SEC Revamps Advertising Rules for the Digital Age

Here are a few important things that happened in 1961. 

John F. Kennedy was sworn in as US President, Yuri Gagarin became the first human in space, the Berlin Wall began construction, and Pampers brought out the first ever disposable diaper. West Side Story was the hit movie of the year and Ben E. King ruled the music charts with Stand By Me. And the US Securities and Exchange Commission (SEC) wrote their rules on advertising financial products into the Investment Advisers Act – a ruleset that has remained unchanged, until now.   

SEC modernization

Since 1961, the world has seen unprecedented political, social, economic, and technological change. Despite these vast shifts, the SEC’s advertising rules have both remained intact and broadly served the asset management industry well. However, like many other pieces of regulation, the SEC periodically updated asset managers and other financial institutions by issuing interpretive letters or through their responses to what’s known as “no-action letter” letter requests, whereby industry participants may ask the SEC for an advance ruling on ambiguous or novel situations not adequately considered in the original ruleset. Over time this process has become onerous for both the SEC as the volume of no action requests has risen and for the industry which has to consider not an integrated rule, but a rule together with plethora of interpretations and applications. 

When the new advertising rules are implemented, they will reduce the need for no-action letters as the SEC looks to explicitly address new areas of advertising that aren’t currently. Recently, we saw a similar shift in ETFs, when the SEC released a new ruleset, eliminating the need for “exemptive relief,” and they’ve looked to modernize the fund sales agenda through their SEC Regulation Best Interest.

The proposals received the unanimous approval of all five SEC Commissioners on November 4. In approving the proposal, the SEC seeks to bring the advertising of mutual funds by registered investment advisors in line with most other industries who have long had far more efficient and modern methods of engaging in communication with their consumer base, such as the use of social media. The proposals now go through a public comment period prior to implementation.  

Industry pleased overall

The proposals are generally seen as a win for the US mutual funds industry (although adviser compliance teams who will have to implement rules governing a wider range of communications media and allowable content may not wholly agree with the statement) as it gives much greater opportunity to connect with customers via technology. This has multiple benefits to both the advisor and the customer. It conceivably reduces costs for advisers as they can more cheaply reach a much larger number of clients and prospects using their website or social media channels. It also benefits the consumers since it streamlines the marketing information and disclosures and allows them to access that information via means that they are used to in their general lives. Since its inception, the US mutual funds industry has engaged with its clients almost exclusively “offline,” but these changes will mean that advisers have an opportunity to properly target “digital natives” in the US for the first time. 

As with all regulatory gains, there will be a degree of pain. The proposals run 507 pages and the devil is in the detail. Initial commentary from the industry suggests that as currently framed, the advertising requirements might result in an obligation to review and approve every single piece of communication between an adviser and its clients for compliance. Advisers will need to bolster their marketing and advertising oversight to avail themselves of the new permissions which may require greater collaboration between sales, marketing, and compliance on whether the advertising meets the standards set out by the SEC.

What’s new?

For the first time, the proposals allow for the use of testimonials, endorsements, third party ratings, and performance results in advertising under certain prescribed terms and conditions. The allowance of performance presentation is a big win for the US funds industry, however as we have seen in Europe with PRIIPs, firms will need to be certain that they are presenting accurate data to customers or firms will risk regulatory sanctions and reputational damage. Firms will have to manage conflicts of interest and attend to the independence for endorsements –there must be explicit disclosure if anyone is paid for a testimonial or endorsement. Also, since the rules will allow for the use of third-party ratings in advertising, fund rating agencies will likely come under more pointed scrutiny as to how they calculate such ratings.

A more detailed Form ADV

All the information on presentation of data will now be included as a part of the annual Form ADV that advisers are required to file with the SEC. This form is already an arduous compliance task, and these new rules could make compiling the data required for Form ADV even more difficult as it adds new fields relating to fund advertising. On the upside, an adviser’s distributors will no longer have to provide prospective investors with the adviser’s full Form ADV. Instead, there must be a written agreement including the compensation arrangements between the adviser and distributor. Review of the upgraded Form ADVs is the primary mechanism through which the SEC will police the new rules making clean and accurate advertising data more important than ever.

The rules also acknowledge that advisers have two primary segments of customers, retail and institutional, and that these two groups have different levels of knowledge and expectations. The proposals give more latitude to advisers in information they can communicate to their more sophisticated customer base.

Another 60 years?

These changes represent a trend at the SEC to revisit long standing and perhaps outdated rules to better meet the needs of the modern funds’ industry. In one fell swoop, the SEC has revised 60 year old advertising rules. Whether this set will last another 60 years is unknown, however the changes are welcome by the industry. There is opportunity in the modernized regulations, but they require asset managers a commensurate modernization of investment adviser processes and procedures regarding how they advertise, distribute, and sell to their customers under the new rules.