Investment advisers, and therefore fund managers once
they register as investment advisers, are limited in how they advertise. Section 206 of the
Investment Advisers Act already prohibits fraud, deception or manipulation,
regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1
imposes additional restrictions on advertising that the SEC has determined
would be fraudulent deceptive or manipulative.
The first item on the list of restrictions is
testimonials. This prohibition reflects the concern that the experience of one
customer is not necessarily typical of the experience for all customers.
To some extent this also covers third party ratings since
they are relying on the testimonials of clients. If you have a good rating you
may want to include that rating as part of your fundraising materials. That
means you are indirectly including a testimonial in your advertising and are
staring squarely at the prohibitions in the advertising rule.
However, the SEC has recognized that the distribution of
unbiased third-party ratings may not be fraudulent. In a 1982 No Action Letter
to New York Investors Group, Inc., the SEC allowed the investment adviser to
include an article from a financial publication that "lauds the Company/ and or
the Company president's success in picking stocks that do well under both
favorable and unfavorable market conditions."
The SEC ruled that "an article by an unbiased-third party
concerning an investment adviser's performance, however, is not a testimonial
unless it includes a statement of a customer's experience or endorsement. "
While clarifying that the article is not a testimonial, it is still an
The more detailed discussion about the use of ratings is
in a 1998 No Action Letter to DALBAR, Inc. The company conducted a survey to
measure the effectiveness of investment advisers and their
representatives. Based on the survey, DALBAR would assign a numerical
ranking. Since the investment adviser was paying for the survey, presumably
they would want to publish a good result to attract more clients. That means
the ratings would be part of an advertisement.
The SEC said that the DALBAR rating is a testimonial
because the rating carries an implicit statement of clients' experiences. The
DALBAR rating is testimonial, made indirectly.
But the SEC turns around and and blesses the DALBAR
rating, granting the sought after "we would not recommend enforcement action."
The SEC lists these factors:
While the SEC blesses the DALBAR rating system, they took
the opportunity to point out that an adviser's use of the rating in their
advertisement materials could still be a violation of Section 206(4)
and Rule 206(4)-1(a)(5). The SEC provided some guidance that advisers should
consider when using a DALBAR or similar rating:
1. Whether the advertisement discloses the criteria on
which the rating was based;
2. Whether an adviser or IAR advertises any favorable
rating without disclosing any facts that the adviser or IAR knows would call
into question the validity of the rating or the appropriateness of advertising
the rating (e.g., the adviser or IAR knows that it has been the subject of
numerous client complaints relating to the rating category or in areas not
included in the survey);
3. Whether an adviser or IAR advertises any favorable
rating without also disclosing any unfavorable rating of the adviser or IAR (or
the adviser that employs the IAR);
4. Whether the advertisement states or implies that an
adviser or IAR was the top-rated adviser or IAR in a category when it was not
rated first in that category;
5. Whether, in disclosing an adviser's or IAR's rating or
designation , the advertisement clearly and prominently discloses the category
for which the rating was calculated or designation determined, the number of advisers
or IARs surveyed in that category, and the percentage of advisers or IARs that
received that rating or designation;
6. Whether the advertisement discloses that the rating
may not be representative of any one client's experience because the rating
reflects an average of all, or a sample of all, of the experiences of the
adviser's or IAR's clients;
7. Whether the advertisement discloses that the rating is
not indicative of the adviser's or IAR's future performance; and
8. Whether the advertisement discloses prominently who
created and conducted the survey, and that advisers and IARs paid a fee to
participate in the survey.
If you are using third-party ratings as part of your
fundraising materials, DALBAR presents you with a laundry list of things you
can and cannot do with those ratings.
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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