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SEC's New "Marketing Rule" Approach Draws Fire
Tom Burroughes
28 November 2023
In August, when the SEC punished an investment firm for the misleading use of hypothetical performance metrics in ads, the case highlighted how the regulator relies on punishments rather than guidance to show how the rules should work. This is unacceptable, creates uncertainties and stifles competition, lawyers say. With regulators around the world continuing to regulate financial services to ensure that clients aren’t misled, or encouraged to take more risk than is wise, advisors face a difficult task of trying to stay competitive without falling foul of increasingly complex rules. Also, the rise of digital channels and social media adds new elements to the mix. Titan case Consequences
On August 21, the watchdog issued a “cease-and-desist” order against Titan Global Capital Management LLC, under the 1940 Investment Advisers Act. Titan’s strategies include traditional, alternative, and crypto strategy investments, catering mainly to retail clients.
The SEC said that Titan broke the new “marketing rule” requirement – recently introduced – by “advertising hypothetical performance without having adopted and implemented policies and procedures reasonably designed to ensure that the hypothetical performance was relevant likely financial situation and investment objectives of the intended audience.” Titan was ordered to pay a civil penalty of $850,000 and pay a disgorgement of $192,454.
The regulator, which has adopted a principles-based approach to the marketing rule, appears to be waiting for hard cases to come up to provide the kind of guidance the industry needs to figure out how to behave, Evan K Hall and Shelley Rosensweig, partners at international corporate law firm Haynes Boone, told Family Wealth Report in a call.
It was “extremely frustrating” that the regulator gives general principles of action and then waits to punish firms that, in its specific judgement, aren’t doing it right, Hall said. This appears to require firms to second-guess what the regulator wants, he continued. A consequence is that firms are going to be very cautious in their advertising, Hall said. A takeaway is that firms cannot afford to be “aggressive” in how, for example, they show hypothetical performance data.
FWR has emailed the SEC about the matter, and may update in due course.
Clarity needed
“No-one in this industry is against going after false or misleading marketing or advertising activity,” Hall continued, adding that rules to deal with these problems exist already. The real issue with the new rule is ambiguity and lack of clarity.
His colleague, Rosensweig, said the new marketing rule has not been fleshed out in detail. There are a few FAQs, but not many, she said.
“Unfortunately what we are finding is that they are enforcing the rule through penalties and compliance actions,” Rosensweig said. She mentioned SEC actions brought against nine registered investment advisors for violations of the marketing rule as recently as September 11 .
“The SEC did not say hypothetical performance disclosures are prohibited per se but at the same time they immediately conducted a sweep and initiated sanctions against advisors rather than initiating a dialogue to assist advisors with compliance of the rule. They aren’t giving us enough of a roadmap,” she said.
The SEC said that Titan also made “conflicting disclosures on its website and in its wrap fee brochure about how Titan Crypto assets were custodied”; since at least June 2019, it included in its client advisory agreements liability disclaimer language…which created the “false impression that clients had waived non-waivable causes of action against Titan provided by state or federal law”; Titan also failed to adopt policies and procedures related to the accuracy of its disclosures concerning its internal controls regarding Titan representatives’ personal trading in crypto assets held in the Titan Crypto strategy as it had represented to clients.” The SEC also identified a number of other shortcomings and failings by the firm.
From August 2021 to October 2022, Titan, which offers strategies to retail investors through a mobile trading app, “made misleading statements on its website regarding hypothetical performance, including by advertising ‘annualized’ performance results as high as 2,700 per cent for its Titan Crypto strategy,” the regulator said in its statement.
Modernization
Prior to the SEC’s new marketing rule solicitation, adverts came under different rules, but these have now been blended.
In a social media age, with rapidly expanding digital communication channels, the ways firms describe their wares has changed, and the SEC in around 2018/19 stated that the regime had to be modernized, Hall said. Advertising has to be “fair and equitable and not misleading.”
The lawyers warned that regulators may not have considered how new rules may hurt competition and the very groups policymakers are trying to encourage.
It is imperative that advisors provide education and training for their marketing/business development people, Rosensweig said.
An issue that concerns Hall, he said, is that the SEC appears not to have thought about how various legislative and regulatory actions are hitting smaller firms. “There is a cascading effect…it is much harder for smaller firms to navigate.”
SEC boss Gary Gensler has complained about the lack of competition in the investment industry – issues such as layers of fees, conflicts of interest, and other other matters. A question is whether regulations that weigh heavily on smaller, newbie firms will worsen their plight.
“Fines on small firms can kill the business,” Hall said. There are even implications for new, women/minority-owned financial services firms, something that the SEC should consider, he added.