RIA Compliance Blog
The Securities Exchange Commission (“SEC”) Office of Investor Education and Advocacy recently released an investor bulletin educating investors on investment performance claims in investment adviser advertising and pointing out specific things they should consider prior to investing. This bulletin and newsletter highlight the increasing emphasis regulators have been placing on performance claims in recent years.
Performance advertising is regulated under the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-1. Pursuant to Section 206 of the Advisers Act and Rule 206(4)-1, it is considered fraudulent for a registered investment adviser to publish, circulate, or distribute any advertisement which contains any untrue statement of material fact or which is false or misleading. The SEC has issued specific guidance regarding performance claims in advertising that all investment adviser firms must follow in order for their performance advertising to be considered non-fraudulent.
The performance data should reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid. In addition, investment advisers should disclose all material facts regarding the performance data and how it was calculated, including the effect of material market or economic conditions on the results portrayed, whether results portrayed include reinvested dividends and other earnings, any material conditions, objectives, or investment strategies used to obtain the results portrayed, if applicable, and any other material fact which may have impacted the results in any way.
If the performance data includes back-tested performance data, or model performance results, investment advisers should also disclose that the results are model or hypothetical results, the limitations inherent in model results, any material changes in the conditions, objectives, or investment strategies of the model portfolio during the period portrayed and the effect of those changes, any differences between the strategy portrayed in the model to actual services currently offered by the adviser, any materially different actual results, and any other material fact which may have impacted the results in any way.
The investor bulletin advises investors to consider the role fees pay in performance calculations, as these will reduce investment returns and should generally be included in the performance calculations. In addition, the bulletin advises investors to consider their own financial circumstances as performance claims do not take into account the many factors that can affect one’s personal financial situation, including age, income, and other investments. The bulletin also advises investors to consider performance claims in light of material market and economic conditions, as these should all be disclosed to the investor. The performance claim should disclose its process for calculating performance and any factors which may have affected the results.
In order to evaluate the reliability of performance claims, the bulletin advises investors to pay particular attention to several red flags. Performance guarantees are “virtually impossible” with investments that have market risk, such as stocks, and should be avoided. Back-tested performance data should be clearly labeled as “hypothetical” or as a “simulation,” and should not claim to predict how the investment strategy will perform in the future. Advisers should also not cherry-pick past performance results to present, such as by excluding periods of bad returns, as this can be misleading. Lastly, the bulletin advises investors to check the benchmark used to compare the performance of the investment strategy and ensure that it appropriate and does not represent a different market segment. These are all areas that have been the subject of regulatory enforcement cases in the past.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.