STC Course Update

NASAA to Update its Exam Questions Related to IA Marketing Rules on April 1, 2022

The North American Securities Administrators Association (NASAA) is updating the Series 63, 65, and 66 Examinations to incorporate information on a new rule regarding investment adviser marketing. Although these changes will have a minor impact on all three exams, they will mostly affect the content on the Series 65 and 66 Examinations.

STC is updating its courses to reflect these changes on or before the April 1 date. These updates will impact on-line study manuals, exam questions and explanations, On-Demand lectures, and Flashcards.

Below is a summary of the changes:

To address evolving marketing practices due to advancements in technology and changes within the investment advisory industry, the SEC has replaced Rule 206(4)-1 (the Advertising Rule) and Rule 206(4)-3 (the Solicitation Rule) with a single “IA Marketing Rule.”

The Marketing Rule separates the definition of “advertisement” in two ways. The first way includes communications that are traditionally treated as investment adviser advertising, while the second way includes compensated testimonials and endorsements. Testimonials are statements that are made by current clients, whereas endorsements are statements that are made by persons who are NOT current clients. When endorsements are used, the entity that provides it is referred to as a promoter.

The definition of “advertising” includes any direct or indirect communication being made by an investment adviser to more than one person which involves an offer for the firm’s securities-related investment advisory services:

– To prospective clients or

– To current customers when new investment advisory services are offered

The definition also includes any endorsement or testimonial for which an IA directly or indirectly provides cash and/or non-cash compensation

Definition of “endorsement” and “testimonial” includes any statement that:

– Indicates approval, support, or a recommendation of the adviser, or describes a person’s experience with the adviser

– Directly or indirectly solicits any current or prospective client or investor to be a client or an investor of the adviser

– Refers any current or prospective client or investor

The following items are generally NOT considered advertising:

 – Individual conversations, whether in person or over the telephone

– Individual letters or e-mails

These communications are considered correspondence and most firms have their own in-house rules for reviewing and approving correspondence that relates to securities, insurance, and advisory products.

– Account statements or performance reports that are sent to existing clients

– Information in regulatory filings, such as Form ADV Part 2A or Form CRS

Although it’s not required, most advisory firms require all marketing materials—whether for advisory programs, broker-dealer products, or insurance products—to be approved prior to use.

Testimonials     For many years, the use of testimonials and endorsements were prohibited in investment adviser advertising. However, in 2021, the SEC revised its advertising rules to permit the use of testimonials and endorsements, but only if certain conditions are met.

Under the provision of the new rule:

When testimonials or endorsements are used, the IA or IA promoter (if one is being used) must provide the following disclosures clearly and prominently:

– Whether the testimonial was given by a current client, or whether the endorsement was given by a person who is NOT a current client

– Whether cash or non-cash compensation was provided for the testimonial or endorsement

– A brief statement regarding any material conflicts of interest for the person who’s providing the testimonial or endorsement

Other disclosures may also need to be made (although they’re not required to be prominent), such as:

– The material terms of any compensation arrangement, and

– A description of the material conflicts of interest.

If an IAR intends to use testimonials or endorsements, it’s very important for her to review her firm’s procedures. Essentially, the IAR must have a reasonable basis for believing that the testimonial or endorsement complies with the SEC rule.

Third Parties    Some investment advisory firms hire marketing firms to promote their business. If an IA promoter is to be paid more than “de minimis compensation” for the testimonial or endorsement, the adviser must sign a written agreement with the promoter which describes the scope and compensation of any agreed upon activities. For purposes of the rule, de minimis compensation is $1,000 or less received during the preceding 12 months.

Third-Party Ratings    A third-party rating is defined by the SEC as a rating or ranking of an investment adviser by a person that’s not affiliated or under the common control of the IA and provides this information in the ordinary course of business. An investment advisory firm is prohibited from using third-party ratings unless it:

Has a reasonable basis for believing that any questionnaire or survey being used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses and is not designed or prepared to produce any predetermined result (referred to as the “due diligence requirement”); and

Clearly and prominently discloses, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses:

– The date on which the rating was given and the period upon which the rating was based

– The identity of the third party that created and tabulated the rating, and

– That compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating (if applicable)

Sample Questions:

If an investment adviser uses a marketing firm to promote its business, it’s NOT required to take which of the following actions?

1) Disclose that the endorsement was given by a person other than a client

2) Disclose any material conflict of interest

3) Ensure that there’s a written agreement between the advisory firm and the promoter

4) Disclose the amount of compensation that the advisory firm is paying the promoter

When testimonials or endorsements are used, the IA or IA promoter (if one is being used) must provide the following disclosures clearly and prominently:

– Whether the testimonial was giving by a current client, or whether the endorsement was given by a person who is NOT a current client

– Whether cash or non-cash compensation was provided for the testimonial or endorsement (the amount of compensation is NOT required to be disclosed)

– A brief statement regarding any material conflict of interest for the person who’s providing the testimonial or endorsement

Although they’re not required to be prominent, other disclosures may also need to be made, such as:

– The material terms of any compensation arrangement, and

– A description of the material conflicts of interest

If an IAR intends to use testimonials or endorsements, it’s very important for her to review her firm’s procedures. In all cases, the IAR must have a reasonable basis for believing that the testimonial or endorsement complies with the SEC rule.

All of the following are considered investment adviser advertising, EXCEPT:

1) Performance reports that are sent to existing clients

2) Testimonials

3) Endorsements

4) An e-mail that’s sent to 20 clients

(A)    The following items are generally NOT considered advertising:

– Individual conversations, whether in person or over the telephone

– Individual letters or e-mails

– These communications are considered correspondence and most firms have their own in-house rules for reviewing and approving correspondence that relates to securities, insurance, and advisory products.

– Account statements or performance reports that are sent to existing clients

– Information in regulatory filings, such as Form ADV Part 2A or Form CRS

An e-mail that’s sent to more than one person is defined as advertising.

3.If an investment adviser wants to use third-party ratings in its marketing materials, which of the following statements is TRUE?

1) This is prohibited unless the third party is registered as an investment adviser.

2) This is permitted as long as certain disclosures are made.

3) This is prohibited under any conditions.

4) This is permitted as long as the firm that provides the rating is not compensated.

(B)  Investment advisory firms are permitted to use third-party ratings if certain conditions are met. The IA must have a reasonable basis for believing that any questionnaire or survey being used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses and is not designed or prepared to produce any predetermined result (i.e., the “due diligence requirement”); and

Clearly and prominently discloses, or the investment adviser reasonably believes that the third-party rating clearly and prominently discloses:

– The date on which the rating was given and the period of time upon which the rating was based

– The identity of the third party that created and tabulated the rating, and

– That compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating (if applicable)

The third party is not required to be a registered investment adviser and may be compensated as long as this is disclosed.

Testimonials