Investment Adviser Advertisements; Compensation …

SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 275 and 279 Release No. IA-5407; File No. S7-21-19 RIN: 3235-AM08 Investment Adviser Advertisements; Compensation for Solicitations AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Securities and Exchange Commission (the "Commission" or the "SEC") is proposing amendments under the Investment Advisers Act of 1940 (the "Advisers Act" or the "Act") to the rules that prohibit certain investment adviser advertisements and payments to solicitors, respectively. The proposed amendments to the advertising rule reflect market developments since the rule's adoption in 1961. The proposed amendments to the solicitation rule update its coverage to reflect regulatory changes and the evolution of industry practices since we adopted the rule in 1979. The Commission is also proposing amendments to Form ADV that are designed to provide the Commission with additional information regarding advisers' advertising practices. Finally, the Commission is proposing amendments under the Advisers Act to the books and records rule, to correspond to the proposed changes to the advertising and solicitation rules. DATES: Comments should be received on or before [INSERT DATE 60 DAYS AFTER PUBLICATION IN THE FEDERAL REGISTER]. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments: ? Use the Commission's Internet comment form

(); or

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Send an email to rule-comments@. Please include File Number S7-21-19

on the subject line.

Paper Comments:

? Send paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange

Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-21-19. This file number should be

included on the subject line if email is used. To help the Commission process and review your

comments more efficiently, please use only one method. The Commission will post all

comments on the Commission's website (). Comments

also are available for website viewing and printing in the Commission's Public Reference Room,

100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00

am and 3:00 pm. All comments received will be posted without change. Persons submitting

comments are cautioned that the Commission does not redact or edit personal identifying

information from comment submissions. You should submit only information that you wish to

make publicly available.

Studies, memoranda or other substantive items may be added by the Commission or staff

to the comment file during this rulemaking. A notification of the inclusion in the comment file

of any such materials will be made available on the Commission's website. To ensure direct

electronic receipt of such notifications, sign up through the "Stay Connected" option at

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Matthew Cook, Emily Rowland, or James

Maclean, Senior Counsels; or Thoreau Bartmann or Melissa Roverts Harke, Senior Special

Counsels, at (202) 551-6787 or IArules@, Investment Adviser Regulation Office,

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Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549. SUPPLEMENTARY INFORMATION: The Commission is proposing for public comment amendments to 17 CFR 275.206(4)-1 (rule 206(4)-1), 17 CFR 275.206(4)-3 (rule 206(4)-3), and 17 CFR 275.204-2 (rule 204-2) under the Investment Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.] (the "Advisers Act"),1 and amendments to Form ADV [17 CFR 279.1] under the Advisers Act.

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Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are

referring to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we refer to rules under the

Advisers Act, or any paragraph of those rules, we are referring to title 17, part 275 of the Code of Federal

Regulations [17 CFR part 275], in which these rules are published.

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TABLE OF CONTENTS

I. INTRODUCTION .................................................................................................................... 7 A. Advertising Rule Background ............................................................................. 8 B. Cash Solicitation Rule Background .................................................................. 15

II. DISCUSSION ....................................................................................................................... 19 A. Proposed Amendments to the Advertising Rule .............................................. 19 1. Structure of the Rule................................................................................ 19 2. Scope of the Rule: Definition of "Advertisement" ................................. 19 3. General Prohibitions ............................................................................... 53 4. Testimonials, Endorsements, and Third Party Ratings. .......................... 75 5. Performance Advertising......................................................................... 99 6. Portability of Performance, Testimonials, Third Party Ratings, and Specific Investment Advice .................................................................... 182 7. Review and Approval of Advertisements ............................................... 190 8. Proposed Amendments to Form ADV ................................................... 195 B. Proposed Amendments to the Solicitation Rule............................................. 200 1. Scope of the Rule: Who is a Solicitor? ................................................. 201 2. Expanding the Rule to Address All Forms of Compensation ................ 205 3. Compensation for the Solicitation of Existing and Prospective Investors ............................................................................................................... 210 4. Solicitor Disclosure ............................................................................... 212 5. Written Agreement................................................................................. 228 6. Adviser Oversight and Compliance; Elimination of Additional Provisions ............................................................................................................... 233 7. Exemptions ............................................................................................ 238 8. Disqualification for Persons Who Have Engaged in Misconduct......... 261 C. Recordkeeping................................................................................................... 285 D. Existing Staff No-Action Letters and Other Related Guidance ................... 296 1. Letters to be reviewed concerning rule 206(4)-1 .................................. 296 2. Letters to be reviewed concerning rule 206(4)-3 .................................. 299 E. Transition Period and Compliance Date ........................................................ 304

III. ECONOMIC ANALYSIS ...................................................................................................... 306 A. Introduction....................................................................................................... 306 B. Broad Economic Considerations ..................................................................... 308

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C. Baseline .............................................................................................................. 313 1. Market for Investment Advisers............................................................. 313 2. Market for Solicitors ............................................................................. 321 3. RIA Clients ............................................................................................ 323

D. Costs and Benefits of the Proposed Rule and Form Amendments............... 326 1. General Costs and Benefits of the Advertising Rule ............................. 327 2. Specific Costs and Benefits of the Advertising Rule.............................. 334 3. Costs and Benefits of the Proposed Amendments to the Solicitation Rule ............................................................................................................... 357

E. Efficiency, Competition, Capital Formation .................................................. 369 1. Advertising............................................................................................. 369 2. Solicitation............................................................................................. 374

F. Reasonable Alternatives Considered............................................................... 376 1. Reduce Specific Limitations on Investment Adviser Advertisements .... 376 2. Not Have an Advertising Rule and Rely on Section 206 ....................... 376 3. Define Non-Retail Investors as Accredited Investors or Qualified Clients ............................................................................................................... 377 4. Further Bifurcate Additional Requirements.......................................... 378 5. No Bifurcation ....................................................................................... 379 6. Hypothetical Performance Alternatives ................................................ 380 7. Alternatives to Proposed Amendments to Rule 206(4)-3 ...................... 381

IV. PAPERWORK REDUCTION ACT ANALYSIS ........................................................................ 382 A. Introduction....................................................................................................... 382 B. Rule 206(4)-1...................................................................................................... 383 1. Testimonials and endorsements in advertisements ............................... 385 2. Third-party ratings in advertisements ................................................... 387 3. Performance Advertising....................................................................... 389 4. Additional Conditions Related to Performance Results in Retail Advertisements....................................................................................... 399 5. Review and Approval of Advertisements ............................................... 403 6. Total hour burden associated with proposed rule 206(4)-1.................. 405 C. Rule 206(4)-3...................................................................................................... 408 D. Rule 204-2 .......................................................................................................... 422 E. Form ADV ......................................................................................................... 429 F. Request for Comments ..................................................................................... 435

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V. INITIAL REGULATORY FLEXIBILITY ANALYSIS ................................................................ 440 A. Reason for and Objectives of the Proposed Action........................................ 441 1. Proposed rule 206(4)-1 ......................................................................... 441 2. Proposed amendments to rule 206(4)-3 ................................................ 442 3. Proposed rule 204-2 .............................................................................. 444 4. Proposed amendments to Form ADV .................................................... 445 B. Legal Basis ......................................................................................................... 446 C. Small Entities Subject to the Rule and Rule Amendments ........................... 447 1. Small entities subject to amendments to advertising rule ..................... 448 2. Small entities subject to amendments to solicitation rule ..................... 449 3. Small entities subject to amendments to the books and records rule 206(4)-2 ................................................................................................. 449 4. Small entities subject to amendments to Form ADV ............................. 450 D. Projected Reporting, Recordkeeping and Other Compliance Requirements 450 1. Proposed rule 206(4)-1 ......................................................................... 450 2. Proposed amendments to rule 206(4)-3 ................................................ 451 3. Proposed amendments to rule 204-2..................................................... 453 4. Proposed amendments to Form ADV .................................................... 454 E. Duplicative, Overlapping, or Conflicting Federal Rules ............................... 455 1. Proposed rule 206(4)-1 ......................................................................... 455 2. Proposed amendments to rule 206(4)-3 ................................................ 456 3. Proposed amendments to Form ADV .................................................... 457 F. Significant Alternatives .................................................................................... 458 1. Proposed rule 206(4)-1 ......................................................................... 458 2. Proposed rule 206(4)-3 ......................................................................... 461 G. Solicitation of Comments ................................................................................. 463

VI. CONSIDERATION OF IMPACT ON THE ECONOMY .............................................. 464 VII. STATUTORY AUTHORITY......................................................................................... 464 IV. APPENDIX A: CHANGES TO FORM ADV.......................................................................... 482 V. APPENDIX B: INVESTOR FEEDBACK FLYER ..................................................................... 483 VI. APPENDIX C: SMALLER ADVISER FEEDBACK FLYER....................................................... 487

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I.

INTRODUCTION

We are proposing reforms of two rules under the Advisers Act relating to how advisers

advertise to and solicit clients and investors. First, we are proposing a rule addressing

advertisements by investment advisers that would replace the rule that we adopted in 1961, rule

206(4)-1, which we have not changed substantively since adoption.2 The proposed rule would

replace the current rule's broadly drawn limitations with principles-based provisions. The

proposed rule contains general prohibitions of certain advertising practices, as well as more

tailored restrictions and requirements that are reasonably designed to prevent fraud with respect

to certain specific types of advertisements. This approach permits the use of testimonials and

endorsements, and third-party ratings, subject to certain conditions. This approach also permits

the presentation of performance with tailored requirements based on an advertisement's intended

audience.3 The proposal recognizes developments in technology, changing profiles of

investment advisers registered with the Commission, and our experience administering the

current rule.

Additionally, we are proposing to amend the Advisers Act cash solicitation rule, rule

206(4)-3, to update its coverage to reflect regulatory changes and the evolution of industry

practices since we adopted the rule in 1979. We are proposing to expand the rule to cover

solicitation arrangements involving all forms of compensation, rather than only cash

compensation, eliminate requirements duplicative of other rules, and tailor the required

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The current rule has been amended once, when the Commission revised the introductory text of paragraph

(a) as part of a broader amendment of several rules under the Advisers Act to reflect changes made by the

National Securities Market Improvement Act of 1996. Rules Implementing Amendments to the Investment

Advisers Act of 1940, Release No. IA-1633 (May 15, 1997) [62 FR 28112, 28135 (May 22, 1997)].

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As discussed below, we are proposing to define clients and investors that are "qualified purchasers" or

"knowledgeable employees" as "Non-Retail Persons" and to define all other clients and investors as "Retail

Persons." Similarly, we are proposing to define advertisements directed at Non-Retail Persons as "Non-

Retail Advertisements" and all other advertisements as "Retail Advertisements."

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disclosures solicitors would provide to investors. The proposed rule would also refine the

existing provisions regarding disciplinary events that would disqualify a person or entity from

acting as a solicitor.

Finally, we are proposing related amendments to Form ADV that are designed to provide

additional information regarding advisers' advertising practices, and amendments to the Advisers

Act books and records rule, rule 204-2, related to the proposed changes to the advertising and

solicitation rules.

A. Advertising Rule Background

Advertisements are a useful tool for investment advisers seeking to obtain new investors

and to retain existing investors.4 Investment advisers disseminate advertisements about their

services to inform prospective investors and to persuade them to obtain and pay for those

services or to learn more about the advisers. Similarly, advertisements can provide existing

investors with information about new or revised services. Accordingly, advertisements can

provide existing and prospective investors with useful information as they choose among

investment advisers and advisory services. At the same time, advertisements present risks of

misleading existing and prospective investors because the investment adviser's interest in

attracting or retaining them may conflict with their interests, and the adviser is in control of the

design, content, format, media, timing, and placement of its advertisements with a goal of

obtaining or retaining business. This goal may create an incentive for advertisements to mislead

existing and prospective investors about the advisory services they would receive, including

indirectly through the services provided to pooled investment vehicles.

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As discussed below, we are proposing to apply the rule to advertisements disseminated by investment

advisers to their clients and prospective clients as well as to investors and prospective investors in pooled

investment vehicles that those advisers manage. For purposes of this release, we refer to any of these

advertising recipients as "investors," unless we specify otherwise.

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