Rule 206(4)-1 under the Investment Advisers Act, better known as the Advertising Rule, prohibits the use of testimonials in advertisements for Registered Investment Advisers (“RIAs”). “Testimonial” is not defined by the Advertising Rule but generally has been interpreted by the SEC staff as a statement regarding a client’s experience with or endorsement of an investment adviser. In addition to barring the use of testimonials, the Advertising Rule specifically prohibits advertisements that are false or misleading in any way. Advertisements can be misleading and non-compliant, even if they do not contain testimonials.
The SEC has expressed concerns about RIAs’ use and misuse of testimonials and accolades in their advertisements. On September 14, 2017, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released a Risk Alert, which discussed the most frequent Advertising Rule compliance deficiencies identified during examinations. The Risk Alert noted that certain advisers were publishing client statements attesting to their services or otherwise endorsing them. These prohibited testimonials included client endorsements listed on firm websites, social media pages, reprints of third-party articles, and pitch books. OCIE’s Risk Alert is available at https://www.sec.gov/ocie/Article/risk-alert-advertising.pdf.
Using testimonials in advertisements can lead to serious compliance problems. On July 10, 2018, the SEC announced enforcement actions against two RIAs, three Investment Adviser Representatives (“IARs”), and a marketing consultant. The RIAs, IARs, and the marketing consultant were accused of violating the Advertising Rule by publishing client testimonials on social media and public websites. The enforcement actions are accessible at https://www.sec.gov/enforce/3-18586-90-s.
TESTIMONIAL ISSUES CROP UP IN THIRD-PARTY RATINGS
OCIE’s Risk Alert observed that advisers were promoting themselves using third-party ratings without disclosing material facts that might diminish their prestige.
Before advertising any third-party ranking or award, RIAs should consider the guidance contained in a December 2, 2005, no-action letter to the Investment Adviser Association. The no-action letter stated that “third-party ratings that rely in part on client evaluations are not necessarily testimonials for purposes of rule 206(4)-1(a)(1). Whether a third-party rating is a testimonial depends upon all of the facts and circumstances relating to the rating.” The no-action letter is available at https://www.sec.gov/divisions/investment/noaction/iaa120205.htm
A third-party rating is less likely to be viewed as a testimonial if client responses are not a significant factor in formulating it. To make that determination, examiners will evaluate whether the advertisement:
- Discloses the criteria on which the rating was based;
- References a favorable rating without disclosing any facts the adviser knows would undercut its validity or appropriateness;
- Mentions a favorable rating without also disclosing any unfavorable ones;
- Clearly and prominently discloses the category for which the rating was calculated, the number of advisers surveyed in that category, and the percentage of advisers receiving the rating;
- States or falsely implies that an adviser was the highest rated in a category;
- Discloses that the rating may not be indicative of one client's experience or predictive of future investment success; and
- Prominently discloses who created and conducted the survey and whether advisers paid a fee to participate.
Third-party ratings from organizations and publications are meaningless if the advertisement does not disclose the criteria on which they are originated. Occasionally, RIAs advertise ratings without stating when they received the recognition or whether circumstances at the firm have changed since the date of the award.
In some cities, local magazines and business publications issue lists of the so-called best financial advisors. Typically, the list is generated by polling readers. In some cases, firms encourage their clients, friends, and relatives to vote for them. Technically, clients’ votes for the firm might be viewed as implied testimonials. Even votes that were not testimonials would potentially be misleading since the voters had no basis for their evaluation of the firm’s qualifications and strategies.
TESTIMONIALS ON SOCIAL MEDIA SITES
Most computer-literate consumers will conduct an internet search before choosing a doctor, lawyer, or investment adviser. Unfortunately, reviews are not always based entirely on objective criteria. Some great doctors receive a bad review because a patient was not happy with the outcome or someone in scheduling made a mistake. A financial planner might receive a bad review, even though the client’s lack of success might be attributed to the individual’s failure to follow the adviser’s advice.
Generally, RIAs are not responsible for testimonials posted on social media sites over which they have no control, assuming they were not involved in the creation of those reviews. Where an RIA does have control over a social media site, they should discourage testimonials and remove any posted previously. For example, an RIA should remove client testimonials from the firm’s Facebook page. In addition, when a firm permits endorsements and recommendations on its LinkedIn page, it risks running afoul of the Advertising Rule.
Based on SEC guidance, RIAs may publish public commentary about their services that are posted on independent social media sites, as long as all reviews are included in the advisory firm’s advertisement. An RIA must not have any influence over the third-party sites and must publish all comments about the firm without editing them. Also, RIAs are permitted to publish testimonials from independent third-party websites that contain a mathematical average of the commentary. They are not, however, permitted to advertise a subjective analysis of the comments on those sites.
RIAs may not draft evaluations for others to post or compensate individuals for writing reviews. Furthermore, RIAs may not highlight or give prominence to individual comments, which invariably praise the adviser.
Examiners are likely to become suspicious if an RIA or IAR has dozens of reviews on third-party review sites. It would be very unusual for a large number of clients to post reviews, especially if these evaluations occur around the same time and contain similar language.
Aside from the compliance problems caused by testimonials and misleading advertisements, advertising accolades can be counter-productive. For example, if an IAR received an award in the past, prospects may wonder why the firm has not received the accolade more recently. It might give the impression that the firm’s services have deteriorated. In any advertisement, content can become false or misleading as it ages.
Some advisers oversell their third-party ratings in advertisements. In addition, RIAs occasionally reference these ratings and awards in advertisements without the appropriate disclosures. For example, RIAs often advertise ratings and awards in their emails, which makes it difficult to provide the necessary disclosures due to space limitations.
This article is not a solicitation of any investment product or service to any person or entity. The content contained in this article is for informational use only and is not intended to be and is not a substitute for professional financial, tax or legal advice.