The SEC’s New Marketing Rule – Presenting Performance

The SEC has adopted a modernized marketing rule for investment advisers. This new advertising rule is designed to replace the outdated patchwork of guidance made through No-Action Letters and Enforcement Actions over the last several decades with principles-based provisions that are relevant to current industry practices. Advisers have 18 months from the effective date of this new rule to comply. Changes can be adopted early, but firms that adopt early must fully comply with all changes and cannot pick and choose between the old and new requirements.

The new marketing rule defines what is considered an advertisement, provides general prohibitions that are never allowed in any advertisement, sets a framework for how testimonials, endorsements, and third-party rankings may be used, and outlines what is specifically prohibited when presenting performance.

One of the key changes for presenting performance is that the new rule prohibits firms from presenting “performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement, with limited exceptions.” Despite advisers requests to continue its use, the SEC no longer allows the presentation of a single representative account.

There are two exceptions to this rule. Advisers can:

1. list the individual results of all portfolios that follow the same mandate rather than aggregating into a composite (not exactly ideal for a marketing presentation), or
2. provide performance based on an aggregation of a sample of the portfolios following the same strategy; however, the firm must support that these results are lower than if the full population had been used.

Based on these exceptions, it appears a representative account(s) may be presented, but only if the adviser can prove the performance is more conservative than that of the full composite. The only way to support this is by constructing a composite and testing if this is true. But once the composite is constructed, there is no longer a good reason to present the representative account instead. Ultimately, composites appear to be required to comply with the SEC’s new advertising rule.

While composites have historically been associated with GIPS compliance, there is no requirement for a firm to be GIPS compliant to utilize composites. With the requirements set forth in this new marketing rule, composites are likely to become much more prevalent, even with firms electing not to claim compliance with the GIPS standards.

Firms that are constructing composites for the first time may benefit from reviewing Longs Peak’s article on How to Construct Composites. Maintaining composites will essentially be required for any SEC registered firm looking to market investment performance in the future and this article helps explain how to set those composites up.

Creating and maintaining composites can have added benefits beyond just providing strategy results to present in marketing materials. Aggregating portfolios with similar investment mandates and analyzing the results can also help firms confirm that strategies are implemented consistently. Our article on Investment Performance Outlier Testing can provide some additional insight into these benefits available to firms maintaining composites.

Constructing and maintaining composites can be time consuming and difficult to manage without errors. Longs Peak specializes in setting up policies and procedures for composite construction as well as following those policies and procedures to implement and maintain composites for our clients. Reach out to us today to discuss how we can help your firm create and maintain composites.