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Q1 2020 - SEC Proposes Greater Regulation Of Private Fund Offerings

Feb 24, 2020

In November 2019, the SEC proposed a massive overhaul of its rules relating to the ways in which investment advisers advertise their products and solicit investors. The proposed amendments are receiving solid support by industry participants welcoming modernization of rules that have remained mostly unchanged since their adoption over 40 years ago. However, if adopted as proposed, the amendments would expand the application of the advertising and solicitation rules issued under the Investment Advisers Act of 1940, as amended (the Advisers Act), to investment advisers marketing private funds to investors.[1] This article discusses the proposed amendments’ potential impact on the regulation of private fund offerings.  


Under the current regulatory framework, Advisers Act Rule 206(4)-1 (the Advertising Rule) governs registered investment advisers’ advertisements to current and prospective clients. ‘Clients,’ for this purpose, are defined to include separate account clients and private funds, but do not include investors in those funds absent a separate advisory relationship whereby the adviser is providing advice based on the individual investment objectives of those investors.[2]  However, private fund advisers are still subject to the general anti-fraud provisions of Advisers Act Rule 206(4)-8, specifically with respect to any investor or prospective investor in private funds they advise.[3]

The SEC is now seeking to clarify what communications would violate the private offering anti-fraud provisions of Advisers Act Rule 206(4)-8. If adopted as proposed, the amendments to the Advertising Rule would expand the definition of ‘advertisement’ to include communications provided indirectly to existing and prospective investors in a private fund (e.g., private placement memorandums [PPMs], pitchbooks and investor letters). In practice, many private fund advisers apply the current Advertising Rule to these types of communications to avoid running afoul of anti-fraud provisions. The proposed definition of ‘advertisement,’ though, would include certain one-on-one communications excluded from the current definition. Accordingly, if the proposal is adopted with the expanded definition, even those private fund advisers currently complying with the Advertising Rule would need to consider a broader universe of communications in scope. These communications could include customized requests for proposals (RFPs), due diligence questionnaire (DDQ) responses and reports.

The SEC’s general approach to the proposed amendments was to shift to principles-based rules to provide flexibility for the continual evolution and interplay of technology and advice. Similar to the current Advertising Rule, the proposed amendments include general prohibitions of certain advertising practices applicable to all advertisements of registered investment advisers as follows:

Untrue statements of material fact or omit material facts, the absence of which make an advertisement misleading. Material claims or statements that are unsubstantiated. Untrue or misleading statements that imply, or that might reasonably cause one to infer, a material fact about an investment adviser. Discussions of potential benefits of the adviser’s services or methods without clearly and prominently disclosing any material risks or other limitationsReferences to specific investment advice provided by the investment adviser that is not presented in a fair and balanced manner. Performance results in a manner that is not fair and balanced.

  • Statements that are otherwise materially misleading.

Additionally, the proposed Advertising Rule would include restrictions or conditions on certain advertising practices (e.g., testimonials, endorsements, and third-party ratings) applicable to all registered investment adviser advertisements. These additional restrictions and conditions are in addition to compliance with the general prohibitions outlined above. 

Testimonials and Endorsements. For a testimonial or endorsement, the adviser would need to clearly and prominently disclose (or have a reasonable belief of the same) that: (i) the testimonial was given by a client or investor, and the endorsement was given by a non-client or non-investor, as applicable; and (ii) if applicable, cash or non-cash compensation has been provided by or on behalf of the adviser in connection with obtaining or using the testimonial or endorsement. Third-Party Ratings. The adviser would need to reasonably believe that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result; and the adviser would need to clearly and prominently disclose (or have a reasonable belief of the same) that the third-party rating clearly and prominently discloses: (i) the date on which the rating was given and the period of time upon which the rating was based; (ii) the identity of the third party that created and tabulated the rating; and (iii) if applicable, that cash or non-cash compensation has been provided by or on behalf of the adviser in connection with obtaining or using the third-party rating.

Since most private funds still rely on the safe harbor provisions of Rule 506(b) of Regulation D issued under the Securities Act of 1933, as amended (the Securities Act), most private fund advisers are not expected to take full advantage of the proposed expanded advertising practices, especially with respect to social media. However, we may see an uptick in private fund advisers using past investment advice, testimonials and performance advertising in their private fund offering materials.

The proposed rule would expressly permit advertising of performance information under certain restrictions and conditions, generally tailored based on whether the advertisement’s intended audience includes retail persons.  ‘Retail persons’ for this purposes would mean those who do not meet the thresholds for either (i) “qualified purchaser,” as defined in Section 2(a)(51) of the Investment Company Act of 1940, as amended (the Company Act); or (ii) a “knowledgeable employee,” as defined in Company Act Rule 3c-5.  For example, presentations of gross performance would need to provide or offer to provide promptly a schedule of the specific fees and expenses deducted (presented in percentage terms) to calculate net performance, among other conditions. Presentations of gross performance in any advertisement to retail persons would also need to present net performance information with at least equal prominence to, and in a format designed to facilitate comparison with, the gross performance; and calculated over the same time period, and using the same type of return and methodology as, the gross performance. The proposed rule would require retail advertisements with performance results of any portfolio or any composite aggregation of related portfolios to include performance results of the same portfolio or composite aggregation for one-, five-, and ten-year periods, each presented with equal prominence and ending on the most recent practicable date. Tailoring presentations for retail persons could have unintended consequences for advisers to private funds that would be an investment company but for the exclusion provided by Company Act Section 3(c)(1). Since those private funds could have both retail and non-retail investors, advisers would need to decide whether to provide all investors the same information or provide only non-retail investors certain performance information. 

Lastly, the proposed rule would require that most advertisements be reviewed and approved in writing by a designated employee before dissemination. Advertisements that are only to a single investor in a private fund would be excepted from this requirement.

The SEC has asked for comment on numerous proposed provisions and remaining questions. In particular, the SEC is considering whether to withdraw a number of SEC staff no-action letters heavily relied upon by private fund advisers who advertise past specific recommendations, prior firm performance and other practices.[4] The SEC’s position in support of withdrawal is that with a move toward a principals-based approach, the letters would be moot, superseded, or otherwise inconsistent with the amended rules. However, many industry participants are concerned that withdrawal of the no-action letters will leave advisers with no comfort of safe harbor for compliance, unless the SEC provides additional guidance in the final rule text or adopting release. A potential unintended consequence could be further regulation through enforcement—advisers learning through press releases what the SEC would consider to be fraudulent advertising practices or insufficient policies and procedures under the new regime.

As noted above, the current Advertising Rule and the proposed amended rule apply only to registered investment advisers. According to the proposed release, as of September 30, 2019, approximately 4,206 advisers file exempt reports in reliance on the exemptions from registration for certain private fund advisers and venture capital fund advisers (ERAs).[5] Unless the proposed amendments are changed following the comment period, ERAs will continue to live with some uncertainty as to what would be deemed fraudulent for registered advisers under Advisers Act Section 206 and Rule 206(4)-8, but not for an ERA. For example, what policies and procedures would ERAs need to adopt to include gross performance information in their private fund marketing materials to avoid liability? Aside from the Advertising Rule and the Advisers Act anti-fraud provisions, ERAs still need to consider the application of the anti-fraud provisions under the Securities Act and other federal and state securities regimes (as do registered advisers). Current practices among ERAs do vary; however, many ERAs look to their legal counsel to provide clarity on these issues that affect their ability to attract private fund investors in a competitive market.


Advisers Act Rule 206(4)-3 (the Solicitation Rule) governs cash payments to solicitors of advisory clients. Similar to the application of the current Advertising Rule, the current Solicitation Rule applies only to advisory clients and does not apply to the solicitation of investors for private funds managed by advisers because such investors generally are not ‘clients’ of the adviser.[6]

Similar to the current Solicitation Rule, the proposed rule would require the adviser to memorialize the compensation arrangement with the solicitor in writing. The Agreement would need to:

  • Describe with specificity the solicitation activities of the solicitor and the terms of the compensation for the solicitation activities;
  • Require the solicitor to perform its solicitation activities in accordance with certain anti-fraud provisions of Advisers Act Section 206;
  • Require and designate the solicitor or the adviser to provide the client or private fund investor, at the time of any solicitation activities (or in the case of a mass communication, as soon as reasonably practicable thereafter), with a separate disclosure that includes, among other items, a description of the compensation to the solicitor and a description of any potential material conflicts of interest on the part of the solicitor resulting from the adviser’s relationship with the solicitor and/or the compensation arrangement.

The adviser must also have a reasonable basis for believing that the solicitor has complied with the required written agreement. As a significant change from the current Solicitation Rule, the proposed rule would cover solicitation arrangements involving all forms of compensation, rather than only cash compensation. The proposed rule would also modify the disciplinary events that would disqualify a person from acting as a solicitor.

[1] See Proposed Amendments to Rules 206(4)-1 and 206(4)-3 of the Advisers Act contained in the “Proposed Rule: Investment Adviser Advertisements; Compensation for Solicitations;” Release No. IA-5407, File No. S7-21-19, November 4, 2019.

[2] See Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).

[3] Advisers Act Ruel 206 (4)-8 was promulgated by the SEC following Goldstein v. SEC.

[4] Some of the classic SEC no-action letters under review include, but are not limited to: Clover Capital Management (pub. avail. July 19, 1991); Clover Capital Management (pub. avail. Oct. 28, 1986); DALBAR, Inc., (pub. avail. March 24, 1998); Franklin Management, Inc. (pub. avail. Dec. 10, 1998); Investment Adviser Association (pub. avail. Dec. 2, 2005); Investment Company Institute (pub. avail. Aug. 24, 1987); Investment Company Institute (pub. avail. Sept. 23, 1988) and The TCW Group (pub. avail. Nov. 7, 2008).

[5] In contrast, approximately 4,856 private fund advisers were registered as of August 2019.

[6] See Mayer Brown LLP, SEC Staff No-Action Letter (Jul. 28, 2008).


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