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In Plain English

A publication of THE SECURITIES LAW GROUP | James E. Grand | July 2016


FACT ONE: Most investment advisers are continually expanding their efforts at asset gathering, so
advertising is becoming more important to your success.

FACT TWO: You can definitely expect the SEC Staff (or state regulator) during any examination to
request copies of any and all “advertising” materials you used during the examination period and
all documentation that supports the calculation of any “advertised” performance.

FACT THREE: Problems with advertising continue to be one of the top problem areas identified by the
SEC—we are seeing fines in this area of as much as $75,000!

It is important to understand the breadth of the advertising rules. Basically, they apply to any
“notice, circular, letter or other written communication addressed to more than one person, or any
notice or announcement in any publication or by radio or television, which offers any investment
advisory service with regard to securities.” In plain English—just about any writing or
announcement addressed to more than one person is an “advertisement” under the rules— including
Internet postings!

In this overview, we cover two separate categories of advertising—the general advertising rules
applicable to all advertisements and the separate and very complex advertising rules covering
“performance” advertising.

At the outset, you should know that the rules specifically prohibit four common types of
advertising as per se fraudulent. “Per se” means even if the information contained in these types
of writings is totally true, they are still considered fraudulent and, therefore, must be avoided.

1. Testimonials. The SEC generally includes as “testimonials” any statement of a person’s
experience with you or an endorsement of you, by any former, existing or prospective client. In
other words, any favorable reference to another person’s experience with you. The SEC’s prohibition
on testimonials is premised on the concern that one person’s experience may give the misleading
impression that that person’s experience is typical of all of your clients. In the SEC’s view, such
statements are innately misleading since advisers will only present testimonials that are favorable
to the adviser and its business. This is an especially tricky problem in the social media area.
For more on this, please
see our November 2015 blog entry:  Guidance On the Use of Social Media by Investment Advisers ( This is also a problem when an article drafted by an independent third party discusses you or your performance. Basically, such articles are not testimonials unless they include a statement of a customer’s experience or endorsement.  But, be careful.  The line is a thin one.

2. Past Specific Recommendations. The problem here is commonly referred to a “cherry picking.” The
SEC takes the position that any advertisement which refers only to one or more profitable
recommendations and ignores unprofitable ones is inherently misleading and deceptive. If you are
going to do this, you must include a list of all recommendations made during the relevant time
frame. For example, if you wish to publish a list of all profitable recommendations made over the
last ten years, you would be required to list every recommendation made from 2006 to the present
together with the following legend: It should not be assumed that recommendations made in the
future will be profitable or will equal the performance of the securities on this list. By the way,
it is not enough to include in the advertisement an offer to provide such information separately.
Note that articles by independent third parties which “happen” to refer to your past specific
recommendations generally are not subject to this prohibition.

3. Charts and Formulas. The rules prohibit an adviser from making any claim in its advertisements
that any graph, chart, formula or other similar device being offered can be used to determine what
securities to buy or sell or when to buy or sell the securities, unless the limitations and
difficulties regarding the use of these devices is prominently disclosed.  The SEC Staff has said
this prohibition is absolute.

4. Free Reports or Services. The rules prohibit any advertisement which states that any report,
analysis or other service will be furnished free or without charge if there are any conditions or
obligations connected with its receipt.

The rules applicable to performance advertising are among the most nuanced and difficult to apply.
Basically, the SEC does not proscribe the method by which you may/must calculate or present past
performance. It relies on the general anti-fraud statute, as interpreted by numerous SEC no-action
letters in this area, to regulate what it deems to be fraudulent or misleading advertising
practices. Generally, an advertisement may be considered fraudulent or misleading if it implies
something about you or your clients’ experiences that is not true, or that a person would not have
inferred if you had disclosed all material facts. The commonly used disclaimer, Past performance is
not a guarantee of future returns, will not, in and of itself, cure a misleading presentation.

To assist the reader in understanding the performance advertising rules, we divide them into three
sets: the basic rules relating to the presentation of actual returns, the rules relating to model
performance, and the rules relating to hypothetical back-tested results.

1. Actual Returns. The SEC takes the position that the following advertising practices with respect
to actual returns are prohibited:

• Failure to disclose the effect of market or economic conditions on the portrayed results
• Use of actual results that do not reflect the deduction of advisory fees, brokerage commissions,
and any expenses a client would have paid
• Failure to disclose whether and to what extent the portrayed results reflect the reinvestment of
• Failure to disclose the possibility of loss when the advertisement suggests or makes claims about
the potential for profit
• Failure to disclose all material facts relevant to any comparison made between your actual
results and an index
• Failure to disclose whether any material conditions, objectives or strategies used to obtain the
actual results portrayed (e.g., when certain circumstances that are not likely to be repeated
contributed overwhelmingly to performance)
• Failure to disclose, if applicable, that the portrayed results relate only to a select portion of
your clients, the basis on which the selection was made and any material effect of this practice on
the portrayed results

2. Model Results. There was a time when the SEC took the position that any advertising of model
results was per se misleading, and could not be cured by any amount of disclosure. It has abandoned
this position. More recently, it now permits the use of model results so long as the advertisement
“equips prospective investors with additional information in light of the heightened chance that
model results may create erroneous inferences about future returns.” In addition to the rules set
forth above applicable to actual returns, the SEC requires you to make the following additional
disclosures when presenting model results:

• You must disclose the limitations inherent in model results, particularly that model results do
not reflect actual trading and may not reflect the impact that material economic and market factors
may have had on your decision-making had you been using actual client funds
• You must disclose, if applicable, that the conditions, objectives or investment strategies of the
model portfolio may have changed materially during the measurement period and, if so, the effect of
any such change on the portrayed results
• You must disclose, if applicable, that your clients’ had actual results materially different from
the results portrayed in the model

3. Hypothetical Back-tested Performance. You should be very careful when presenting back-tested
performance. Although it is not prohibited, the SEC Staff considers such advertising highly
suspect. It should only be presented to sophisticated clients and prospects—never to “retail”
clients. SEC guidance in this area is relatively light. However, we know of cases where advisers
have been disciplined for failing to disclose the following in connection with the advertisement of back-tested performance. You must clearly

• That the back-tested performance was derived from the retroactive application of a model
developed with the benefit of hindsight
• The inherent limitations of data derived from the retroactive application of a model and the
reasons why actual results may have differed
• Whether the trading strategies retroactively applied were not available during the periods
• If applicable, that actual performance of your clients’ accounts was materially less than then
advertised hypothetical results for the same period
• That material economic and market factors may have impacted your decision- making when using the
model to actually manage client funds
• Whether the advertised performance reflects the deduction of advisory fees, brokerage commissions
and any other expenses that a client would have paid
• All material facts relevant to any comparison between back-tested performance and its benchmark
•     The potential for loss

The Global Investment Performance Standards (“GIPS” or “Standards”) are performance presentation
standards that were established and are sponsored and interpreted by the CFA Institute (which was
formerly known as the Association for Investment Management and Research or “AIMR”). The objectives
of the Standards are to foster industry self-regulation on a global basis.  Although firms must always adhere to the fundamental principles of fair representation and full disclosure, the Standards primarily address the presentation of performance to prospective clients. Presentations to existing clients do not have to adhere to the GIPS standards
since “performance reporting to existing clients is something that should be agreed upon between
the firm and the client.” The Standards are comprised of eight sections that reflect what the CFA Institute believes to be the basic components involved in presenting performance. Within each section, the Standards are
divided into required provisions and recommended provisions. Each firm that claims compliance with the Standards must adhere to the required provisions and is strongly encouraged to adhere to the recommended provisions under the Standards.


The SEC imposes a standard of conduct for investment advisers’ advertisements that is stricter than that for other vendors or products or services. When the SEC adopted its modern advertising rules in 1961, it said that “advisers are professionals and should adhere to a stricter standard of conduct than that applicable to merchants.” It also said, “securities are ‘intricate merchandise’ and clients or prospective clients of investment advisers are frequently unskilled and unsophisticated in investment matters.” As an investment adviser—whether state or SEC-registered—you are accountable for all of the information that is included in your advertising. In sum, the information therein must be truthful and supportable, and if it includes any performance results, you must follow the specific rules set forth herein, and have documentation supporting that performance.

This newsletter is published as a source of information only for clients and friends of The
Securities Law Group and should not be construed as legal advice or opinion on any specific facts
or circumstances. The mailing of this publication is not intended to create, and receipt of it does
not constitute, an attorney- client relationship.

The Securities Law Group
James Grand