THE “MARKETING RULE”: Predecessor Performance

In Plain English

A publication of THE SECURITIES LAW GROUP | James E. Grand | July 2024

This post highlights some of the guardrails imposed on private fund advisers when they are presenting predecessor performance information in a fund’s marketing materials and offering documents.

“Predecessor performance” commonly arises when investment personnel attempt to port their performance track record to a new investment adviser. Our industry is entrepreneurial by nature, so it follows that while working for large advisory firms where they perfected their craft, investment personnel often decide to register as investment advisers and form private funds of their own. When launching their first fund, these new advisers often seek to use a track record achieved at a prior firm, performance data generally referred to as predecessor performance. The SEC’s “Marketing Rule” contains recently updated rules governing the use of predecessor performance data. In short, it views predecessor performance as potentially misleading because it may imply that an investment adviser achieved performance for which other investment personnel were partly or actually responsible. Given that the SEC believes the marketing and solicitation activities covered by the Rule are inherently misleading, it is best practice for a new fund manager to ensure that its marketing practices adhere to the principles of the Rule to avoid running afoul of the antifraud standards.

Under the Rule, an investment adviser may NOT include predecessor performance (i.e., such investment adviser’s track record while working at a former firm) in an advertisement UNLESS:

· The person was “primarily responsible” for achieving the prior performance results at the predecessor firm. The Rule does not define the term “primarily responsible,” but the SEC has stated that it generally refers to the person or persons who have the authority or influence in making the decisions that produced the investment results. In sum, a person is “primarily responsible” for achieving prior performance results if the person made the applicable investment decisions.

· The accounts managed at the predecessor firm were sufficiently similar to the accounts the person will manage at the new firm, such that the performance results would provide relevant information to the new firm’s investors;

· The advertisement covers all accounts that were managed in a substantially similar manner (subject to certain permitted exclusions); and

· The advertisement clearly and prominently includes all relevant disclosures, including that the performance results were from accounts managed at another entity.

In addition to the conditions imposed on predecessor performance by the Marketing Rule, the Recordkeeping Rule requires an investment adviser that presents predecessor performance to retain records to support such performance. If an investment adviser wishes to include in its track record the performance achieved while working for a prior firm, the investment adviser must either have possession of, or obtain, records from that prior firm to support the calculation of the predecessor performance to comply with the Recordkeeping Rule. In practice, this can present challenges for new investment advisers, since advisory personnel are commonly prohibited (e.g., in employment agreements or otherwise) by their prior firm from taking the firm’s performance records when they depart to work for another firm.

The Rules set forth above only apply to SEC-registered investment advisers. Many of our “break-away” clients initially register as exempt reporting advisers (ERAs) so, technically, they do not apply to these clients. That said, as a matter of “best practice,” all private fund advisers should ensure that their marketing policies and procedures reflect these standards and limitations. At the very least, a private fund adviser should consider the Rule’s general prohibitions and the antifraud provisions under the Advisers Act when presenting track record and performance information in any advertisement. In all cases, an investment adviser should consider whether it has provided investors with the necessary context for evaluating its track record so the track record is not misleading, is presented in a fair and balanced manner, and includes disclosure of any relevant assumptions, factors, and limitations.

This blog is published as a source of information only for clients and friends of The Securities Law Group. It should not be construed as legal advice or an opinion on any specific facts or circumstances. The receipt 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

jgrand@tslg-law.com

760-773-4700