Partners Joe Morrissey and Kevin Neubauer co-authored an article in Law360 titled, “Private Equity Takeaways From SEC Marketing Rule Changes.”

February 10, 2020

Private Equity Takeaways From SEC Marketing Rule Changes

Law360 (February 10, 2020) On Nov. 4, 2019, the U.S. Securities and Exchange Commission proposed amendments to Rule 206(4)-1, known as the Advertising Rule under the Investment Advisers Act of 1940. In developing the proposal, staff in the SEC’s Division of Investment Management reviewed the extensive no-action letters and other guidance addressing the application of the Advertising Rule and proposed material changes.

The proposed rule would impact the marketing efforts of private equity managers in a significant manner. While many of the changes reflected in the proposed rule would be welcomed by the private equity industry, the proposed rule contains other provisions that may cause confusion and add additional complexity to private equity managers’ marketing efforts.

Proposed Advertising Rule Amendments

The proposed amendments to the Advertising Rule would replace the per se prohibitions of the Advertising Rule with a principles-based approach under which an advertisement may not, among other things, (1) include any untrue statements or omissions; (2) include any unsubstantiated material claim or statement; (3) include any untrue or misleading implications or inferences to be drawn about a material fact relating to the adviser; (4) discuss or imply any potential benefits of the adviser’s services or methods of operation without discussing any associated material risks or limitations; or (5) be materially misleading.

The amendments would also expand and modernize the definition of “advertisement” to mean:

[A]ny communication disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser.

In a departure from the existing rule and SEC staff interpretive guidance, the amendments would permit: (1) past specific recommendations, or specific investment advice, provided they are presented in a fair and balanced manner; (2) testimonials and endorsements, and third-party ratings, subject to certain conditions; and (3) hypothetical performance, related performance and extracted performance, subject to certain conditions.

Importantly, the proposal would establish additional requirements for advertisements directed to retail investors. Nonretail investors would be defined as any clients and fund investors that are considered qualified purchasers or knowledgeable employees, as such terms are defined in the Investment Company Act of 1940.

Everyone else would be defined as a retail investor. Advertisements directed to retail investors would be subject to a number of additional requirements.

Aspects of the proposed rule would have a significant impact on the marketing activities of private equity managers.

Past Specific Investment Advice

The current rule prohibits an adviser from including past specific recommendations in advertisements, unless, among other conditions, the adviser includes a list of all recommendations made within the immediately preceding period of not less than one year.

In practice, private equity managers include references to past specific investment advice when they either (1) comply with the requirements of the rule (e.g., by including the full performance of each portfolio company in the relevant strategy); or (2) select the investments using objective, nonperformance-based criteria and do not include references to the performance of the specific investments, in reliance on SEC staff interpretive guidance.

The proposed rule loosens these restrictions and only requires that the past specific investment advice be presented in a fair and balanced manner. Whether the fair and balanced standard is met will depend on facts and circumstances, but the proposal indicates that sufficient information and context to evaluate the merits of the past specific advice would be required.

In making this determination, advisers would be permitted to take into account the nature and sophistication of the audience. The proposal notes that advisers could continue to rely on past SEC staff interpretive guidance as a guide to what the SEC would consider fair and balanced.

While the contours of what is fair and balanced will involve a facts and circumstances analysis, notably, the proposed rule would grant private equity managers flexibility in including case studies of particular past investments in advertising materials without the need to include the full performance of each portfolio company in the relevant strategy.

Extracted Performance

The proposal would give private equity managers certainty when showing the performance results of a subset of investments extracted from a portfolio. An adviser would only be permitted to include extracted performance in an advertisement if the advertisement provides or offers to provide promptly the performance results of all investments in the portfolio from which the performance was extracted.

This part of the proposed rule would allow private equity managers to show the performance of portfolio companies in a particular sector or led by a particular investment professional, including when the investment performance was achieved at a prior adviser, if the other requirements of the rule were met.

Presentation of Gross Performance Results

Current SEC staff interpretive guidance provides that, in presenting investment performance in advertisements, advisers may distribute advertisements containing performance figures both gross and net of fees and expenses so long as both sets of investment performance are presented in an equally prominent manner.

The proposal would roll back this requirement for advertisements disseminated solely to nonretail investors, meaning that an adviser would be permitted to show gross-only performance results as long as it provided or offered to provide promptly a schedule of the specific fees and expenses deducted to calculate net performance.

The SEC indicated that it believes that nonretail investors often do not always find advisers’ presentations of net performance useful and prefer to apply to gross performance their own assumptions and calculations of fees and expenses on performance presentations.

This proposed change could be particularly beneficial to private equity managers disseminating advertisements to nonretail investors. We would expect that in presenting the performance of private equity funds, managers may continue to present the performance of funds net of actual fees and expenses incurred, irrespective of whether the recipients of the advertisements were retail or nonretail investors.

However, private equity managers often wish to show the performance of a single portfolio company or subset of portfolio companies, such as (1) a case study showing an example the PE manager’s investment process; (2) the performance of all investments in a particular sector; or (3) portfolio companies within the responsibility of a single investment professional at a predecessor adviser.

Calculating net performance in these instances is challenging and involves the adviser making numerous assumptions, particularly related to the allocation of fund-level expenses to the particular portfolio companies being shown. Under the proposal, a private equity manager could avoid these challenges in nonretail advertisements and present gross performance.

Portability of Investment Performance

Private equity managers often advertise performance achieved by its personnel when they were employed by another investment adviser.

This may occur, for example, when an investment professional or team of investment professionals spins out of one private equity manager and joins another, or begins another advisory firm. In such instance, under current SEC staff guidance, in order for predecessor performance to be included in advertising, a number of conditions need to be satisfied, including that the person or persons who manage accounts at the successor adviser were also primarily responsible for achieving the prior performance results.

This condition can be difficult to satisfy when one or more investment professionals are spinning out of a private equity manager and all final investment decisions at the predecessor adviser are made by an investment committee comprised in part of individuals who are not part of the group spinning out.

While the SEC did not make a specific proposal in this area, it raised a number of questions for commenters to consider, signaling a potential softening of this requirement.

Retail Advertisements

While private equity managers may applaud some of the flexibility the proposal includes, particularly with respect to nonretail advertisements, both the fact that the retail/nonretail distinction would exist and some of the requirements imposed on private equity managers with respect to retail advertisements cause potential difficulties for private equity managers.

First, private equity managers who may potentially market to retail investors (i.e., prospective investors who are not qualified purchasers) would need to determine whether to incur the expense of maintaining two sets of advertising materials — one set for retail investors and the other for nonretail investors — or simply maintain one set that would comply with the requirements applicable to the more stringent retail requirements.

Moreover, private equity managers deciding to maintain two sets of materials would need to obtain information about prospective investors’ qualified purchaser status (including prospective non-U.S. investors) prior to the dissemination of advertising materials, which may be earlier than most private equity managers obtain that information under their current processes.

With respect to specific conditions imposed on retail advertisements, in addition to the net performance requirement discussed above, performance results in retail advertisements would be required to be presented for one-, five- and 10-year periods.

Performance of a private equity fund over these periods, of course, may be distorted by the effect of a J-curve, and therefore this aspect of the proposal would require private equity managers to present performance results that would be, at best, not meaningful to an investor and, at worst, misleading.


While many of the changes reflected in the proposed rule would be welcomed by private equity managers, the rule contains other provisions that may cause confusion and impede private equity managers’ marketing efforts.

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