Highlights of Highlights of Investment Adviser Investment Adviser

Advertising and MarketingAdvertising and Marketing

FIRMA National Training ConferenceFIRMA National Training Conference

April 9, 2008April 9, 2008

Orlando, FLOrlando, FL

Chris HardyPartner

Ascendant Compliance Management, Inc.

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Investment Adviser Investment Adviser AdvertisingAdvertising

DefinitionDefinition

Rules and GuidelinesRules and Guidelines

SEC interpretationsSEC interpretations

RecordkeepingRecordkeeping

SEC ExaminationsSEC Examinations

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Definition of an Advertisement Definition of an Advertisement

• ““Any written communication addressed Any written communication addressed to more than one person” that offers to more than one person” that offers investment advisory services related to investment advisory services related to securitiessecurities

• Broadest definition includes any Broadest definition includes any communication designed to attract new communication designed to attract new clients or maintain existing clients clients or maintain existing clients

• Includes electronic and broadcast Includes electronic and broadcast advertisementsadvertisements

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What Is Not an What Is Not an Advertisement? Advertisement?

• Oral communicationsOral communications

• Customized RFP responses, Customized RFP responses, letters or e-mails (not sent to letters or e-mails (not sent to more than one person)more than one person)

• Personal account information sent Personal account information sent to a clientto a client

• Still possible to violate Section Still possible to violate Section 206 antifraud provision206 antifraud provision

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Investment Adviser Investment Adviser AdvertisingAdvertising

• Specific GuidanceSpecific Guidance

– Section 206 (general antifraud provision Section 206 (general antifraud provision of Advisers Act)of Advisers Act)

– Rule 206(4)-1 (SEC advertising rule)Rule 206(4)-1 (SEC advertising rule)

– No-Action LettersNo-Action Letters

– SEC inspections and enforcement actionsSEC inspections and enforcement actions

– Rules focus solely on disclosure, not Rules focus solely on disclosure, not calculation of performancecalculation of performance

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SEC Advertisements SEC Advertisements

• General Antifraud RuleGeneral Antifraud Rule

• Applicable to both registered and Applicable to both registered and unregistered investment advisersunregistered investment advisers

• Perennially one of the top SEC exam Perennially one of the top SEC exam deficienciesdeficiencies

““[It is] unlawful to engage in any act, [It is] unlawful to engage in any act, practice or course of conduct which is practice or course of conduct which is fraudulent, deceptive or manipulative.”fraudulent, deceptive or manipulative.”

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SEC Advertisements SEC Advertisements

• Specific prohibitions applicable to Specific prohibitions applicable to registeredregistered investment advisers: investment advisers:

– TestimonialsTestimonials

•Third Party ReportsThird Party Reports

•Partial Client Lists Partial Client Lists

– Past specific recommendationsPast specific recommendations

– Charts/FormulasCharts/Formulas

– Claim of free service unless it really isClaim of free service unless it really is

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SEC Advertisements SEC Advertisements

• General Prohibitions:General Prohibitions:

– Anti-Fraud Provision Depends OnAnti-Fraud Provision Depends On

•FormForm

•ContentContent

• Inferences that may be drawn by Inferences that may be drawn by readerreader

•Client sophisticationClient sophistication

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SEC Performance Advertising SEC Performance Advertising • Guiding Principals:Guiding Principals:

– Investment performance is false or misleading Investment performance is false or misleading if:if:

• it implies, or a reader would infer, something it implies, or a reader would infer, something about the adviser’s competence or about future about the adviser’s competence or about future investment results that would not be true had investment results that would not be true had the advertisement included all material factsthe advertisement included all material facts

– Comply with investment performance Comply with investment performance presentation guidelinespresentation guidelines

•Clover Capital series of No-Action LettersClover Capital series of No-Action Letters

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Clover Capital No-Action Letter Clover Capital No-Action Letter • Actual and Model Results Actual and Model Results

– Disclose the effect of market conditionsDisclose the effect of market conditions

– Disclose relevant facts in comparison to index Disclose relevant facts in comparison to index

– Must be net of feesMust be net of fees

– Must disclose reinvestment of Must disclose reinvestment of income/dividendsincome/dividends

– Disclose the possibility of a lossDisclose the possibility of a loss

– Disclose material conditions, objectives, or Disclose material conditions, objectives, or strategies usedstrategies used

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Clover Capital No-Action Letter Clover Capital No-Action Letter • Model Performance ResultsModel Performance Results

– Disclose prominently the limitations inherent in Disclose prominently the limitations inherent in model resultsmodel results

– Disclose, if applicable, Disclose, if applicable, material changes in the material changes in the conditions, objectives, or investment strategies conditions, objectives, or investment strategies of the model portfolio during the period of the model portfolio during the period portrayed and the effect of those changes portrayed and the effect of those changes

– Disclose, if applicable, that the securities or Disclose, if applicable, that the securities or strategies reflected in the model do not relate, or strategies reflected in the model do not relate, or relate only partially, to services currently offeredrelate only partially, to services currently offered

– Disclose, if applicable, that the adviser's clients Disclose, if applicable, that the adviser's clients had investment results had investment results were materially different were materially different from those portrayed in the model from those portrayed in the model

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Clover Capital No-Action Letter Clover Capital No-Action Letter

• Actual ResultsActual Results

– Disclose prominently, if applicable, Disclose prominently, if applicable, that the results portrayed relate only that the results portrayed relate only to a select group of the adviser's to a select group of the adviser's clients, the basis on which the clients, the basis on which the selection was made, and the effect selection was made, and the effect of this practice on the results of this practice on the results portrayed, if material.portrayed, if material.

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Clover Capital Exceptions Clover Capital Exceptions

• Exceptions to Net of FeesExceptions to Net of Fees

– Gross of fees performanceGross of fees performance

•Sophistication of prospectSophistication of prospect

•Must always be shown after Must always be shown after transaction coststransaction costs

•Private, one-on-one meetingPrivate, one-on-one meeting

•Ability to ask questions and negotiate Ability to ask questions and negotiate advisory feesadvisory fees

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Clover Capital Exceptions Clover Capital Exceptions • ““One-on-One” Presentations must disclose:One-on-One” Presentations must disclose:

– Performance does not reflect deduction of advisory Performance does not reflect deduction of advisory feesfees

– The client’s return will be reduced by advisory and The client’s return will be reduced by advisory and other expenses the client may incur in the other expenses the client may incur in the management of its investment advisory accountmanagement of its investment advisory account

– Advisory fees are disclosed in Form ADV Part IIAdvisory fees are disclosed in Form ADV Part II

– A representative example (table, chart, graph or A representative example (table, chart, graph or narrative) showing the effect advisory fees, narrative) showing the effect advisory fees, compounded over years, could have on the value of compounded over years, could have on the value of a portfolioa portfolio

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Clover Capital Exceptions Clover Capital Exceptions

• Net vs. Gross of Fees PresentationNet vs. Gross of Fees Presentation

– Model advisory fees Model advisory fees

– Side-by-side gross and netSide-by-side gross and net

– Multi-manager accountsMulti-manager accounts

– Model feesModel fees

•Permissible to use highest fee charged Permissible to use highest fee charged to client in strategyto client in strategy

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““Backtested” PerformanceBacktested” Performance

• Use of theoretical performance Use of theoretical performance developed by applying a particular developed by applying a particular investment strategy (typically, a investment strategy (typically, a quantitative or formula-based strategy) quantitative or formula-based strategy) to historical financial datato historical financial data

• Viewed as highly suspect as the adviser Viewed as highly suspect as the adviser can run the backtested model again and can run the backtested model again and again until it gets the results it wants.again until it gets the results it wants.

• Does not involve market riskDoes not involve market risk

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““Backtested” PerformanceBacktested” Performance• In addition to Clover requirements, disclose, In addition to Clover requirements, disclose,

at an absolute minimum:at an absolute minimum:– That the adviser only began offering the given That the adviser only began offering the given

service after the performance period depicted by service after the performance period depicted by the advertisementthe advertisement

– That the results do not represent the results of That the results do not represent the results of actual trading but were achieved by means of actual trading but were achieved by means of the retroactive application of a model designed the retroactive application of a model designed with the benefit of hindsightwith the benefit of hindsight

– All material economic and market factors that All material economic and market factors that might have had an impact on the adviser’s might have had an impact on the adviser’s decision-making when using the model to decision-making when using the model to manage actual client accounts;manage actual client accounts;

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Portability of PerformancePortability of Performance• Permitted if following conditions are metPermitted if following conditions are met::

– The person who manages accounts at the The person who manages accounts at the successor adviser was also primarily responsible successor adviser was also primarily responsible for achieving prior performancefor achieving prior performance

– The accounts managed at predecessor are so The accounts managed at predecessor are so similar to the accounts currently under similar to the accounts currently under management that the performance results would management that the performance results would provide relevant information to prospective provide relevant information to prospective clients of the successor adviserclients of the successor adviser

– All accounts that were managed in a All accounts that were managed in a substantially similar manner are advertised substantially similar manner are advertised unless exclusion of any account would not result unless exclusion of any account would not result in materially higher performancein materially higher performance

– Advertisement includes all relevant disclosures, Advertisement includes all relevant disclosures, including that performance results were from including that performance results were from accounts managed at another entity.accounts managed at another entity.

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Investment Advisor Investment Advisor Advertisements Advertisements

• Article ReprintsArticle Reprints

– Permitted, if comply with Advertising RulesPermitted, if comply with Advertising Rules

– Can’t be false or misleadingCan’t be false or misleading

•Edit problematic statementsEdit problematic statements

– Use legends and footnotes toUse legends and footnotes to

•Correct inaccuraciesCorrect inaccuracies

•Update informationUpdate information

•Fill in gaps (e.g., provide net performance if Fill in gaps (e.g., provide net performance if article discusses only gross)article discusses only gross)

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Past Specific Past Specific RecommendationsRecommendations

• SEC concerns re “cherry picking”SEC concerns re “cherry picking”• Exclusion from Advertising Rule prohibition if Exclusion from Advertising Rule prohibition if

advertisementadvertisement::

– Offers to furnish list of all recommendations made by Offers to furnish list of all recommendations made by adviser within previous 12 month periodadviser within previous 12 month period

– States States

•name of each security recommendedname of each security recommended

•date and nature of each recommendationdate and nature of each recommendation

•market price of the security at time of recommendationmarket price of the security at time of recommendation

•price at which the recommendation was to be acted onprice at which the recommendation was to be acted on

• the market price of each security as of the most recent the market price of each security as of the most recent practicable datepracticable date

– Discloses that “It should not be assumed that the Discloses that “It should not be assumed that the recommendations made in the future will be profitable or recommendations made in the future will be profitable or will equal the performance of the securities in this list”will equal the performance of the securities in this list”

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Holdings Lists – “Top Ten”Holdings Lists – “Top Ten”

• Permissible, but adviser must:Permissible, but adviser must:

– use objective, non-performance based use objective, non-performance based criteria in selecting securitiescriteria in selecting securities

– use same selection criteria for each use same selection criteria for each quarter for each investment categoryquarter for each investment category

– Ensure report does not discuss extent to Ensure report does not discuss extent to which the investments were, or were which the investments were, or were not, profitable not, profitable

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Investment Advisor Investment Advisor Advertisements Advertisements

• RecordkeepingRecordkeeping

– Client communications and distribution listsClient communications and distribution lists

•Copies of all written communicationCopies of all written communication

– Advertisements and RecommendationsAdvertisements and Recommendations

•All advertisements sent to more than 10 All advertisements sent to more than 10 recipientsrecipients

•Document basis of all recommendationsDocument basis of all recommendations

•Document basis of all claimsDocument basis of all claims

– Retention PeriodsRetention Periods

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Investment Advisor Investment Advisor Advertisements Advertisements

• Performance RecordkeepingPerformance Recordkeeping

– Records to support performance calculationsRecords to support performance calculations

•Necessary to form the basis for or demonstrate the Necessary to form the basis for or demonstrate the calculation of the performancecalculation of the performance

• Internal account statements and worksheetsInternal account statements and worksheets

•Prepared contemporaneouslyPrepared contemporaneously

•Third party records to substantiate claimsThird party records to substantiate claims

– Necessary to support performance:Necessary to support performance:

• In articlesIn articles

•From prior firmFrom prior firm

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SEC Advertising and GIPS SEC Advertising and GIPS • How to avoid false claims of How to avoid false claims of

compliance:compliance:

– Educate marketing staff on appropriate Educate marketing staff on appropriate presentation usagepresentation usage

– Understand the limitations of verificationUnderstand the limitations of verification

– Take GIPS compliance seriouslyTake GIPS compliance seriously

– Comply with all guidance statementsComply with all guidance statements

– Review all applicable Q&A on CFA Review all applicable Q&A on CFA Institute websiteInstitute website

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SEC Exams SEC Exams • Recurring Problems:Recurring Problems:

– Cherry pickingCherry picking

– Comparing performance to inappropriate indexComparing performance to inappropriate index

– Representing model or back tested strategy as Representing model or back tested strategy as actual performanceactual performance

– Portability of performancePortability of performance

– Submission of misleading information to Submission of misleading information to publications or consultantspublications or consultants

– Inaccurate assets under managementInaccurate assets under management

– False GIPS compliance claimsFalse GIPS compliance claims

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Questions?Questions?

Chris HardyChris Hardy

Tel: (860) 435-2255Tel: (860) 435-2255

chardy@ascendantcompliance.chardy@ascendantcompliance.comcom

www.ascendantcompliance.cowww.ascendantcompliance.comm