The Securities and Exchange Commission is taking a closer look at how RIAs are using testimonials and hypothetical performance in advertising.
The financial industry is constantly evolving and with it, so are rules about how registered investment advisors can market to prospective clients.
Over two years ago the Securities and Exchange Commission amended rules under the Investment Advisers Act of 1940 that dictate how advisors can advertise to clients. It wasn’t the first change to 83-year-old governing guidelines, one set of updates came in 1960 and another followed in 1979. But in the nearly 50 years since the last update, the financial world — and its participants — changed greatly. There are now new financial products, new technologies to facilitate communication and delivery of those products, and more avenues for clients and prospects to give their opinion on the service they receive on platforms like LinkedIn and Google
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Taken together, it makes sense that the SEC would want a new regulatory standard to meet the needs of today’s financial world while also keeping an eye to what the future could look like. With regards to marketing, the framework primarily focuses on three areas: the use of hypothetical performance figures, anti “cherry picking” provisions for performance, and the use of client testimonials and endorsements.
While the changes were finalized in May 2021, the compliance period began at the end of 2022. And even though the rule changes were only in full force for less than a year, the SEC has already accused firms of violating the new standard with at least ten of those alleged violations coming to light in September. For all RIA firms, any allegations of rule breaking should serve as a reminder to audit current marketing campaigns and to amend any future campaigns to remain in compliance.
Be careful about marketing performance. Naturally, any prospective client considering using an RIA will want to know how their portfolios have performed in the past. To explain this, advisors have sometimes created a hypothetical portfolio, which may be similar to those of their existing clients. The SEC found that these hypothetical portfolios may be misleading to clients and says if advisors use such portfolios for marketing, they must be explained as such with any other risks spelled out.
“When a firm pursues its marketing objectives with 20/20 hindsight on how a fictitious portfolio would have performed, it creates a temptation to set unrealistic expectations for the client,” said Brian Hamburger, president of MarketCounsel Consulting.
Similarly, the new rule also requires that RIAs use standardized 1-year, 5-year, and 10-year return periods when displaying performance to avoid so-called “cherry-picking” more opportune time frames. If performance history falls short of one of those time periods — and is seven years instead of 10, for instance — firms must disclose the standardized periods for which there is data and the performance since inception.
While these guidelines make sense for providing clients and prospects with consistent and prudently presented information, it should also serve as a reminder for RIAs to be careful about how important financial performance is to their marketing strategy.
As any advisor who has been in the business for a long time knows, markets can move up and down with little warning. An advisor is surely bound to do what is in their client’s best interests, but there may be times that performance can lag. That does not always mean that an advisor is not doing their job, which is why marketing performance alone can be tricky. Which brings us to the next point.
Remember that financial planning is holistic. It may be tempting to lead with performance figures when marketing but doing so may miss the bigger picture of attracting clients. Financial planning is a process and investment performance is just one piece of the puzzle. Accordingly, advisors will want to make sure that their marketing materials convey the full scope of their services and not send misleading expectations about performance.
“Advisors should spend time to ensure their scope of engagement and disclosures pair with the actual services they’re performing so that client’s know what to expect from their advisors,” added Hamburger.
Clients may often seek advisors to help manage their investments but they often have other, more-pressing money-related matters to consider too: estate planning, insurance concerns, tax planning, family business succession, and philanthropic giving are just a few of the many reasons a person may seek an RIA. All of these things certainly have a financial component to them but to focus just on performance risks connecting with potential clients who may need other advice.
Be careful with testimonials and referrals. One other piece of the new framework is that allows RIAs to use testimonials for advertising. Similarly, endorsements from non-clients, such as estate lawyers, bankers, and accountants, who have done business with the investment advisor are also permitted.
At first glance, that may seem like a big win for RIAs. For most businesses it may seem natural to have the happiest, most loyal clients serve as spokespeople. But firms may want to tread carefully here. On the practical side, companies will have to disclose if there are any compensation arrangements or other conflicts of interest with the party providing the testimonial or endorsement.
But more broadly, it’s important to remember that wealth management is a unique and customized business. Things that may delight one client may not even be a priority for another. And because of other limits to the information that RIAs can use in marketing, client testimonials may not even have much useful information to convey to clients, while carrying the risk of running afoul the new rules.
“This is an area where advisors need to be deliberate; if they want to market using testimonials, they need to ensure that they are clear on their limitations and include appropriate disclosures,” opined Hamburger.
While the new marketing framework provides some opportunities for RIAs, it’s also an area for firms to tread carefully.
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