04/30/2024 | News release | Distributed by Public on 04/30/2024 08:17
In this issue, we discuss the SEC Examinations Division's risk alert regarding compliance with the Advisers Act Marketing Rule, and recent enforcement actions involving, among other things, off-channel communications and alleged violations of the Marketing Rule with respect to hypothetical performance.
In a March 27, 2024 release (Adopting Release), the SEC adopted amendments to Rule 203A-2(e) (the Internet Adviser Exemption) under the Advisers Act. The Internet Adviser Exemption allows certain investment advisers to register with the SEC, rather than with state securities authorities, if they meet certain conditions, including those relating to the investment adviser's use of an interactive website to advise clients.
According to the Adopting Release, the amendments are designed to modernize the Internet Adviser Exemption to reflect the evolution in technology and the investment adviser industry since the rule's adoption in 2002 and to better align current practices in the investment adviser industry with Congress's intended allocation of responsibility between the SEC and the states. In the Adopting Release, the SEC noted that there has been an uptick in the number of investment advisers relying exclusively on the Internet Adviser Exemption to register with the SEC. The SEC noted that based on Form ADV data, the number of investment advisers relying exclusively on the exemption has grown from approximately 107 investment advisers as of December 2015 to 261 investment advisers as of June 2023.
The amendment requires investment advisers relying on the Internet Adviser Exemption to at all times have an operational interactive website through which the investment adviser provides investment advisory services to one or more clients. The amendment also eliminates the de minimis exception in the current rule, which currently permits an investment adviser relying on the exemption to have fewer than 15 non-internet clients in a 12-month period. As a result, an investment adviser relying on the exemption is now required to provide advice to all of its clients exclusively through an operational interactive website. Finally, the amendment makes certain corresponding changes to Form ADV. The amended rule is effective July 8, 2024, with a compliance date on March 31, 2025.
On April 17, 2024, the SEC's Division of Examinations staff (staff) issued a risk alert that identified initial observations regarding investment advisers' compliance with amended Rule 206(4)-1 (Marketing Rule) under the Advisers Act. The staff noted that the purpose of the risk alert is to promote compliance with the Marketing Rule-related items contained in Form ADV, Advisers Act Rule 206(4)-7 (Compliance Rule), Advisers Act Rule 204-2 (Books and Records Rule), and the general prohibitions set out in subsections (a)(1) to (a)(7) of Marketing Rule.
The Risk Alert outlined observations surrounding whether investment advisers had adopted and implemented the written policies and procedures to prevent violations of the Advisers Act, including the Marketing Rule thereunder:
According to the risk alert, the staff's review for Marketing Rule compliance has also assessed whether investment advisers have disseminated advertisements that violate any of the following general prohibitions:
The SEC staff observed various deficiencies related to the Marketing Rule's general prohibitions, including the following:
Untrue statements of material fact and unsubstantiated statements of material fact:
Omission of material facts or misleading inference:
Fair and balanced treatment of material risks or limitations:
References to specific investment advice that were not presented in a fair and balanced manner:
Inclusion or exclusion of performance results or time periods in manners that were not fair and balanced:
Advertisements that were otherwise materially misleading:
In the risk alert, the staff urged advisers to reflect on their own practices, policies, and procedures and to implement modifications as necessary to their training, supervisory, oversight, and compliance programs.
On April 12, 2024, the SEC announced five orders (Marketing Rule Orders) instituting and settling administrative and cease and desist proceedings against five registered investment advisers, GeaSphere LLC, Bradesco Global Advisors Inc., Credicorp Capital Advisors LLC, InSight Securities Inc., and Monex Asset Management Inc. The Orders found that the five firms were allegedly advertising "hypothetical performance to the general public without adopting and implementing policies and procedures reasonably designed to ensure that the hypothetical performance was relevant to the likely financial situation and investment objectives of each advertisement's intended audience, as required by the Marketing Rule." These orders follow nine similar orders that were announced in September 2023.[1]
Under the Marketing Rule (i.e., Rule 206(4)-1 under the Advisers Act), "hypothetical performance" information includes performance results that were not actually achieved by any portfolio of the relevant adviser, such as performance results for model portfolios, backtested performance (results generated by applying a strategy to prior time periods when the strategy in question was not in use), and projected future results. Advisers are generally prohibited from advertising using hypothetical performance unless, among other things, the adviser adopts policies and procedures reasonably designed to ensure that the hypothetical performance presented is relevant to the likely financial situation and investment objectives of the intended audience. The Marketing Rule Orders note that "[A]dvisers generally would not be able to include hypothetical performance in advertisements directed to a mass audience or intended for general circulation . . . because the advertisement would be available to mass audiences, an adviser generally could not form any expectations about their financial situation or investment objectives."
According to the Marketing Rule Orders, each of the five advisers included hypothetical performance information on their public websites; such information included results from model portfolios (GeaSphere, InSight, Monex, Credicorp, Bradesco) as well as backtested performance (GeaSphere). Four of the five advisers, InSight Securities, Monex Asset Management, Credicorp Capital Advisors, and Bradesco Global Advisors, removed hypothetical performance information from their public website after the Compliance Date under the Marketing Rule, but before SEC staff contacted them about the information.
In addition to presenting hypothetical performance information, GeaSphere allegedly made false or misleading statements, such as claiming in a promotional video that it did not "charge clients twice," for fund management fees and advisory fees, when in fact clients who invested in the fund paid both fees, and presented inaccurate and unsubstantiated performance information. GeaSphere was also charged with compensating two unaffiliated accounting firms for endorsements without having a written agreement with either firm, failing to substantiate documents for material statements of fact when requested by the SEC, failing to keep adequate books and records, and other compliance failures responsive to the requirements in its compliance manual.
On account of the conduct alleged, the SEC asserts that GeaSphere violated Sections 206(4), 206(2), and 204 of the Advisers Act and Rules 206(4)-1(a), 206(4)-1(b), 206(4)-1(d), 206(4)-7, 206(4)-8, 204-2(a)(11) and (16) thereunder. InSight, Monex, Credicorp, and Bradesco were charged with violating Section 206(4) of the Adviser's Act and Rule 206(4)-1(d) thereunder. GeaSphere was also charged with violating Section 34(b) of the Investment Company Act. All five firms agreed to pay a civil money penalty of $200,000 in combined penalties, to cease and desist from future violations, and to be censured. GeaSphere agreed to pay $100,000, while the other four firms agreed to pay civil penalties in the range of $20,000 to $30,000. Bradesco, Credicorp, InSight, and Monex received reduced penalties due to corrective steps taken in advance of SEC contact.
On April 3, 2024, the SEC announced another in a substantial series of settlements regarding so-called "off-channel communications," that is, business communications among employees using messaging services other than the employer-provided communications services. This order (Senvest Order) was issued against Senvest Management, LLC, a New York-based registered investment adviser.
Pursuant to Section 204 of the Advisers Act and Rule 204-2 thereunder, advisers must preserve and retain certain records, including certain written communications related to the adviser's business. Senvest's policies and procedures stated that Senvest would "retain all electronic communications that it sends and receives," and in that regard, forbid employees from using unapproved communication methods for business purposes except in emergencies or when communications were disrupted, in which case employees were required to copy the content of such communications to firm messaging systems so that the content could be archived.
According to the Senvest Order, from January 2019 to December 2021, Senvest employees sent and received "thousands of business-related messages using off-channel communications"; Senvest allegedly failed to "access employees' personal devices" to confirm that employees were following Senvest's policy barring off-channel communications, and, as a result, some communications were deleted as certain employees' personal devices were set to automatically delete such messages after 30 days. Because of such failures, the SEC alleges, Senvest "likely deprived the Commission" of off-channel communications that would have been responsive to SEC requests and subpoenas propounded during the relevant time period.
In addition, Senvest allegedly also failed to properly implement its securities transaction pre-clearance policies, resulting in Senvest employees transacting in securities without obtaining preclearance.
On account of the conduct described above, Senvest allegedly violated Sections 204, 204A, and 206(4) of the Advisers Act and Rules 204-2, 204A-1, and 206(4)-7 thereunder. Senvest agreed to retain a compliance consultant, to cease and desist from future violations, to be censured, and to pay a civil money penalty of $6.5 million.