Compliance November 5, 2019

SEC Seeks to Bring Adviser Advertising Rules into the Digital Age

As one source points out, the SEC’s advertising rules have not been substantively amended since 1961, long before social media and the dominance of the Internet—even before fax machines.

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The U.S. Securities and Exchange Commission (SEC) voted Monday to propose a set of amendments meant to modernize the advertising rules and restrictions applying to advisers under the Investment Advisers Act.  

According to SEC Chair Jay Clayton, the proposed amendments are intended to update the advertising rules to reflect changes in technology, the expectations of investors seeking advisory services, and the evolution of industry practices.

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“The advertising and solicitation rules provide important protections when advisers seek to attract clients and investors, yet neither rule has changed significantly since its adoption several decades ago,” Clayton said in prepared testimony published ahead of the vote. “The reforms we have proposed today are designed to address market developments and to improve the quality of information available to investors, enabling them to make more informed choices.”

The rule amendments are detailed in summary form on the SEC’s website, and the full rulemaking language will appear soon in the Federal Register. At a high level, Clayton explained, the proposed amendments to the advertising rule would replace the current rule’s broadly drawn limitations with principles-based provisions. The proposed approach would also “permit the use of testimonials, endorsements, and third-party ratings, subject to certain conditions, and would include tailored requirements for the presentation of performance results based on an advertisement’s intended audience.”

Also notable, the proposed amendments to the solicitation rule would expand the current rule to cover solicitation arrangements involving all forms of compensation, rather than only cash—subject to a new de minimis threshold. They also would update other aspects of the rule, such as who is disqualified from acting as a solicitor under the rule.

Advisers and other interested parties can submit comments to the SEC during the next 60 days.

Initial Industry Reaction Is Positive

With the news breaking that the SEC is seeking to update its advertising rules, various parties have already reached out to PLANADVISER to express their support. While they note that it will take time to digest the 500-plus pages of proposed rulemaking text, they like what has been included in the SEC’s summaries.

In his written comments, Investment Adviser Association President and CEO Karen Barr commends the SEC for its proposal, calling it “a significant step in the right direction.”

“The SEC advertising rule hasn’t been substantively amended since 1961—long before social media, long before the Internet, even before fax machines,” Barr says. “We’ve been urging the SEC to update the rule for nearly 20 years. Advancements in technology and communications have drastically changed the ways that every service provider in our economy engages with clients and prospective clients.”

Barr and others have argued that, because of the SEC’s outdated rule, investment advisers are generally prevented from using communications and marketing methods that long ago became standard business practice elsewhere in the economy.

“The IAA has asked the Commission to take a principles-based approach to modernizing the rule that is flexible enough to adapt as technology  and business practices continue to evolve,” Barr adds. “It will take some time to digest the complex 500-plus page release, but our initial observation is that the proposal appears to address several of the specific themes we have raised with the SEC over the years. Most notably, it appears to take a principles-based, evergreen, approach to the rule in contrast to the per se prohibitions that currently exist.”

According to Barr, the SEC’s proposal also appears to distinguish between retail and institutional investors in several important ways and would no longer ban the use of testimonials and past specific recommendations.

“These would be welcome changes,” Barr says. “However, there are aspects of the proposal that merit further analysis and we look forward to providing constructive comments to the SEC. The SEC also proposed to amend the cash solicitation rule to expand its scope significantly while streamlining its requirements.  We look forward to analyzing these changes and providing feedback to the SEC.”

Early Interpretation

According to SEC summary documents, the proposal will update the definition of “advertisement” so that it is flexible enough to remain relevant and effective in the face of advances in technology and evolving industry practices. The definition would include “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.”

The Commission proposes exclusions from this definition for (i) live oral communications that are not broadcast; (ii) responses to certain unsolicited requests for specified information; (iii) advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other Commission rules; and (iv) information required to be contained in a statutory or regulatory notice, filing, or other communication.

The proposed rule would also generally prohibit the following advertising practices:

  • Making an untrue statement of a material fact, or omission of a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading;
  • Making a material claim or statement that is unsubstantiated;
  • Making an untrue or misleading implication about, or being reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the investment adviser;
  • Discussing or implying any potential benefits without clear and prominent discussion of associated material risks or other limitations;
  • Referring to specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
  • Including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and
  • Being otherwise materially misleading.

In a major shift, the proposal would permit testimonials and endorsements, subject to specified disclosures, including whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the adviser. Furthermore, the proposed rule would permit third-party ratings, subject to specified disclosures and certain criteria pertaining to the preparation of the rating.

The inclusion of performance information in advertisements is still subject to various restrictions by the proposal. Namely, the proposal would prohibit the use of gross performance results unless the advertisement also provides or offers to provide promptly a schedule of fees and expenses deducted to calculate net performance. Other restrictions include a prohibition on the use of performance results “from fewer than all portfolios with substantially similar investment policies, objectives and strategies as those being offered or promoted.”

Hypothetical performance information is also subject to restrictions, including that the adviser must adopt and implement policies and procedures reasonably designed to ensure that the performance is relevant to the financial situation and investment objectives of the recipient, and the adviser provides certain specified information underlying the hypothetical performance.

The proposed rule would provide additional protections for an advertisement targeted to a retail audience, such as requiring the presentation of net performance alongside any presentation of gross performance, and requiring generally the presentation of the performance results of any portfolio or certain composite aggregations across one, five, and 10 year periods.”

In addition, the proposed amendments would require advertisements to be reviewed and approved in writing by a designated employee before dissemination, with some exceptions.

Other important elements of the proposed rules address Rule 206(4)-3, which governs the activities of solicitors. One key change is that the proposed rule would apply regardless of whether an adviser pays cash or non-cash compensation to a solicitor. Additionally, the proposed rule would apply to the solicitation of current and prospective investors in private funds, rather than only to the solicitation of current and prospective clients of the adviser. Under the proposed rule, an adviser that compensates a solicitor for solicitation activities would be required to enter into written agreement with the solicitor, unless an exemption applies. The proposed rule would require that the adviser have a reasonable basis for believing that the solicitor has complied with the rule’s written agreement, including complying with the solicitor disclosure requirement.

Compliance November 4, 2019

DOL and SEC Weigh New Proxy Voting Standards

Both the Department of Labor and the Securities and Exchange Commission are revisiting their proxy voting rules, creating an opportunity for greater regulatory alignment.

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The U.S. Securities and Exchange Commission (SEC) will be meeting on November 5, 2019, for an open meeting, at which the regulator is expected to vote on a proposal for new rules that could limit the role of proxy advisers and impact investors’ ability to engage with companies on environmental, social and governance (ESG) matters.

The meeting comes several months after the Commission issued a separate proxy voting rule interpretation which established that advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules. With the interpretation, the SEC has taken the stance that proxy advisory firms are, by providing their advice, not simply delivering objective information to a third party but are, in fact, appealing to the client to vote in a certain way. This in turn means the proxy voting firm must meet a set of specific responsibilities in terms of the accuracy, delivery and intention of its recommendations.

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Sara Crovitz, a partner at Stradley Ronon who formerly served as Deputy Chief Counsel and Associate Director in Investment Management at the SEC, says retirement plan advisers and wealth managers should be paying close attention to these developments.

“During my time at the SEC, there was certainly some debate and evolution in terms of interpreting what a ‘solicitation’ means in the proxy voting context,” she explains. “Put simply, the core goal of the solicitation rule is to make sure someone isn’t trying to control your shares via proxy voting advice. However, the question about whether someone is giving advice or a solicitation to control your shares is a subtle one.”

By way of background, Crovitz recalls, the SEC created its main proxy voting standards framework back in 2003.

“When the SEC put out its rules in this area, it was actually in large part a response to a specific news event,” Crovitz says. “Your readers may recall the Hewlett Packard-Compact merger. In that case, an asset manager was found to have changed its proxy vote at the last minute, basically because HP said that if they wouldn’t vote to approve the merger, HP would not have its people do business with that asset manager in the future. So, the solicitation rule was definitely created at a time when there was some distrust and a certain tone hanging over this whole discussion about proxy voting.”

In a phrase, the presumption from the perspective of the SEC is that fiduciary advisers with the ability to exercise shareholder rights on behalf of clients should be engaged and should be casting votes. If the adviser is not going to vote, the SEC expects the adviser to have run a cost-benefit analysis demonstrating that it is not in the clients’ best interest to be voting on a particular matter.

“Under the Trump Administration, the SEC now seems to be suggesting that it is okay not to vote in various circumstances,” Crovitz says. “In my view, this is almost a meeting in the middle of the Department of Labor [DOL] and the SEC on this issue. The DOL’s stance is different, in that you have to do a cost-benefit analysis to prove that it is worth voting. The outlooks are really almost opposite, and for that reason it will be very interesting to track this issue as it unfolds across regulators in the coming years.”

George Michael Gerstein, partner and co-chair of the fiduciary governance team at Stradley Ronon, agrees with that characterization. He also says he expects the DOL could issue new guidance on this topic within the next few weeks. This expectation is based on the fact that, back in April, the White House issued an executive order stipulating that the Secretary of Labor should, within 180 days of the date of the order, “complete a review of existing DOL guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”

“Technically there was no requirement in the order for new guidance to be issued, but we are nonetheless on the lookout,” Gerstein says. “From the perspective of the DOL, the real question is, how granular does the regulator expect any cost-benefit analysis of shareholder engagement activities to be? Republican and Democratic administrations have gone back and forth on this over the years.”

In his view, Gerstein says, the Bush Administration’s guidance in this area was too onerous. It required very careful and detailed analysis proving that shareholder activism would be beneficial to plan participants.

“Many parties thought the DOL’s stance was that a cost-benefit analysis was required on a vote-by-vote basis,” Gerstein says. “Then, under the Obama Administration, the step was taken to ‘clarify’ that it really didn’t have to be on a vote-by-vote basis. Plan fiduciaries could run a general analysis of the costs and benefits of shareholder engagement.”

Moving forward, Gerstein says, the DOL could go in a few different directions.

“I am concerned they could require a far deeper analysis of the calculation of the costs of exercising shareholder rights—going back to something similar to the Bush-era guidance,” Gerstein says. “That would prove particularly problematic in the context of the expanding use of ESG investing, in my view. If the DOL tightens the screws so much, it could potentially spook some fiduciaries into thinking they have to show some immediate benefit to the plan from any shareholder engagement activity they engage in.  I think the DOL understands the opposite side of the coin from engagement is divestment, to be frank. So, the executive order’s original goal of energy infrastructure promotion could actually backfire if the DOL is too strict about shareholder engagement under ERISA. You could even see plan fiduciaries choosing to divest from energy companies rather than engage with those companies to help improve their long-term viability.”

*Editor’s note: PLANADVISER Magazine is owned by Institutional Shareholder Services (ISS). ISS has filed a lawsuit seeking to halt the implementation of the new proxy voting rules. 

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