Preparing for the New SEC “Marketing Rule”

In May of 2021, the US Securities and Exchange Commission’s “Marketing Rule” went into effect, modernizing advertising and cash solicitation rules for investment advisors. Organizations have had 18 months to comply with the new rules and regulations, which have officially become enforced beginning November 4, 2022. Those seeking a smooth transition must understand the amendment’s effects on investment advisors and private fund managers, and the potential implications on management liability insurance.

Restructuring the Investment Advisers Act

The “Marketing Rule” updates the predecessor "Advertising” (Rule 206(4)-1 and Cash Solicitation (Rule 206(4)-3) Rules as a codification under Rule 206(4)-1; as a part of the Investment Advisers Act of 1940. The modernized rule is intended to more closely regulate advisors’ marketing communications and use principles-based prohibitions that will be applicable to all advertisements. One of Its most striking changes is the definition of advertisement. Under the new rule, advertising now takes on two prongs — The first part generally 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 private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The second prong now generally expands advertisements to mean: Endorsements and testimonials, social media comments, or nonwritten communications like pre-recorded videos, etc., for which the adviser receives compensation. Compensation can include cash and non-cash compensation paid directly or indirectly to the adviser.

General Prohibitions

Per the SEC, new rules mandate that advertisements may not:

• Include an untrue statement of a material fact or 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.
• 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 SEC.
• 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.
• 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.
• Reference specific investment advice provided by the investment adviser, where such investment advice is not presented in a manner that is fair and balanced.
• Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced.
• Be otherwise materially misleading.

Modern Regulatory Development

This revision of the Investment Advisers Act enables the SEC to better regulate today’s more modern and technologically advanced environment where social media and other platforms have allowed businesses to skirt regulations such as those involving endorsements. Prior to the update, an amendment to the marketing rulebook had not been updated for decades. Meanwhile, technological progress allowed advisors to disclose information, endorsements, and testimonials through third-party online platforms without violating solicitation regulations. The SEC is also expanding existing oversight to be more stringent categorizing fraud and misrepresentation – seeking to ensure an organization is not saying anything that may be considered misleading or inaccurate.

While the overhaul may seem to be about policing, it serves more as a necessary update. Fixing issues brought on by technological advancement while also trying to anticipate future problems, this amendment protects both sophisticated and non-sophisticated investors from deception.

Anticipated Reactions

Management Liability underwriters will expect organizations to be fully compliant with the new rules and regulations and will seek evidence that senior management has updated its compliance program accordingly.

Only time will tell how premiums will be impacted by the new requirements in the long term. We can, though, anticipate a new basis on which investors have to make claims for omission of information, or materially misleading statements which they purport caused them a loss in investor value. At a minimum, defense costs incurred in the defense of these new allegations may begin to impact insurance companies’ premium charge. However, these lawsuits will provide a learning opportunity for organizations -- allowing them to strengthen their own ecosystem to protect from litigation.

Preparation Tactics

As this new regulatory environment becomes set in stone, it is imperative for organizations to look at their D&O insurance policies to make sure that they are covered in the event of misrepresentation allegations. It is imperative to have robust exceptions to the fraud exclusions with severability built in, as well as conforming the definition of Investment Advisory Services to include “marketing, and solicitation”.

Additional ways to prepare for the “Marketing Rule”:

• Hire outside counsel to review modified marking materials to ensure a safe transition.
• Reevaluate investor communications that could be considered advertisements.
• Update policies and procedures for communications with clients and social media.
• Comply with all new and expanded recordkeeping requirements. Private fund managers need to examine pitch books and other material paired with private placement memorandums (PPMs) that could be newly defined as “advertisement”.

Change is never easy, but quickly getting in step with a new regulatory environment mitigates risks and possible litigation. Follow the Risk Strategies blog to stay up to date on initial impressions and reactions as the regulatory transition sets in.

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Connect with the Risk Strategies Management Liability team at MLPG@risk-strategies.com