Investment Adviser Advertising: For the Uninitiated, the SEC's Complex Rules Can Have Unintended Consequences

By Carroll, Brian | Journal of Accountancy, November 2003 | Go to article overview

Investment Adviser Advertising: For the Uninitiated, the SEC's Complex Rules Can Have Unintended Consequences


Carroll, Brian, Journal of Accountancy


In the competitive field of investment advisory services, effective advertising can make the difference between an adviser's success or failure. Government agencies, including the SEC, heavily regulate the form and content of investment adviser advertising. Financial services professionals may be subject to periodic checks through on-site SEC examinations of advertising and other compliance issues. (See "When the SEC Knocks ...," JofA, Aug.02, page 35.)

CPAs in at least three areas have a clear stake in ensuring accurate investment adviser advertising. Those who formally offer advisory services as registered investment advisers are directly subject to SEC regulation: Running afoul of the commission's advertising rules may result in costly and embarrassing legal problems. CPAs who rely on advertisements when counseling clients on selecting an investment adviser should be aware of certain "red flags" signaling potentially false advertising. And practitioners who offer attestation services to investment advisers aimed at verifying advertised investment performance must have a solid understanding of the SEC's approach to regulating investment adviser advertising.

This article explains key prohibitions against false and misleading advertising by explaining how the SEC applies rule 206(4)-1, Advertisements by Investment Advisers, of the Investment Adviser Act of 1940. CPAs can review this cornerstone of the regulatory scheme and other SEC rules governing investment advisers at the SEC Web site, www.sec.gov. CPAs should be aware the act reaches beyond SEC registered advisers to encompass all those who meet the definition of an investment adviser and are not excepted. (See "SEC Jurisdiction Over Investment Advice," JofA, Aug.01, page 32.) By understanding this rule, CPAs will be better prepared to avoid violating it themselves, help clients select an investment adviser and offer at testation services to investment advisers.

THE FIVE RESTRICTIONS

Rule 206(4)-1(a) includes limitations on advertising. The rule bars advertisements that directly or indirectly

* Refer to testimonials.

* Refer to past investment recommendations unless specified disclosures appear.

* Represent reliance on a graph, chart, formula or device to determine investment strategy unless the advertisement discloses its limitations and difficulties.

* State that certain adviser services are free, unless true.

* Contain any untrue statement of material fact or which are otherwise false or misleading.

Significantly, this rule is promulgated under section 206, the act's antifraud provision. Violating the rule may result in civil prosecution by the SEC or criminal prosecution by the Department of Justice, or both. CPAs must view the advertising rule and its prohibitions in fight of their overall fiduciary duty as an investment adviser. Under federal law the U.S. Supreme Court has held that an investment adviser owes its clients "an affirmative duty of 'utmost good faith, and full and fair disclosure of all material facts,' as well as an obligation 'to employ reasonable care to avoid misleading' clients" (SEC v. Capital Gains Research Bureau Inc., 375 US 180, 194 (1963)). This federal fiduciary duty provides a backdrop against which the SEC can measure an investment adviser's compliance with this rule. How the SEC applies the rule is grounded in its definition of advertisement and misleading.

WHAT IS AN ADVERTISEMENT?

Rule 206(4)-1(b) generally defines an advertisement as covering, in addition to television and radio, any written communication--including notices, circulars and letters--addressed to more than one person and any notice or other announcement appearing in any publication that offers investment advisory services with regard to securities, as well as other specified services. Although the term advertisement most obviously applies to materials intended to attract potential clients, such as newspaper and trade journal ads, press releases, Web site postings and submissions to third-party rating or reporting services, its use here extends as well to adviser newsletters, brochures, pamphlets, leaflets and reports intended primarily to retain current clients. …

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