From Ulmer’s Broker-Dealer Law Corner Blog
“The SEC score(s) one for the digital age.” These are the words of SEC Commissioner Heist, though, not my own. After a nearly year-long comment period, the SEC announced last week that it was replacing its former advertising and cash solicitation rules with a single, streamlined merged marketing rule. The former advertising rule has not been updated since 1961, back in the Mad Men era of advertising. Recognizing that social media and other digital communications play a significant role in current advertising practices, the SEC agreed that investment advisers can now use such methods as social media, third-party ratings, and testimonials for their marketing.
At first, the expanded marketing rule sounds promising for investment advisers looking to take advantage of the Amazon age of online reviews and ratings. While some industry leaders applaud the long-awaited rule update, the SEC does not shy away from the fact that its new marketing rule is meant to serve the agency’s real raison d’être: investor protection. Indeed, the SEC makes it clear throughout the final rule that since marketing practices have a higher risk of being fraudulent, the rule’s real purpose is to ensure investor protection, rather than to “score one for the digital age.”
To further its regulatory goal within the new rule, the SEC imposes a set of seven “principles-based” prohibitions (which largely mirror the anti-fraud provisions of the Advisers Act) that apply to all advertisements under the rule. The SEC also sets out three types of regulated marketing practices under the rule: (1) testimonials and endorsements; (2) third-party ratings; and (3) performance advertising, which are all subject to stringent disclosures and other requirements.
To better understand the magnitude of the new marketing rule, I rely on what the SEC has to say about it: “we estimate that all investment advisers will disseminate at least one communication that meets the rule’s definition of ‘advertisement’ and therefore be subject to the requirements of the marketing rule.” The SEC’s near-guarantee that “100 percent of investment advisers” will communicate to an investor in a way that invokes the new marketing rule speaks volumes as to its breadth.
In addition to the rule’s broad application and onerous disclosure requirements, the SEC also updated related requirements under its Form ADV and books and records rules, adding a higher compliance burden on firms. For instance, the new recordkeeping requirement now applies to all advertisements (instead of only to those made to ten persons or more under the old rule).
The final rule also includes an oversight and compliance provision that requires an investment adviser to have a reasonable basis for complying with certain elements of the rule to “address the accuracy of disclosures made to investors.” Collectively, these oversight activities, recordkeeping obligations, and disclosure requirements come at a cost, and not just to investment advisers, but also to the very investors the SEC seeks to protect. As the SEC admits, “although the direct costs of advertisements would be borne by the investment adviser, it is possible that some portion of the costs of advertisements will be indirectly borne by investors. As a result, investments in advertisements may result in higher fees for investors.” And since the SEC expects that “100 percent” of investment advisers will engage in some activity regulated by the new rule, it is likely that nearly every investor will bear the costs of compliance with this rule.
The SEC provides an 18-month grace period for firms to adapt to these new changes once the rule goes into effect. It will be interesting to see how investment advisers will avail themselves of the new marketing rule considering the cumbersome restrictions imposed on them. While I was initially idealistic about the new marketing rule, it seems that the SEC’s attempt to modernize advertising practices falls short of the millennial style of digital advertising I was hoping for.