The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminates the “private adviser” exemption in the Investment Advisers Act of 1940, a statutory exemption historically relied upon by advisors to private investment funds to remain exempt from SEC registration.
As a result, many advisors to private investment funds are required to register with the SEC by 30 March, 2012. Registered investment advisors must be mindful of SEC advertising/marketing rules and restrictions while on the fundraising trail. Several of these restrictions are discussed below.
• The Investment Advisers Act defines “advertisement” as any written communication addressed to more than one person which offers any investment advisory services with regard to securities. SEC staff has interpreted “advertisement” broadly to encompass any materials designed to maintain existing clients or solicit new clients, including websites. The SEC regulates investment advisor advertising under the antifraud provisions of the Investment Advisers Act. Under the antifraud provisions, it is unlawful for investment advisors to engage in manipulative, fraudulent or deceptive activities. Violations do not require intentional or deliberate conduct; merely “engaging” in deceptive conduct, even unintentionally, may be a violation.
• There is no explicit prohibition on the use of performance data in advertising material. However, the SEC has set forth a number of practices that it considers to be intrinsically false or misleading, including, without limitation, the “net of fees” requirement, failing to disclose whether and to what extent the data reflects the reinvestment of dividends or proceeds, comparing results to an index without disclosing all material factors relevant to the comparison, and disclosing performance results for a select group of funds or client accounts without disclosing the basis on which the selection was made and the effect of this practice on the results portrayed (if material).
• The “Net of Fees” Requirement. Registered advisors may only disclose performance results on a “net of fees” basis. Accordingly, before disclosing prior investment performance, a private investment fund advisor must first deduct all investment advisory fees, carried interest, brokerage commissions and other expenses and transaction costs that the applicable fund or client account paid. Nevertheless, SEC staff has stated that an advisor may distribute materials containing both gross and net performance numbers so long as both sets of numbers are presented in an equally conspicuous manner and the materials contain certain disclosures.
• “Portability” of Performance Data. The SEC has stated that performance of funds or accounts managed at a predecessor advisor or an advisor at which investment personnel previously managed accounts can be used by a successor advisor only if the investment personnel at the successor advisor were primarily responsible for achieving the prior performance results and no other person played a significant role in achieving that prior performance. The same investment personnel also must be primarily responsible for managing similar accounts at the successor advisor. The accounts managed at the prior advisor must be sufficiently similar such that the comparison is meaningful and relevant to investors. The adviser must include the performance of all accounts managed in a substantially similar manner at the prior advisor (unless the exclusion would not result in materially higher performance) and must disclose that the performance results were achieved at the prior advisor. The successor advisor must have access to all data necessary to demonstrate the performance of the relevant funds or accounts at the prior advisor and such data must be retained, as discussed below.
Past Investment Recommendations
• Registered advisors may not advertise, directly or indirectly, past specific investment recommendations
that were profitable unless certain conditions are met. Thus marketing materials highlighting the success or performance metrics of specific investments (such as case studies or liquidity events) may be problematic. In order to use past recommendations in marketing materials, advertisements must include a complete list of all recommendations made by the advisor within the immediately preceding period of not less than one year and certain disclosures, including the name, purchase price and current market value of the investment, and a cautionary legend stating that it should not be assumed that future recommendations will be profitable. Given the practical difficulty and questionable value of such extensive lists, SEC staff has permitted advisors to display a limited number of investment recommendations that are selected using objective, non-performance based criteria and which do not discuss profitability.
• Advisors are prohibited from referring to testimonials concerning the advisor. “Testimonial” generally means any favorable statement of a client or investor’s experience with, or endorsement of, the advisor. SEC staff has permitted the use of legitimate third-party articles about the advisor that do not include a client or investor’s endorsement or experience with the advisor, provided that such third-party articles remain subject to the general prohibition against false or misleading advertisements. SEC staff also has permitted advisors to include partial client lists in advertisements, so long as the advisor does not use performance-based data to determine which clients to include and includes certain disclosures. Advisors should also keep in mind that endorsements by clients or investors made publicly available via social media outlets could be viewed by the SEC as testimonials.
• Advisors are generally required to retain a copy of any advertisement for not less than five years from the end of the fiscal year in which the advertisement was last published or otherwise disseminated. If an advertisement contains performance data, an advisor must keep any records necessary to demonstrate the performance for a minimum of five years after the last advertising material that includes the relevant performance is disseminated.
• Newly registered advisors that are required to register with the SEC pursuant to the elimination of the “private adviser” exemption may continue to use performance information relating to the period prior to registration without being subject to the recordkeeping requirements for that time period, but must keep such records to the extent that they were already being preserved.
Howard J. Beber is a Partner in the Corporate Department and co-head of the Private Investment Funds Group at Proskauer and Gregory A. Dodge is an Associate in the Corporate Department and member of the Private Investment Funds Group. Both are resident in Proskauer’s Boston office.