SEC Marketing Rule Enforcement Actions Emphasize Need for Policies and Procedures Regarding the Use of Hypothetical Performance

The US Securities and Exchange Commission (the SEC) announced on September 11, 2023, that it had settled with nine SEC-registered investment advisers (the Advisers) over alleged violations of Rule 206(4)-1 under the Investment Advisers Act (the Marketing Rule) and the corresponding provisions of the books and records requirements in Rule 204-2(a)(11) under the Act as a result of their use of hypothetical model or backtested performance returns on their public websites in the absence of required policies and procedures.¹ The Advisers ranged in size from $42.00 million to $1.28 billion in regulatory assets under management, and civil money penalties paid by the Advisers ranged from $50,000 to $175,000. These enforcement actions follow the first SEC enforcement action under the Marketing Rule on August 24, 2023, that also focused on the lack of required policies and procedures regarding the use of hypothetical performance.²

The Marketing Rule requires advisers to have policies and procedures reasonably designed to ensure that hypothetical performance, among other things, is relevant to the likely financial situation and investment objectives of the intended audience.³ The SEC alleged that the Advisers violated this requirement by not having such policies and procedures in place. Furthermore, the SEC implied that it takes the position that any dissemination of hypothetical performance to a public audience (or for general circulation) generally cannot comply with the Marketing Rule because the adviser generally cannot form any expectations about the likely financial situation and investment objectives of the intended audience. Neither the SEC nor its staff has provided any guidance on what type of hypothetical performance (if any) and/or what form of hypothetical performance presentation would be an exception to this position.

Additionally, Rule 204-2(a)(11) requires, among other things, that advisers maintain a copy of all advertisements that they disseminate directly or indirectly. The SEC charged two Advisers with violating Rule 204-2(a)(11) because the Advisers were unable to produce all advertisements that they published on their websites due to their failure to save all performance advertisements on their websites before they were subsequently revised.

These enforcement actions should serve as a reminder to: (i) adopt and implement policies and procedures to ensure compliance with the Marketing Rule, including policies and procedures to confirm that dissemination of hypothetical performance is relevant to the financial situation and investment objectives of the intended audience; (ii) review publicly accessible websites for the use of hypothetical performance; and (iii) maintain copies of all advertisements disseminated, including saving all advertisements that are posted electronically and subsequently revised, such as prior versions of website pages.

In the related SEC press release announcing the actions, Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, stated that the SEC staff is engaged in, and will continue to focus on, investment advisers’ compliance with the Marketing Rule, with a particular focus on the use of hypothetical performance.⁴

^[1] SEC, “SEC Sweep into Marketing Rule Violations Results in Charges Against Nine Investment Advisers” (Sep. 11, 2023).
^[2] Goodwin Client Alert, “SEC Announces the First Enforcement Action under the New Marketing Rule” (Aug. 24, 2023).
^[3] See Rule 206(4)-1(d)(6) under the Investment Advisers Act; also Marketing Rule Release, page 217.
^[4] See supra Note 1.