The “Advertising Rule,” encapsulated in Rule 206(4)-1 under the Investment Advisers Act of 1940, serves as a regulatory cornerstone for investment advisers, guiding the ethical marketing of advisory services. This rule strictly prohibits advisers from publishing or distributing advertisements containing untrue statements or that are otherwise misleading.

Understanding Advertising Under the Advisers Act

The SEC defines “advertising” broadly to include any public or private announcement or communication, whether through written, digital, or audio-visual media, which markets advisory services or offers investment analysis. Advertising encompasses any material containing analyses, reports, charts, or recommendations related to securities that assist investors in making buy or sell decisions.

Key Prohibitions Under the Advertising Rule

Rule 206(4)-1 specifies several areas that are particularly sensitive under the Advertising Rule:

• Testimonials: Use of client testimonials is prohibited.
• Performance Claims: Advisers cannot highlight past profitable recommendations without balanced disclosure of losses or risks.
• Claims of Predictive Formulas: Any claim that a specific formula or chart can reliably indicate market trends or investment timing is prohibited.
• Free Offers: Offering free services, reports, or analysis without transparency regarding terms is prohibited.

In addition to these specific prohibitions, the SEC has issued guidance and interpretations, including through the Office of Compliance Inspections and Examinations (OCIE) and no-action letters, to provide further clarity on acceptable advertising practices.

Common Advertising Rule Violations

The OCIE has identified recurrent violations of the Advertising Rule. Here are some common issues:

1. Misleading Performance Results: Advertising performance data that fails to deduct advisory fees or presents hypothetical results without disclosing underlying assumptions can be misleading. Advisers must be transparent about the costs and limitations of performance metrics to provide investors with a fair view of potential results.
2. Cherry-Picking Profitable Recommendations: Highlighting only profitable recommendations is a form of “cherry-picking” and is misleading without the inclusion of non-profitable outcomes or additional context. The SEC’s TCW Group and Franklin no-action letters offer guidelines, suggesting that if positive recommendations are shown, an equal number of negative recommendations must also be disclosed.
3. One-on-One Presentations: Even in private meetings, advisers must ensure that all presented information, such as performance results, includes necessary disclosures (like advisory fees), or risk misleading the investor.
4. Unsubstantiated Claims of Compliance: Advisers sometimes claim compliance with voluntary performance standards without having sufficient evidence to support such claims. Inaccurate claims can mislead investors about the reliability of performance metrics and services.
5. Touting Awards or Rankings: The OCIE’s Touting Initiative uncovered that advisers frequently misuse awards and third-party rankings by omitting key details, such as the selection criteria or whether payment was made to obtain the award. Additionally, advisers have sometimes used false information to secure awards, which further misleads prospective clients.

Key Takeaways for Compliance

A robust compliance program is essential to ensure adherence to the Advertising Rule. Here are recommended steps:

• Pre-Approval Processes: Establish a process to review and approve all marketing materials before they are published.
• Clear Disclosures: Include clear disclosures about advisory fees, benchmarks used, and hypothetical performance limitations.
• Documented Compliance Policies: Maintain written policies on permissible advertising practices and ensure all staff members understand them.
• Transparent Award and Ranking Information: Disclose all relevant details about awards or rankings, including the selection criteria and whether the adviser paid for the award.

In summary, understanding and adhering to the Advertising Rule is critical for maintaining trust and integrity in the advisory industry. By adopting robust policies, investment advisers can ensure their advertising practices remain compliant, transparent, and effective.