Act, Section 
10(b) of the Exchange Act, rule 10b-5, and rule 206(4)-8 under the 
Advisers Act.
---------------------------------------------------------------------------

    As a consequence, advisers might bear greater compliance costs in 
interpreting the rule or may otherwise restrict their advertising 
activities unnecessarily, and may reduce their advertising as a result. 
Alternatively, advisers may face lower compliance costs associated with 
the specific prohibitions. In addition, under such an approach, 
investors may also not obtain some of the benefits associated with the 
final rule. For example, in the absence of a specific advertising rule, 
investors would not necessarily obtain the benefits associated with the 
comparability of performance presentations provided in the proposed 
rule, or the requirement to provide performance over a variety of 
periods (except in private fund advertisements) so that an investor may 
sufficiently evaluate the adviser's performance. Investors would also 
not benefit from the specific protections against the potential for 
misleading hypothetical performance contained in the final rule, such 
as the requirement to have policies and procedures designed to ensure 
that such performance is relevant to the likely financial situation and 
investment objectives of the investor and includes sufficient 
disclosures to enable persons receiving it to understand how it is 
calculated and the risks and limitations of relying on it. Although 
some advisers might provide such information, even in the absence of 
the final specific requirements to help ensure that their performance 
presentations comply with section 206 of the Act or other applicable 
anti-fraud provisions, others may not. As a consequence, this approach 
may benefit certain advisers by allowing them to avoid the costs of the 
specific requirements of the final rule, but investors would not 
receive the benefit of the other protections of the rule.
    One variation of this alternative would be to eliminate the 
marketing rule and instead rely solely on the general prohibitions 
against fraud or deceit in section 206 of the Advisers Act and certain 
rules thereunder. Under such an approach, a rule specifically targeting 
adviser advertising practices might be unnecessary. In the absence of a 
marketing rule, however, an adviser might have not sufficient clarity 
and guidance on whether certain advertising practices would likely be 
fraudulent and deceptive. As a consequence, advisers may bear costs in 
obtaining such guidance or may otherwise restrict their advertising 
activities unnecessarily in the absence of such clarity and guidance 
that would be provided through a rule, and may reduce their advertising 
as a result.
    Conversely, another alternative to the marketing rule would be to 
make the rule more prescriptive, prescribing certain specific and 
standardized disclosures in lieu of the principles-based approach of 
the final rule. On the one hand, such an approach may provide investors 
with disclosures that may be more comparable across advisers, and ease 
the costs associated with interpretation and compliance. However, 
standardized disclosures could both impose costs on investment advisers 
by requiring disclosures when they might not provide much investor 
protection benefit, and also not require disclosures when an investor 
might benefit from one. The broad framework of the final rule is 
designed to permit investment advisers to tailor their disclosures to 
their specific marketing practices, subject to certain specific 
requirements.
    A related alternative to the final rule would be to align the 
marketing rule more closely with FINRA rule 2210 and related rules. 
FINRA rule 2210 governs broker-dealers' communications with the public, 
including communications with retail and institutional investors, and 
provides standards for the content, approval, recordkeeping, and filing 
of communications with FINRA.\972\ To the extent that such an 
alternative resembles Rule 2210, this alternative might impose lower 
compliance cost burdens for dual-registrants who are subject to Rule 
2210 and related rules than under the final rule. However, as discussed 
above, standardized disclosures for investment advisers could be over- 
or under-inclusive given the variety of investment advisory services 
and advertising practices associated with investment advisers, and we 
believe that the final rule's approach of providing advisers' with a 
broad framework within which to determine how best to present 
advertisements so they are not false and misleading is consistent with 
the features of the market for investment advice.\973\ Further, because 
FINRA rule 2210 does not contain similar provisions to all of the 
requirements of the final rule, this alternative would not have offered 
the same investor protections of the final rule. For example, FINRA 
rule 2210 does not contain a similar provision to the final rule's 
requirement to disclose compensation for a solicitation or referral or 
for the conflict of interest that results.\974\
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    \972\ See supra section III.C.1.b.
    \973\ See supra footnote 279 and accompanying text for a 
discussion of comments we received on this point.
    \974\ See supra section II.C.5.c.
---------------------------------------------------------------------------

2. Bifurcate Some Requirements
    One alternative to the final rule would be to separate requirements 
of the originally proposed rule that currently apply to all 
advertisements. For example, one alternative approach to regulation 
that we considered is prohibiting hypothetical performance in 
advertisements to retail investors, but not others, provided that 
certain disclosures were made.
    Evidence from academic research suggests that investors are highly 
segmented in their financial literacy and access to resources.\975\ The 
fact that certain market segments are susceptible to misconduct 
suggests that the lack of financial literacy or access to resources may 
also leave them susceptible to false or misleading statements in 
advertisements or solicitations.
---------------------------------------------------------------------------

    \975\ See Financial Literacy Study, supra footnote 846. See also 
Mark Egan, Gregor Matvos and Amit Seru, The Market for Financial 
Adviser Misconduct, 127 J. Pol. Econ. 233 (2019). The paper uses the 
term ``financial advisors,'' to refer to broker-dealer 
representatives. The authors argue that broker-dealer 
representatives target different groups of investors and that this 
segmentation permits firms with high tolerance for misconduct on the 
part of their associated persons to coexist with firms maintaining 
clean records in the current market. They find that misconduct is 
more common among firms that advise retail investors, and in 
counties with low education, elderly populations and high incomes 
(when controlling for other characteristics).
---------------------------------------------------------------------------

    Tailoring requirements to suit the segmented nature of the market 
for investment advice may yield benefits to investor protection for 
investors with lower financial literacy or access to resources, as 
advertisements directed towards these specific market segments 
vulnerable to misleading statements would face additional requirements. 
Similarly, advertisements not directed towards those segments would 
benefit from additional flexibility and information contained in these 
advertisements. However, bifurcating the requirements in the final rule 
might also impose additional costs on investment advisers, who may need 
to expend additional resources to create advertisements that complied 
with two increasingly different sets of requirements.

[[Page 13118]]

3. Hypothetical Performance Alternatives
    One alternative to the final rule's treatment of hypothetical 
performance would be to prohibit all forms of hypothetical performance 
in all advertisements. The Commission considered this alternative 
because it believes hypothetical performance generally presents a high 
risk of misleading investors. This alternative would eliminate the 
possibility that investors are misled by hypothetical performance, but 
also eliminates the possibility that investors might gain useful 
information from some types of hypothetical information. This 
additional information might have been useful for improving the quality 
of the matches that investors make with investment advisers. While a 
prohibition on hypothetical performance might improve the efficiency of 
investment adviser advertising by reducing the chance that investors 
are misled by advertisements, efficiency can also be reduced if 
investors are less able to receive relevant information about the 
investment adviser.
    Conversely, another alternative would be to permit all hypothetical 
performance in all advertisements, without any additional requirements. 
This could increase the relevant hypothetical performance that reaches 
investors. While such statements would still be subject to the final 
rule's general prohibitions, we believe that this approach would still 
pose a high risk that hypothetical performance would mislead investors. 
This approach would lack the final rule's protections that are designed 
to help ensure that hypothetical performance is disseminated to 
investors who have access to the resources to independently analyze 
this information and who have the financial expertise to understand the 
risks and limitations of these types of presentations.
4. Alternatives to the Combined Marketing Rule
    In the proposal, we also considered retaining separate advertising 
and solicitation rules and instead updating and clarifying each rule 
separately. However, in the proposal the advertising rule was expanded 
to permit advertisements containing testimonials and endorsements, 
subject to certain requirements, which had the potential to subject 
promoters and solicitors to duplicative requirements from both the 
advertising and the solicitation rule. These duplicative requirements 
would have imposed additional costs to promoters and their investment 
advisers, and potentially decreased the usefulness of the disclosures 
made to investors.
    We also considered the alternative of not applying the final 
amended merged marketing rule to the solicitation of existing and 
prospective private fund investors. Under this alternative, the rule 
would apply only to the adviser's clients (including prospective 
clients), which, in the case of funds, are the private funds 
themselves, and would not apply to investors in private funds. However, 
while investors in private funds may often be financially 
sophisticated, they may not be aware that the person engaging in the 
solicitation activity may be compensated by the adviser or aware of the 
other disclosure items that we are requiring, and we believe investors 
in such funds should be informed of that fact, those disclosure items 
and the related conflicts. In addition, we believe that the application 
of the final merged marketing rule to investors in private funds is 
consistent with the portions of the rule that concern investment 
adviser advertising. This consistency could avoid any competitive 
disparities between investment advisers that advise private funds and 
those that do not, and reduce the costs that investment advisers bear, 
by potentially removing costs associated with identifying whether the 
target of a communication is a private fund investor or not. We believe 
that harmonizing the scope of the merged rule with the advertising 
portions of the rule to the extent possible should ease compliance 
burdens.
5. Alternatives to Disqualification Provisions
    We also considered an alternative to current rule 206(4)-3 wherein 
the disqualification provisions of the rule would not apply if the 
solicitor has performed solicitation activities for the investment 
adviser during the preceding twelve months and the investment adviser's 
compensation payable to the solicitor for those solicitation activities 
was $1,000 or less (or the equivalent value in non-cash compensation). 
We considered the alternative of not having any de minimis exemption in 
the proposal, which would expand the set of individuals for whom the 
investment adviser would need to assess for disqualification, 
potentially extending the costs and benefits of the proposed 
solicitation rule to these solicitation activities, we believe the 
solicitor's incentives to defraud an investor are significantly reduced 
when receiving de minimis compensation, and that the need for 
heightened safeguards is likewise reduced.
    Conversely, we also considered the alternative of adopting a higher 
threshold for a de minimis exemption. However, we believe that an 
aggregate $1,000 de minimis amount over a trailing year period is 
consistent with our goal of providing an exception for small or nominal 
payments. Regarding the trailing period, we understand that a very 
engaged solicitor who is paid even a small amount per referral could 
potentially receive a significant amount of compensation from an 
adviser over time even if the solicitor receives less than $1,000 per 
year. Over multiple years, such an investment adviser's compensation 
could accumulate to a more significant amount. In such a case we 
believe that investors should be informed of the conflict of interest 
and gain the benefit of the other provisions of the rule.

IV. Paperwork Reduction Act Analysis

A. Introduction

    Certain provisions of our rule amendments will result in new 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\976\ The rule amendments 
will have an impact on the current collection of information burdens of 
rule 204-2 under the Investment Advisers Act (``the Act'') and Form 
ADV. The title of the new collection of information we are proposing is 
``Rule 206(4)-1 under the Investment Advisers Act.'' The Office of 
Management and Budget (``OMB'') has not yet assigned a control number 
for ``Rule 206(4)-1 under the Investment Advisers Act.'' The titles for 
the existing collections of information that we are amending are: (i) 
``Rule 206(4)-3 under the Investment Advisers Act of 1940 (17 CFR 
275.206(4)-3)'' (OMB number 3235-0242); (ii) ``Rule 204-2 under the 
Investment Advisers Act of 1940'' (OMB control number 3235-0278); and 
(iii) ``Form ADV'' (OMB control number 3235-0049). The Commission is 
submitting these collections of information to OMB for review and 
approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An 
agency may not conduct or sponsor, and a person is not required to 
respond to, a collection of information unless it displays a currently 
valid OMB control number.
---------------------------------------------------------------------------

    \976\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    We published notice soliciting comments on the collection of 
information requirements in the 2019 Proposing Release and submitted 
the

[[Page 13119]]

proposed collections of information to OMB for review and approval in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Although we 
received no comments directly on the proposed collections of 
information burdens, we did receive three comments on aspects of the 
economic analysis that implicated estimates we used to calculate the 
collection of information burdens. Two commenters generally stated that 
advisers would disseminate new advertisements and update existing 
advertisements much more frequently than estimated in our proposal, due 
to the proposed expanded definition of advertisement.\977\ Two other 
commenters suggested that our assumptions underestimated the amount of 
time and costs required to implement the proposed amendments to the 
advertising and solicitation rules.\978\ We address these comments 
below.
---------------------------------------------------------------------------

    \977\ Fidelity Comment Letter; IAA Comment Letter.
    \978\ MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

    We discuss below the new collection of information burdens 
associated with the amendments to rule 206(4)-1, as well as the revised 
existing collection of information burdens associated with the 
amendments to rule 204-2 and Form ADV. There will no longer be a 
collection of information burden with respect to rule 206(4)-3 because 
we are rescinding this rule. Responses provided to the Commission in 
the context of its examination and oversight program concerning the 
amendments to rule 206(4)-1 and rule 204-2 will be kept confidential 
subject to the provisions of applicable law. However, because some of 
the information collection pursuant to rule 206(4)-1 requires 
disclosures to investors, these disclosures will not be kept 
confidential. Responses to the disclosure requirements of the 
amendments to Form ADV, which are filed with the Commission, are not 
kept confidential.

B. Rule 206(4)-1

    The marketing rule states that, as a means reasonably designed to 
prevent fraudulent, deceptive, or manipulative acts, practices, or 
courses of business within the meaning of section 206(4) of the Act, it 
is unlawful for any investment adviser registered or required to be 
registered under section 203 of the of the Act, directly or indirectly, 
to disseminate any advertisement that violates any of paragraphs (a) 
through (d) of the rule, which include the rule's general prohibitions, 
as well as conditions applicable to an adviser's use of testimonials, 
endorsements, third-party ratings, and performance information.\979\
---------------------------------------------------------------------------

    \979\ Final rule 206(4)-1(b), (c).
---------------------------------------------------------------------------

    Each requirement under the final rule that an adviser disclose 
information, offer to provide information, or adopt policies and 
procedures constitutes a ``collection of information'' requirement 
under the PRA. The respondents to these collections of information 
requirements will be investment advisers that are registered or 
required to be registered with the Commission. As of August 1, 2020, 
there were 13,724 investment advisers registered with the 
Commission.\980\ Investment adviser marketing is not mandatory; 
however: (i) Marketing is an essential part of retaining and attracting 
clients; (ii) marketing may be conducted easily through the internet 
and social media; and (iii) the definition of ``advertisement'' expands 
the scope of the advertising rule. Accordingly, we estimate that all 
investment advisers will disseminate at least one communication that 
meets the rule's definition of ``advertisement'' and therefore be 
subject to the requirements of the marketing rule.
---------------------------------------------------------------------------

    \980\ See supra section III.C.1.c.
---------------------------------------------------------------------------

    While commenters claimed that our assumptions in the proposal 
significantly underestimated the scope of communications that would 
constitute an advertisement under the proposed amendment to the 
advertising rule, we made several modifications versus the proposal 
that will reduce the amount of communications subject to the rule to 
address commenters' concerns.\981\ For example, the marketing rule will 
exclude certain one-on-one communications from the first prong of the 
definition and communications to current clients that do not offer new 
or additional advisory services. These changes from the proposal will 
significantly reduce the scope of communications subject to the 
marketing rule.
---------------------------------------------------------------------------

    \981\ See MFA/AIMA Comment Letter I; Fidelity Comment Letter.
---------------------------------------------------------------------------

    Because the use of testimonials, endorsements, third-party ratings, 
and performance results in advertisements is voluntary, the percentage 
of investment advisers that would include these items in an 
advertisement is uncertain. However, we have made certain estimates of 
this data, as discussed below, solely for the purpose of this PRA 
analysis.
1. General Prohibitions
    The general prohibitions under the rule do not create a collection 
of information and are, therefore, not discussed, with one exception. 
The final rule will prohibit advertisements that include a material 
statement of fact that the adviser does not have a reasonable basis for 
believing that it will be able to substantiate upon demand by the 
Commission. As discussed above, advisers would be able to demonstrate 
this reasonable belief in a number of ways.\982\ For example, they 
could make a record contemporaneous with the advertisement 
demonstrating the basis for their belief. An adviser might also choose 
to implement policies and procedures to address how this requirement is 
met. This will create a collection of information burden within the 
meaning of the PRA.
---------------------------------------------------------------------------

    \982\ See supra section II.B.2.
---------------------------------------------------------------------------

    As stated above, we estimate that all investment advisers will 
disseminate at least one communication that meets the rule's definition 
of ``advertisement'' and therefore be subject to the requirements of 
the marketing rule. We also estimate that such advertisements will 
include at least one statement of material fact that will be subject to 
this general prohibition, for which an adviser will create and/or 
maintain a record documenting its reasonable belief that it can 
substantiate the statement. This estimate reflects that many types of 
statements typically included in an advertisement (e.g. performance) 
can likely be substantiated by other records that an adviser will be 
required to create and maintain under the final rule.\983\ Table 1 
summarizes the final PRA estimates for the internal and external 
burdens associated with this requirement.
---------------------------------------------------------------------------

    \983\ See supra section II.B.2.

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[[Page 13120]]

[GRAPHIC] [TIFF OMITTED] TR05MR21.001

2. Testimonials and Endorsements in Advertisements
    Under the marketing rule, investment advisers are prohibited from 
including in any advertisement, or providing any compensation for, any 
testimonial or endorsement unless the adviser discloses, or the 
investment adviser reasonably believes that the person giving the 
testimonial or endorsement discloses: (i) Clearly and prominently: (A) 
That the testimonial was given by a current client or investor, or the 
endorsement was given by a person other than a current client or 
investor; (B) that cash or non-cash compensation was provided for the 
testimonial or endorsement, if applicable; and (C) a brief statement of 
any material conflicts of interest on the part of the person giving the 
testimonial or endorsement resulting from the investment adviser's 
relationship with such person; (ii) the material terms of any 
compensation arrangement, including a description of the compensation 
provided or to be provided, directly or indirectly, to the person for 
the testimonial or endorsement; and (iii) a description of any material 
conflicts of interest on the part of the person giving the testimonial 
or endorsement resulting from the investment adviser's relationship 
with such person and/or any compensation arrangement.\984\ The rule 
also imposes an oversight obligation that requires that an investment 
adviser have a reasonable basis to believe that the testimonial or 
endorsement complies with the marketing rule and have a written 
agreement with the person giving a testimonial or endorsement (except 
for certain affiliated persons of the adviser) that describes the scope 
of the agreed upon activities and the terms of the compensation for 
those activities when making payments for compensated testimonials and 
endorsements that are above the de minimis threshold.\985\ This 
collection of information consists of two components: (i) The 
requirement to disclose certain information in connection with the 
testimonial and endorsement, and (ii) the requirement to oversee the 
testimonial or endorsement, including a written agreement with certain 
persons giving the testimonial or endorsement.
---------------------------------------------------------------------------

    \984\ Final rule 206(4)-1(b)(1).
    \985\ Id.
---------------------------------------------------------------------------

    The final rule's definitions of testimonials and endorsements 
generally contain three elements: (i) Statements about the client's/
non-client's or investor's experience with the investment adviser or 
its supervised persons, (ii) statements that directly or indirectly 
solicit any prospective client or investor in a private fund for the 
investment adviser, or (iii) statements that refer any prospective 
client or investor in a private fund to the investment adviser. The 
first element is drawn from the definitions of these terms in our 
proposed advertising rule. The second and third elements are drawn from 
the scope of our proposed solicitation rule.\986\ Accordingly, our PRA 
analysis will be drawn from our proposed estimates and discussion of 
both proposed rules in the 2019 Proposing Release.\987\
---------------------------------------------------------------------------

    \986\ Id.
    \987\ See 2019 Proposing Release, supra footnote 7, at section 
IV.
---------------------------------------------------------------------------

    In our advertising rule proposal, from which the first element of 
these definitions is drawn, we estimated that 50 percent of advisers 
would include a testimonial or endorsement under the proposed 
advertising rule. We also estimated in our advertising proposal that an 
investment adviser that includes testimonials or endorsements in 
advertisements would use approximately 5 testimonials or endorsements 
per year, and would create new advertisements with new or updated 
testimonials and endorsements approximately once per year. In the 
solicitation rule proposal, from which elements two and three of the 
definitions are drawn, we estimated that 47.8 percent of advisers would 
compensate a solicitor for solicitation activity under the proposed 
solicitation rule.\988\ We also estimated in our proposal that for each 
registered investment adviser that would conduct solicitation activity, 
they would use approximately 30 referrals annually, distributed by an 
average of three solicitors. We did not receive comment on any of these 
estimates.
---------------------------------------------------------------------------

    \988\ See 2019 Proposing Release, supra footnote 7, at section 
IV.
---------------------------------------------------------------------------

    We are revising our estimates from the advertising rule proposal to 
account for the merger of solicitation concepts into the definitions of 
testimonial and endorsement. We continue to estimate that 50 percent of 
advisers will use a testimonial or endorsement; however,

[[Page 13121]]

we are increasing our estimate of the amount of testimonials and 
estimates each adviser will use to reflect the definitions' inclusion 
of solicitation concepts.\989\ Accordingly, we estimate that each 
adviser will use an average of five promoters and use 35 testimonials 
or endorsements annually, which includes testimonials and endorsements 
incorporated into an adviser's own advertisement and those communicated 
by promoters directly. This estimate also reflects the elimination of 
the proposed exemptions for solicitations for impersonal advisory 
services or by non-profit referral programs, as well as the addition of 
the final rule's exemptions for registered broker-dealers and ``covered 
persons'' under rule 506(d) of Regulation D.
    Under the marketing rule, an adviser that uses a testimonial or 
endorsement will be required to disclose certain information at the 
time it is disseminated, which incorporates many of the disclosure 
elements required under the proposed solicitation rule. As such, we are 
drawing from the burden estimate we attributed to solicitation 
disclosures in the 2019 Proposing Release in developing the burden 
estimate for all testimonials and endorsements under the final rule, 
not just for the types of testimonials and endorsements that were drawn 
from the proposed rule. To address one commenter's contention that we 
underestimated this burden, and recognizing the changes from the 
proposal, we are revising this estimate upwards to 0.20 hours per 
disclosure.\990\ We believe that advisers will incur this same burden 
each year, since each testimonial and/or endorsement used will likely 
be different and thus require updated disclosures. An investment 
adviser's in-house compliance managers and compliance attorneys will 
likely prepare disclosures, which will likely be included in the 
advertisement.\991\
---------------------------------------------------------------------------

    \990\ MFA/AIMA Comment Letter I.
    \991\ We estimate the hourly wage rate for compliance manager is 
$309 and a compliance attorney is $337. The hourly wages used are 
from SIFMA's Management & Professional Earnings in the Securities 
Industry 2013 (``SIFMA Report''), modified by Commission staff to 
account for an 1800-hour work-year and inflation, and multiplied by 
5.35 to account for bonuses, firm size, employee benefits, and 
overhead.
---------------------------------------------------------------------------

    Some of these third-party testimonials and endorsements will 
require delivery; thus, we estimate that 20 percent of the disclosures 
would be delivered by the U.S. Postal Service, with the remaining 80 
percent delivered electronically or as part of another delivery of 
documents. For the 20% of advisers that will use physical mail, we 
estimate that the average annual costs associated with printing and 
mailing this information will be collectively $500 for all disclosure 
documents associated with a single registered investment adviser.\992\
---------------------------------------------------------------------------

    \992\ We do not have specific data regarding how the cost of 
printing and mailing the underlying information would differ, nor 
are we able to specifically identify how the cost of printing and 
mailing the underlying information might be affected by the rule. 
For these reasons, we estimate $500 per year to collectively print 
and mail, upon request, the underlying information associated with 
hypothetical performance for purposes of our analysis. In addition, 
investors may also request to receive the underlying information 
electronically. We estimate that there would be negligible external 
costs associated with emailing electronic copies of the underlying 
information.
---------------------------------------------------------------------------

    We estimate the average burden hours each year per adviser to 
oversee testimonials and endorsements will be one hour for each 
promoter, or five hours in total for each adviser that is subject to 
this collection of information.\993\ While the final rule provides 
flexibility as to how advisers conduct this oversight, we generally 
believe that this burden will include contacting solicited clients, 
pre-reviewing testimonials or endorsements, or other similar methods. 
Additionally, we estimate that each adviser will incur an average 
burden hour of one hour for each promoter, or five hours in total, to 
prepare the required written agreements. In-house compliance managers 
and compliance attorneys are likely to provide oversight of the third 
party testimonials and endorsements and prepare the written agreements.
---------------------------------------------------------------------------

    \993\ This estimate is based on the following calculation: 1 
hour per each solicitor relationship x 5 promoter relationships. 
Although in our proposal we estimated that the oversight requirement 
would impose a burden of 2 hours per adviser, we believe that 
because the marketing rule does not require a written agreement, the 
burden to oversee the promoter relationship will be less than 
proposed.
---------------------------------------------------------------------------

    Finally, in response to one commenter who argued that we did not 
account for upfront implementation costs for using testimonials and 
endorsements, we estimate that each adviser that uses a compensated 
testimonial or endorsement will incur an initial burden of two hours to 
modify its policies and procedures to reflect the adviser's oversight 
of testimonials and endorsements.\994\ We believe that an adviser's 
chief compliance officer will complete this task.\995\ Table 2 
summarizes the final PRA estimates for the internal and external 
burdens associated with these requirements.
---------------------------------------------------------------------------

    \994\ MFA/AIMA Comment Letter I. Accordingly, the amortized 
average burden will be 0.67 hours for each of the first 3 years.
    \995\ We estimate that the hourly wage for a chief compliance 
officer is $530. The hourly wage is from SIFMA's Management & 
Professional Earnings in the Securities Industry 2013, modified by 
Commission staff to account for an 1800-hour work-year and 
inflation, and multiplied by 5.35 to account for bonuses, firm size, 
employee benefits, and overhead.

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[[Page 13122]]

[GRAPHIC] [TIFF OMITTED] TR05MR21.002

3. Third-Party Ratings in Advertisements
    As discussed above, rule 206(4)-1(c) will prohibit an investment 
adviser from including a third-party rating in an advertisement unless 
certain conditions are met, including that the adviser must clearly and 
prominently disclose (or reasonably believe that the third-party rating 
clearly and prominently discloses): (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 cash or non-cash compensation has been 
provided directly or indirectly by the adviser in connection with 
obtaining or using the third-party rating.
    As discussed in the advertising rule proposal, we continue to 
believe that approximately 50 percent of advisers will use third-party 
ratings in advertisements, and that they will typically use one third-
party rating on an annual basis. We believe that advisers will incur an 
initial internal burden of 3.0 hours to draft and finalize the required 
disclosures for third-party ratings, which we are adjusting upwards 
from 1.5 hours in the advertising rule proposal to address one 
commenter's concern that we underestimated this burden.\996\ As 
discussed in the advertising rule proposal, because many of these 
ratings or rankings are done yearly (e.g., 2018 Top Wealth Adviser), we 
continue to estimate that an adviser that continues to use a third-
party rating will incur ongoing, annual costs of 0.75 burden hours to 
draft the third-party rating disclosure updates.\997\ Table 3 
summarizes the final PRA estimates for the internal and external 
burdens associated with these requirements.
---------------------------------------------------------------------------

    \996\ See MFA/AIMA Comment Letter I. Accordingly, we estimate 
that the amortized average burden will be 1 hour for each of the 
first 3 years for each investment adviser to comply with the 
conditions for including third-party ratings in an advertisement 
(3.0 hours/3 years = 1 hour). We believe that this burden will be 
split evenly between an adviser's compliance attorney and compliance 
manager.
    \997\ We believe that this burden will also be split evenly 
between an adviser's compliance attorney and compliance manager.

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[[Page 13123]]

[GRAPHIC] [TIFF OMITTED] TR05MR21.003

4. Performance Advertising
    The marketing rule will impose certain conditions on the 
presentation of performance results in advertisements, as discussed 
above. Below we discuss the conditions that create ``collection of 
information'' requirements within the meaning of the PRA. First, the 
rule will prohibit any presentation of gross performance unless the 
advertisement also presents net performance that meets certain 
criteria.\998\ Second, the rule will prohibit any presentation of 
performance results of any portfolio or any composite aggregation of 
related portfolios, other than any private fund, unless the 
advertisement includes performance results of the same portfolio or 
composite aggregation for one-, five-, and ten-year periods, except 
that if the relevant portfolio did not exist for a particular 
prescribed period, then the life of the portfolio must be substituted 
for that period.\999\ Third, the rule will prohibit an advertisement 
from including related performance, unless it includes all related 
portfolios, subject to a conditional exception.\1000\ Fourth, the rule 
will prohibit an advertisement from including extracted performance, 
unless the advertisement provides, or offers to provide promptly, the 
performance results of the total portfolio from which the performance 
was extracted.\1001\ Fifth, the rule will also prohibit an 
advertisement from including predecessor performance, unless certain 
conditions are satisfied.\1002\ Finally, the rule will require that an 
adviser that advertises hypothetical performance: (i) Adopts and 
implements policies and procedures reasonably designed to ensure that 
the hypothetical performance is relevant to the likely financial 
situation and investment objectives of the intended audience of the 
advertisement; (ii) provide reasonably sufficient information to enable 
the intended audience to understand the criteria used and assumptions 
made in calculating such hypothetical performance; and (iii) provide 
(or, if the intended audience is an investor in a private fund provide, 
or offers to provide promptly) reasonably sufficient information to 
enable the intended audience to understand the risks and limitations of 
using such hypothetical performance in making investment decisions.
---------------------------------------------------------------------------

    \998\ Final rule 206(4)-1(d).
    \999\ Id. at (d)(2).
    \1000\ Id. at (d)(4).
    \1001\ Id. at (d)(5).
    \1002\ Id. at (d)(7).
---------------------------------------------------------------------------

    We estimate that almost all advisers provide, or seek to provide, 
performance information to their clients. Based on staff experience, we 
estimate that 95 percent, or 13,038 advisers, provide performance 
information in their advertisements. The estimated numbers of burden 
hours and costs regarding performance results in advertisements may 
vary depending on, among other things, the complexity of the 
calculations, the type of performance and the risks that investors may 
not understand the limitations of the information, and whether 
preparation of the disclosures is performed by internal staff or 
outside counsel.
a. Presentation of Net Performance in Advertisements
    We estimate that an investment adviser that elects to present gross 
performance in an advertisement will incur an initial burden of 15 
hours in preparing net performance for each portfolio, including the 
time spent determining and deducting the relevant fees and expenses to 
apply in calculating the net performance and then actually running the 
calculations.\1003\ We have adjusted this estimate upwards from the 
proposal to reflect one commenter's claim that we underestimated this 
burden in the proposal.\1004\ Based on staff experience, we estimate 
that the average investment adviser will present performance for 3 
portfolios over the course of a year, excluding any related portfolios 
that an adviser may need to include for purposes of presenting related 
performance.\1005\ As noted above, we estimate that 95 percent, or 
13,038 advisers, provide performance information in their 
advertisements and

[[Page 13124]]

thus will be subject to this collection of information burden.
---------------------------------------------------------------------------

    \1003\ Accordingly, we estimate that the amortized initial 
burden will be 5 hours for each of the first 3 years for each 
investment adviser to prepare net performance (15 hours/3 years = 5 
hours/year). We believe that this burden will be split evenly 
between an adviser's compliance attorney and compliance manager (2.5 
hours each).
    \1004\ See MFA/AIMA Comment Letter I.
    \1005\ The burden associated with calculating net performance in 
connection with presenting related performance is discussed in 
section IV.B.3.c. below.
---------------------------------------------------------------------------

    We expect that the calculation of net performance may be modified 
every time an adviser chooses to update the advertised performance. We 
estimate that after initially preparing net performance for each 
portfolio, investment advisers will incur a burden of 3 hours to update 
the net performance for each subsequent presentation. Again, we 
adjusted this estimate upwards from the proposal to reflect one 
commenter's claim that we underestimated this burden in the 
analysis.\1006\ For purposes of this analysis, we estimate that 
advisers will update the relevant performance of each portfolio 3.5 
times each year.\1007\
---------------------------------------------------------------------------

    \1006\ See MFA/AIMA Comment Letter I.
    \1007\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (3 hours x 
3.5 times per year = 10.5 hours; 10.5 hours/2 = 5.25 hours each).
---------------------------------------------------------------------------

b. Time Period Requirement in Advertisements
    We estimate that an investment adviser that elects to present 
performance results in an advertisement will incur an initial burden of 
35 hours in preparing performance results of the same portfolio for 
one-, five-, and ten-year periods (excluding private funds), taking 
into account that these results must be prepared on a net basis (and 
may also be prepared and presented on a gross basis).\1008\ We estimate 
that after initially preparing one-, five-, and ten-year performance 
for each portfolio, investment advisers will incur a burden of 8 hours 
to update the performance for these time periods for each subsequent 
presentation. For purposes of this analysis, we estimate that advisers 
will update the relevant performance 3.5 times each year.\1009\ We 
received no comments on these estimates and continue to believe they 
are appropriate.
---------------------------------------------------------------------------

    \1008\ Accordingly, we estimate that the amortized initial 
burden will be 11.67 hours for each of the first 3 years for each 
investment adviser to prepare performance results that comply with 
this requirement (35 hours/3 years = 11.67 hours/year). We believe 
that this burden will be split evenly between an adviser's 
compliance attorney and compliance manager (5.83 hours each).
    \1009\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (8 hours x 
3.5 times per year = 28 hours; 28 hours/2 = 14 hours each).
---------------------------------------------------------------------------

c. Related Performance
    We estimate that an investment adviser that elects to present 
related performance in an advertisement will incur an initial burden of 
30 hours, with respect to each advertised portfolio or composite 
aggregation of portfolios, in preparing the relevant performance of all 
related portfolios.\1010\ We have revised this estimate upwards to 
address one commenter's claim that we underestimated this time burden 
in the proposal.\1011\ This time burden will include the adviser's time 
spent classifying which portfolios meet the rule's definition of 
``related portfolio''--i.e., which portfolios have ``substantially 
similar investment policies, objectives, and strategies as those of the 
services offered in the advertisement.'' \1012\ This burden also will 
include time spent determining whether to exclude any related 
portfolios in accordance with the rule's provision allowing exclusion 
of one or more related portfolios if ``the advertised performance 
results are not materially higher than if all related portfolios had 
been included'' and ``the exclusion of any related portfolio does not 
alter the presentation of the time periods prescribed by paragraph 
(d)(2).'' \1013\ Finally, this time burden will include the adviser's 
time calculating and presenting the net performance of any related 
performance presented.
---------------------------------------------------------------------------

    \1010\ Accordingly, we estimate that the amortized initial 
burden will be 10 hours for each of the first 3 years for each 
investment adviser to prepare related performance in connection with 
this requirement (30 hours/3 years = 10 hours/year). We believe that 
this burden will be split evenly between an adviser's compliance 
attorney and compliance manager (5 hours each).
    \1011\ See MFA/AIMA Comment Letter I.
    \1012\ See final rule 206(4)-1(e)(16). Our estimate accounts for 
advisers that may already be familiar with any composites that meet 
the definition of ``related portfolio.''
    \1013\ See final rule 206(4)-1(d)(4).
---------------------------------------------------------------------------

    We continue to estimate that 80 percent of advisers (or 10,979 
advisers) will have other portfolios with substantially similar 
investment policies, objectives, and strategies as those offered in the 
advertisement and choose to include related performance. We estimate 
that after initially preparing related performance for each portfolio 
or composite aggregation of portfolios, investment advisers will incur 
a burden of 5 hours to update the performance for each subsequent 
presentation. Although we expect that advisers might update their 
performance fewer times per year than we had proposed because the final 
rule permits performance to be shown as of the most recent calendar 
year end, we continue to estimate that advisers will update the 
relevant related performance 3.5 times each year.\1014\ We received no 
comments on these estimates and continue to believe they are 
appropriate.
---------------------------------------------------------------------------

    \1014\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (5 hours x 
3.5 times per year = 17.5 hours; 17.5 hours/2 = 8.75 hours each).
---------------------------------------------------------------------------

d. Extracted Performance
    As in the advertising rule proposal, we estimate that an investment 
adviser that elects to present extracted performance in an 
advertisement will incur an initial burden of 10 hours in preparing the 
performance results of the total portfolio from which the performance 
is extracted in order to provide or offer to provide such performance 
results to investors.\1015\ For purposes of this analysis, we continue 
to assume 5 percent of advisers will include extracted performance. We 
estimate that after initially preparing the performance of the total 
portfolio from which extracted performance is extracted, investment 
advisers will incur a burden of 2 hours to update the performance for 
each subsequent presentation. For purposes of this analysis, we 
estimate that advisers will update the relevant total portfolio 
performance 3.5 times each year.\1016\ We also estimate that registered 
investment advisers may incur external costs in connection with the 
requirement to provide performance results of a total portfolio from 
which extracted hypothetical performance is extracted. We estimate that 
the average annual costs associated with printing and mailing this 
information upon request will be collectively $500 for all documents 
associated with a single registered investment adviser. We received no 
comments on these estimates and continue to believe they are 
appropriate.
---------------------------------------------------------------------------

    \1015\ Accordingly, we estimate that the amortized initial 
burden will be 3.33 hours for each of the first 3 years for each 
investment adviser to prepare the performance of the total portfolio 
from which the presentation of extracted performance is extracted 
(10 hours/3 years = 3.33 hours/year). We believe that this burden 
will be split evenly between an adviser's compliance attorney and 
compliance manager (1.67 hours each).
    \1016\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (2 hours x 
3.5 times per year = 7 hours; 7 hours/2 = 3.5 hours each).
---------------------------------------------------------------------------

e. Hypothetical Performance
    We estimate that an investment adviser that elects to present 
hypothetical performance in an advertisement will incur an initial 
burden of 7 hours in preparing and adopting policies and procedures 
reasonably designed to ensure that the hypothetical performance is 
relevant to the likely financial situation and investment objectives of 
the intended audience of the advertisement.\1017\ We

[[Page 13125]]

have revised this estimate upwards from the advertising rule proposal 
to address one commenter's claim that we underestimated this time 
burden.\1018\ For purposes of this analysis, we continue to estimate 
that 50 percent of advisers will include hypothetical performance in 
advertisements.
---------------------------------------------------------------------------

    \1017\ Accordingly, we estimate that the amortized initial 
burden will be 2.33 hours for each of the first 3 years for each 
investment adviser to comply with this requirement (7 hours/3 years 
= 2.33 hours/year). We believe that an adviser's chief compliance 
officer will complete this task.
    \1018\ See MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

    We continue to estimate that advisers that use hypothetical 
performance will disseminate advertisements containing hypothetical 
performance 20 times each year, including in certain one-on-one 
communications that meet the final rule's definition of advertisement. 
We estimate that after adopting appropriate policies and procedures, an 
adviser will incur a burden of 0.25 hours to categorize investors 
according to their likely financial situation and investment objectives 
pursuant to the adviser's policies and procedures.\1019\
---------------------------------------------------------------------------

    \1019\ We believe that an adviser's chief compliance officer 
will complete this task (20 presentations per year x 0.25 hours each 
= 5 hours per year).
---------------------------------------------------------------------------

    Additionally, we estimate that an investment adviser that elects to 
present hypothetical performance in an advertisement will incur an 
initial burden of 20 hours in preparing the information sufficient to 
understand the criteria used and assumptions made in calculating, as 
well as risks and limitations in using, the hypothetical performance, 
in order to provide such information, which may in certain 
circumstances be upon request.\1020\ We have also revised this estimate 
upwards from the proposal to address one commenter's claim that we 
underestimated this time burden.\1021\ We estimate that after initially 
preparing the underlying information, investment advisers will incur a 
burden of 3 hours to update the information for each subsequent 
presentation. For purposes of this analysis, we estimate that advisers 
will update their hypothetical performance, and thus the underlying 
information, 3.5 times each year.\1022\
---------------------------------------------------------------------------

    \1020\ Accordingly, we estimate that the amortized initial 
burden will be 6.67 hours for each of the first 3 years for each 
investment adviser to comply with this requirement (20 hours/3 years 
= 6.67 hours/year). We believe that this burden will be split evenly 
between an adviser's compliance attorney and compliance manager 
(3.33 hours each). This estimate includes the time spent by an 
adviser in preparing the information. The time spent calculating the 
hypothetical performance that is based on such information is not 
accounted for in this estimate, as the rule does not require that an 
advertisement present hypothetical performance.
    \1021\ See MFA/AIMA Comment Letter I.
    \1022\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (3 hours x 
3.5 times per year = 10.5 hours; 10.5 hours/2 = 5.25 hours each).
---------------------------------------------------------------------------

    We estimate that registered investment advisers may incur external 
costs in connection with the requirement to provide this underlying 
information upon the request of an investor or prospective investor in 
a private fund. We estimate that the average annual costs associated 
with printing and mailing this underlying information upon request will 
be collectively $500 for all documents associated with a single 
registered investment adviser.\1023\
---------------------------------------------------------------------------

    \1023\ See supra footnote 992 for a discussion of estimated 
mailing costs.
---------------------------------------------------------------------------

f. Predecessor Performance
    The final rule will impose conditions on an adviser's use of 
predecessor performance. We estimate that an investment adviser that 
elects to present predecessor performance in an advertisement will 
incur an initial burden of 10 hours in preparing the relevant 
performance results and associated disclosures.\1024\ This time burden 
will include the adviser's time spent classifying which performance 
results are eligible to be ported--i.e., to determine whether accounts 
at a predecessor adviser are ``sufficiently similar'' and the persons 
are ``primarily responsible'' for the performance, or that the relevant 
algorithm was responsible for achieving the prior performance 
results.\1025\ This burden also will include time spent determining 
whether to exclude any account in accordance with the rule's provision 
allowing exclusion of one or more accounts if the advertised 
performance results ``would not result in materially higher 
performance.'' Finally, this time burden will include the adviser's 
time calculating and presenting the net performance and appropriate 
time periods of any predecessor performance presented.
---------------------------------------------------------------------------

    \1024\ Accordingly, we estimate that the amortized initial 
burden will be 3.33 hours for each of the first 3 years for each 
investment adviser to prepare predecessor performance in connection 
with this requirement (10 hours/3 years = 3.33 hours/year). We 
believe that this burden will be split evenly between an adviser's 
compliance attorney and compliance manager (1.67 hours each).
    \1025\ Final rule 206(4)-1(d)(7)(i)-(ii).
---------------------------------------------------------------------------

    We estimate that 2% of advisers (or 275 advisers) will include 
predecessor performance in an advertisement. We estimate that after 
initially preparing predecessor performance, investment advisers will 
incur a burden of 1 hour to update the relevant disclosures and 
performance information for each subsequent presentation. For purposes 
of this analysis, we estimate that advisers will update the relevant 
disclosures 3.5 times each year.\1026\ Table 4 summarizes the final PRA 
estimates for the internal and external burdens associated with these 
requirements.
---------------------------------------------------------------------------

    \1026\ We believe that this burden will be split evenly between 
an adviser's compliance attorney and compliance manager (1 hour x 
3.5 times per year = 3.5 hours; 3.5 hours/2 = 1.75 hours each).
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BILLING CODE 8011-01-P

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BILLING CODE 8011-01-C
5. Total Hour Burden Associated With Rule 206(4)-1
    Accordingly, we estimate the total annual hour burden for 
investment advisers registered or required to be registered with the 
Commission under proposed rule 206(4)-1 to prepare testimonials and 
endorsements, third-party ratings, and performance results disclosures 
will be 1,414,291 hours, at a time cost of $468,287,816. The total 
external burden costs would be $4,460,200. The following chart 
summarizes the various components of the total annual burden for 
investment advisers.

----------------------------------------------------------------------------------------------------------------
                                                              Internal hour    Internal burden    External cost
                                                                 burden           time cost          burden
----------------------------------------------------------------------------------------------------------------
General Prohibitions......................................      82,344 hours        $9,016,668  ................
Testimonials and Endorsements.............................     121,252 hours       $41,749,094          $686,200
Third-Party Ratings.......................................      12,009 hours         4,046,933  ................
Performance...............................................   1,198,686 hours       413,475,121         3,774,000
                                                           -----------------------------------------------------
    Total annual burden...................................   1,414,291 hours       468,287,121         4,460,200
----------------------------------------------------------------------------------------------------------------


[[Page 13128]]

C. Rule 206(4)-3

    Rule 206(4)-3 (OMB number 3235-0242) currently prohibits investment 
advisers from paying cash fees to solicitors for client referrals 
unless certain conditions are met. As discussed above, we are 
rescinding rule 206(4)-3 and merging some of its components into the 
combined marketing rule. The collection of information burden 
associated with the requirements of rule 206(4)-3 has been incorporated 
into the collection of information burden for rule 206(4)-1. There will 
no longer be a collection of information burden associated with rule 
206(4)-3.

D. Rule 204-2

    Under section 204 of the Advisers Act, investment advisers 
registered or required to register with the Commission under section 
203 of the Advisers Act must make and keep for prescribed periods such 
records (as defined in section 3(a)(37) of the Exchange Act), furnish 
copies thereof, and make and disseminate such reports as the 
Commission, by rule, may prescribe as necessary or appropriate in the 
public interest or for the protection of investors. Rule 204-2 sets 
forth the requirements for maintaining and preserving specified books 
and records. This collection of information is found at 17 CFR 275.204-
2 and is mandatory. The Commission staff uses the collection of 
information in its examination and oversight program. As noted above, 
responses provided to the Commission in the context of its examination 
and oversight program concerning the amendments to rule 204-2 will be 
kept confidential subject to the provisions of applicable law.
    We are amending rule 204-2 to require investment advisers to retain 
copies of all advertisements.\1027\ The current rule requires 
investment advisers to retain copies of advertisements to 10 or more 
persons.\1028\ For oral advertisements, amended rule 204-2 provides 
that an adviser may instead retain a copy of any written or recorded 
materials used by the adviser in connection with the oral 
advertisement.\1029\ For compensated oral testimonials and 
endorsements, the adviser may instead make and keep a record of the 
disclosures provided to clients or investors required by the final 
rule.\1030\ We are also amending the rule to require investment 
advisers to retain: (i) Documentation of communications relating to 
predecessor performance; (ii) copies of all information provided or 
offered pursuant to the marketing rule's conditions on advertising 
hypothetical performance; and (iii) records of who the ``intended 
audience'' relating to the conditions of hypothetical performance. The 
amendments will not require an adviser to maintain copies of written 
approvals of advertisements, since we are not adopting the proposed 
requirement that an adviser review and approve advertisements before 
dissemination.
---------------------------------------------------------------------------

    \1027\ See final rule 204-2(a)(11); see also supra section II.I 
(discussing the amendments to the books and records rule).
    \1028\ Rule 204-2(a)(11).
    \1029\ See final rule 204-2(a)(11)(i)(A)(1).
    \1030\ See id.
---------------------------------------------------------------------------

    Amended rule 204-2 will require registered investment advisers to 
maintain a copy of any questionnaire or survey used in preparation of 
the third-party rating. Advisers must also make and retain: (i) A 
record of the disclosures provided to clients or investors pursuant to 
the marketing rule, if not included in the advertisement, (ii) 
documentation related to the adviser's determination that it has a 
reasonable basis for believing that a testimonial, endorsement, or 
third-party rating complies with the applicable conditions of the 
marketing rule, and (iii) a record of all affiliated personnel of the 
adviser.\1031\ Each of these records will be required to be maintained 
in the same manner, and for the same period of time, as other books and 
records required to be maintained under rule 204-2(a). Specifically, 
investment advisers will be required to maintain and preserve these 
records in an easily accessible place for not less than 5 years from 
the end of the fiscal year during which the last entry was made on such 
record, the first 2 years in an appropriate office of the investment 
adviser. Requiring maintenance of these records will facilitate the 
Commission's ability to inspect and enforce compliance with the 
marketing rule.\1032\ The information generally is kept confidential 
subject to the applicable law.\1033\
---------------------------------------------------------------------------

    \1031\ See final rule 204-2(a)(15)(i)-(ii).
    \1032\ Id.
    \1033\ See section 210(b) of the Advisers Act (15 U.S.C. 80b-
10(b)).
---------------------------------------------------------------------------

    The respondents to this collection of information are investment 
advisers registered or required to be registered with the Commission. 
The use of advertisements is not mandatory, but as discussed above, we 
estimate that 100 percent of investment advisers will disseminate at 
least one communication meeting the rule's definition of 
``advertisement'' (including oral advertisements) and therefore be 
subject to the requirements of the rule. The Commission therefore 
estimates that, based on Form ADV filings as of August 1, 2020, 
approximately 13,724 investment advisers will be subject to the 
proposed amendments to rule 204-2 under the Advisers Act.
    Based on staff experience, we estimate that 95 percent of advisers 
(or 13,038 advisers) provide, or seek to provide, performance 
information to their clients.\1034\ The amendments to the recordkeeping 
rule will require advisers to maintain communications to clients or 
investors that contain performance calculations of portfolios, in 
addition to those that reference performance of managed accounts and 
securities recommendations as currently required. We believe based on 
staff experience that advisers already have recordkeeping processes in 
place to maintain client communications; however, this amendment will 
expand the types of communications subject to the recordkeeping rule 
and thus increase this collection of information burden.
---------------------------------------------------------------------------

    \1034\ See 2016 Form ADV Amendments Release, supra footnote 249 
at 149.
---------------------------------------------------------------------------

    The amendments will require advisers to maintain copies of any 
documents provided or offered to clients or investors explaining the 
assumptions and criteria underlying the hypothetical performance 
calculation and the risks and limitations in using hypothetical 
performance. In addition, the amendments will require advisers to 
create and maintain a record of who the ``intended audience'' is in 
connection with its advertisements that include hypothetical 
performance. We estimate that approximately 50 percent of advisers (or 
6,862 advisers) will use hypothetical performance in an advertisement 
and therefore be subject to the expanded recordkeeping obligations 
relating to the retention of documents that support those performance 
calculations. The recordkeeping rule will also require advisers that 
present predecessor performance to maintain sufficient records to 
support the performance results provided. As discussed above, we 
estimate that 2% of advisers (or 275 advisers) will present predecessor 
performance thus be subject to this collection of information burden.
    The rule will require advisers that use a testimonial or 
endorsement to create and maintain a record of the names of all 
affiliated personnel of the adviser and documentation substantiating 
the adviser's reasonable basis for believing that the testimonial or 
endorsement complies with the specific conditions of the marketing 
rule. As discussed above,

[[Page 13129]]

we estimate that 50 percent of advisers (or 6,862 advisers) will use a 
testimonial or endorsement.
    In addition, we estimate that approximately 50 percent of advisers 
(or 6,862 advisers) will use third-party ratings in advertisements, and 
will therefore also be subject to the recordkeeping amendments 
corresponding to the rule's conditions relating to the use of third-
party ratings. These amendments require that an adviser: (i) Retain a 
copy of any questionnaire or survey used in the preparation of a third-
party rating included or appearing in any advertisement, and (ii) make 
and retain documentation substantiating the investment adviser's 
reasonable basis for believing that the third-party rating complies 
with the specific conditions of the marketing rule.\1035\ In a change 
from the proposal, the marketing rule does not require advisers to 
obtain the questionnaire or survey to satisfy the specific conditions 
for third-party ratings; instead, advisers can comply with the 
conditions for third-party ratings by other means (which will not 
trigger a recordkeeping obligation). Accordingly, we estimate that 
approximately 50 percent of the investment advisers that will use a 
third-party rating, or 3,431 advisers, will comply with the third-party 
ratings conditions of the rule by obtaining the underlying 
questionnaire or survey.
---------------------------------------------------------------------------

    \1035\ See supra section III.B.2.
---------------------------------------------------------------------------

    For the recordkeeping amendments relating to testimonials and 
endorsements, we estimate that the amendments will result in a 
collection of information burden estimate of 5 hours for each of the 
estimated 6,862 advisers that will use a testimonial or endorsement. We 
are revising this estimate upwards versus the proposal to reflect the 
additional recordkeeping obligations we are adopting, such as the 
requirement to create documentation of the adviser's reasonable belief 
that the testimonial or endorsement complies with the specific 
conditions of the marketing rule.
    We also estimate the amendments will result in a collection of 
information burden of 3 hours for the 50 percent of advisers (or 6,862 
advisers) that we estimate will use third-party ratings. Again, we have 
revised this estimate upwards from the proposal to reflect the 
additional obligations imposed by the amended recordkeeping rule, such 
as the requirement to create documentation of the adviser's reasonable 
belief that the third-party rating complies with the specific 
conditions of the marketing rule. Table 5 summarizes the final PRA 
estimates for the internal and external burdens associated with these 
requirements.
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    As noted above, the approved annual aggregate burden for rule 204-2 
is currently 2,435,364 hours, based on an estimate of 13,299 registered 
advisers, or 183 hours per registered adviser, with a total monetized 
costs of $154,304,664.\1036\ We therefore estimate that the amendments 
to the recordkeeping rule will result in an aggregate increase in the 
collection of information burden estimate by 18.44 hours for each of 
the estimated 13,724 registered advisers, resulting in a total of 
201.44 hours per adviser.\1037\ This would yield an annual estimated 
aggregate burden of 2,764,563 hours under amended rule 204-2 for all 
registered advisers,\1038\ for a monetized cost of $175,980,426.\1039\ 
This represents in an increase of 329,199 \1040\ annual aggregate hours 
in the hour burden and an annual increase of $21,675,762 from the 
currently approved total aggregate monetized cost for rule 204-2.\1041\ 
These increases are attributable to a larger registered investment 
adviser population since the most recent approval and adjustments for 
inflation, as well as the rule 204-2 amendments relating to the new 
marketing rule. The following chart shows the differences from the 
approved annual hourly burden for the current books and records rule.
---------------------------------------------------------------------------

    \1036\ 2,435,364 hours/13,299 registered advisers = 183 hours 
per adviser.
    \1037\ 10 hours (advertising retention) + 3 hours (performance 
retention) x 95% + 3 hours (hypothetical performance) x 50% + 3 
hours (predecessor performance) x 2% + 5 hours (testimonials and 
endorsements) x 50% + 3 hours (third-party ratings) x 50% = 18.44 
hours.
    \1038\ 13,724 registered investment advisers x 201.44 hours = 
2,764,563 hours.
    \1039\ $16,636,198/252,661 hours = $65.84/hour for these 
amendments; $65.84/hour x 329,199 hours = $21,675,762. $21,675,762 + 
$154,304,664 = $175,980,426.
    \1040\ 2,764,563 hours-2,435,364 hours = 329,199 hours.
    \1041\ $175,980,426-$154,304,664 = $21,675,762.

------------------------------------------------------------------------
                                 Estimated burden
          Requirement              increase  or      Brief explanation
                                     decrease
------------------------------------------------------------------------
All collections of information  18.44 hour         The currently
 under rule 204-2 (including     increase..         approved burden
 new requirements).             The overall hour    reflects the current
                                 burden per         rule's requirement
                                 adviser would      that investment
                                 increase from      advisers retain
                                 183 hours to       copies of
                                 201.44 hours.      advertisements to 10
                                                    or more persons. The
                                                    amended rule will
                                                    require that they
                                                    retain copies of all
                                                    advertisements, as
                                                    well as copies of
                                                    any questionnaires
                                                    or surveys obtained
                                                    in connection with
                                                    third-party ratings
                                                    in advertisements.
                                                    The amended rule
                                                    will also require
                                                    that advisers that
                                                    use testimonials,
                                                    endorsements, or
                                                    third-party ratings
                                                    make and retain a
                                                    record documenting
                                                    that the adviser has
                                                    a reasonable belief
                                                    that these items
                                                    comply with the
                                                    applicable
                                                    conditions of the
                                                    marketing rule.
------------------------------------------------------------------------

E. Form ADV

    Form ADV (OMB Control No. 3235-0049) is the investment adviser 
registration form under the Advisers Act. Rule 203-1 under the Advisers 
Act requires every person applying for investment adviser registration 
with the Commission to file Form ADV. Rule 204-4 under the Advisers Act 
requires certain investment advisers exempt from registration with the 
Commission (``exempt reporting advisers'') to file reports with the 
Commission by completing a limited number of items on Form ADV. Rule 
204-1 under the Advisers Act requires each registered and exempt 
reporting adviser to file amendments to Form ADV at least annually, and 
requires advisers to submit electronic filings through IARD. On June 5, 
2019, the Commission adopted amendments to Form ADV and related rules 
under the Act to add new Form ADV Part 3: Form CRS (relationship 
summary) requiring certain registered investment advisers to prepare 
and file a relationship summary for retail investors.
    The paperwork burdens associated with rules 203-1, 204-1, and 204-4 
are included in the approved annual burden associated with Form ADV and 
thus do not entail separate collections of information. These 
collections of information are found at 17 CFR 275.203-1, 275.204-1, 
275.204-4 and 279.1 (Form ADV itself) and are mandatory. Responses are 
not kept confidential. We are adopting amendments to Form ADV to add a

[[Page 13132]]

subsection L to Item 5 of Part 1A (``Marketing Activities'') to require 
information about an adviser's use in its advertisements of 
testimonials, endorsements, third-party ratings, and previous 
investment advice. Specifically, we will require an adviser to state 
whether any of its advertisements include performance results, 
hypothetical performance, or predecessor performance. We will also 
require an adviser to state whether any of its advertisements includes 
testimonials, endorsements, or a third-party rating, and if so, whether 
the adviser pays or otherwise provides cash or non-cash compensation, 
directly or indirectly, in connection with their use. Finally, we will 
require an adviser to state whether any of its advertisements includes 
a reference to specific investment advice provided by the adviser.
    The collection of information is necessary to improve information 
available to us and to the general public about advisers' advertising 
practices. Our staff will use this information to help prepare for 
examinations of investment advisers. This information will be 
particularly useful for staff in reviewing an adviser's compliance with 
the marketing rule, including the restrictions and conditions on 
advisers' use in advertisements of performance presentations and third-
party statements. We are not proposing amendments to Form ADV Parts 2 
or 3.
1. Respondents
    The respondents to current Form ADV are investment advisers 
registered with the Commission or applying for registration with the 
Commission and exempt reporting advisers.\1042\ Based on the IARD 
system data as of August 1, 2020, approximately 13,724 investment 
advisers were registered with the Commission, and 4,455 exempt 
reporting advisers file reports with the Commission. The amendments to 
Form ADV will increase the information requested in Form ADV Part 1A 
for registered investment advisers. Because exempt reporting advisers 
are required to complete a limited number of items in Part 1A of Form 
ADV, which excludes Item 5, they will not be subject to these 
amendments and will therefore not be subject to this collection of 
information.\1043\ However, these exempt reporting advisers are 
included in the PRA for purposes of updating the overall Form ADV 
information collection. In addition, as noted above, in 2019 the 
Commission adopted amendments to Form ADV to add a new Part 3, 
requiring registered investment advisers that offer services to retail 
investors to prepare and file with the Commission, post to the 
adviser's website (if it has one), and deliver to retail investors a 
relationship summary.\1044\ The burdens associated with completing Part 
3 are included in the PRA for purposes of updating the overall Form ADV 
information collection.\1045\
---------------------------------------------------------------------------

    \1042\ An exempt reporting adviser is an investment adviser that 
relies on the exemption from investment adviser registration 
provided in either section 203(l) of the Advisers Act because it is 
an adviser solely to one or more venture capital funds or 203(m) of 
the Advisers Act because it is an adviser solely to private funds 
and has assets under management in the United States of less than 
$150 million.
    \1043\ An exempt reporting adviser is not a registered 
investment adviser and therefore will not be subject to the 
amendments to Item 5 of Form ADV Part 1A. Exempt reporting advisers 
are required to complete a limited number of items in Form ADV Part 
1A (consisting of Items 1, 2.B., 3, 6, 7, 10, 11 and corresponding 
schedules), and are not required to complete Part 2.
    \1044\ See Form CRS Relationship Summary; Amendments to Form 
ADV, Release No. IA-5247 (June 5, 2019) [84 FR 33492 (Jul. 12, 
2019)].
    \1045\ See Updated Supporting Statement for PRA Submission for 
Amendments to Form ADV Under the Investment Advisers Act of 1940 
(the ``Approved Form ADV PRA'').
---------------------------------------------------------------------------

    The currently approved burdens for Form ADV are set forth 
below:\1046\
---------------------------------------------------------------------------

    \1046\ The information in the following table is from the 
Approved Form ADV PRA, id.

----------------------------------------------------------------------------------------------------------------
                                  RIAs not obligated   RIAs obligated to
                                     to prepare and    prepare and file    Exempt reporting
                                  file  relationship     relationship          advisers          All advisers
                                       summaries           summaries
----------------------------------------------------------------------------------------------------------------
Number of advisers included in    5,064 + 571         8,235 + 656         4,280 + 441         17,597 advisers +
 the currently approved burden.    expected newly      expected newly      expected new ERAs   1,740 expected
                                   registered RIAs     registered RIAs     annually.           new RIAs and ERAs
                                   annually.           annually.                               annually.
Currently approved total annual   29.22 hours.......  37.47 hours.......  3.60 hours........  29.28 annual
 hour estimate per adviser.                                                                    blended average
                                                                                               hours per
                                                                                               adviser.
Currently approved aggregate      164,655 hours.....  333,146 hours.....  16,996 hours......  514,797 hours.
 annual hour burden.
Currently approved aggregate      $44,950,816.......  $90,978,858.......  $4,639,908........  $140,569,582.
 monetized cost.
----------------------------------------------------------------------------------------------------------------

    Based on updated IARD system data as of August 1, 2020, we estimate 
that the number of registered investment advisers that are required to 
complete, amend, and file Form ADV (Part 1 and Part 2) with the 
Commission, but who are not obligated to prepare and file relationship 
summaries as of the applicable compliance date for Form ADV Part 3, is 
5,506, and we also continue to believe, based on IARD system data, that 
that 1,227 new advisers will register with us annually, 571 of which 
will not be required to prepare a relationship summary.\1047\ Based on 
updated IARD system data as of August 1, 2020, we estimate that the 
number of registered investment advisers that are required to complete, 
amend, and file Form ADV (Part 1 and Part 2) and prepare and file 
relationship summaries is 8,218, and we continue to believe, based on 
IARD system data, that that 1,227 new advisers will register with us 
annually, 656 of which will be required to prepare a relationship 
summary.\1048\ Based on updated IARD system data as of August 1, 2020, 
we estimate that the number of exempt reporting advisers is 4,455; 
however, we continue to believe that, based on IARD system data, there 
would be 441 new exempt reporting advisers annually.\1049\
---------------------------------------------------------------------------

    \1047\ As of August 1, 2020, there are 13,724 registered 
investment advisers, 8,218 of which file a Form CRS. See also 
Approved Form ADV PRA, id., at text accompanying nn.55-56 (``[W]e 
estimate that 1,227 new advisers will register with us annually, 656 
of which will be required to prepare a relationship summary.'')
    \1048\ See id.
    \1049\ Id., at n.42.
---------------------------------------------------------------------------

2. Estimated New Annual Hour Burden for Advisers
    As a result of the proposed amendments to Form ADV Part 1A 
discussed above, we estimate that the average total annual collection 
of information burden for registered investment advisers that are not 
obligated to prepare and file relationship summaries will increase 0.5 
hours to 29.72 hours per registered

[[Page 13133]]

investment adviser per year for Form ADV. We estimate that the average 
total annual collection of information burden for registered investment 
advisers who are obligated to prepare and file relationship summaries 
will increase 0.5 hour to 38.97 hours per registered investment adviser 
per year for Form ADV. We do not expect that the amendments will 
increase or decrease the currently approved total burden estimate of 
3.60 per exempt reporting adviser completing Form ADV. We are not 
modifying our estimates from the proposal. Although one commenter 
claimed that we underestimated the Form ADV burden, this commenter 
mischaracterized our statements in the proposal.\1050\ We stated in the 
proposal that the Form ADV amendments would not increase the time 
required to complete the form for exempt reporting advisers (not 
registered investment advisers), which we continue to believe is the 
case.
---------------------------------------------------------------------------

    \1050\ In the proposal, we estimated that the amendments would 
not change the burden for exempt reporting advisers because they 
will not be required to complete the new portion of Form ADV.
---------------------------------------------------------------------------

    The currently approved annual aggregate burden for Form ADV for all 
registered advisers and exempt reporting advisers is 514,797 hours, for 
a monetized cost of $140,569,582.\1051\ This is an annual blended 
average per adviser burden for Form ADV of 29.28 hours, and $7,996 per 
adviser.\1052\ Factoring in the new questions on Part 1 of Form ADV 
that will be required for all registered investment advisers (but not 
for exempt reporting advisers), and increases due to increased number 
in RIAs since the burden estimate was last approved (but a decreased 
number in ERAs), the revised annual aggregate burden hours for Form ADV 
(Parts 1, 2 and 3) for all registered advisers and exempt reporting 
advisers will be 544,053 hours per year, with a monetized value of 
$148,526,578.\1053\ This will be an aggregate increase of 29,256 hours, 
or $7,956,996 in the monetized value of the hour burden, from the 
currently approved annual aggregate burden estimates, increases which 
are attributed to the factors described above.
---------------------------------------------------------------------------

    \1051\ Id., at nn.44-45 and accompanying text,
    \1052\ Id., at nn.46-47 and accompanying text.
    \1053\ 544,053.4 aggregate annual hour burden is the sum of: 
((i) 29.72 hours x (5,506 RIAs + 571 expected newly registered RIAs 
annually) = 180,608 total aggregate annual hour burden for RIAs not 
obligated to prepare and file relationship summaries; (ii) 38.97 
hours x (8,218 + 656 expected newly registered RIAs annually) = 
345,819.8 total aggregate annual hour burden for RIAs not obligated 
to prepare and file relationship summaries; (iii) 3.60 hours x 
(4,455 + 441 expected new ERAs annually) = 17,625.6 total aggregate 
annual hour burden for ERAs). We believe that performance of this 
function will most likely be equally allocated between a senior 
compliance examiner and a compliance manager. Data from the SIFMA 
Management and Professional Earnings Report suggest that costs for 
these positions are $237 and $309 per hour, respectively, with a 
blended rate of $273. Therefore: 544,053.4 hours x $273 = 
$148,526,578.
---------------------------------------------------------------------------

    Estimated new annual hour burden for advisers:

----------------------------------------------------------------------------------------------------------------
                                  RIAs not obligated   RIAs obligated to
                                     to prepare and    prepare and file    Exempt reporting
                                  file  relationship     relationship          advisers          All advisers
                                       summaries           summaries
----------------------------------------------------------------------------------------------------------------
Number of advisers to be          5,506 + 571         8,218 + 656         4,455 + 441         ..................
 included in the final burden.     expected newly      expected newly      expected new ERAs
                                   registered RIAs     registered RIAs     annually.
                                   annually.           annually.
Final total annual hour estimate  29.72.............  38.97.............  3.60 hours........  ..................
 per adviser.
Final aggregate burden hours....  180,608 hours.....  345,819.8 hours...  17,625.6 hours....  544,053.4 hours.
Final aggregate monetized cost..  $49,306,104.......  $94,408,800.......  $4,811,789........  $148,526,578.
----------------------------------------------------------------------------------------------------------------

V. Final Regulatory Flexibility Analysis

    The Commission has prepared the following Final Regulatory 
Flexibility Analysis (``FRFA'') in accordance with section 4(a) of the 
Regulatory Flexibility Act (``RFA'').\1054\ It relates to: (i) Final 
amendments to rule 206(4)-1 under the Investment Advisers Act; (ii) 
final amendments to rule 204-2, and (iii) final amendments to Form ADV 
Part 1A.
---------------------------------------------------------------------------

    \1054\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Reason for and Objectives of the Final Amendments

1. Final Rule 206(4)-1
    We are adopting amendments to rule 206(4)-1 (now known as the 
``marketing rule''), which we adopted in 1961 to target advertising 
practices that the Commission believed were likely to be misleading. We 
are also incorporating into rule 206(4)-1 certain aspects of rule 
206(4)-3 (previously referred to as the ``cash solicitation rule''), 
which we adopted in 1979 to help ensure clients are aware that paid 
solicitors who refer them to advisers have a conflict of interest. We 
are accordingly eliminating rule 206(4)-3.
    As discussed above, we are adopting amendments to rule 206(4)-1 to 
impose: (i) General prohibitions of certain advertising practices 
applicable to all advertisements; (ii) tailored restrictions or 
conditions on specific practices applicable to testimonials, 
endorsements, and third-party ratings; and (iii) tailored requirements 
for the presentation of performance results, including predecessor 
performance. The final rule is designed to restrict or place conditions 
on specific practices we believe may cause investors to be misled 
without appropriate conditions or limitations. The final rule will also 
include a new definition of ``advertisement'' that is intended to be 
flexible enough to remain relevant and effective in the face of 
advances in technology and evolving industry practices. The reasons 
for, and objectives of, the final amendments are discussed in more 
detail in sections I and II, above. The burdens of these requirements 
on small advisers are discussed below as well as above in sections III 
and IV, which discuss the burdens on all advisers. The professional 
skills required to meet these specific burdens are also discussed in 
section IV.
    We believe that our final amendments are appropriate and in the 
public interest and will improve investor protection. We are adopting 
amendments to the current rule because while we believe that the 
concerns that motivated the Commission to adopt rule 206(4)-1 and 
206(4)-3 still exist today, we also believe that we can achieve our 
regulatory goals in a more tailored manner. We believe that our final 
amendments will update the rule's coverage to reflect regulatory 
changes and evolution of industry practices, improve the quality of 
disclosures to investors, and streamline elements of the rules our 40 
years of experience has

[[Page 13134]]

suggested may no longer be necessary for investor protection.
2. Final Rule 204-2
    We are also adopting related amendments to rule 204-2, the books 
and records rule, which sets forth requirements for maintaining, 
making, and retaining advertisements. We are amending the rule to 
require investment advisers to make and keep records of all 
advertisements they disseminate. In addition, we are adopting the 
provisions to the books and records rule that will explicitly require 
investment advisers: (i) That use third-party ratings in an 
advertisement to record and keep a copy of any questionnaire or survey 
used in the preparation of the third-party rating; and (ii) to maintain 
documentation of communications relating to predecessor performance and 
to support performance calculations. We are also adopting the 
recordkeeping requirement that corresponds to the amendments related to 
testimonials, endorsements, and third-party ratings under the final 
rule such that advisers must retain: (i) If not included in the 
advertisement, a record of the disclosures provided to clients or 
investors pursuant to final rule 206(4)-1; (ii) documentation 
substantiating the adviser's reasonable basis for believing that the 
testimonial or endorsement complies with the final rule and that the 
third-party rating complies with the final rule 206(4)-1(c)(1); and 
(iii) a record of the names of all persons who are an investment 
adviser's partners, officers, directors, or employees, or a person that 
controls, is controlled by, or is under common control with the 
investment adviser, or is a partner, officer, director or employee of 
such a person.
    As discussed above, we are adopting these amendments to rule 204-2 
to: (i) Conform the books and records rule to the final rule; (ii) help 
ensure that an investment adviser retains records of all its 
advertisements; and (iii) facilitate the Commission's inspection and 
enforcement capabilities. The reasons for and objectives of, the final 
amendments to the books and records rule are discussed in more detail 
in section II.I above. The burdens of these requirements on small 
advisers are discussed below as well as above in our Economic Analysis 
and Paperwork Reduction Act Analysis, which discuss the burdens on all 
advisers. The professional skills required to meet these specific 
burdens are also discussed in Section IV.
3. Final Amendments to Form ADV
    We are also adopting amendments to Item 5 of Part 1A of Form ADV to 
improve information available to us and to the general public about 
advisers' advertising practices. We will be adding a subsection L 
(``Marketing Activities'') to require information about an adviser's 
use in its advertisements of performance results, its previous 
investment advice, testimonials, endorsements, and third-party ratings.
    Specifically, we will require an adviser to state whether any of 
its advertisements includes testimonials, endorsements, or a third-
party rating, and if so, whether the adviser pays cash or non-cash 
compensation, directly or indirectly, in connection with their use. We 
will also require an adviser to state whether any of its advertisements 
includes performance results or a reference to specific investment 
advice provided by the adviser. Finally, we will require an adviser to 
state whether any of its advertisements include hypothetical or 
predecessor performance. Our staff will use this information to help 
prepare for examinations of investment advisers. This information will 
be particularly useful for staff in reviewing an adviser's compliance 
with the final rule, including the restrictions and conditions on 
advisers' use in advertisements of performance presentations, 
testimonials and endorsements, and third-party ratings. The reasons for 
and objectives of, the final amendments to Form ADV are discussed in 
more detail in section II.A.8 above. The burdens of these requirements 
on small advisers are discussed below as well as above in our Economic 
Analysis and Paperwork Reduction Act Analysis, which discuss the 
burdens on all advisers. The professional skills required to meet these 
specific burdens are also discussed in Section IV.

B. Significant Issues Raised by Public Comments

    In the 2019 Proposing Release, we requested comment on the matters 
discussed in the IRFA, including the number of small entities subject 
to the proposed amendments to rules 206(4)-1, 206(4)-3, and 204-2, and 
Form ADV, as well as the potential impacts discussed in this analysis; 
and whether the proposal could have an effect on small entities that 
has not been considered. We requested that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of such impact. In addition, we included in the 
proposal a ``Feedback Flyer'' as Appendix C thereto. The ``Feedback 
Flyer'' solicited feedback from smaller advisers on the effects on 
small entities subject to our proposal, and the estimated compliance 
burdens of our proposal and how they would affect small entities.
    After consideration of the comments we received on the proposed 
rules and amendments, we are adopting the amendments with several 
modifications that are designed to reduce certain operational 
challenges that commenters identified, while maintaining protections 
for investors and providing investors with useful and important 
disclosures. However, none of the modifications was significant to the 
small-entity cost burden estimates discussed below. Revisions to the 
estimates are instead based on updated figures regarding the number of 
small entities affected by the new rule and amendments and updated 
estimated wage rates.

C. Legal Basis

    The Commission is adopting amendments to rule 206(4)-1 under the 
Advisers Act under the authority set forth in sections 203(d), 206(4), 
211(a) and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 
80b-3(d), 10b-6(4) and 80b-11(a) and (h)]. The Commission is adopting 
amendments to rule 204-2 under the Advisers Act under the authority set 
forth in sections 204 and 211 of the Investment Advisers Act of 1940 
[15 U.S.C. 80b-4 and 80b-11]. The Commission is adopting amendments to 
Form ADV under section 19(a) of the Securities Act of 1933 [15 U.S.C. 
77s(a)], sections 23(a) and 28(e)(2) of the Securities Exchange Act of 
1934 [15 U.S.C. 78w(a) and 78bb(e)(2)], section 319(a) of the Trust 
Indenture Act of 1939 [15 U.S.C. 7sss(a)], section 38(a) of the 
Investment Company Act of 1940 [15 U.S.C. 80a-37(a)], and sections 
203(c)(1), 204, and 211(a) of the Investment Advisers Act of 1940 [15 
U.S.C. 80b-3(c)(1), 80b-4, and 80b-11(a)].

D. Small Entities Subject to the Rule and Rule Amendments

    In developing these amendments, we have considered their potential 
impact on small entities that would be subject to the final amendments. 
The final amendments will affect many, but not all, investment advisers 
registered with the Commission, including some small entities.
    Under Commission rules, for the purposes of the Advisers Act and 
the RFA, an investment adviser generally is a small entity if it: (1) 
Has assets under management having a total value of less than $25 
million; (2) did not have total assets of $5 million or more on the 
last day of the most recent fiscal year; and

[[Page 13135]]

(3) does not control, is not controlled by, and is not under common 
control with another investment adviser that has assets under 
management of $25 million or more, or any person (other than a natural 
person) that had total assets of $5 million or more on the last day of 
its most recent fiscal year.\1055\ Our final amendments will not affect 
most investment advisers that are small entities (``small advisers'') 
because they are generally registered with one or more state securities 
authorities and not with the Commission. Under section 203A of the 
Advisers Act, most small advisers are prohibited from registering with 
the Commission and are regulated by state regulators. Based on IARD 
data, we estimate that as of August 1, 2020, approximately 545 SEC-
registered advisers are small entities under the RFA.\1056\
---------------------------------------------------------------------------

    \1055\ Advisers Act rule 0-7(a).
    \1056\ Based on SEC-registered investment adviser responses to 
Items 5.F. and 12 of Form ADV. Only SEC- registered investment 
advisers with RAUM of less than $25 million, as indicated in Form 
ADV Item 5.F.(2)(c) are required to respond to Form ADV Item 12. For 
purposes of this analysis, a registered investment adviser is 
classified as a ``small business'' or ``small organization'' if they 
respond ``No'' to Form ADV Item 12.A., 12.B.(1), 12.B.(2), 12.C.(1), 
and 12.C.(2). These responses indicate that the registered 
investment adviser had RAUM of less than $25 million, did not have 
total assets of $5 million or more on the last day of the most 
recent fiscal year; and does not control, is not controlled by, and 
is not under common control with another investment adviser that has 
RAUM of $25 million or more, or any person (other than a natural 
person) that had total assets of $5 million or more on the last day 
of the most recent fiscal year, consistent with the definition of a 
small entity under the Advisers Act for purposes of the RFA.
---------------------------------------------------------------------------

1. Small Entities Subject to Amendments to Marketing Rule
    As discussed above in section III. (the Economic Analysis), the 
Commission estimates that based on IARD data as of August 1, 2020, 
approximately 13,724 investment advisers would be subject to the final 
amendments to rule 206(4)-1 under the Advisers Act and the related 
final amendments to rule 204-2 under the Advisers Act.\1057\
---------------------------------------------------------------------------

    \1057\ See supra footnote 1038 and accompanying text.
---------------------------------------------------------------------------

    All of the approximately 545 SEC-registered advisers that are small 
entities under the RFA will be subject to the amended rule 206(4)-1 and 
corresponding amendments to rule 204-2. This is because, as discussed 
above in the PRA, we estimate that all investment advisers will 
disseminate at least one communication meeting the final rule's 
definition of ``advertisement'' and therefore be subject to the 
requirements of the final rule.\1058\ Furthermore, the rule's 
additional conditions and restrictions on testimonials, endorsements, 
and third-party ratings, as well as certain presentations of 
performance, will apply to many advertisements under the rule.\1059\
---------------------------------------------------------------------------

    \1058\ See PRA discussion, above, at sections IV.A and B.
    \1059\ As discussed above, the use of testimonials, 
endorsements, and third-party ratings in advertisements is voluntary 
but we estimate that approximately 50% of registered investment 
advisers would use testimonials or endorsements in advertisements, 
and approximately 50% of registered investment advisers would use 
third-party ratings in advertisements. See PRA discussion, above, at 
sections IV.A and B.
---------------------------------------------------------------------------

2. Small Entities Subject to Amendments to the Books and Records Rule 
204-2
    As discussed above, there are approximately 545 small advisers 
currently registered with us, and we estimate that 100 percent of 
advisers registered with us will be subject to amendments to the books 
and records rule.
3. Small Entities Subject to Amendments to Form ADV
    As discussed above, there are approximately 545 small advisers 
currently registered with us, and we estimate that 100 percent of 
advisers registered with us will be subject to amendments to Form ADV.

E. Projected Reporting, Recordkeeping and Other Compliance Requirements

1. Final Rule 206(4)-1
    Final rule 206(4)-1 will impose certain reporting and compliance 
requirements on certain investment advisers, including those that are 
small entities. All registered investment advisers that distribute 
advertisements under the rule, which we estimate to be all advisers, 
will be required to comply with the final rule's general prohibition of 
fraudulent or misleading advertisements. In addition, all advisers that 
use testimonials, endorsements, and third-party ratings will be 
required to include disclosures and comply with other conditions. Small 
entity advisers will be required to comply with restrictions and other 
conditions related to the presentation of certain performance results 
in advertisements. The final amendments, including compliance and 
recordkeeping requirements, are summarized in this FRFA (section V.A., 
above). All of these final requirements are also discussed in detail, 
above, in sections I and II, and these requirements and the burdens on 
respondents, including those that are small entities, are discussed 
above in sections III and IV (the Economic Analysis and Paperwork 
Reduction Act Analysis, respectively) and below. The professional 
skills required to meet these specific burdens are also discussed in 
section IV.
    As discussed above, there are approximately 545 small advisers 
currently registered with us, and we estimate that 100 percent of 
advisers registered with us will be subject to amendments to the 
marketing rule. As discussed above in our Paperwork Reduction Act 
Analysis in section III above, we estimate that the final amendments to 
rule 206(4)-1 under the Advisers Act, which will require advisers to 
prepare disclosures for testimonials and endorsements, third-party 
ratings, and performance results, will create a new annual burden of 
approximately 98 hours per adviser, or 56,135 hours in aggregate for 
small advisers.\1060\ We therefore expect the annual monetized 
aggregate cost to small advisers associated with our final amendments 
to be $18,596,390.\1061\
---------------------------------------------------------------------------

    \1060\ 1,414,291 hours/13,724 advisers = 103 hours per adviser. 
103 hours x 545 small advisers = 56,135 hours.
    \1061\ $468,287,816 total cost x (545 small advisers/13,724 
advisers) = $18,596,390.
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2. Final Amendments to Rule 204-2
    The final amendments to rule 204-2 will require investment advisers 
to retain records of all advertisements they disseminate. \1062\ We are 
also requiring investment advisers that use a third-party rating in an 
advertisement to retain a copy of any questionnaire or survey used in 
preparation of the third-party rating, as well as documentation of 
communications relating to predecessor performance and supporting 
performance calculations.\1063\ To correspond to the provisions with 
respect to testimonials, endorsements, and third-party ratings, we are 
amending the books and records rule to require investment advisers to 
make and keep records of: (i) If not included in the advertisement, a 
record of the disclosures provided to clients or investors pursuant to 
the final rule 206(4)-1; (ii) documentation substantiating the 
adviser's reasonable basis for believing that the testimonial or 
endorsement complies with the final rule and that the third-party 
rating complies with rule 206(4)-1(c)(1); and (iii) a record of the 
names of all persons who are an investment adviser's partners, 
officers, directors, or employees, or a person that controls, is 
controlled by, or is under common control with the investment adviser, 
or is a partner, officer, director or employee of such a person, 
pursuant to

[[Page 13136]]

the final rule 206(4)-1(b)(4)(ii).\1064\ Each of these records will be 
required to be maintained in the same manner, and for the same period 
of time, as other books and records required to be maintained under 
rule 204-2(a).
---------------------------------------------------------------------------

    \1062\ See final rule 204-2(a)(11)(i)(A).
    \1063\ See final rule 204-2(a)(7)(iv), (11)(ii), and (16).
    \1064\ See final rule 204-2(a)(15)(i) through (ii).
---------------------------------------------------------------------------

    As discussed above, there are approximately 545 small advisers 
currently registered with us, and we estimate that 100 percent of 
advisers registered with us will be subject to amendments to the books 
and records rule. As discussed above in our Paperwork Reduction Act 
Analysis in section IV.D above, the amendments to rule 204-2 under the 
Advisers Act will increase the annual burden by approximately 18.44 
hours per adviser, or 10,049.8 hours in aggregate for small 
advisers.\1065\ We therefore believe the annual monetized aggregate 
cost to small advisers associated with our amendments will be 
$6,960,596.\1066\
---------------------------------------------------------------------------

    \1065\ 18.44 hour x 545 small advisers = 10,049.8 hours.
    \1066\ 545 registered investment advisers x 201.44 hours = 
109,784.8 hours. (17% x 109,784.8 hours x $70) + (83% x 109,784.8 
hours x $62) = $6,960,596.
---------------------------------------------------------------------------

3. Final Amendments to Form ADV
    Final amendments to Form ADV will impose certain reporting and 
compliance requirements on certain investment advisers, including those 
that are small entities, requiring them to provide information about 
their use in its advertisements of performance results, previous 
investment advice, testimonials, endorsements, and third-party ratings. 
The final amendments, including recordkeeping requirements, are 
summarized above in this FRFA (section V.A). All of these final 
requirements are also discussed in detail, above, in section II.I, and 
these requirements and the burdens on respondents, including those that 
are small entities, are discussed above in sections III and IV (the 
Economic Analysis and Paperwork Reduction Act Analysis) and below. The 
professional skills required to meet these specific burdens are also 
discussed in section IV.
    Our Economic Analysis, discussed in section III above, discusses 
these costs and burdens for respondents, which include small advisers. 
As discussed above in our Paperwork Reduction Act Analysis in section 
IV.E above, the final amendments to Form ADV will increase the annual 
burden for advisers (other than exempt reporting advisers, who will not 
be required to respond to the new Form ADV questions) by approximately 
0.5 hours per adviser, or 272.5 hours in aggregate for small advisers 
(other than exempt reporting advisers).\1067\ We therefore expect the 
annual monetized aggregate cost to small advisers (other than exempt 
reporting advisers, for whom there will be no additional cost) 
associated with our final amendments will be $74,392.50.\1068\
---------------------------------------------------------------------------

    \1067\ 38.97 hour x 545 small advisers = 21,238.6 hours.
    \1068\ 272.5 hours x $273 = $74,392.50. See supra footnote 1053 
for a discussion of who we believe would perform this function, and 
the applicable blended rate.
---------------------------------------------------------------------------

F. Duplicative, Overlapping, or Conflicting Federal Rules

1. Final Rule 206(4)-1
    Other than existing rule 206(4)-1 and the prohibitions contained in 
section 208(a)-(c) of the Act, investment advisers do not have 
obligations under the Act specifically for adviser advertisements. As 
discussed above in section II.A.4., we recognize that advisers to 
private funds, who would be included in the scope of the final rule 
206(4)-1, are prohibited from making misstatements or materially 
misleading statements to investors under rule 206(4)-8.\1069\ Although 
the final marketing rule may overlap with the prohibitions in rule 
206(4)-8 in certain circumstances, just as it overlaps with section 206 
with respect to an adviser's clients and prospective clients, we 
believe it is important from an investor protection standpoint to 
delineate these obligations to all investors in the advertising context 
and provide a framework for an adviser's advertisements to comply with 
these obligations. We also understand that many private fund advisers 
already consider the current staff positions related to the current 
advertising rule when preparing their marketing communications. As a 
result, we believe that our application of the final rule to 
advertisements to private fund investors would result in limited 
additional regulatory or compliance costs for many of these advisers.
---------------------------------------------------------------------------

    \1069\ There may be other legal protections of investors from 
fraud. See, e.g., section 17(a) of the Securities Act, as well as 
section 10(b) of the Exchange Act and rule 10b-5 thereunder.
---------------------------------------------------------------------------

    We also recognize that advisers have other compliance oversight 
obligations under the Federal securities laws, including the Act. For 
example, advisers are subject to the Act's compliance rule, which we 
adopted in 2003.\1070\ Therefore, when an adviser utilizes a promoter 
as part of its business, the adviser must have in place under the Act's 
compliance rule policies and procedures that address this relationship 
and are reasonably designed to ensure that the adviser is in compliance 
with the final rule. We believe the final rule's adviser oversight and 
compliance provision applicable to testimonials and endorsements will 
work well with the Act's compliance rule, as both are principles-based 
and will allow advisers to tailor their compliance with the final rule 
as appropriate for each adviser. There are no duplicative, overlapping, 
or conflicting Federal rules with respect to the final amendments to 
rule 204-2.
---------------------------------------------------------------------------

    \1070\ See supra footnote 371 and accompanying text. The 
compliance rule contains principles based requirements for advisers 
to adopt compliance policies and procedures that are tailored to 
their businesses. Id.
---------------------------------------------------------------------------

    With respect to testimonials and endorsements, our amendments to 
rule 206(4)-1 will eliminate some regulatory duplication. For example, 
rule 206(4)-3 has had a duplicative requirement that a solicitor 
deliver to clients the adviser's Form ADV brochure, even though 
advisers are already required to deliver their ADV brochures to their 
clients under rule 204-3. To the extent that both advisers and 
solicitors currently deliver the adviser's Form ADV brochure, the final 
rule will reduce the redundancy of disclosures. In addition, as 
discussed above, the final rule's disqualification provisions will 
apply to situations in which an adviser compensates a person, directly 
or indirectly, for a testimonial or endorsement. This includes persons 
who provide testimonials or endorsements to private fund investors such 
as broker-dealers. Such broker-dealers may also be subject to the 
statutory disqualification provisions under the Exchange Act. To the 
extent that a person is subject to both disqualification provisions, 
there would be some overlapping categories of disqualifying events 
(i.e., certain bad acts would disqualify a person under both 
provisions). For instance, certain types of final orders of certain 
Federal and foreign regulators would be disqualifying events under both 
provisions. Accordingly, as discussed above, we are providing an 
exemption from the disqualification provisions for registered broker-
dealers that are subject to and complying with the statutory 
disqualification provisions under the Exchange Act.
    We understand that some promoters will also be subject to the ``bad 
actor'' disqualification requirements, which disqualify securities 
offerings from reliance on exemptions if the issuer or other relevant 
persons (such as underwriters, placement agents and the directors, 
officers and significant shareholders of the issuer) have been 
convicted of, or are subject to court or administrative sanctions for, 
securities

[[Page 13137]]

fraud or other violations of specified laws.\1071\ Some types of bad 
acts could disqualify a person from engaging in certain capacities in a 
securities offering under Rule 506 of Regulation D under the Securities 
Act, as well as from engaging as a promoter under the final rule. 
Accordingly, as discussed above, we are providing an exemption from the 
disqualification provisions for covered persons that are subject to and 
not disqualified under Rule 506 of Regulation D under the Securities 
Act.
---------------------------------------------------------------------------

    \1071\ See Disqualification of Felons and Other ``Bad Actors'' 
from Rule 506 Offerings, Release No. 33-9414 (July 10, 2013) [78 FR 
44729 (July 24, 2013).
---------------------------------------------------------------------------

    As discussed above, the final rule's required disclosures 
provisions will apply to all testimonials and endorsements, including 
those that are provided by registered broker-dealers in certain 
circumstances. Such broker-dealers may also be subject to other 
regulatory disclosure provisions such as under Regulation Best 
Interest. To the extent that a broker-dealer's testimonial or 
endorsement is a recommendation subject to Regulation BI, then there 
would be some overlapping requirements with our final rule (i.e., 
disclosing compensation arrangements and material conflicts of interest 
under both provisions). For instance, under the Regulation BI 
disclosure obligations, when making a recommendation to a retail 
customer, a broker-dealer must disclose all material facts about the 
scope and terms of its relationship with a retail customer, such as the 
material fees and costs the customer will incur as well as all material 
facts relating to its conflicts of interest associated with the 
recommendation, including third-party payments and compensation 
arrangements.\1072\ Similarly, under the final rule, when soliciting 
for an adviser, the broker-dealer would have to disclose any material 
conflicts of interest on his or her part resulting from their 
relationship and/or any compensation arrangement with the 
adviser.\1073\ Accordingly, as discussed above, we are providing an 
exemption from the final rule's required disclosures provisions for 
testimonials and endorsements that are disseminated by registered 
broker-dealers to the extent that such testimonials or endorsements are 
recommendations subject to Regulation BI in order to help eliminate 
regulatory duplication.
---------------------------------------------------------------------------

    \1072\ See Regulation Best Interest Release, supra footnote 146, 
at 14.
    \1073\ See final rule 206(4)-1(b)(1)(iii).
---------------------------------------------------------------------------

    In addition to testimonials and endorsements that are 
recommendations subject to Regulation BI, we are providing a partial 
exemption from certain disclosure requirements where a broker-dealer 
provides a testimonial or endorsement to an investor that is not a 
retail customer as defined in Regulation BI. As discussed above in 
section II.C.5.c., we believe that the clear and prominent disclosures 
such a broker-dealer will be required to provide under our final rule 
are sufficient to alert an investor that is not a retail customer that 
a testimonial or endorsement is a paid solicitation. In addition, we 
believe that these investors will be able to request from the broker-
dealer other information about the solicitation.
2. Final Amendments to Form ADV
    Our new subsection L (``Marketing Activities'') to Item 5 of Part 
1A of Form ADV will require information about an adviser's use in its 
advertisements of performance results, testimonials, endorsements, 
third-party ratings and its previous investment advice. These final 
requirements will not be duplicative of, or overlap with, other 
information advisers are required to provide on Form ADV.

G. Significant Alternatives

1. Final Rule 206(4)-1
    The RFA directs the Commission to consider significant alternatives 
that would accomplish our stated objectives, while minimizing any 
significant adverse impact on small entities. We considered the 
following alternatives for small entities in relation to the final rule 
and the corresponding amendments to rule 204-2 under the Advisers Act 
and to Form ADV: (i) Differing compliance or reporting requirements 
that take into account the resources available to small entities; (ii) 
the clarification, consolidation, or simplification of compliance and 
reporting requirements under the final rule for such small entities; 
(iii) the use of performance rather than design standards; and (iv) an 
exemption from coverage of the final rule, or any part thereof, for 
such small entities.
    Regarding the first and fourth alternatives, the Commission 
believes that establishing different compliance or reporting 
requirements for small advisers, or exempting small advisers from the 
final rule, or any part thereof, would be inappropriate under these 
circumstances.\1074\ Because the protections of the Advisers Act are 
intended to apply equally to clients of both large and small firms, it 
would be inconsistent with the purposes of the Advisers Act to specify 
differences for small entities under the final rule and corresponding 
changes to rule 204-2 and Form ADV. However, we are adopting an 
exemption for de minimis compensation with respect to the use of 
testimonials and endorsements, which we expect will apply to some small 
entities that offer de minimis compensation to promoters.\1075\ 
Although, as discussed above, we believe heightened safeguards would 
generally be appropriate for an adviser's use of testimonials or 
endorsements, a promoter's incentives are significantly reduced when 
receiving de minimis compensation. We believe the need for heightened 
safeguards for de minimis compensation is likewise reduced.
---------------------------------------------------------------------------

    \1074\ For example, one commenter stated that smaller advisers 
would face challenges under the proposed rule in demonstrating that 
the performance of a representative account is no higher than if all 
related portfolios had been included. See IAA Comment Letter. See 
also proposed rule 206(4)-1(c)(1)(iii)(A). However, we do not 
believe that providing smaller advisers with the benefit of 
presenting a single representative account that is not subject to 
prescribed conditions would justify the risks of cherry-picking 
related portfolios with higher-than-usual returns. As a result, we 
are not adopting different compliance requirements or exemptions for 
smaller advisers. Instead, we have modified our final rule to allow 
all advisers to include performance returns of a single portfolio if 
they can demonstrate that the performance is not materially higher 
than if all related portfolios had been included, and the 
performance meets the rule's general prohibitions. See final rule 
206(4)-1(d)(4)(i). See also section II.E.4. (discussing related 
performance).
    \1075\ Specifically, the disqualification provisions of the rule 
related to testimonials and endorsements will not apply if the 
person has provided testimonials or endorsements for the investment 
adviser during the preceding twelve months and the investment 
adviser's compensation payable to such person for those testimonials 
or endorsements is $1,000 or less (or the equivalent value in non-
cash compensation).
---------------------------------------------------------------------------

    As discussed above, we believe that the final rule will result in 
multiple benefits to clients. For example, the final rule's disclosure 
requirements and other conditions applicable to the use of 
advertisements will provide investors with information they need to 
assess the adviser's advertising claims (for performance results) and 
third-party claims about the adviser (for testimonials, endorsements, 
and third-party ratings). In particular, the disclosures related to 
testimonials and endorsements will: (i) Help to ensure that investors 
are aware that promoters have a conflict of interest in referring them 
to advisers that compensate them for the referral; (ii) extend the 
current solicitation rule's investor protection to investors whose 
advisers compensate their promoters with non-cash compensation; (iii) 
extend the rule to private fund investors; and (iv) eliminate 
duplicative disclosures. We believe that these benefits should apply

[[Page 13138]]

to clients of smaller firms as well as larger firms.
    We also believe that the rule's disqualification provisions with 
respect to testimonials and endorsements will result in transparency 
and consistency for advisory clients, promoters, and advisers, as the 
provisions will generally eliminate the need for advisers to seek 
separate relief from the rule. In addition, as discussed above, we 
believe that our final rule's placing guardrails on displays of 
performance will increase investor protection and the utility of the 
information provided and decrease the likelihood that it is misleading. 
Establishing different promoter disqualification provisions or 
performance provisions for large and small advisers would negate these 
benefits. Also, as discussed above, our staff will use the 
corresponding information that advisers report on the amended Form ADV 
to help prepare for examinations of investment advisers. Establishing 
different conditions for large and small advisers that advertise their 
services to investors would negate these benefits.
    Regarding the second alternative, we believe the final rule is 
clear and that further clarification, consolidation, or simplification 
of the compliance requirements is not necessary. As discussed above, 
the final rule will provide general anti-fraud principles applicable to 
all advertisements under the rule; will provide further restrictions 
and conditions on certain specific types of presentations, such as 
testimonials and endorsements; and will provide additional conditions 
for advertisements containing certain performance information. These 
provisions will address a number of common advertising practices that 
have not been explicitly addressed or broadly restricted (e.g., the 
current advertising rule prohibits testimonials concerning the 
investment adviser or its services, and direct or indirect references 
to specific profitable recommendations that the investment adviser has 
made in the past). The proposed provisions will clarify and modernize 
the advertising regime, which has come to depend on a large number of 
no-action letters over the years to fill the gaps.
    Regarding the third alternative, we determined to use a combination 
of performance and design standards. The general prohibitions will be 
principles-based and will give advisers a broad framework within which 
to determine how best to present advertisements so they are not false 
or misleading. There will also be the principles-based requirement that 
an adviser must have a reasonable basis for believing that a person 
providing a testimonial or endorsement has complied with the final 
rule. We believe that providing advisers with the flexibility to 
determine how to implement the requirements of the rule allows them the 
opportunity to tailor these obligations to the facts and circumstances 
of their particular arrangements. The final rule will also contain 
design standards, as it contains additional conditions for certain 
third-party statements, and certain restrictions and conditions on 
performance claims. These restrictions and conditions are narrowly 
tailored to prevent certain types of advertisements that are not a 
fraudulent, deceptive, or manipulative act, practice, or course of 
business within the meaning of section 206(4) of the Act from 
misleading investors. The corresponding changes to rule 204-2 and Form 
ADV are also narrowly tailored to reflect the final rule.
    We also considered an alternative that would not have included 
design standards, and that would have relied entirely on performance 
standards. In this alternative, as discussed in the Economic Analysis 
at section III above, we would reduce the limitations on investment 
adviser advertising, and rely on the general prohibitions to achieve 
the programmatic costs and benefits of the rule. As discussed in the 
Economic Analysis, we believe that many of the types of advertisements 
that would be prohibited by the final rule's limitations have the 
potential to be fraudulent or misleading. We do not believe that 
removal of the limitations on advertisements we are adopting would, in 
comparison with the final rule, permit advertisements that would not be 
inherently fraudulent or misleading. In addition, we believe that the 
removal of limitations may create uncertainty about what types of 
advertisements would fall under the general prohibitions.

Statutory Authority

    The Commission is adopting amendments to rule 206(4)-1 under the 
Advisers Act under the authority set forth in sections 203(d), 206(4), 
211(a), and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 
80b-3(d), 10b-6(4) and 80b-11(a) and (h)]. The Commission is rescinding 
rule 206(4)-3 under the Advisers Act under the authority set forth in 
sections 203(d), 206(4), 211(a), and 211(h) of the Investment Advisers 
Act of 1940 [15 U.S.C. 80b-2(d), 80b-6(4), and 80b-11(a) and (h)]. The 
Commission is adopting amendments to rule 204-2 under the Advisers Act 
under the authority set forth in sections 204 and 211 of the Investment 
Advisers Act of 1940 [15 U.S.C. 80b-4 and 80b-11]. The Commission is 
adopting amendments to Form ADV under section 19(a) of the Securities 
Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2) of the 
Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 78bb(e)(2)], 
section 319(a) of the Trust Indenture Act of 1939 [15 U.S.C. 7sss(a)], 
section 38(a) of the Investment Company Act of 1940 [15 U.S.C. 80a-
37(a)], and sections 203(c)(1), 204, and 211(a) of the Investment 
Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-11(a)].

List of Subjects in 17 CFR Parts 275 and 279

    Reporting and recordkeeping requirements; Securities.

Text of Amendments

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

0
1. The authority citation for part 275 continues to read in part as 
follows:

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless 
otherwise noted.
* * * * *
    Section 275.204-2 is also issued under 15 U.S.C 80b-6.
* * * * *

0
2. Amend Sec.  275.204-2 by
0
a. Revising paragraphs (a)(7)(iv), (a)(11), (15), and (16); and
0
b. Adding paragraph (a)(19).
    The revisions and addition read as follows:


Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

    (a) * * *
    (7) * * *
    (iv) Predecessor performance (as defined in Sec.  275.206(4)-
1(e)(12) of this chapter) and the performance or rate of return of any 
or all managed accounts, portfolios (as defined in Sec.  275.206(4)-
1(e)(11) of this chapter), or securities recommendations; Provided, 
however:
    (A) That the investment adviser shall not be required to keep any 
unsolicited market letters and other similar communications of general 
public distribution not prepared by or for the investment adviser; and
    (B) That if the investment adviser sends any notice, circular, or 
other advertisement (as defined in Sec.  275.206(4)-1(e)(1) of this 
chapter)

[[Page 13139]]

offering any report, analysis, publication or other investment advisory 
service to more than ten persons, the investment adviser shall not be 
required to keep a record of the names and addresses of the persons to 
whom it was sent; except that if such notice, circular, or 
advertisement is distributed to persons named on any list, the 
investment adviser shall retain with the copy of such notice, circular, 
or advertisement a memorandum describing the list and the source 
thereof.
* * * * *
    (11) (i) A copy of each
    (A) Advertisement (as defined in Sec.  275.206(4)-1(e)(1) of this 
chapter) that the investment adviser disseminates, directly or 
indirectly, except:
    (1) For oral advertisements, the adviser may instead retain a copy 
of any written or recorded materials used by the adviser in connection 
with the oral advertisement; and
    (2) For compensated oral testimonials and endorsements (as defined 
in Sec.  275.206(4)-1(e)(17) and (5) of this chapter), the adviser may 
instead make and keep a record of the disclosures provided to clients 
or investors pursuant to Sec.  275.206(4)-1(b)(1) of this chapter; and
    (B) Notice, circular, newspaper article, investment letter, 
bulletin, or other communication that the investment adviser 
disseminates, directly or indirectly, to ten or more persons (other 
than persons associated with such investment adviser); and
    (C) If such notice, circular, advertisement, newspaper article, 
investment letter, bulletin, or other communication recommends the 
purchase or sale of a specific security and does not state the reasons 
for such recommendation, a memorandum of the investment adviser 
indicating the reasons therefor; and
    (ii) A copy of any questionnaire or survey used in the preparation 
of a third-party rating included or appearing in any advertisement in 
the event the adviser obtains a copy of the questionnaire or survey.
* * * * *
    (15) (i) If not included in the advertisement, a record of the 
disclosures provided to clients or investors pursuant to Sec.  
275.206(4)-1(b)(1)(ii) and (iii) of this chapter;
    (ii) Documentation substantiating the adviser's reasonable basis 
for believing that a testimonial or endorsement (as defined in Sec.  
275.206(4)-1(e)(17) and (5) of this chapter) complies with Sec.  
275.206(4)-1 and that the third-party rating (as defined in Sec.  
275.206(4)-1(e)(18) of this chapter) complies with Sec.  275.206(4)-
1(c)(1) of this chapter.
    (iii) A record of the names of all persons who are an investment 
adviser's partners, officers, directors, or employees, or a person that 
controls, is controlled by, or is under common control with the 
investment adviser, or is a partner, officer, director or employee of 
such a person pursuant to Sec.  275.206(4)-1(b)(4)(ii) of this chapter.
    (16) All accounts, books, internal working papers, and any other 
records or documents that are necessary to form the basis for or 
demonstrate the calculation of any performance or rate of return of any 
or all managed accounts, portfolios (as defined in Sec.  275.206(4)-
1(e)(11) of this chapter), or securities recommendations presented in 
any notice, circular, advertisement (as defined in Sec.  275.206(4)-
1(e)(1) of this chapter), newspaper article, investment letter, 
bulletin, or other communication that the investment adviser 
disseminates, directly or indirectly, to any person (other than persons 
associated with such investment adviser), including copies of all 
information provided or offered pursuant to Sec.  275.206(4)-1(d)(6) of 
this chapter; provided, however, that, with respect to the performance 
of managed accounts, the retention of all account statements, if they 
reflect all debits, credits, and other transactions in a client's or 
investor's account for the period of the statement, and all worksheets 
necessary to demonstrate the calculation of the performance or rate of 
return of all managed accounts shall be deemed to satisfy the 
requirements of this paragraph.
* * * * *
    (19) A record of who the ``intended audience'' is pursuant to Sec.  
275.206(4)-1(d)(6) and(e)(10)(ii)(B) of this chapter.
* * * * *

0
3. Revise Sec.  275.206(4)-1 to read as follows:


Sec.  275.206(4)-1   Investment Adviser Marketing.

    As a means reasonably designed to prevent fraudulent, deceptive, or 
manipulative acts, practices, or courses of business within the meaning 
of section 206(4) of the Act (15 U.S.C. 80b-6(4)), it is unlawful for 
any investment adviser registered or required to be registered under 
section 203 of the Act (15 U.S.C. 80b-3), directly or indirectly, to 
disseminate any advertisement that violates any of paragraphs (a) 
through (d) of this section.
    (a) General prohibitions. An advertisement may not:
    (1) Include any untrue statement of a material fact, or omit to 
state a material fact necessary in order to make the statement made, in 
the light of the circumstances under which it was made, not misleading;
    (2) Include a material statement of fact that the adviser does not 
have a reasonable basis for believing it will be able to substantiate 
upon demand by the Commission;
    (3) Include information that would reasonably be likely to cause an 
untrue or misleading implication or inference to be drawn concerning a 
material fact relating to the investment adviser;
    (4) Discuss any potential benefits to clients or investors 
connected with or resulting from the investment adviser's services or 
methods of operation without providing fair and balanced treatment of 
any material risks or material limitations associated with the 
potential benefits;
    (5) Include a reference to specific investment advice provided by 
the investment adviser where such investment advice is not presented in 
a manner that is fair and balanced;
    (6) Include or exclude performance results, or present performance 
time periods, in a manner that is not fair and balanced; or
    (7) Otherwise be materially misleading.
    (b) Testimonials and endorsements. An advertisement may not include 
any testimonial or endorsement, and an adviser may not provide 
compensation, directly or indirectly, for a testimonial or endorsement, 
unless the investment adviser complies with the conditions in 
paragraphs (b)(1) through (3) of this section, subject to the 
exemptions in paragraph (b)(4) of this section.
    (1) Required disclosures. The investment adviser discloses, or 
reasonably believes that the person giving the testimonial or 
endorsement discloses, the following at the time the testimonial or 
endorsement is disseminated:
    (i) Clearly and prominently:
    (A) That the testimonial was given by a current client or investor, 
and the endorsement was given by a person other than a current client 
or investor, as applicable;
    (B) That cash or non-cash compensation was provided for the 
testimonial or endorsement, if applicable; and
    (C) A brief statement of any material conflicts of interest on the 
part of the person giving the testimonial or endorsement resulting from 
the investment adviser's relationship with such person;
    (ii) The material terms of any compensation arrangement, including 
a description of the compensation provided or to be provided, directly 
or

[[Page 13140]]

indirectly, to the person for the testimonial or endorsement; and
    (iii) A description of any material conflicts of interest on the 
part of the person giving the testimonial or endorsement resulting from 
the investment adviser's relationship with such person and/or any 
compensation arrangement.
    (2) Adviser oversight and compliance. The investment adviser must 
have:
    (i) A reasonable basis for believing that the testimonial or 
endorsement complies with the requirements of this section, and
    (ii) A written agreement with any person giving a testimonial or 
endorsement that describes the scope of the agreed-upon activities and 
the terms of compensation for those activities.
    (3) Disqualification. An investment adviser may not compensate a 
person, directly or indirectly, for a testimonial or endorsement if the 
adviser knows, or in the exercise of reasonable care should know, that 
the person giving the testimonial or endorsement is an ineligible 
person at the time the testimonial or endorsement is disseminated. This 
paragraph shall not disqualify any person for any matter(s) that 
occurred prior to May 4, 2021, if such matter(s) would not have 
disqualified such person under Sec.  275.206(4)-3(a)(1)(ii) of this 
chapter, as in effect prior to May 4, 2021.
    (4) Exemptions. (i) A testimonial or endorsement disseminated for 
no compensation or de minimis compensation is not required to comply 
with paragraphs (b)(2)(ii) and (3) of this section;
    (ii) A testimonial or endorsement by the investment adviser's 
partners, officers, directors, or employees, or a person that controls, 
is controlled by, or is under common control with the investment 
adviser, or is a partner, officer, director or employee of such a 
person is not required to comply with paragraphs (b)(1) and (2)(ii) of 
this section, provided that the affiliation between the investment 
adviser and such person is readily apparent to or is disclosed to the 
client or investor at the time the testimonial or endorsement is 
disseminated and the investment adviser documents such person's status 
at the time the testimonial or endorsement is disseminated;
    (iii) A testimonial or endorsement by a broker or dealer registered 
with the Commission under section 15(b) of the Securities Exchange Act 
of 1934 (15 U.S.C. 78o(a)) is not required to comply with:
    (A) Paragraph (b)(1) of this section if the testimonial or 
endorsement is a recommendation subject to Sec.  240.15l-1 of this 
chapter (Regulation Best Interest) under that Act;
    (B) Paragraphs (b)(1)(ii) and (iii) of this section if the 
testimonial or endorsement is provided to a person that is not a retail 
customer (as that term is defined in Sec.  240.15l-1 of this chapter 
(Regulation Best Interest) under the Securities Exchange Act of 1934 
(15 U.S.C. 78o(a)); and
    (C) Paragraph (b)(3) of this section if the broker or dealer is not 
subject to statutory disqualification, as defined under section 
3(a)(39) of that Act; and
    (iv) A testimonial or endorsement by a person that is covered by 
rule 506(d) of Regulation D under the Securities Act of 1933 (Sec.  
230.506(d) of this chapter) with respect to a rule 506 securities 
offering under the Securities Act of 1933 (Sec.  230.506 of this 
chapter) and whose involvement would not disqualify the offering under 
that rule is not required to comply with paragraph (b)(3) of this 
section.
    (c) Third-party ratings. An advertisement may not include any 
third-party rating, unless the investment adviser:
    (1) Has a reasonable basis for believing that any questionnaire or 
survey used in the preparation of the third-party rating is structured 
to make it equally easy for a participant to provide favorable and 
unfavorable responses, and is not designed or prepared to produce any 
predetermined result; and
    (2) Clearly and prominently discloses, or the investment adviser 
reasonably believes that the third-party rating clearly and prominently 
discloses:
    (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 directly 
or indirectly by the adviser in connection with obtaining or using the 
third-party rating.
    (d) Performance. An investment adviser may not include in any 
advertisement:
    (1) Any presentation of gross performance, unless the advertisement 
also presents net performance:
    (i) With at least equal prominence to, and in a format designed to 
facilitate comparison with, the gross performance; and
    (ii) Calculated over the same time period, and using the same type 
of return and methodology, as the gross performance.
    (2) Any performance results, of any portfolio or any composite 
aggregation of related portfolios, in each case other than any private 
fund, unless the advertisement includes performance results of the same 
portfolio or composite aggregation for one-, five-, and ten-year 
periods, each presented with equal prominence and ending on a date that 
is no less recent than the most recent calendar year-end; except that 
if the relevant portfolio did not exist for a particular prescribed 
period, then the life of the portfolio must be substituted for that 
period.
    (3) Any statement, express or implied, that the calculation or 
presentation of performance results in the advertisement has been 
approved or reviewed by the Commission.
    (4) Any related performance, unless it includes all related 
portfolios; provided that related performance may exclude any related 
portfolios if:
    (i) The advertised performance results are not materially higher 
than if all related portfolios had been included; and
    (ii) The exclusion of any related portfolio does not alter the 
presentation of any applicable time periods prescribed by paragraph 
(d)(2) of this section.
    (5) Any extracted performance, unless the advertisement provides, 
or offers to provide promptly, the performance results of the total 
portfolio from which the performance was extracted.
    (6) Any hypothetical performance unless the investment adviser:
    (i) Adopts and implements policies and procedures reasonably 
designed to ensure that the hypothetical performance is relevant to the 
likely financial situation and investment objectives of the intended 
audience of the advertisement;
    (ii) Provides sufficient information to enable the intended 
audience to understand the criteria used and assumptions made in 
calculating such hypothetical performance; and
    (iii) Provides (or, if the intended audience is an investor in a 
private fund, provides, or offers to provide promptly) sufficient 
information to enable the intended audience to understand the risks and 
limitations of using such hypothetical performance in making investment 
decisions; Provided that the investment adviser need not comply with 
the other conditions on performance in paragraphs (d)(2), (4), and (5) 
of this section.
    (7) Any predecessor performance unless:
    (i) The person or persons who were primarily responsible for 
achieving the prior performance results manage accounts at the 
advertising adviser;
    (ii) The accounts managed at the predecessor investment adviser are 
sufficiently similar to the accounts

[[Page 13141]]

managed at the advertising investment adviser that the performance 
results would provide relevant information to clients or investors;
    (iii) All accounts that were managed in a substantially similar 
manner are advertised unless the exclusion of any such account would 
not result in materially higher performance and the exclusion of any 
account does not alter the presentation of any applicable time periods 
prescribed in paragraph (d)(2) of this section; and
    (iv) The advertisement clearly and prominently includes all 
relevant disclosures, including that the performance results were from 
accounts managed at another entity.
    (e) Definitions. For purposes of this section:
    (1) Advertisement means:
    (i) Any direct or indirect communication an investment adviser 
makes to more than one person, or to one or more persons if the 
communication includes hypothetical performance, that offers the 
investment adviser's investment advisory services with regard to 
securities to prospective clients or investors in a private fund 
advised by the investment adviser or offers new investment advisory 
services with regard to securities to current clients or investors in a 
private fund advised by the investment adviser, but does not include:
    (A) Extemporaneous, live, oral communications;
    (B) Information contained in a statutory or regulatory notice, 
filing, or other required communication, provided that such information 
is reasonably designed to satisfy the requirements of such notice, 
filing, or other required communication; or
    (C) A communication that includes hypothetical performance that is 
provided:
    (1) In response to an unsolicited request for such information from 
a prospective or current client or investor in a private fund advised 
by the investment adviser; or
    (2) To a prospective or current investor in a private fund advised 
by the investment adviser in a one-on-one communication; and
    (ii) Any endorsement or testimonial for which an investment adviser 
provides compensation, directly or indirectly, but does not include any 
information contained in a statutory or regulatory notice, filing, or 
other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication.
    (2) De minimis compensation means compensation paid to a person for 
providing a testimonial or endorsement of a total of $1,000 or less (or 
the equivalent value in non-cash compensation) during the preceding 12 
months.
    (3) A disqualifying Commission action means a Commission opinion or 
order barring, suspending, or prohibiting the person from acting in any 
capacity under the Federal securities laws.
    (4) A disqualifying event is any of the following events that 
occurred within ten years prior to the person disseminating an 
endorsement or testimonial:
    (i) A conviction by a court of competent jurisdiction within the 
United States of any felony or misdemeanor involving conduct described 
in paragraph (2)(A) through (D) of section 203(e) of the Act;
    (ii) A conviction by a court of competent jurisdiction within the 
United States of engaging in, any of the conduct specified in 
paragraphs (1), (5), or (6) of section 203(e) of the Act;
    (iii) The entry of any final order by any entity described in 
paragraph (9) of section 203(e) of the Act, or by the U.S. Commodity 
Futures Trading Commission or a self-regulatory organization (as 
defined in the Form ADV Glossary of Terms)), of the type described in 
paragraph (9) of section 203(e) of the Act;
    (iv) The entry of an order, judgment or decree described in 
paragraph (4) of section 203(e) of the Act, and still in effect, by any 
court of competent jurisdiction within the United States; and
    (v) A Commission order that a person cease and desist from 
committing or causing a violation or future violation of:
    (A) Any scienter-based anti-fraud provision of the Federal 
securities laws, including without limitation section 17(a)(1) of the 
Securities Act of 1933 (15 U.S.C. 77q(a)(1)), section 10(b) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78j(b)) and Sec.  240.10b-5 
of this chapter, section 15(c)(1) of the Securities Exchange Act of 
1934 (15 U.S.C. 78o(c)(1)), and section 206(1) of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-6(1)), or any other rule or 
regulation thereunder; or
    (B) Section 5 of the Securities Act of 1933 (15 U.S.C. 77e);
    (vi) A disqualifying event does not include an event described in 
paragraphs (e)(4)(i) through (v) of this section with respect to a 
person that is also subject to:
    (A) An order pursuant to section 9(c) of the Investment Company Act 
of 1940 (15 U.S.C. 80a-9) with respect to such event; or
    (B) A Commission opinion or order with respect to such event that 
is not a disqualifying Commission action; provided that for each 
applicable type of order or opinion described in paragraphs 
(e)(4)(vi)(A) and (B) of this section:
    (1) The person is in compliance with the terms of the order or 
opinion, including, but not limited to, the payment of disgorgement, 
prejudgment interest, civil or administrative penalties, and fines; and
    (2) For a period of ten years following the date of each order or 
opinion, the advertisement containing the testimonial or endorsement 
must include a statement that the person providing the testimonial or 
endorsement is subject to a Commission order or opinion regarding one 
or more disciplinary action(s), and include the order or opinion or a 
link to the order or opinion on the Commission's website.
    (5) Endorsement means any statement by a person other than a 
current client or investor in a private fund advised by the investment 
adviser that:
    (i) Indicates approval, support, or recommendation of the 
investment adviser or its supervised persons or describes that person's 
experience with the investment adviser or its supervised persons;
    (ii) Directly or indirectly solicits any current or prospective 
client or investor to be a client of, or an investor in a private fund 
advised by, the investment adviser; or
    (iii) Refers any current or prospective client or investor to be a 
client of, or an investor in a private fund advised by, the investment 
adviser.
    (6) Extracted performance means the performance results of a subset 
of investments extracted from a portfolio.
    (7) Gross performance means the performance results of a portfolio 
(or portions of a portfolio that are included in extracted performance, 
if applicable) before the deduction of all fees and expenses that a 
client or investor has paid or would have paid in connection with the 
investment adviser's investment advisory services to the relevant 
portfolio.
    (8) Hypothetical performance means performance results that were 
not actually achieved by any portfolio of the investment adviser.
    (i) Hypothetical performance includes, but is not limited to;
    (A) Performance derived from model portfolios;
    (B) Performance that is backtested by the application of a strategy 
to data from

[[Page 13142]]

prior time periods when the strategy was not actually used during those 
time periods; and
    (C) Targeted or projected performance returns with respect to any 
portfolio or to the investment advisory services with regard to 
securities offered in the advertisement, however:
    (ii) Hypothetical performance does not include:
    (A) An interactive analysis tool where a client or investor, or 
prospective client, or investor, uses the tool to produce simulations 
and statistical analyses that present the likelihood of various 
investment outcomes if certain investments are made or certain 
investment strategies or styles are undertaken, thereby serving as an 
additional resource to investors in the evaluation of the potential 
risks and returns of investment choices; provided that the investment 
adviser:
    (1) Provides a description of the criteria and methodology used, 
including the investment analysis tool's limitations and key 
assumptions;
    (2) Explains that the results may vary with each use and over time;
    (3) If applicable, describes the universe of investments considered 
in the analysis, explains how the tool determines which investments to 
select, discloses if the tool favors certain investments and, if so, 
explains the reason for the selectivity, and states that other 
investments not considered may have characteristics similar or superior 
to those being analyzed; and
    (4) Discloses that the tool generates outcomes that are 
hypothetical in nature; or
    (B) Predecessor performance that is displayed in compliance with 
paragraph (d)(7) of this section.
    (9) Ineligible person means a person who is subject to a 
disqualifying Commission action or is subject to any disqualifying 
event, and the following persons with respect to the ineligible person:
    (i) Any employee, officer, or director of the ineligible person and 
any other individuals with similar status or functions within the scope 
of association with the ineligible person;
    (ii) If the ineligible person is a partnership, all general 
partners; and
    (iii) If the ineligible person is a limited liability company 
managed by elected managers, all elected managers.
    (10) Net performance means the performance results of a portfolio 
(or portions of a portfolio that are included in extracted performance, 
if applicable) after the deduction of all fees and expenses that a 
client or investor has paid or would have paid in connection with the 
investment adviser's investment advisory services to the relevant 
portfolio, including, if applicable, advisory fees, advisory fees paid 
to underlying investment vehicles, and payments by the investment 
adviser for which the client or investor reimburses the investment 
adviser. For purposes of this rule, net performance:
    (i) May reflect the exclusion of custodian fees paid to a bank or 
other third-party organization for safekeeping funds and securities; 
and/or
    (ii) If using a model fee, must reflect one of the following:
    (A) The deduction of a model fee when doing so would result in 
performance figures that are no higher than if the actual fee had been 
deducted; or
    (B) The deduction of a model fee that is equal to the highest fee 
charged to the intended audience to whom the advertisement is 
disseminated.
    (11) Portfolio means a group of investments managed by the 
investment adviser. A portfolio may be an account or a private fund and 
includes, but is not limited to, a portfolio for the account of the 
investment adviser or its advisory affiliate (as defined in the Form 
ADV Glossary of Terms).
    (12) Predecessor performance means investment performance achieved 
by a group of investments consisting of an account or a private fund 
that was not advised at all times during the period shown by the 
investment adviser advertising the performance.
    (13) Private fund has the same meaning as in section 202(a)(29) of 
the Act.
    (14) Related performance means the performance results of one or 
more related portfolios, either on a portfolio-by-portfolio basis or as 
a composite aggregation of all portfolios falling within stated 
criteria.
    (15) Related portfolio means a portfolio with substantially similar 
investment policies, objectives, and strategies as those of the 
services being offered in the advertisement.
    (16) Supervised person has the same meaning as in section 
202(a)(25) of the Act.
    (17) Testimonial means any statement by a current client or 
investor in a private fund advised by the investment adviser:
    (i) About the client or investor's experience with the investment 
adviser or its supervised persons;
    (ii) That directly or indirectly solicits any current or 
prospective client or investor to be a client of, or an investor in a 
private fund advised by, the investment adviser; or
    (iii) That refers any current or prospective client or investor to 
be a client of, or an investor in a private fund advised by, the 
investment adviser.
    (18) Third-party rating means a rating or ranking of an investment 
adviser provided by a person who is not a related person (as defined in 
the Form ADV Glossary of Terms), and such person provides such ratings 
or rankings in the ordinary course of its business.


Sec.  275.206(4)-3   [Removed and reserved]

0
4. Remove and reserve Sec.  275.206(4)-3.

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

0
5. The authority citation for part 279 continues to read as follows:

    Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, 
et seq., Pub. L.111-203, 124 Stat. 1376.


0
6. Amend Form ADV (referenced in Sec.  279.1) by:
0
a. Adding Item 5.L to Part 1A;
0
b. Revising the instructions to the form, in the section entitled 
``Form ADV: Glossary of Terms;''
0
c. Revising the instructions to the form, in the section entitled 
``Part 2A of Form ADV: Firm Brochure,'' by removing the phrase ``SEC 
rule 206(4)-3'' in the Note in Item 14.B. and adding, in its place, 
``SEC rule 206(4)-1.''
    The addition and revision read as follows:

    Note:  The text of Form ADV does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM ADV (Paper Version)

 UNIFORM APPLICATION FOR INVESTMENT ADVISER REGISTRATION AND

 REPORT BY EXEMPT REPORTING ADVISERS PART lA

* * * * *
Item 5: Information About Your Advisory Business
ADVISORY ACTIVITIES
L. Marketing Activities
    (1) Do any of your advertisements include:
    a. Performance results?
    Y N
    b. A reference to specific investment advice provided by you (as 
that phrase is used in rule 206(4)-1(a)(5))?
    Y N
    c. Testimonials (other than those that satisfy rule 206(4)-
1(b)(4)(ii))?
    Y N
    d. Endorsements (other than those that satisfy rule 206(4)-
1(b)(4)(ii))?
    Y N
    e. Third-party ratings?

[[Page 13143]]

    Y N
    (2) If you answer ``yes'' to L(1)(c), (d), or (e) above, do you pay 
or otherwise provide cash or non-cash compensation, directly or 
indirectly, in connection with the use of testimonials, endorsements, 
or third-party ratings?
    Y N
    (3) Do any of your advertisements include hypothetical performance?
    Y N
    (4) Do any of your advertisements include predecessor performance?
    Y N
* * * * *

FORM ADV: GLOSSARY OF TERMS

    1. Advertisement: (i) Any direct or indirect communication an 
investment adviser makes to more than one person, or to one or more 
persons if the communication includes hypothetical performance, that 
offers the investment adviser's investment advisory services with 
regard to securities to prospective clients or investors in a private 
fund advised by the investment adviser or offers new investment 
advisory services with regard to securities to current clients or 
investors in a private fund advised by the investment adviser, but does 
not include: (A) Extemporaneous, live, oral communications; (B) 
information contained in a statutory or regulatory Notice, filing, or 
other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication; or (C) a communication that includes 
hypothetical performance that is provided: (1) In response to an 
unsolicited request for such information from a prospective or current 
client or investor in a private fund advised by the investment adviser; 
or (2) to a prospective or current investor in a private fund advised 
by the investment adviser in a one-on-one communication; and (ii) any 
endorsement or testimonial for which an investment adviser provides 
compensation, directly or indirectly, but does not include any 
information contained in a statutory or regulatory notice, filing, or 
other required communication, provided that such information is 
reasonably designed to satisfy the requirements of such notice, filing, 
or other required communication. [Used in: Part 1A, Item 5]
    2. Advisory Affiliate: Your advisory affiliates are (1) all of your 
officers, partners, or directors (or any person performing similar 
functions); (2) all persons directly or indirectly controlling or 
controlled by you; and (3) all of your current employees (other than 
employees performing only clerical, administrative, support or similar 
functions).
    If you are a ``separately identifiable department or division'' 
(SID) of a bank, your advisory affiliates are: (1) All of your bank's 
employees who perform your investment advisory activities (other than 
clerical or administrative employees); (2) all persons designated by 
your bank's board of directors as responsible for the day-to-day 
conduct of your investment advisory activities (including supervising 
the employees who perform investment advisory activities); (3) all 
persons who directly or indirectly control your bank, and all persons 
whom you control in connection with your investment advisory 
activities; and (4) all other persons who directly manage any of your 
investment advisory activities (including directing, supervising or 
performing your advisory activities), all persons who directly or 
indirectly control those management functions, and all persons whom you 
control in connection with those management functions. [Used in: Part 
1A, Items 7, 11, DRPs; Part 1B, Item 2]
    3. Annual Updating Amendment: Within 90 days after your firm's 
fiscal year end, your firm must file an ``annual updating amendment,'' 
which is an amendment to your firm's Form ADV that reaffirms the 
eligibility information contained in Item 2 of Part 1A and updates the 
responses to any other item for which the information is no longer 
accurate. [Used in: General Instructions; Part 1A, Instructions, 
Introductory Text, Item 2; Part 2A, Instructions, Appendix 1 
Instructions; Part 2B, Instructions]
    4. Borrowings: Borrowings include secured borrowings and unsecured 
borrowings, collectively. Secured borrowings are obligations for 
borrowed money in respect of which the borrower has posted collateral 
or other credit support and should include any reverse repos (i.e., any 
sale of securities coupled with an agreement to repurchase the same (or 
similar) securities at a later date at an agreed price). Unsecured 
borrowings are obligations for borrowed money in respect of which the 
borrower has not posted collateral or other credit support. [Used in: 
Part 1A, Instructions, Item 5, Schedule D]
    5. Brochure: A written disclosure statement that you must provide 
to clients and prospective clients. See SEC rule 204-3; Form ADV, Part 
2A. [Used in: General Instructions; Used throughout Part 2]
    6. Brochure Supplement: A written disclosure statement containing 
information about certain of your supervised persons that your firm is 
required by Part 2B of Form ADV to provide to clients and prospective 
clients. See SEC rule 204-3; Form ADV, Part 2B. [Used in: General 
Instructions; Used throughout Part 2]
    7. Charged: Being accused of a crime in a formal complaint, 
information, or indictment (or equivalent formal charge). [Used in: 
Part 1A, Item 11; DRPs]
    8. Client: Any of your firm's investment advisory clients. This 
term includes clients from which your firm receives no compensation, 
such as family members of your supervised persons. If your firm also 
provides other services (e.g., accounting services), this term does not 
include clients that are not investment advisory clients. [Used 
throughout Form ADV and Form ADV-W]
    9. Commodity Derivative: Exposures to commodities that you do not 
hold physically, whether held synthetically or through derivatives 
(whether cash or physically settled). [Used in: Part 1A, Schedule D]
    10. Control: The power, directly or indirectly, to direct the 
management or policies of a person, whether through ownership of 
securities, by contract, or otherwise.
     Each of your firm's officers, partners, or directors 
exercising executive responsibility (or persons having similar status 
or functions) is presumed to control your firm.
     A person is presumed to control a corporation if the 
person: (i) Directly or indirectly has the right to vote 25 percent or 
more of a class of the corporation's voting securities; or (ii) has the 
power to sell or direct the sale of 25 percent or more of a class of 
the corporation's voting securities.
     A person is presumed to control a partnership if the 
person has the right to receive upon dissolution, or has contributed, 
25 percent or more of the capital of the partnership.
     A person is presumed to control a limited liability 
company (``LLC'') if the person: (i) Directly or indirectly has the 
right to vote 25 percent or more of a class of the interests of the 
LLC; (ii) has the right to receive upon dissolution, or has 
contributed, 25 percent or more of the capital of the LLC; or (iii) is 
an elected manager of the LLC.
     A person is presumed to control a trust if the person is a 
trustee or managing agent of the trust.

[Used in: General Instructions; Part 1A, Instructions, Items 2, 7, 10, 
11, 12, Schedules A, B, C, D, R; DRPs]

    11. Credit Derivative: Single name credit default swap, including 
loan credit default swap, credit default swap referencing a 
standardized basket of

[[Page 13144]]

credit entities, including credit default swap indices and indices 
referencing leveraged loans, and credit default swap referencing 
bespoke basket or tranche of collateralized debt obligations and 
collateralized loan obligations (including cash flow and synthetic) 
other than mortgage backed securities.

[Used in: Part 1A, Schedule D]

    12. Custody: Holding, directly or indirectly, client funds or 
securities, or having any authority to obtain possession of them. You 
have custody if a related person holds, directly or indirectly, client 
funds or securities, or has any authority to obtain possession of them, 
in connection with advisory services you provide to clients. Custody 
includes:
     Possession of client funds or securities (but not of 
checks drawn by clients and made payable to third parties) unless you 
receive them inadvertently and you return them to the sender promptly, 
but in any case within three business days of receiving them;
     Any arrangement (including a general power of attorney) 
under which you are authorized or permitted to withdraw client funds or 
securities maintained with a custodian upon your instruction to the 
custodian; and
     Any capacity (such as general partner of a limited 
partnership, managing member of a limited liability company or a 
comparable position for another type of pooled investment vehicle, or 
trustee of a trust) that gives you or your supervised person legal 
ownership of or access to client funds or securities.
[Used in: Part 1A, Item 9; Part 1B, Instructions, Item 2; Part 2A, 
Items 15, 18]
    13. Discretionary Authority or Discretionary Basis: Your firm has 
discretionary authority or manages assets on a discretionary basis if 
it has the authority to decide which securities to purchase and sell 
for the client. Your firm also has discretionary authority if it has 
the authority to decide which investment advisers to retain on behalf 
of the client. [Used in: Part 1A, Instructions, Item 8; Part 1B, 
Instructions; Part 2A, Items 4, 16, 18; Part 2B, Instructions]
    14. Employee: This term includes an independent contractor who 
performs advisory functions on your behalf. [Used in: Part 1A, 
Instructions, Items 1, 5, 11; Part 2B, Instructions]
    15. Endorsement: Any statement by a person other than a current 
client or investor in a private fund advised by the investment adviser 
that: (i) Indicates approval, support, or recommendation of the 
investment adviser or its supervised persons or describes that person's 
experience with the investment adviser or its supervised persons; (ii) 
directly or indirectly solicits any current or prospective client or 
investor to be a client of, or an investor in a private fund advised 
by, the investment adviser; or (iii) refers any current or prospective 
client of, or an investor in a private fund advised by, the investment 
adviser. [Used in: Part 1A, Item 5]
    16. Enjoined: This term includes being subject to a mandatory 
injunction, prohibitory injunction, preliminary injunction, or a 
temporary restraining order. [Used in: Part 1A, Item 11; DRPs]
    17. Equity Derivative: Includes both listed equity derivative and 
derivative exposure to unlisted securities. Listed equity derivative 
includes all synthetic or derivative exposure to equities, including 
preferred equities, listed on a regulated exchange. Listed equity 
derivative also includes a single stock future, equity index future, 
dividend swap, total return swap (contract for difference), warrant and 
right. Derivative exposure to unlisted equities includes all synthetic 
or derivative exposure to equities, including preferred equities, that 
are not listed on a regulated exchange. Derivative exposure to unlisted 
securities also includes a single stock future, equity index future, 
dividend swap, total return swap (contract for difference), warrant and 
right. [Used in: Part 1A, Schedule D]
    18. Exempt Reporting Adviser: An investment adviser that qualifies 
for the exemption from registration under section 203(l) of the 
Advisers Act because it is an adviser solely to one or more venture 
capital funds, or under rule 203(m)-1 of the Advisers Act because it is 
an adviser solely to private funds and has assets under management in 
the United States of less than $150 million. [Used in: Throughout Part 
1A; General Instructions; Form ADV-H; Form ADV-NR]
    19. Felony: For jurisdictions that do not differentiate between a 
felony and a misdemeanor, a felony is an offense punishable by a 
sentence of at least one year imprisonment and/or a fine of at least 
$1,000. The term also includes a general court martial. [Used in: Part 
1A, Item 11; DRPs; Part 2A, Item 9; Part 2B, Item 3]
    20. Filing Adviser: An investment adviser eligible to register with 
the SEC that files (and amends) a single umbrella registration on 
behalf of itself and each of its relying advisers. [Used in: General 
Instructions; Part 1A, Items 1, 2, 3, 10 and 11; Schedule R]
    21. FINRA CRD or CRD: The Web Central Registration Depository 
(``CRD'') system operated by FINRA for the registration of broker-
dealers and broker-dealer representatives. [Used in: General 
Instructions; Part 1A, Item 1, Schedules A, B, C, D, R, DRPs; Form ADV-
W, Item 1]
    22. Foreign Exchange Derivative: Any derivative whose underlying 
asset is a currency other than U.S. dollars or is an exchange rate. 
Cross-currency interest rate swaps should be included in foreign 
exchange derivatives and excluded from interest rate derivatives. [Used 
in: Part 1A, Schedule D]
    23. Foreign Financial Regulatory Authority: This term includes (1) 
a foreign securities authority; (2) another governmental body or 
foreign equivalent of a self-regulatory organization empowered by a 
foreign government to administer or enforce its laws relating to the 
regulation of investment-related activities; and (3) a foreign 
membership organization, a function of which is to regulate the 
participation of its members in the activities listed above. [Used in: 
Part 1A, Items 1, 11, DRPs; Part 2A, Item 9; Part 2B, Item 3]
    24. Found: This term includes adverse final actions, including 
consent decrees in which the respondent has neither admitted nor denied 
the findings, but does not include agreements, deficiency letters, 
examination reports, memoranda of understanding, letters of caution, 
admonishments, and similar informal resolutions of matters. [Used in: 
Part 1A, Item 11; Part 1B, Item 2; Part 2A, Item 9; Part 2B, Item 3]
    25. Government Entity: Any state or political subdivision of a 
state, including (i) any agency, authority, or instrumentality of the 
state or political subdivision; (ii) a plan or pool of assets 
controlled by the state or political subdivision or any agency, 
authority, or instrumentality thereof; and (iii) any officer, agent, or 
employee of the state or political subdivision or any agency, 
authority, or instrumentality thereof, acting in their official 
capacity. [Used in: Part 1A, Item 5]
    26. Gross Notional Value: The gross nominal or notional value of 
all transactions that have been entered into but not yet settled as of 
the reporting date. For contracts with variable nominal or notional 
principal amounts, the basis for reporting is the nominal or notional 
principal amounts as of the reporting date. For options, use delta 
adjusted notional value. [Used in: Part 1A, Schedule D]
    27. High Net Worth Individual: An individual who is a qualified 
client or who is a ``qualified purchaser'' as defined in section 
2(a)(51)(A) of the

[[Page 13145]]

Investment Company Act of 1940. [Used in: Part 1A, Item 5]
    28. Home State: If your firm is registered with a state securities 
authority, your firm's ``home state'' is the state where it maintains 
its principal office and place of business. [Used in: Part 1B, 
Instructions]
    29. Hypothetical Performance: Performance results that were not 
actually achieved by any portfolio of the investment adviser. (i) 
Hypothetical performance includes, but is not limited to: (A) 
Performance derived from model portfolios; (B) performance that is 
backtested by the application of a strategy to data from prior time 
periods when the strategy was not actually used during those time 
periods; and (C) targeted or projected performance returns with respect 
to any portfolio or to the investment services offered in the 
advertisement; however: (ii) Hypothetical performance does not include: 
(A) An interactive analysis tool where a client or investor, or 
prospective client, or investor, uses the tool to produce simulations 
and statistical analyses that present the likelihood of various 
investment outcomes if certain investments are made or certain 
investment strategies or styles are undertaken, thereby serving as an 
additional resource to investors in the evaluation of the potential 
risks and returns of investment choices; provided that the investment 
adviser: (1) Provides a description of the criteria and methodology 
used, including the investment analysis tool's limitations and key 
assumptions; (2) explains that the results may vary with each use and 
over time; (3) if applicable, describes the universe of investments 
considered in the analysis, explains how the tool determines which 
investments to select, discloses if the tool favors certain investments 
and, if so, explains the reason for the selectivity, and states that 
other investments not considered may have characteristics similar or 
superior to those being analyzed; and (4) discloses that the tool 
generates outcomes that are hypothetical in nature; or (B) predecessor 
performance that is displayed in compliance with rule 206(4)-1(d)(7). 
[Used in: Part 1A, Item 5]
    30. Impersonal Investment Advice: Investment advisory services that 
do not purport to meet the objectives or needs of specific individuals 
or accounts. [Used in: Part 1A, Instructions; Part 2A, Instructions; 
Part 2B, Instructions]
    31. Independent Public Accountant: A public accountant that meets 
the standards of independence described in rule 2-01(b) and (c) of 
Regulation S-X (17 CFR 210.2-01(b) and (c)). [Used in: Part 1A, Item 9; 
Schedule D]
    32. Interest Rate Derivative: Any derivative whose underlying asset 
is the obligation to pay or the right to receive a given amount of 
money accruing interest at a given rate. Cross-currency interest rate 
swaps should be included in foreign exchange derivatives and excluded 
from interest rate derivatives. This information must be presented in 
terms of 10-year bond equivalents. [Used in: Part 1A, Schedule D]
    33. Investment Adviser Representative: Any of your firm's 
supervised persons (except those that provide only impersonal 
investment advice) is an investment adviser representative, if --
     the supervised person regularly solicits, meets with, or 
otherwise communicates with your firm's clients,
     the supervised person has more than five clients who are 
natural persons and not high net worth individuals, and
     more than ten percent of the supervised person's clients 
are natural persons and not high net worth individuals.
    Note: If your firm is registered with the state securities 
authorities and not the SEC, your firm may be subject to a different 
state definition of ``investment adviser representative.'' Investment 
adviser representatives of SEC-registered advisers may be required to 
register in each state in which they have a place of business.

[Used in: General Instructions; Part 1A, Item 5; Part 2B, Item 1]

    34. Investment-Related: Activities that pertain to securities, 
commodities, banking, insurance, or real estate (including, but not 
limited to, acting as or being associated with an investment adviser, 
broker-dealer, municipal securities dealer, government securities 
broker or dealer, issuer, investment company, futures sponsor, bank, or 
savings association).

[Used in: Part 1A, Items 7, 11, Schedule D, DRPs; Part 1B, Item 2; Part 
2A, Items 9 and 19; Part 2B, Items 3, 4 and 7]

    35. Involved: Engaging in any act or omission, aiding, abetting, 
counseling, commanding, inducing, conspiring with or failing reasonably 
to supervise another in doing an act. [Used in: Part 1A, Item 11; Part 
2A, Items 9 and 10; Part 2B, Items 3 and 7]
    36. Legal Entity Identifier: A ``legal entity identifier'' assigned 
by a utility endorsed by the Global LEI Regulatory Oversight Committee 
(ROC) or accredited by the Global LEI Foundation (GLEIF). [Used in: 
Part 1A, Item 1, Schedules D and R]
    37. Management Persons: Anyone with the power to exercise, directly 
or indirectly, a controlling influence over your firm's management or 
policies, or to determine the general investment advice given to the 
clients of your firm.
    Generally, all of the following are management persons:
     Your firm's principal executive officers, such as your 
chief executive officer, chief financial officer, chief operations 
officer, chief legal officer, and chief compliance officer; your 
directors, general partners, or trustees; and other individuals with 
similar status or performing similar functions;
     The members of your firm's investment committee or group 
that determines general investment advice to be given to clients; and
     If your firm does not have an investment committee or 
group, the individuals who determine general investment advice provided 
to clients (if there are more than five people, you may limit your 
firm's response to their supervisors).
[Used in: Part 1B, Item 2; Part 2A, Items 9, 10 and 19]
    38. Managing Agent: A managing agent of an investment adviser is 
any person, including a trustee, who directs or manages (or who 
participates in directing or managing) the affairs of any 
unincorporated organization or association that is not a partnership. 
[Used in: General Instructions; Form ADV-NR; Form ADV-W, Item 8]
    39. Minor Rule Violation: A violation of a self-regulatory 
organization rule that has been designated as ``minor'' pursuant to a 
plan approved by the SEC. A rule violation may be designated as 
``minor'' under a plan if the sanction imposed consists of a fine of 
$2,500 or less, and if the sanctioned person does not contest the fine. 
(Check with the appropriate self- regulatory organization to determine 
if a particular rule violation has been designated as ``minor'' for 
these purposes.) [Used in: Part 1A, Item 11]
    40. Misdemeanor: For jurisdictions that do not differentiate 
between a felony and a misdemeanor, a misdemeanor is an offense 
punishable by a sentence of less than one year imprisonment and/or a 
fine of less than $1,000. The term also includes a special court 
martial. [Used in: Part 1A, Item 11; DRPs; Part 2A, Item 9; Part 2B, 
Item 3]
    41. Non-Resident: (a) An individual who resides in any place not 
subject to the jurisdiction of the United States; (b) a corporation 
incorporated in or that has its principal office and place of business 
in any place not subject to the jurisdiction of the United States; and 
(c) a partnership or other unincorporated

[[Page 13146]]

organization or association that is formed in or has its principal 
office and place of business in any place not subject to the 
jurisdiction of the United States. [Used in: General Instructions; Form 
ADV-NR]
    42. Notice Filing: SEC-registered advisers may have to provide 
state securities authorities with copies of documents that are filed 
with the SEC. These filings are referred to as ``notice filings.'' 
[Used in: General Instructions; Part 1A, Item 2; Execution Page(s); 
Form ADV-W]
    43. Order: A written directive issued pursuant to statutory 
authority and procedures, including an order of denial, exemption, 
suspension, or revocation. Unless included in an order, this term does 
not include special stipulations, undertakings, or agreements relating 
to payments, limitations on activity or other restrictions. [Used in: 
Part 1A, Items 2 and 11, Schedules D and R; DRPs; Part 2A, Item 9; Part 
2B, Item 3]
    44. Other Derivative: Any derivative that is not a commodity 
derivative, credit derivative, equity derivative, foreign exchange 
derivative or interest rate derivative. [Used in: Part 1A, Schedule D]
    45. Parallel Managed Account: With respect to any registered 
investment company or series thereof or business development company, a 
parallel managed account is any managed account or other pool of assets 
that you advise and that pursues substantially the same investment 
objective and strategy and invests side by side in substantially the 
same positions as the identified investment company or series thereof 
or business development company that you advise. [Used in: Part 1A, 
Schedule D]
    46. Performance-Based Fee: An investment advisory fee based on a 
share of capital gains on, or capital appreciation of, client assets. A 
fee that is based upon a percentage of assets that you manage is not a 
performance-based fee. [Used in: Part 1A, Item 5; Part 2A, Items 6 and 
19]
    47. Person: A natural person (an individual) or a company. A 
company includes any partnership, corporation, trust, limited liability 
company (``LLC''), limited liability partnership (``LLP''), sole 
proprietorship, or other organization. [Used throughout Form ADV and 
Form ADV-W]
    48. Predecessor Performance: Investment performance achieved by a 
group of investments consisting of an account or a private fund that 
was not advised at all times during the period shown by the investment 
adviser advertising the performance. [Used in: Part 1A, Item 5]
    49. Principal Office and Place of Business: Your firm's executive 
office from which your firm's officers, partners, or managers direct, 
control, and coordinate the activities of your firm. [Used in: Part 1A, 
Instructions, Items 1 and 2; Schedules D and R; Form ADV-W, Item 1]
    50. Private Fund: An issuer that would be an investment company as 
defined in section 3 of the Investment Company Act of 1940 but for 
section 3(c)(1) or 3(c)(7) of that Act. [Used in: General Instructions; 
Part 1A, Instructions, Items 2, 5, 7, and 9; Part 1A, Schedule D]
    51. Proceeding: This term includes a formal administrative or civil 
action initiated by a governmental agency, self-regulatory organization 
or foreign financial regulatory authority; a felony criminal indictment 
or information (or equivalent formal charge); or a misdemeanor criminal 
information (or equivalent formal charge). This term does not include 
other civil litigation, investigations, or arrests or similar charges 
effected in the absence of a formal criminal indictment or information 
(or equivalent formal charge). [Used in: Part 1A, Item 11, DRPs; Part 
1B, Item 2; Part 2A, Item 9; Part 2B, Item 3]
    52. Qualified Client: A client that satisfies the definition of 
qualified client in SEC rule 205-3. [Used in: General Instructions; 
Part 1A, Schedule D]
    53. Related Person: Any advisory affiliate and any person that is 
under common control with your firm. [Used in: Part 1A, Items 7, 8 and 
9; Schedule D; Form ADV-W, Item 3; Part 2A, Items 10, 11, 12 and 14; 
Part 2A, Appendix 1, Item 6]
    54. Relying Adviser: An investment adviser eligible to register 
with the SEC that relies on a filing adviser to file (and amend) a 
single umbrella registration on its behalf. [Used in: General 
Instructions; Part 1A, Items 1, 7 and 11; Schedules D and R]
    55. Self-Regulatory Organization or SRO: Any national securities or 
commodities exchange, registered securities association, or registered 
clearing agency. For example, the Chicago Board of Trade (``CBOT''), 
FINRA and New York Stock Exchange (``NYSE'') are self-regulatory 
organizations. [Used in: Part 1A, Item 11; DRPs; Part 1B, Item 2; Part 
2A, Items 9 and 19; Part 2B, Items 3 and 7]
    56. Sovereign Bonds: Any notes, bonds and debentures issued by a 
national government (including central government, other governments 
and central banks but excluding U.S. state and local governments), 
whether denominated in a local or foreign currency. [Used in: Part 1A, 
Schedule D]
    57. Sponsor: A sponsor of a wrap fee program sponsors, organizes, 
or administers the program or selects, or provides advice to clients 
regarding the selection of, other investment advisers in the program. 
[Used in: Part 1A, Item 5, Schedule D; Part 2A, Instructions, Appendix 
1 Instructions]
    58. State Securities Authority: The securities commissioner or 
commission (or any agency, office or officer performing like functions) 
of any state of the United States, the District of Columbia, Puerto 
Rico, the Virgin Islands, or any other possession of the United States. 
[Used throughout Form ADV]
    59. Supervised Person: Any of your officers, partners, directors 
(or other persons occupying a similar status or performing similar 
functions), or employees, or any other person who provides investment 
advice on your behalf and is subject to your supervision or control. 
[Used throughout Part 2]
    60. Testimonial: Any statement by a current client or investor in a 
private fund advised by the investment adviser: (i) About the client or 
investor's experience with the investment adviser or its supervised 
persons (ii) that directly or indirectly solicits any current or 
prospective client or investor to be a client of, or an investor in a 
private fund advised by, the investment adviser; or (iii) that refers 
any current or prospective client or investor to be a client of, or an 
investor in a private fund advised by, the investment adviser. [Used 
in: Part 1A, Item 5]
    61. Third-party Rating: A rating or ranking of an investment 
adviser provided by a person who is not a related person and such 
person provides such ratings or rankings in the ordinary course of its 
business. [Used in: Part 1A, Item 5]
    62. Umbrella Registration: A single registration by a filing 
adviser and one or more relying advisers who collectively conduct a 
single advisory business and that meet the conditions set forth in 
General Instruction 5. [Used in: General Instructions; Part 1A, Items 
1, 2, 3, 7, 10 and 11, Schedules D and R]
    63. United States Person: This term has the same meaning as in rule 
203(m)-1 under the Advisers Act, which includes any natural person that 
is resident in the United States. [Used in: Part 1A, Instructions, Item 
5; Schedule D]
    64. Wrap Brochure or Wrap Fee Program Brochure: The written 
disclosure statement that sponsors of

[[Page 13147]]

wrap fee programs must provide to each of their wrap fee program 
clients. [Used in: Part 2, General Instructions; Used throughout Part 
2A, Appendix 1]
    65. Wrap Fee Program: Any advisory program under which a specified 
fee or fees not based directly upon transactions in a client's account 
is charged for investment advisory services (which may include 
portfolio management or advice concerning the selection of other 
investment advisers) and the execution of client transactions. [Used 
in: Part 1, Item 5; Schedule D; Part 2A, Instructions, Item 4, used 
throughout Appendix 1; Part 2B, Instructions]

    By the Commission.

    Dated: December 22, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-28868 Filed 3-4-21; 8:45 am]
BILLING CODE 8011-01-P

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