With the November 4 deadline looming, a recent Wall Street Journal article highlighted to the investment adviser community one of the areas of the SEC’s New Marketing Rule (NMR) that poses significant regulatory risk, even though the rule itself and the corresponding guidance provided by the SEC staff suffers from a lack of clarity and specificity. When it comes to the presentation of Net Performance at the deal or transaction level—especially for client investments that have not yet been monetized or realized—the NMR’s requirements are open to interpretation. To heighten the risk, Kroll expects that the SEC staff will shortly commence inquiries or examinations to determine whether advisers are in compliance with the requirements of the rule.
For investor communications that are deemed to be “advertisements” under the NMR, the rule generally prohibits the adviser from presenting gross performance unless net performance is presented “side-by-side” or otherwise with equal prominence, along with other conditions including material accuracy and documentary support. In another complex layer relating to the determination of Net Performance, the NMR requires that Net Performance must be calculated over the same time period and using the same methodology as gross performance. Assumptions and hypotheticals must be fully and fairly disclosed. The complexities of determining Net Performance at the deal or transaction level are particularly difficult for private equity fund managers, especially when unrealized investments with longer “tails” are involved. Given the uncertainties of the rule’s requirements, some advisers are struggling to devise workable, compliant solutions to present Net Performance based on the particular set of facts and circumstances of their investments.
Kroll's experts have devised the following framework to assist advisers in providing what we believe is a credible basis to demonstrate to the regulators that the adviser has implemented risk-based and reasonable policies, procedures and disclosures regarding their presentation of Net Performance.
NMR Compliance Action Items
- Calculate and display Net Performance each time gross performance is included in a qualified advertisement, whenever feasible
- Coordinate with fund accounting personnel to memorialize the methodologies that are used to allocate expenses at the deal level and the related Net Performance calculations
- Design and implement risk-based and tailored compliance policies and procedures regarding the calculation, testing and documentation of all performance determinations
- Evaluate documents and confirm that Net Performance is presented either “side-by-side with gross or with equal prominence
- Determine whether the performance numbers are fairly presented, not misleading, and materially accurate, taking into account the sophistication of the target investor
- Disclose clearly the methodology, assumptions, limitations and hypotheticals (if used)
- Confirm and maintain documentary support for the material accuracy of all performance numbers and other material statements
- Disclose promptly any changes in methodology, assumptions, time periods, etc.
- Review and update as necessary performance numbers in historical marketing documents that may still be accessible to actual or prospective investors, including materials in data rooms, DDQs, firm websites, or used by third-party marketers
- Confirm the consistency of the performance numbers and disclosures across all investor correspondence that are deemed advertisements
- Provide training to applicable personnel, including those in the finance, marketing, investor relations and portfolio management functions
- Update Form ADV
Kroll's Experts Will Help
Kroll’s team of compliance experts can help advisers navigate the complexities of the SEC’s New Marketing Rule. Among other complex nuances of the rule, advisers should contact Kroll for confidential assistance with the following:
- Independently evaluating the material accuracy of the performance numbers and methodologies
- Reviewing documents that could be deemed advertising or marketing
- Developing, implementing and periodically testing the adequacy of risk-based compliance policies and procedures
- Complying with the books and records provisions of the federal securities laws
- Training of key firm personnel and supervisors
- Monitoring social media and web platforms for marketing and advertising statements that may be attributable to the adviser
- Responding to SEC examination and enforcement inquiries
Kroll’s team of compliance experts can help you navigate the SEC’s new Marketing Rule options and requirements and help you prepare for the rapidly approaching November deadline. We will develop and update tailored policies and procedures that are compliant and practical for your firm, address any implementation concerns, train your employees and assist with crafting appropriate and customized disclaimers to prepare you for the SEC's follow-up enforcement actions and exams.
To learn more about the new Marketing Rule and to prepare your firm for these upcoming changes, contact one of our experts.