Under Rule 206(4) of the Investment Advisors Act of 1940 (“the Act”), the SEC states that a Registered Investment Advisor (“RIA”) is prohibited from engaging “in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.” Registered Investment Advisors consist of individuals or firms that are in the business of giving advice about securities, and thus must be registered with the Securities and Exchange Commission or a state’s securities agency. Rule 206(4) was designed to protect the public from deceptive advertising tactics by investment advisors across the nation. Sounds simple enough, right?
If only that were so…
The imprecision of this rule has created confusion and uncertainty for RIAs for decades following its enactment. Fortunately for RIAs, the SEC released “SEC No-Action Letter, Clover Capital Management, Inc.” in 1983, which outlines certain circumstances the Commission deems to be prohibited under Rule 206(4). The Clover no-action letter prohibits certain activities including, but not limited to:
- Failing to disclose the effect of material market or economic conditions on the results portrayed (e.g., an advertisement stating that the accounts of the adviser’s clients appreciated in the value 25% without disclosing that the market generally appreciated 40% during the same period);
- Including models or actual results in an advertisement that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;
- Failing to disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
- Using advertisements that include testimonials or that refer to past specific recommendations unless certain information is provided
While Clover created greater confidence for RIAs at the time of its release, it has failed to evolve with advancing technology and changes in advertising practices. For instance, the surge in social media has convoluted RIA efforts to comply with SEC regulations considerably. According to the seventh annual Investment Management Compliance Testing Survey, released in July of 2012, social media use among RIAs increased over the past year, with 80% of RIAs stating they have adopted formal written policies concerning social networking, up from 64% in 2011 and 43% in 2010.
For instance, many firms have adopted social media policies and procedures stipulating who is permitted to use social networking for business purposes. All of those posts should be pre-approved by the firm’s chief compliance officer or a designee. This process helps to avoid situations in which a member of the firm distributes inconsistent or noncompliant information using social media.
However, how should RIAs with several thousand employees monitor the use of each employee’s personal social media profiles? If a sales representative of an RIA endorses a specific portfolio on his personal Facebook page, what ramifications could the RIA face? If client testimonials are subject to SEC regulations, what effect does that have on client postings on an investment advisor’s Linkedin profile? For instance, recent cases have indicated that “Liking a Page” on Facebook is allowed and encouraged since it is not considered a type of testimonial, but “Liking a Status Update” is an “endorsement” of another user’s post and is a violation of SEC standards.
To address these ambiguities, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released a National Examination Risk Alert in January of 2012 entitled “Investment Adviser Use of Social Media.” The alert recommends various precautionary measures RIAs can implement in order to better prevent potential social media violations by their employees. However, the list is by no means exhaustive and explicitly states that adhering to all suggested procedures will not create a “safe harbor” for an RIA in the event of a violation.
As technological advancements continue to transform marketing strategies across the financial industry, RIAs must work diligently to devise compliance and corporate governance procedures which help overcome the uncertainty surrounding the outdated, ambiguous regulations set forth by both the SEC and FINRA.