SECURITIES CORNER

Recently the SEC expanded the areas of focus that will be subject to its ongoing examination sweeps in compliance with the Marketing Rule under the Investment Advisers Act of 1940. While the SEC has not released any observations nor has there been guidance on the Marketing Rule’s requirements since its initial unveiling, the SEC has expanded the scope of the sweeps with additional “general prohibitions.” These additions indicate the SEC’s intent to issue deficiencies for violations of the broad and undefined “fair and balanced” and “materially misleading” standards.  

The SEC states it is reviewing whether advisers are in compliance with the Marketing Rule requirements in regard to the use of testimonials and endorsements in advertisements. The new requirements the SEC will be focused on are: (1) clear and prominent disclosures, (2) oversight conditions being in compliance with the Marketing Rule, (3) proper written agreements with promoters, and (4) whether ineligible persons have been compensated for testimonials or endorsements. While many advisors were hopeful for more guidance following challenging negotiations with placement agents, the SEC’s latest expansion, however, only served as a notice that the SEC will pay close attention in exams and advisers should expect deficiencies

Recently, the SEC proposed new rules (the “Proposal”) for broker-dealers (“broker”) and investment advisers (“adviser”) on the use of predictive data analytics (“PDA”) and PDA-like technologies when interacting with investors. This Proposal comes absent any evidence of abuse by brokers or advisers using PDAs or PDA-like technologies. Yet, the Proposal would require brokers and advisers to evaluate the technology for conflicts of interest and eliminate such conflicts when engaging with an investor.

The Proposal broadly defines “covered technology” to include any “analytical, technological, or computational function” that predicts investment-related outcomes, which includes “PDA-like” technology. Proposal also broadly defined “conflicts of interest” as any use of “covered technology” that considers the interest of the broker, advisor, or any associated person. If adopted, these rules would impose significant operational challenges as well as expensive burdens on the brokers and advisors who use PDA-like technology, especially since “covered technology” could also mean basic technology such a spreadsheet, or commonly used math formulas.

Accordingly, to adhere to SEC regulation, brokers and advisers must disclose such PDA-related conflicts to investors fully and fairly. However, under the proposed rule, if a broker or adviser uses PDAs technologies, they must eliminate conflicts of interest caused by it. This directly contradicts the current SEC regulations which only require full disclosure of the conflict. Thus, eliminating the disclosure requirement will effectively prevent brokers and advisers from communicating with investors using technology that is expressly permitted under different SEC regulations.

While the Proposal appears “to be technology neutral,” dissenting Commissioners highlight that the new rules are likely to impose a substantial burden on the use of any technology in communicating with investors or managing investments.