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Blog > SEC Roundup: 9 RIAs Settle With the SEC on Marketing Rule Violation Charges

SEC Roundup: 9 RIAs Settle With the SEC on Marketing Rule Violation Charges

Critical lessons from RIA violations

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On September 11, 2023, the SEC announced charges against nine investment advisers for violating the Marketing Rule’s requirements for performance advertising. These violations included the improper use of hypothetical performance metrics and failing to comply with recordkeeping requirements. They resulted in settlements totaling $850,000 in penalties across the nine RIAs and civil penalties that ranged from $50,000 to $175,000 per adviser.

The nine firms all agreed to remove their hypothetical performance models. This settlement issues a clear message from the SEC that it’s committed to enforcing the Marketing Rule in efforts to increase transparency and reiterate it will punish those who violate advertising practices.

In this article, Arootah advisor, Michelle McGurk unpacks what this violation means for you, your firm, and the hedge fund industry at large.

SEC Enforcement of the Marketing Rule Violation

The SEC judgment resulted from firms placing hypothetical performance metrics in their advertising materials that were shared with broader audiences. These advertisements contravene the Marketing Rule’s mandate to present performance metrics that are relevant to the financial situation and investment objectives of the intended audience. While the SEC provided limited insight into the nature of the hypothetical performance, the settlements highlight that these advisers primarily presented performances derived from the application of models, back-tested investment strategies, or both.

The Marketing Rule does not prohibit the use of metrics entirely, as RIAs can advertise to intended audiences so long as they conduct a thorough review of the hypothetical performance’s placement on the website, advertising materials, and have policies and procedures in place to restrict access to the designated audience. Some of the firms faced additional penalties for violating these rules.

In one of the nine settlements, for example, the SEC charged firms with the failure to produce archived copies of their website that showcased the hypothetical performances they had advertised. This failure to maintain records charge resulted from both insufficient oversight of an external service provider and insufficient recordkeeping of the firm’s own website data. The Marketing Rule requires firms to maintain comprehensive records of all website archives and oral advertisements, and requires them to disclose additional marketing practice information on a Form ADV.

Key Takeaways for RIAs

As noted in an earlier article, the SEC introduced the Marketing Rule under the Investment Advisers Act of 1940 in December 2020, which ushered in a new era for investment adviser marketing practices since its compliance deadline on November 4, 2022. In light of the recent SEC enforcement actions, it’s important all RIAs revisit and thoroughly review Commission requirements and reevaluate internal policies and procedures to ensure they are compliant with them.

If these changes have taught advisors anything, transparency is paramount to the presentation of hypothetical performance metrics. Advisors must not only disclose their methodologies for deriving results but policies and procedures to ensure these disclosures align with the investment objectives of their intended audience. Additionally, investment advisers should ensure they have established robust recordkeeping systems for archives of past presentations, advertisements, and website archives, so they can readily produce the required documentation to regulators upon request. Lastly, when utilizing an external service provider, RIAs should perform extensive due diligence and monitor their activities, particularly regarding regulatory compliance and archival responsibilities.

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The Importance of Material Disclosures: Key Takeaways from the YieldStreet Enforcement Action

In addition to its settlement over marketing disclosure and recordkeeping violations, the SEC recently settled an enforcement action against YieldStreet Inc. and its registered investment adviser subsidiary, YieldStreet Management LLC, for their failure to disclose critical information to investors during a $14.5 million asset-backed securities offering. The SEC’s investigation revealed that YieldStreet didn’t adequately disclose the elevated risks that emerged from seizing the collateral, a retired ship, in the event of default.

Remarkably, YieldStreet possessed prior knowledge of similar ships securing loans to the same group, which had been deconstructed without any repayments. Despite this, YieldStreet proceeded with the offering without adequately informing investors of these significant material risks which resulted in substantial losses when the borrowing group orchestrated the deconstruction of the ship securing the offering and failed to repay the loan.

YieldStreet could have avoided these violations by taking several prudent measures such as conducting a more meticulous due diligence process concerning the collateral and associated risks, implementing more rigorous risk assessment protocols, formalizing a systematic approach for evaluating and monitoring the collateral’s value and condition, and maintaining transparency in conveying material risks to investors through their communications.

The SEC has been stressing the significance of disclosures and proper documentation, so it’s vital for advisers to consult with legal counsel to ensure they understand disclosure requirements. Then, they can establish straightforward internal processes to ensure they’re giving top priority to safeguarding investors through stringent risk disclosures.

The Bottom Line

By presenting various inquiries in advertising materials, firms can provide prospective investors with the context necessary to better assess if an investment is suitable and provide transparency. This may help ensure the firm meets regulatory compliance standards by avoiding the use of prohibited hypothetical investment scenarios.

If you have any questions regarding your offering materials, and if they’re in compliance with this rule, please contact us and we can connect you with a Compliance Expert to help keep you ahead of the ever-evolving regulatory environment.



Disclaimer: This article is for general informational purposes only and does not constitute legal, investment, financial, accounting, or tax advice, or establish an attorney-client relationship. Arootah does not warrant or guarantee the accuracy, reliability, completeness, or suitability of its content for a particular purpose. Please do not act or refrain from acting based on anything you read in our newsletter, blog, or anywhere else on our website.

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