Trust is essential to the investment management process. But all too often firms commit unforced errors in their advertising that undermine the credibility they work so hard to build.
That credibility is especially critical for managers of alternative assets like hedge funds, private equity, real estate, and tangible assets where the competition to build and maintain client relationships is fierce and trust is harder to earn and easier to lose. According to “The Next Generation of Trust Survey,” for example, trust in hedge funds was 59% and in other alternative investment managers only 60% among institutional investors. By contrast, institutional investors’ trust in mainstream managers was 72%.
So what can alternative asset managers do?
First off, they need to understand the SEC requirements under the Advertising Rule and associated no-action letters.
Last year, the SEC’s Office of Compliance Inspections and Examinations (OCIE) identified the most frequent Advertising Rule compliance issue encountered during SEC examinations. These were misleading performance results claims, misleading one-on-one presentations, and misleading claims of compliance with voluntary reporting standards. In recent months, the SEC announced five settlements related to Advertising Rule violations, all of which involved improper use of testimonials on social media, and fined another firm$1.9 million for misleading performance advertising. The firm’s compliance personnel did not know that the marketing material included hypothetical, backtested returns rather than actual results. Without the necessary disclosures, the SEC found the marketing to be misleading.
To avoid making similar mistakes, alternative asset managers should follow these 10 common sense rules when it comes to marketing and compliance.
- Write and regularly review internal compliance policies and procedures and communicate them to all employees. Conduct staff training at least once a year to keep employees up to date on changes to rules and regulations.
- Pay attention to SEC regulations, including the specific rules announced through no-action letters and enforcement cases that can illustrate the pitfalls to watch out for. Sign up for alerts from consultants and law firms and Risk Alerts directly from the SEC.
- Inform prospective clients of the fund’s objectives, risks, charges, and expenses. The prospectus should disclose all of this simply and in full detail.
- Check all written and electronic materials, including social media and websites, for compliance before publishing them. Not all compliance rules are intuitive, so have a robust review process in place.
- Document reviews to satisfy books and record-keeping requirements. If marketing materials include performance claims, the internal account statements and worksheets supporting those performance claims must be kept for at least five years from when the performance was last published or disseminated.
- Never promise or guarantee future performance in any written, verbal, or electronic communication.
- Never claim advertised performance results comply with voluntary performance standards without verification.
- Never use misleading performance results, third-party rankings, or awards in marketing materials. That means always deduct advisory fees, disclose the limitations of the benchmark used, and explain whether the performance results are hypothetical, backtested, or actual. In many cases, the same results, rankings, or awards can be included as long as they are accompanied by adequate disclosures.
- Never cherry-pick the profitable stock selections or recommendations in person-to-person presentations.
- Never use testimonials or sample reports as endorsements of services or advice.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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Sidney Hardee, CFA, is the managing partner of Hardee Brothers, LLC. He has a broad base of experience in global portfolio management, market research, and quantitative analysis. Hardee is a former trading manager at the Bank of NT Butterfield in Bermuda, where he led its fixed-income and derivatives trading initiatives. He began his career as a market analyst at Salomon Brothers focused on European bond markets. Later he joined Lehman Brothers in both New York and London as a bond trader. He was also vice president in both the credit markets trading and global rates strategy groups at JPMorgan. Hardee holds a bachelors’s degrees in economics and mathematics from Yale University and an MS in applied statistics from Columbia University. He is a CFA charterholder and a member of the alternative investments committee of CFA Society New York and the US Investment Performance Committee (USIPC) for the Global Investment Performance Standards (GIPS). He serves on the board of advisory for the master’s of science program in financial risk management at the University of Connecticut (UCONN) School of Business.
Adam DiPaolo is associate general counsel and senior consultant at Ascendant Compliance Management. He designs practical solutions to manage regulatory challenges faced by hedge funds, private equity funds, funds of funds, and other investment advisers. In addition to providing compliance services such as annual compliance program reviews and mock audits, he established Ascendant’s Section 13 reporting capabilities and EDGAR filing agent services. He drafts and maintains corporate filings ranging from Forms ADV and PF to Forms 13F and 13H. DiPaolo also provides cybersecurity risk management services to Ascendant’s clients as part of Ascendant’s technology team. These services range from network vulnerability scanning to on-site cybersecurity risk assessments to assistance in implementing the NIST cybersecurity framework. He is a Certified Information Systems Auditor (CISA®) and is Certified in Risk and Information Systems Control (CRISC™). DiPaolo practiced corporate law prior to joining Ascendant and has an extensive background in both the public and private sectors. He earned his BA from Pitzer College, his JD from UC Berkeley – Boalt Hall School of Law, and his LLM in taxation from New York University School of Law. He is a member of the New York State Bar.