The SEC Makes an Update to Their Marketing Rule FAQ: New Answers

On January 11th, 2023, the Securities and Exchange Commission’s Division of Investment Management issued another frequently asked question regarding the updated rule 206(4)-1 under the Investment Advisers Act of 1940. This rule has become colloquially known as the “Marketing Rule”. The full rule, which can be found here, was fully effective in November of 2022.

It’s been a few months since the compliance effective date of the rule but there are still many lingering questions about adoption protocols, nuances, dos, and don'ts. The most recent FAQ released by the SEC pertains to Gross and Net Performance. Joot comments are in italics.

Q: When an adviser displays the gross performance of one investment (e.g., a case study) or a group of investments from a private fund, must the adviser show the net performance of the single investment and the group of investments?

A: Yes. The staff believes that displaying the performance of one investment or a group of investments in a private fund is an example of extracted performance under the new marketing rule. Because the extracted performance provision was intended, in part, to address the risk that advisers would present misleadingly selective profitable performance with the benefit of hindsight, the staff believes the provision should be read to apply to a subset of investments (i.e., one or more). Accordingly, an adviser may not show gross performance of one investment or a group of investments without also showing the net performance of that single investment or group of investments, respectively. In addition, the adviser must satisfy the other tailored disclosure requirements as well as the general prohibitions, including the general prohibition against specific investment advice not presented in a fair and balanced manner, when showing extracted performance.

Based on our experience this has been one of the more challenging requirements for private fund managers. Depending on the types of investments in the private fund, applying expenses at the individual investment level is not as easy as applying the expenses at the fund level. We have helped our clients come up with ways of approaching this and meeting the net expense compliance requirement as well as the fair and balanced requirement.

The SEC has previously released answers to other frequently asked question that can be found here. As time moves on and more RIAs have questions, we hope more answers will come from the SEC. Until then, the compliance team at Joot is more than capable of helping you and your firm navigate the Marketing Rule maze. Our team has followed the adoption and implementation of the Marketing Rule from the beginning and can review your investor marketing materials with a fine-toothed comb. We have also released multiple blogs breaking down different elements of the Marketing Rule, including one in which we discussed social media advertising under the new Marketing Rule.

As always, if you have outstanding questions or need more expertise regarding the Marketing Rule and its application, please reach out to our compliance team. We make compliance easy.