1. Stephen P. Wilkes, Esq. Livia Q. Aber, Esq.
Risk Alert on Advertising Rule
and
Performance Reporting
Stephen P. Wilkes, Esq.
Livia Q. Aber, Esq. .

2. Agenda Overview 9/14/17 Risk Alert – Advertising Rule
Antifraud Rule
Advertising Rule
9/14/17 Risk Alert – Advertising Rule
Performance Reporting
Model and Actual Performance
Portability
Backtested Performance
Recordkeeping Requirements
Global Investment Performance Standards (GIPS)

3. Overview

4. Overview – Anti-fraud Rule
Anti-fraud Rule - §206 of Investment Advisers Act (“Advisers Act”)
Unlawful to employ any device, scheme or artifice to deceive or manipulate any client or prospective client
Unlawful to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.
Intent is not relevant. (SEC v Capital Gains Research)
Additional rulemaking power to define acts that are fraudulent or deceptive and to establish rules reasonably designed to prevent fraud.

5. Overview – Advertising Rule
Advisers Act Rule 206(4)-1 – Advertising Rule
“Advertisement” is defined broadly
Any “notice, circular, letter or other written communication” to “more than one person”. Any “notice or announcement in any publication or by radio or television, which offers…any…investment advisory service with regard to securities.”
May include statements made though social media
Oral communications, tailored communications, certain investment company (mutual fund) communications are NOT advertisements

6. Overview – Advertising Rule (cont’d)
Guidance in the form of Commission opinions, court cases, enforcement proceedings, no-action letters, guidance updates
Four specific prohibitions and a “catch-all” provision
Specific prohibitions
Testimonials
Past Specific Recommendations
Graph, charts, formula
Statement to effect that something is “free”

7. Overview – Advertising Rule (cont’d)
“Catch-all” – Untrue statement of material fact, or which is otherwise false or misleading
Criteria for false/misleading
Client sophistication
Form/content
Implications and inferences

8. Risk Alert – Advertising Rule (Sept. 14, 2017)

9. Risk Alert – Advertising Rule (Sept. 14, 2017)
6 compliance issues
Misleading performance results
Deduction for fees
Limits of the comparison to benchmark
Hypothetical and back-tested performance results must include explanation and other material info

10. Risk Alert – Advertising Rule (Sept. 14, 2017)
Misleading one-to-one presentations
Performance results did not include relevant disclosures
Performance results did not reflect deduction of advisory fees and client’s return would be reduced by such fees, expenses
Misleading claim of compliance with voluntary performance standards
Cherry-picked profitable stock selections

11. Risk Alert – Advertising Rule (Sept. 14, 2017)
Misleading selection of recommendations
Compliance policies and procedures lacking
Advertising materials must be reviewed and approved first
When using composites, policies and procedures needed to determine the accounts to be included in performance calculations
Confirming accuracy of performance results

12. Risk Alert – Advertising Rule (Sept. 14, 2017)
3 observations from Touting Initiative
Third-party rankings or awards
Advertisement included a favorable ranking that had been obtained through misrepresentation
Marketing materials referenced stale rankings
Advertisements were misleading when they failed to (i) include selection criteria, (ii) identify party creating/conducting the raking or award, or (iii) disclose adviser paid to participate in survey.
Professional designations
Testimonials

13. Performance Reporting

14. Performance Reporting
Background
No prohibition per se in the Rules
Performance reporting guidelines established in Clover Capital Management no-action letter (1986)
SEC guidance has evolved over the years, from “inherently problematic” to “facts and circumstances.” (Clover)

15. Performance Reporting (cont’d)
Reporting of Model and Actual Performance – misleading practices
Failing to disclose effect of material market or economic conditions on results portrayed
Failing to meet “net of fees” requirement
Failing to disclose reinvestment of dividends and earnings
Discussing profit potential without similar discussion on possibility of loss
Comparing results to index without disclosure of relevant material facts
Disclosure of material conditions, objectives or investment strategies

16. Performance Reporting (cont’d)
Model Performance – misleading practices
Failing to disclose inherent limitations of the model
Failing to disclosure of material changes, if applicable, to conditions, objectives or investment strategies.
Failing to disclose, if applicable, of relevance of securities and services in the model compared to the investment adviser
Failing to disclose, if applicable, of actual investment results that are materially at variance from model
Actual Performance – misleading practice
Select group of investment adviser’s clients

17. Performance Reporting (cont’d)
Net of Fees Exception – “Gross of Fees”
Side by Side Gross and Net of Fees
Equally prominent, disclosures
Custodial Fees
One to One Presentation. Requires special written disclosures.
Model Advisory Fees Deduction
Wrap and non-wrap accounts
Multimanager Account
Show on net basis with regard all transaction costs and fees paid to adviser or affiliates

18. Performance Reporting
Portability
Performance of Manager at Prior Firm. “No other person”
Similar accounts
All accounts reported within advertisement
SEC compliant
Fully disclosed
Recordkeeping
Performance of Accounts Carried Over from Prior Firm. (Great Lakes Advisors, Inc. No-Action Letter)
Performance of JV Partner. (Taurus Advisory Group, Inc. No- Action Letter).
Continuing Role of Manager. (Horizon Asset Management LLC No-Action Letter).

19. Performance Reporting
Backtested Performance
Not per se or intrinsically misleading, but…….

20. Recordkeeping Recordkeeping Rule 204-2
Working papers and all other records necessary to form the basis for or demonstrate the calculation of the performance or rate of return.
5 year retention period. Also for the entire measure of reporting period.
Policies/Procedures.

21. Global Investment Performance Standards (GIPS)
Voluntary standards
SEC enforcement – verify claim of compliance. If conflict, SEC requirements should govern
Total return, accrual accounting
Time-weighted return
10 year record

22. Important Information
This presentation is intended for general informational purposes only, and it does not constitute legal, tax or investment advice from The Wagner Law Group. Financial advisors and other plan service providers should consult with their own legal counsel to understand the nature and scope of their responsibilities under the Advisers Act, ERISA and other applicable law.

23. Stephen P. Wilkes, Esq. Livia Q. Aber, Esq. A0205873
Risk Alert on Advertising Rule
and
Performance Reporting
Stephen P. Wilkes, Esq.
Livia Q. Aber, Esq. A .