Adviser Advertising – Marketing Rule FAQs

September 13, 2021

This Alert is the second of a series analyzing the Marketing Rule and its impact on advisers to private funds. In this Alert, we consider how the Marketing Rule will impact placement and solicitation activities for private funds.

1. Does the Marketing Rule expand upon the persons and activities to which the Cash Solicitation Rule applied? If so, how will these requirements potentially impact an adviser to private funds and related placement and solicitation activities?

Yes. The Marketing Rule expands upon the persons and activities to which the Cash Solicitation Rule¹ applied. As we indicated in our first alert, both prongs of the definition of advertisement expressly include marketing communications to private fund investors. The second prong of the definition of advertisement – which addresses testimonials² and endorsements³ for which the adviser provides compensation (directly or indirectly) –includes referrals and solicitations of investors to private funds. Accordingly, traditional private fund placement arrangements involving broker-dealers and other intermediaries, which were not covered by the Cash Solicitation Rule,⁴ fall within the requirements of the Marketing Rule.

In addition, the Marketing Rule could impact the placement and solicitation activities of an adviser to private funds in the following ways:

Definition of Testimonial. A testimonial includes any statement by a current private fund investor that directly or indirectly solicits any investor to be an investor in a private fund advised by the adviser. Accordingly, this definition could apply to any unaffiliated fund-of-funds or a feeder fund that solicits investors in an underlying fund or a master fund, respectively.
Compensation. The second prong of the definition of advertisement is triggered by any form of compensation that an adviser provides directly or indirectly for an endorsement or testimonial. Compensation can take many forms, including fees, retainers, reduced advisory fees, fee waivers, directed brokerage, prizes and gifts and entertainment.⁵ Consequently, the Marketing Rule covers a broad range of activities and types of promoters,⁶ including website operators that match a potential investor with one or more advisers compensating it to participate in the service.

Compliance Considerations

A private fund adviser should inventory and then assess its current placement agent, solicitation and other arrangements to determine whether such arrangements fall within the requirements of the Marketing Rule. In particular, the adviser should consider and assess (i) other methods by which investors are referred to its private funds, such as through fund-of-fund arrangements, and (ii) the types of compensation – direct and indirect and cash and non-cash – that it may be deemed to have paid, to determine whether these arrangements may be subject to the requirements of the Marketing Rule.

2. What are the basic conditions of the Marketing Rule that apply to solicitations that constitute endorsements or testimonials?

The Marketing Rule imposes the following conditions on an adviser’s use of endorsements and testimonials:

Disclosure. The adviser must disclose, or reasonably believe that the promoter discloses, certain information at the time of solicitation (the “Disclosure Requirements”).

The following must be clearly and prominently⁷ disclosed:

(i) if a testimonial, that it was given by a current client or investor, or if an endorsement, that it was given by a person other than a current client or investor;

(ii) if applicable, that cash or non-cash compensation was provided for the testimonial or endorsement; and

(iii) a brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the adviser’s relationship with such person.

The adviser must also disclose, or reasonably believe that the promoter discloses, information regarding material terms of compensation and material conflicts of interest, as described below.⁸

Material Terms. The material terms of any compensation arrangement must be disclosed, including a description of the compensation provided or to be provided, directly or indirectly, to the promoter. The Release describes several specific points that the SEC believes must be disclosed, if applicable.⁹
Material Conflicts. The material conflicts of interest on the part of the promoter resulting from (i) the adviser’s relationship with the promoter and/or (ii) any compensation arrangement must be disclosed. At a minimum, if the promoter is receiving compensation for its solicitation services, there should be explicit disclosure stating that the promoter, due to the compensation, has an incentive to recommend the adviser, resulting in a material conflict of interest. In addition, an adviser should consider whether its relationship with the promoter creates any other material conflicts that could affect the credibility of the testimonial or endorsement.

• Oversight and Compliance. Testimonials and endorsements are subject to an “oversight and compliance” provision, which includes two separate requirements:

(A) Reasonable Basis. The adviser must have a reasonable basis for believing that any testimonial or endorsement complies with the requirements of the Marketing Rule (the “Reasonable Basis Requirement”). What constitutes a “reasonable basis” depends on the facts and circumstances, but the SEC has stated that an adviser could, for example:

(i) periodically make inquiries of a sample of investors solicited or referred by the promoter in order to assess whether that promoter’s statements comply with the Marketing Rule;

(ii) implement policies and procedures; or

(iii) include terms in its written agreement with the promoter to help form a reasonable basis (e.g., permitting the adviser to pre-review or impose limitations on the promoter’s statements).¹⁰

(B) Written Agreement. The adviser must have a written agreement with any person giving a compensated testimonial or endorsement that describes the scope of the agreed upon activities and the terms of the compensation for those activities (the “Written Agreement Requirement”).¹¹ For example, an adviser could satisfy this requirement by entering into a private placement agreement (relating to interests in the private fund) that describes the scope of the solicitation/placement activities and the terms of the compensation.

• Disqualification. The adviser may not compensate certain “bad actors” and other ineligible persons for their solicitation activities (e.g., giving testimonials or endorsements) (the “Disqualification Provision”). In particular, the adviser is prohibited from compensating a person, directly or indirectly, for a testimonial or endorsement if the adviser knows, or in the exercise of reasonable care should know, that the person giving the testimonial or endorsement is an ineligible person at the time of solicitation. An “ineligible person” is a person who is subject either to a disqualifying Commission action¹² or a disqualifying event,¹³ and certain of that person’s employees and other persons associated with an ineligible person.

Compliance Considerations

If an adviser engages a promoter to solicit investors for private funds managed by the adviser, the adviser’s written agreement with the promoter should be designed to address the Reasonable Basis Requirement, the Written Agreement Requirement and the Disqualification Provision. An adviser will also need to adopt policies and procedures concerning how the adviser will comply with the new requirements, and should review its existing solicitation/placement agent agreements and modify them, as necessary, in order to address the new requirements. An adviser might consider updating its investment management agreements or private fund subscription documents to include certifications concerning clients’ and investors’ receipt of disclosures.

3. Are there any exemptions from the Disclosure Requirements?

Yes. There are three exemptions from the Disclosure Requirements:

(i) Affiliates. Testimonials and endorsements by certain affiliates¹⁴ of an adviser are exempt from the Disclosure Requirements if (a) the affiliation between the adviser and the affiliate is “readily apparent” to or is disclosed to the client or investor at the time of solicitation, and (b) the adviser documents the affiliate’s status at the time of solicitation. (See Question 4 below.)

(ii) Recommendations Subject to Regulation Best Interest. If an SEC-registered broker-dealer provides a testimonial or endorsement that is a recommendation subject to Regulation Best Interest (“Regulation BI”), the testimonial or endorsement is exempt from all of the Disclosure Requirements.¹⁵ This is because Regulation BI imposes its own disclosure obligations, which are similar to the Marketing Rule’s Disclosure Requirements.¹⁶

(iii) Persons Who are Not “Retail Customers”. If an SEC-registered broker-dealer provides a testimonial or endorsement to a person that is not a “retail customer” (as defined in Regulation BI)¹⁷, the testimonial or endorsement is exempt from two of the Disclosure Requirements: (a) material terms of any compensation arrangement and (b) material conflicts of interest. Such broker-dealer is still required to make the disclosures that are subject to the “clear and prominent” standard.¹⁸

Compliance Considerations

In order to rely on one or more of these exemptions, it will be important for an adviser to understand (i) the status of the person it has engaged to serve as a promoter (e.g., whether the promoter is an affiliate) and (ii) the nature of the relationship between the promoter and the individuals or entities being solicited (e.g., if the promoter is a broker-dealer, how Regulation BI applies to the promoter’s relationship with such individuals or entities).

An adviser that wishes to conduct solicitation activities for private funds (by itself or through a third party) without complying with all of the Disclosure Requirements should review the solicitation activities that it proposes to undertake and then design policies and procedures that address the applicable exemptions. For example, an adviser employing an affiliate to solicit private funds investors should consider whether the affiliate’s status is “readily apparent” to prospective investors and consider how such status will be documented as required in order to rely on the exemption. Where certain disclosures are required (e.g., the “clear and prominent” disclosures), an adviser should tailor its disclosures based on the specific type of arrangement and coordinate with the promoter to seek to ensure that such disclosures are provided in a timely manner.

4. Does the Marketing Rule apply to an adviser’s employees and other affiliates who are compensated by the adviser to solicit investors for a private fund to which it serves as adviser?

It depends on the type of compensation. For purposes of the second prong of the definition of advertisement, “compensation” does not include “regular salary or bonuses” paid to an adviser’s personnel for their investment advisory activities or clerical, administrative, support or similar functions.¹⁹

Where an adviser provides an employee or other affiliate with other types of compensation,²⁰ the Marketing Rule provides a partial exemption for solicitations by an adviser’s affiliates, including employees.²¹ Such solicitations are exempt from the Disclosure Requirements and the Written Agreement Requirement,²² provided that:

(i) the affiliation between the adviser and the affiliate is “readily apparent” to or is disclosed to the client or investor at the time of solicitation; and

(ii) the adviser documents the affiliate’s status at the time of solicitation.²³

Although what constitutes “readily apparent” depends on the facts and circumstances, the SEC has provided examples of circumstances where the relationship between an adviser and an affiliate may be deemed to be readily apparent, such as when:

(i) an in-house promoter and the adviser share the same name;

(ii) the affiliate (either a firm or an individual) operates under the same name brand as the adviser; and

(iii) the affiliate is clearly identified as related to the adviser in its communications with the investor at the time of solicitation (e.g., a business card clearly and prominently states that the affiliate is a representative of the adviser).

Compliance Considerations

If an adviser compensates its employees or other affiliates for soliciting investors and wishes to be exempt from the Disclosure Requirements and the Written Agreement Requirement, the adviser should adopt policies and procedures that are designed to address solicitations by such persons and should document the availability of the exemptions, including (i) how the affiliation between the adviser and the affiliate is “readily apparent” to or is disclosed to the client or investor at the time of solicitation; and (ii) the affiliate’s status (such as an employee) at the time of solicitation.

5. Are there partial exemptions for certain persons from the Disqualification Provisions?

Yes. Under the Marketing Rule, there are partial exemptions from the Disqualification Provisions for eligible promoters who are registered broker-dealers and covered persons. Specifically, the Marketing Rule exempts from the Disqualification Provisions:

(i) any testimonial or endorsement by an SEC-registered broker-dealer if the broker-dealer is not subject to statutory disqualification under Section 3(a)(39) of the Securities Exchange Act of 1934;²⁴ and

(ii) any testimonial or endorsement by a “covered person”²⁵ under Rule 506(d) of Regulation D with respect to a Rule 506 offering, provided that the person’s involvement would not disqualify the offering under Rule 506.²⁶

The SEC provided these partial exemptions for these persons because there are existing requirements applicable to them that further the policy goals of the requirements. Importantly, these partial exemptions from the Disqualification Provisions do not, however, relieve an adviser from the other requirements of the Marketing Rule.

Compliance Considerations

If an adviser intends to engage an SEC-registered broker-dealer to act as a promoter, the adviser can obtain in its agreement with the broker-dealer representations from the broker-dealer regarding its status under Section 3(a)(39). If an adviser intends to engage a “covered person” to act as a promoter with respect to a Rule 506 offering, the adviser should obtain written confirmation from the covered person that he or she is in compliance with the Rule 506 disqualification provision – that is, the person is not a “bad actor” under Regulation D requirements.

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If you have any questions regarding the matters covered in this e-mail, please contact any of the partners and counsel listed below or your primary attorney in Seward & Kissel’s Investment Management Group.

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¹ Rule 206(4)-3 – known as the “Cash Solicitation Rule” – generally prohibited an adviser from paying a cash fee to a third-party solicitor for soliciting clients on the adviser’s behalf unless certain conditions were satisfied. The conditions included, among other things, that (i) the adviser and the solicitor enter into a written agreement that required the solicitor to provide the client with the adviser’s Form ADV brochure and a separate written disclosure document and (ii) the adviser receive from the client a signed and dated acknowledgment of receipt of those documents. The SEC rescinded the Cash Solicitation Rule in connection with its adoption of the Marketing Rule.

² A “testimonial” includes any statement by a current private fund investor that directly or indirectly solicits any investor to be a client of the adviser or an investor in a private fund advised by the adviser.

³ An “endorsement” is any statement by a person other than a current client or investor in a private fund that directly or indirectly solicits any investor to be a client of the adviser or an investor in a private fund advised by the adviser.

⁴The Cash Solicitation Rule did not apply to an adviser’s payment of cash compensation to persons solely for soliciting investors in private funds managed by the adviser. See Mayer Brown LLP, SEC Staff No-Action Letter (July 28, 2008).

⁵ However, “compensation” for purposes of the second prong does not include regular salary or bonuses paid to an adviser’s personnel for their investment advisory activities or clerical, administrative, support or similar functions.

⁶Persons who were compensated for performing solicitation activities under the Cash Solicitation Rule have traditionally been referred to as “solicitors.” However, consistent with the adopting release for the Marketing Rule, given the expanded scope of the Marketing Rule, we use the term “promoter” to refer to a person providing a testimonial or endorsement, whether compensated or uncompensated. See Investment Adviser Marketing, Release No. IA-5653 (Dec. 22, 2020) (the “Release”) at 8, footnote 6.

⁷In order to be clear and prominent, the disclosures must be at least as prominent as the testimonial or endorsement. In other words, the “clear and prominent” standard requires that the disclosures be included within the testimonial or endorsement, or in the case of an oral testimonial or endorsement, provided at the same time. such disclosures should appear close to the associated statement such that the statement and disclosures are read at the same time, rather than referring the reader somewhere else to obtain the disclosures. In cases in which an oral testimonial or endorsement is provided, it would be consistent with the clear and prominent standard if the disclosures are provided in a written format, so long as they are provided at the time of the testimonial or endorsement. The requirement to provide the disclosures with respect to testimonials and endorsements “clearly and prominently” may necessitate formatting and tailoring based on the form of the communication.

⁸ These two disclosure items are not subject to the “clear and prominent” standard (see footnote 7).

⁹In particular, the SEC stated the following: (i) if a specific amount of cash compensation is paid, the advertisement should disclose that amount; (ii) if the compensation takes the form of a percentage of the total advisory fee over a period of time, the advertisement should disclose such percentage and time period; (iii) with respect to non-cash compensation, if the value of the non-cash compensation is readily ascertainable, the disclosures should include that amount; and (iv) if all or part of the compensation (cash or non-cash) is payable upon dissemination of the testimonial or endorsement or is deferred or contingent on a certain future event – e.g., an investor’s continuation or renewal of its advisory relationship, agreement or investment – then the advertisement should disclose those terms.

¹⁰ The SEC has stated that having a written agreement, by itself, would not satisfy the Reasonable Basis Requirement, which means an adviser needs to take additional steps to demonstrate the “reasonable belief” beyond simply entering into a written agreement.

¹¹The Marketing Rule provides two exemptions from the Written Agreement Requirement: (i) testimonials and endorsements disseminated for no compensation or de minimis compensation (i.e., $1,000 or less during the preceding 12 months), and (ii) testimonials and endorsements by an adviser’s affiliates (see Question 4).

¹²A “disqualifying Commission action” is any SEC opinion or order barring, suspending or prohibiting a person from acting in any capacity under the Federal securities laws.

¹³A “disqualifying event” is any of five categories of events that occurred within ten years prior to the person disseminating an endorsement or testimonial, and generally includes a finding, order or conviction by a United States court or certain regulatory agencies that a person has engaged in any act or omission referenced in one or more of the five categories. The five categories are: (i) a conviction by court of competent jurisdiction within the United States of any felony or misdemeanor involving conduct described in paragraph of Section 203(e)(2)(A)-(D) of the Advisers Act; (ii) a conviction by a court of competent jurisdiction within the United States of engaging in, any of the conduct specified in Section 203(e)(1), (5) or (6) of the Advisers Act; (iii) the entry of any final order by any entity described in Section 203(e)(9) of the Advisers Act, or by the U.S. Commodity Futures Trading Commission (“CFTC”) or a self-regulatory organization (as defined in the Form ADV Glossary of Terms), of the type described in Section 203(e)(9) of the Advisers Act; (iv) the entry of an order, judgment or decree that is described in Section 203(e)(4) of the Advisers Act, and that is in effect at the time of such dissemination by any court of competent jurisdiction within the United States; and (v) an SEC order that a person cease and desist from committing or causing a violation or future violation of any scienter-based anti-fraud provision of the Federal securities laws or Section 5 of the Securities Act.

¹⁴This exemption applies to an adviser’s partners, officers, directors and employees, and any person that controls, is controlled by, or is under common control with the adviser, or is a partner, officer, director or employee of such a person.

¹⁵ A recommendation is subject to Regulation BI if it relates to any securities transaction or investment strategy involving securities and is provided to a “retail customer” (defined in footnote 17 below).

¹⁶ For example, Regulation BI requires disclosure of all material facts about the scope and terms of the broker-dealer’s relationship with the retail customer, such as the material fees and costs the customer will incur, as well as all material facts relating to its conflicts of interest associated with the recommendation, including third-party payments and compensation arrangements.

¹⁷ Regulation BI defines “retail customer” as a natural person, or the legal representative of such natural person, who (i) receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer, and (ii) uses the recommendation primarily for personal, family or household purposes.

“Legal representative” of a natural person only covers non-professional legal representatives (e.g., a non-professional trustee that represents the assets of a natural person and similar representatives such as executors, conservators, and persons holding a power of attorney for a natural person), and does not include regulated financial industry professionals such as broker-dealers, investment advisers and corporate fiduciaries (e.g., banks, trust companies and similar financial institutions).

“Personal, family or household purposes” means any recommendation to a natural person for his or her account (including retirement accounts), other than recommendations to natural persons seeking services for commercial or business purposes.

¹⁸In particular, the broker-dealer would have to disclose (i) that the testimonial was given by a current client or investor, and the endorsement was given by a person other than a current client or investor, as applicable; (ii) that cash or non-cash compensation was provided for the testimonial or endorsement, if applicable; and (iii) a brief statement of any material conflicts of interest on the part of the person giving the testimonial or endorsement resulting from the adviser’s relationship with such person.

¹⁹Release at 49, footnote 142.

²⁰ Any person receiving transaction-based compensation (e.g., sales commissions, finders’ fees or other compensation that depends on the size or completion of a securities transaction) in connection with the sale of a security should consider whether it is required to register as a broker-dealer.

²¹See footnote 14.

²² In particular, a solicitation by an affiliate is exempt from the requirements that (i) the adviser disclose, or reasonably believe that the promoter discloses, certain required information at the time of solicitation and (ii) the adviser have a written agreement with the promoter that describes the scope of the solicitation activities and the terms of the compensation. However, a solicitation by an affiliate remains subject to the Reasonable Basis Requirement and the Disqualification Provision.

²³ The Marketing Rule does not prescribe how an adviser must document affiliate status, however the SEC stated in the Release that an adviser could, for example, record a person’s status on an internal form at the time the person conducts solicitation activities. The adviser would not have to create a new form of separate documentation and, instead, could notate a person’s status in the adviser’s corporate records, employee payroll records, the Central Registration Depository (CRD) or other similar records, provided that such records are kept current.

²⁴A person is subject to “statutory disqualification” under the Exchange Act if, among other things, such person (i) is subject to an SEC order denying, suspending for a period not exceeding 12 months, or revoking the person’s registration as a broker or dealer or barring or suspending for a period not exceeding 12 months the person’s being associated with a broker or dealer; (ii) is subject to a CFTC order denying, suspending or revoking his registration under the Commodity Exchange Act; or (iii) has been convicted of any specified offense or other felony within 10 years of the date of filing of an application for membership of a self-regulatory organization.

²⁵ “Covered persons” under Rule 506(d) include the issuer, its predecessors and affiliated issuers; directors, general partners, and managing members of the issuer; executive officers of the issuer, and other officers of the issuer that participate in the offering; beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power; promoters connected to the issuer in any capacity at the time of sale; for pooled investment fund issuers, the fund’s investment manager and any general partner, managing member, director, executive officer or other officer participating in the offering of any such investment manager; and persons compensated for soliciting investors, including any general partner, managing member, director, executive officer or other officer participating in the offering of any such solicitor.

²⁶ This exemption applies to covered persons under Rule 506(d) only to the extent they are acting thereunder in a Rule 506 securities offering – e.g., if a broker-dealer is acting as a placement agent for a private fund in a Rule 506 offering that is covered by this exemption, the broker-dealer will only be covered with respect to the testimonials and endorsements made in its capacity under Rule 506(d) as part of the offering.

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