By Les Abromovitz, Senior Director
On November 9, 2021, the SEC’s Division of Examinations published a Risk Alert that summarized its observations from examinations of advisors providing robo-advisory services. According to the Risk Alert, examiners found advertisement-related deficiencies at more than half of the robo-advisors. The advertising problems observed are not unique to robo-advisors.
Too many traditional Registered Investment Advisors (“RIAs”) are making the same mistakes with their advertisements. Although the Risk Alert dealt with violations of the old Advertising Rule, these same deficiencies are likely to cause problems for RIAs under the new Marketing Rule.
You don’t have to be a robo-advisor to make these advertising mistakes
In addition to a broader review of RIAs’ adherence to their fiduciary duty, examiners looked at whether the advertised securities selection and portfolio management techniques were used when managing clients’ accounts. Many RIAs’ websites and other advertisements boast about their sophisticated process for selecting securities and managing clients’ portfolios. Assuming that the advertisement does not guarantee success, these claims are unlikely to cause compliance problems. However, examiners will scrutinize whether the RIA actually adheres to that process in making investment decisions.
Among the many deficiencies discussed in the Risk Alert, examiners determined that RIAs’ advertisements contained vague or unsubstantiated claims that could cause an untrue or misleading implication or inference to be drawn. These claims related to the advisory services provided and investment options available, as well as performance expectations and costs incurred in investing.
Examiners found that many RIAs advertised materially misleading performance results on their websites, including the hypothetical returns of an investment model that was applied retroactively. Furthermore, these hypothetical performance returns were presented without including disclosures that would keep the presentation from being misleading. The Marketing Rule, which has a compliance date of November 4, 2022, generally restricts an RIA’s use of hypothetical performance in advertisements. The RIA must adopt and implement policies and procedures that are reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience, and the advisor provides certain information underlying the hypothetical performance.
The Risk Alert criticized robo-advisors that used press logos, such as ABC, CNN, and Forbes, without links or disclosures to explain their relevance. Traditional RIAs sometimes plaster the logos of media outlets on their websites and marketing materials. In some instances, the RIAs fail to give the back story to explain why those logos are incorporated in their advertisements. Some RIAs attempt to clarify press logos by adding the words, “Featured in.” That term is likely to lead to a misleading inference on the part of investors. Does that phrase mean the advisor was quoted in an article by a particular publication or was the subject of a feature story? It often turns out that the advisor was quoted briefly only once by that media outlet decades earlier. Therefore, it is disingenuous or even misleading for the advisor to highlight press logos without disclosing why they are relevant to investors.
In addition, the Risk Alert concluded that robo-advisors misrepresented SIPC protections by implying that client accounts would be protected from market declines. Similarly, it is misleading for a traditional RIA to oversell the benefits of SIPC protection in advertisements, since it does not protect against investment losses. SIPC protects investors if a broker-dealer fails, and coverage is limited to $500,000, including a $250,000 limit for cash. However, it is not uncommon for RIAs that are not robo-advisors to mention SIPC coverage in their advertisements without explaining or disclosing that investors are not protected against investment losses.
The Risk Alert also chastised robo-advisors for referring to, or providing links to, positive third-party commentary without disclosing its relevance or any conflicts of interest. A traditional RIA might commit the same mistake.
RIAs that lose clients to robo-advisors might want to take note of another observation from the Risk Alert. Certain robo-advisors provided inadequate or insufficient disclosure about “human” services, such as whether interactions with live individuals are available, mandatory, or restricted. They also did not disclose if those interactions cost more or whether the client is assigned to a financial professional. To differentiate themselves, traditional RIAs may wish to focus in their marketing materials on the personal services they provide that are unavailable with a robo-advisor.
Both robo-advisors and RIAs with a traditional business model will benefit from adopting, implementing, and adhering to written policies and procedures that are designed to prevent advertising mistakes. According to the Risk Alert, firms with strong policies and procedures rarely made mistakes with performance advertising.
The examinations described in this Risk Alert culminated in a broad range of actions. Some RIAs elected to amend their disclosures and marketing materials. They modified or eliminated performance advertisements and revised their policies and procedures.
The Risk Alert is available at https://www.sec.gov/files/exams-eia-risk-alert.pdf. For an overview of this Risk Alert, be sure to review Alan Foxman of Foreside’s fine article on this topic, which can be found here.