Investment Adviser Advertisements; Compensation For Solicitations

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SECURITIES AND EXCHANGE COMMISSION17 CFR Part 275 and 279Release No. IA-5407; File No. S7-21-19RIN: 3235-AM08Investment Adviser Advertisements; Compensation for SolicitationsAGENCY: Securities and Exchange Commission.ACTION: Proposed rule.SUMMARY: The Securities and Exchange Commission (the “Commission” or the “SEC”) isproposing amendments under the Investment Advisers Act of 1940 (the “Advisers Act” or the“Act”) to the rules that prohibit certain investment adviser advertisements and payments tosolicitors, respectively. The proposed amendments to the advertising rule reflect marketdevelopments since the rule’s adoption in 1961. The proposed amendments to the solicitationrule update its coverage to reflect regulatory changes and the evolution of industry practicessince we adopted the rule in 1979. The Commission is also proposing amendments to FormADV that are designed to provide the Commission with additional information regardingadvisers’ advertising practices. Finally, the Commission is proposing amendments under theAdvisers Act to the books and records rule, to correspond to the proposed changes to theadvertising and solicitation rules.DATES: Comments should be received on or before [INSERT DATE 60 DAYS AFTERPUBLICATION IN THE FEDERAL REGISTER].ADDRESSES: Comments may be submitted by any of the following methods:Electronic Comments: Use the Commission’s Internet comment form(http://www.sec.gov/rules/proposed.shtml); or

Send an email to rule-comments@sec.gov. Please include File Number S7-21-19on the subject line.Paper Comments: Send paper comments to Vanessa A. Countryman, Secretary, Securities and ExchangeCommission, 100 F Street NE, Washington, DC 20549-1090.All submissions should refer to File Number S7-21-19. This file number should beincluded on the subject line if email is used. To help the Commission process and review yourcomments more efficiently, please use only one method. The Commission will post allcomments on the Commission’s website (http://www.sec.gov/rules/proposed.shtml). Commentsalso are available for website viewing and printing in the Commission’s Public Reference Room,100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00am and 3:00 pm. All comments received will be posted without change. Persons submittingcomments are cautioned that the Commission does not redact or edit personal identifyinginformation from comment submissions. You should submit only information that you wish tomake publicly available.Studies, memoranda or other substantive items may be added by the Commission or staffto the comment file during this rulemaking. A notification of the inclusion in the comment fileof any such materials will be made available on the Commission’s website. To ensure directelectronic receipt of such notifications, sign up through the “Stay Connected” option atwww.sec.gov to receive notifications by email.FOR FURTHER INFORMATION CONTACT: Matthew Cook, Emily Rowland, or JamesMaclean, Senior Counsels; or Thoreau Bartmann or Melissa Roverts Harke, Senior SpecialCounsels, at (202) 551-6787 or IArules@sec.gov, Investment Adviser Regulation Office,2

Division of Investment Management, Securities and Exchange Commission, 100 F Street NE,Washington, DC 20549-8549.SUPPLEMENTARY INFORMATION: The Commission is proposing for public commentamendments to 17 CFR 275.206(4)-1 (rule 206(4)-1), 17 CFR 275.206(4)-3 (rule 206(4)-3), and17 CFR 275.204-2 (rule 204-2) under the Investment Advisers Act of 1940 [15 U.S.C. 80b-1 etseq.] (the “Advisers Act”), 1 and amendments to Form ADV [17 CFR 279.1] under the AdvisersAct.1Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we arereferring to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we refer to rules under theAdvisers Act, or any paragraph of those rules, we are referring to title 17, part 275 of the Code of FederalRegulations [17 CFR part 275], in which these rules are published.3

TABLE OF CONTENTSI.II.INTRODUCTION . 7A.Advertising Rule Background . 8B.Cash Solicitation Rule Background . 15DISCUSSION . 19A.B.1.Structure of the Rule . 192.Scope of the Rule: Definition of “Advertisement” . 193.General Prohibitions . 534.Testimonials, Endorsements, and Third Party Ratings. . 755.Performance Advertising . 996.Portability of Performance, Testimonials, Third Party Ratings, andSpecific Investment Advice . 1827.Review and Approval of Advertisements . 1908.Proposed Amendments to Form ADV . 195Proposed Amendments to the Solicitation Rule . 2001.Scope of the Rule: Who is a Solicitor? . 2012.Expanding the Rule to Address All Forms of Compensation . 2053.Compensation for the Solicitation of Existing and Prospective Investors. 2104.Solicitor Disclosure . 2125.Written Agreement . 2286.Adviser Oversight and Compliance; Elimination of Additional Provisions. 2337.Exemptions . 2388.Disqualification for Persons Who Have Engaged in Misconduct . 261C.Recordkeeping . 285D.Existing Staff No-Action Letters and Other Related Guidance . 296E.III.Proposed Amendments to the Advertising Rule . 191.Letters to be reviewed concerning rule 206(4)-1 . 2962.Letters to be reviewed concerning rule 206(4)-3 . 299Transition Period and Compliance Date . 304ECONOMIC ANALYSIS . 306A.Introduction . 306B.Broad Economic Considerations . 3084

C.D.E.F.IV.Baseline . 3131.Market for Investment Advisers . 3132.Market for Solicitors . 3213.RIA Clients . 323Costs and Benefits of the Proposed Rule and Form Amendments . 3261.General Costs and Benefits of the Advertising Rule . 3272.Specific Costs and Benefits of the Advertising Rule . 3343.Costs and Benefits of the Proposed Amendments to the Solicitation Rule. 357Efficiency, Competition, Capital Formation . 3691.Advertising. 3692.Solicitation. 374Reasonable Alternatives Considered. 3761.Reduce Specific Limitations on Investment Adviser Advertisements . 3762.Not Have an Advertising Rule and Rely on Section 206 . 3763.Define Non-Retail Investors as Accredited Investors or Qualified Clients. 3774.Further Bifurcate Additional Requirements . 3785.No Bifurcation . 3796.Hypothetical Performance Alternatives . 3807.Alternatives to Proposed Amendments to Rule 206(4)-3 . 381PAPERWORK REDUCTION ACT ANALYSIS . 382A.Introduction . 382B.Rule 206(4)-1. 3831.Testimonials and endorsements in advertisements . 3852.Third-party ratings in advertisements . 3873.Performance Advertising . 3894.Additional Conditions Related to Performance Results in RetailAdvertisements. 3995.Review and Approval of Advertisements . 4036.Total hour burden associated with proposed rule 206(4)-1. 405C.Rule 206(4)-3. 408D.Rule 204-2 . 422E.Form ADV . 429F.Request for Comments . 4355

V.INITIAL REGULATORY FLEXIBILITY ANALYSIS . 440A.Reason for and Objectives of the Proposed Action. 4411.Proposed rule 206(4)-1 . 4412.Proposed amendments to rule 206(4)-3 . 4423.Proposed rule 204-2 . 4444.Proposed amendments to Form ADV . 445B.Legal Basis . 446C.Small Entities Subject to the Rule and Rule Amendments . 447D.E.F.G.1.Small entities subject to amendments to advertising rule . 4482.Small entities subject to amendments to solicitation rule . 4493.Small entities subject to amendments to the books and records rule206(4)-2 . 4494.Small entities subject to amendments to Form ADV . 450Projected Reporting, Recordkeeping and Other Compliance Requirements4501.Proposed rule 206(4)-1 . 4502.Proposed amendments to rule 206(4)-3 . 4513.Proposed amendments to rule 204-2 . 4534.Proposed amendments to Form ADV . 454Duplicative, Overlapping, or Conflicting Federal Rules . 4551.Proposed rule 206(4)-1 . 4552.Proposed amendments to rule 206(4)-3 . 4563.Proposed amendments to Form ADV . 457Significant Alternatives . 4581.Proposed rule 206(4)-1 . 4582.Proposed rule 206(4)-3 . 461Solicitation of Comments . 463VI.CONSIDERATION OF IMPACT ON THE ECONOMY . 464VII.STATUTORY AUTHORITY . 464IV.APPENDIX A: CHANGES TO FORM ADV . 482V.APPENDIX B: INVESTOR FEEDBACK FLYER . 483VI.APPENDIX C: SMALLER ADVISER FEEDBACK FLYER. 4876

I.INTRODUCTIONWe are proposing reforms of two rules under the Advisers Act relating to how advisersadvertise to and solicit clients and investors. First, we are proposing a rule addressingadvertisements by investment advisers that would replace the rule that we adopted in 1961, rule206(4)-1, which we have not changed substantively since adoption. 2 The proposed rule wouldreplace the current rule’s broadly drawn limitations with principles-based provisions. Theproposed rule contains general prohibitions of certain advertising practices, as well as moretailored restrictions and requirements that are reasonably designed to prevent fraud with respectto certain specific types of advertisements. This approach permits the use of testimonials andendorsements, and third-party ratings, subject to certain conditions. This approach also permitsthe presentation of performance with tailored requirements based on an advertisement’s intendedaudience. 3 The proposal recognizes developments in technology, changing profiles ofinvestment advisers registered with the Commission, and our experience administering thecurrent rule.Additionally, we are proposing to amend the Advisers Act cash solicitation rule, rule206(4)-3, to update its coverage to reflect regulatory changes and the evolution of industrypractices since we adopted the rule in 1979. We are proposing to expand the rule to coversolicitation arrangements involving all forms of compensation, rather than only cashcompensation, eliminate requirements duplicative of other rules, and tailor the required2The current rule has been amended once, when the Commission revised the introductory text of paragraph(a) as part of a broader amendment of several rules under the Advisers Act to reflect changes made by theNational Securities Market Improvement Act of 1996. Rules Implementing Amendments to the InvestmentAdvisers Act of 1940, Release No. IA-1633 (May 15, 1997) [62 FR 28112, 28135 (May 22, 1997)].3As discussed below, we are proposing to define clients and investors that are “qualified purchasers” or“knowledgeable employees” as “Non-Retail Persons” and to define all other clients and investors as “RetailPersons.” Similarly, we are proposing to define advertisements directed at Non-Retail Persons as “NonRetail Advertisements” and all other advertisements as “Retail Advertisements.”7

disclosures solicitors would provide to investors. The proposed rule would also refine theexisting provisions regarding disciplinary events that would disqualify a person or entity fromacting as a solicitor.Finally, we are proposing related amendments to Form ADV that are designed to provideadditional information regarding advisers’ advertising practices, and amendments to the AdvisersAct books and records rule, rule 204-2, related to the proposed changes to the advertising andsolicitation rules.A.Advertising Rule BackgroundAdvertisements are a useful tool for investment advisers seeking to obtain new investorsand to retain existing investors. 4 Investment advisers disseminate advertisements about theirservices to inform prospective investors and to persuade them to obtain and pay for thoseservices or to learn more about the advisers. Similarly, advertisements can provide existinginvestors with information about new or revised services. Accordingly, advertisements canprovide existing and prospective investors with useful information as they choose amonginvestment advisers and advisory services. At the same time, advertisements present risks ofmisleading existing and prospective investors because the investment adviser’s interest inattracting or retaining them may conflict with their interests, and the adviser is in control of thedesign, content, format, media, timing, and placement of its advertisements with a goal ofobtaining or retaining business. This goal may create an incentive for advertisements to misleadexisting and prospective investors about the advisory services they would receive, includingindirectly through the services provided to pooled investment vehicles.4As discussed below, we are proposing to apply the rule to advertisements disseminated by investmentadvisers to their clients and prospective clients as well as to investors and prospective investors in pooledinvestment vehicles that those advisers manage. For purposes of this release, we refer to any of theseadvertising recipients as “investors,” unless we specify otherwise.8

The Commission recognized the potential harm to investors from misleadingadvertisements when it adopted the current advertising rule in 1961. 5 The Commissionexplained when it proposed the current rule that investment advisers generally must adhere to astricter standard of conduct in advertisements than that applicable to “ordinary merchants”because securities “are intricate merchandise,” and investors “are frequently unskilled andunsophisticated in investment matters.” 6 These concerns have motivated the Commission toadopt other rules on advertising investment services and products, including for registeredinvestment companies (“RICs”). 7In adopting the current rule, the Commission used its authority under section 206(4) ofthe Advisers Act to target advertising practices that it believed were likely to be misleading byimposing four per se prohibitions.8 First, the current rule prohibits testimonials concerning theinvestment adviser or its services. 9 Second, the current rule prohibits direct or indirect referencesto specific profitable recommendations that the investment adviser has made in the past (“pastspecific recommendations”). 10 Third, the current rule prohibits representations that any graph or5Advertisements by Investment Advisers, Release No. IA-121 (Nov. 1, 1961) [26 FR 10548 (Nov. 9, 1961)](“Advertising Rule Adopting Release”).6Investment Advisers Notice of Proposed Rulemaking, Release No. IA-113 (Apr. 4, 1961) [26 FR 3070,3071 (Apr. 11, 1961)] (“Advertising Rule Proposing Release”).7See 17 CFR 230.482 (regulating advertising with respect to securities of RICs and business developmentcompanies (“BDCs”)); 17 CFR 230.156 (regulating investment company sales literature).8See Section 206(4) of the Advisers Act (authorizing the Commission to define and prescribe “meansreasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, ormanipulative”).9Rule 206(4)-1(a)(1) (prohibiting publication, circulation, or distribution of any advertisement “whichrefers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerningany advice, analysis, report or other service rendered by such investment adviser”).10Rule 206(4)-1(a)(2) (prohibiting publication, circulation, or distribution of any advertisement “whichrefers, directly or indirectly, to past specific recommendations of such investment adviser which were orwould have been profitable to any person” but providing that an advertisement may set out or offer tofurnish a list of all recommendations within the immediately preceding period of not less than one yearunder certain conditions).9

other device being offered can by itself be used to determine which securities to buy and sell orwhen to buy and sell them. 11 Fourth, the current rule prohibits any statement to the effect thatany service will be furnished free of charge, unless such service actually is or will be furnishedentirely free and without any condition or obligation. 12In addition to the four per se prohibitions, the current rule prohibits any advertisementwhich contains any untrue statement of a material fact, or which is otherwise false ormisleading. 13 This prohibition operates more generally than the specific prohibitions to addressadvertisements that do not violate any per se prohibition but still may be fraudulent, deceptive,or manipulative and, accordingly, be misleading.The concerns that motivated the Commission to adopt the current rule still exist todayand are echoed in the rules adopted under other regulatory and self-regulatory regimes governingthe use of communications by financial professionals. 14 However, in the nearly 60 years since11Rule 206(4)-1(a)(3) (prohibiting publication, circulation, or distribution of any advertisement “whichrepresents, directly or indirectly, that any graph, chart, formula or other device being offered can in and ofitself be used to determine which securities to buy or sell, or when to buy or sell them; or which representsdirectly or indirectly, that any graph, chart, formula or other device being offered will assist any person inmaking his own decisions as to which securities to buy, sell, or when to buy or sell them, withoutprominently disclosing in such advertisement the limitations thereof and the difficulties with respect to itsuse”).12Rule 206(4)-1(a)(4) (prohibiting publication, circulation, or distribution of any advertisement “whichcontains any statement to the effect that any report, analysis, or other service will be furnished free orwithout charge, unless such report, analysis or other service actually is or will be furnished entirely free andwithout any condition or obligation, directly or indirectly”).13Rule 206(4)-1(a)(5).14For example, the Financial Industry Regulatory Authority’s (“FINRA”) rule 2210 governs broker-dealers’communications with the public, including communications with retail and institutional investors, andprovides standards for the content, approval, recordkeeping, and filing of communications with FINRA.See Advertising Regulation, available at on. TheCommodity Futures Trading Commission likewise regulates certain types of advertising by commoditypool operators, commodity trading advisors, and their respective principals. 17 CFR 4.41 Advertising byCommodity Pool Operators, Commodity Trading Advisors, and the Principals Thereof (prohibiting, in part,any advertisements that employ any device, scheme or artifice to defraud any client or prospective client).The Municipal Securities Rulemaking Board regulates advertisements concerning the products or servicesof certain brokers, dealers, and municipal securities dealers, and, beginning in 2019, will regulateadvertisements by municipal advisers. Self-Regulatory Organizations; Municipal Securities Rulemaking10

the current rule’s adoption, issues and questions have arisen about the current rule’s application,particularly the application of the prohibitions of testimonials and past specificrecommendations. Additionally, some of the most common questions related to the current rule(and the anti-fraud provisions of the Advisers Act) relate to the appropriate presentation ofperformance in advertisements, which the current rule does not explicitly address. The breadthof the current rule’s prohibitions, as well as the lack of explicit prescriptions related to thepresentation of performance in the rule, can present compliance challenges and potentially have achilling effect on advisers’ ability to provide useful information in communications that areconsidered advertisements.Moreover, changes that have occurred since the current rule’s adoption lead us to believeproviding a more principles-based approach would be beneficial. Specifically, in ourdevelopment of the proposed rule, we have considered changes in the technology used forcommunications, the expectations of investors shopping for advisory services, and the nature ofthe investment advisory industry, including the types of investors seeking and receivinginvestment advisory services. These changes have informed not only how we propose to updatethe rule to address current technology, expectations, and market practice but also our generalapproach of proposing principles-based rules in order to accommodate the continual evolutionand interplay of technology and advice. 15Board; Order Granting Approval of a Proposed Rule Change, Consisting to Amendments to Rule G-21, onAdvertising, Proposed New Rule G-40, on Advertising by Municipal Advisers, and a TechnicalAmendment to Rule G-42, on Duties of Non-Solicitor Municipal Advisers, Release No. 34-83177 (May 7,2018) [83 FR 21794 (May 10, 2018)]. MSRB Rule G-40 became effective on August 23, 2019.15See, e.g., Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-10668 (Aug. 8, 2019)[84 FR 44358 (Aug. 23, 2019)] (discussing the role of “principles-based” disclosure requirements inarticulating a disclosure concept rather than a specific line-item requirement).11

Advances in Technology. Advances in technology have altered the ways in which serviceproviders, including advisers, interface with consumers generally, including with existing andprospective investors. These advances have also changed the manner in which those consumersevaluate products and services. In the decades since the current rule was adopted, the use of theinternet, mobile applications, and social media 16 has become an integral part of businesscommunications. These advances in technology have led to significant growth in the nature andvolume of information available to individuals and businesses, 17 for example, by allowing themto access and share user reviews. However, websites and social media can create challenges incomplying with the current rule’s prohibition on testimonials, particularly for advisers that relyheavily on electronic platforms to communicate with existing and prospective investors. 18Expectations of Consumers Shopping for Services. Consumers today often rely on theinternet to obtain information when considering buying goods and services across the world,including advisory services and those of other financial professionals. Many websites allowpotential buyers to compare and contrast the goods and services being offered, including throughreviews and ratings provided by those who have previously bought the relevant goods and16“Social media” is an umbrella term that encompasses various activities that integrate technology, socialinteraction, and content creation. Social media may use many technologies, including, but not limited to,blogs, microblogs, wikis, photos and video sharing, podcasts, social networking, and virtual worlds. Theterms “social media,” “social media sites,” “sites,” and “social networking sites” are used interchangeablyin this release.17See Report on the Review of the Definition of “Accredited Investor” (Dec. 18, 2015) (“Accredited InvestorStaff Report”), available at 8-2015.pdf, at 5 (noting “increased informational availability” and “changes in theway investors communicate” since adoption of the “accredited investor” definition in 1982).18See also Guidance on the Testimonial Rule and Social Media, Division of Investment ManagementGuidance Update No. 2014-04 (Mar. 2014) (“IM Staff Social Media Guidance”), in which our staffdiscussed its views on application of the current rule to various situations involving social media. Any staffguidance or no-action letters discussed in this release represent the views of the staff of the Division ofInvestment Management. They are not a rule, regulation, or statement of the Commission. Furthermore,the Commission has neither approved nor disapproved their content. Staff guidance has no legal force oreffect; it does not alter or amend applicable law, and it creates no new or additional obligations for anyperson.12

services. We believe that consumers’ ability to seek out reviews and other information, as wellas their interest in doing so, when evaluating products and services has changed since theadoption of the current rule.Profiles of the Investment Advisory Industry. The variety of advisers subject to theadvertising rule has changed since the current rule’s adoption. Specifically, the type of advisoryservices provided by advisers generally has changed over time, from impersonal investmentadvice distributed to many prospective investors in the form of newsletters and other periodicalsto more personalized advisory services. The ways advisers and investors interact and engage ha

Similarly, advertisements can provide existing investors with information about new or revised services. Accordingly, advertisements can provide existing and prospective investors with useful information as they choose among investment advisers and advisory services. At the same time, advertisements present risks of

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