Kreischer Miller recently held its annual investment industry update, which covered a host of topics including the latest updates on GIPS, the SEC Marketing Rule, fair value guidance, taxes, and compliance, as well as a discussion on valuation drivers in an investment firm.
During the event, Thomas Peters, Director of Kreischer Miller’s Investment Industry Group, moderated an SEC Marketing Rule panel discussion with Joshua Kramer, Manager in Kreischer Miller’s Investment Industry Group, John Canning, Director at Chenery Compliance Group, and Michael Beck, Performance Measurement Vice President at Glenmede Trust. The goal of the panel was to address various questions from the audience surrounding the new SEC Marketing Rule and to provide an update on any recent changes since Kreischer Miller’s previous panel on the Rule held last July. Below is a summary of the questions covered during the session and the panelists’ responses.
Question: Is it really a common practice to charge a model fee with the highest fee from the composite’s inception fee regarding the SEC Marketing Rule’s net of fee return requirement?
Response: Advisors have three general options when reporting net performance under the SEC Marketing Rule. They can use actual fees charged to the portfolios. Advisors can also use a model fee that results in performance results that are less than or equal to performance that would have been calculated had actual fees had actual fees been used. The final option is using a model fee where the fee applied must be equal to the highest fee that would be charged to the intended investors. Panelists noted that the decision is highly dependent on the facts and circumstances of the advisor. However, the model fee approach will typically be easier to implement for larger firms due to the varied actual fees that may be charged to a large pool of investors. When advisors are contemplating which option to employ, panelists stressed the importance of always keeping in mind the general prohibitions, which require that all advertisements are presented in a manner that is fair and balanced and not otherwise misleading.
Question: How does the SEC Marketing Rule relate to sub-portfolios, carveouts, and extracted performance included in composites?
Response: The main issue discussed by the panelists dealt with how advisors define what a portfolio is and how that definition is then applied to the definition of extracted performance provided in the SEC Marketing Rule. In general, panelists explained that multi-strategy portfolios can either be identified as a single portfolio, inclusive of all the strategies, or as multiple portfolios segmented for each strategy. The definition given to these portfolios by the advisor will then allow them to determine whether the or not they should be treated as extracted performance under the SEC Marketing Rule. In making these decisions, panelists offered various factors to consider including whether the strategies are managed with separate cash accounts, whether each strategy is managed under a separate investment management agreement, and whether the strategies are managed by investment teams at the advisor. The panel also referenced a recent SEC Marketing Compliance FAQ, which was updated January 11, 2023.
Question: Does net attribution and risk returns on data that is presented outside of the performance returns need to be shown?
Response: Panelists acknowledged that it has been standard industry practice to present attribution based on gross returns due to most internal systems applying fees at the total return level and not allocating the fee to individual sectors or asset classes. However, it should also be disclosed that the availability exists to calculate net returns. While this has historically been the case, panelists raised concerns surrounding the recent FAQ published the SEC staff, which reiterated the need for advisors to show the net performance of a single investment or a group of investments when presenting the gross performance. Panelists cautioned that additional information and clarity surrounding this FAQ may indicate a need for advisors to start presenting attribution on a net basis.
Question: What is considered a material fact that would need to be substantiated?
Response: Materiality consideration should be given to any advertising material, third party source, or performance claim that can be selected for substantiation by an auditor. The importance of backing up recordkeeping was also emphasized.
Question: What are considerations of material risks and material risk disclosures?
Response: The panelists advised leaning on investment professionals to identify and ensure that risks and potential benefits are being disclosed to potential investors.
Question: Should performance submitted to an online consultant database be considered an indirect advertisement subject to the SEC Marketing Rule?
Response: Performance submitted to an online database is subject to the SEC Marketing Rule if that performance will then be presented to a broader audience. Panelists discussed a rift among advisors and databases related to the information that some databases are accepting and the information that advisors are required to provide in order to comply with the SEC Marketing Rule. This disconnect is causing advisors to make the difficult decision of whether to continue to provide databases with incomplete information under the SEC Marketing Rule, thereby incurring risk, or discontinue providing information to databases until the issue is resolved.
Question: Do advertisements that pre-date the SEC Marketing Rule need to be updated in order to be in compliance?
Response: It would depend on whether the advertisements are still being used and able to be viewed by potential investors. Advertisements that are still being used would need to be updated, while those that are no longer in use and are not viewed by potential investors would not need to be updated.
Question: Can a firm provide a link to a disclosure, testimonial, or endorsement?
Response: External links cannot be used for testimonials or endorsements; the source needs to be clear within the testimonial or endorsement. Other types of advertising disclosures can provide a link.
Question: What is considered hypothetical performance now for the SEC Marketing Rule?
Response: Hypothetical performance is considered to be any instance where performance is back/forward tested, projected, or calculated on hypothetical assets; availability restrictions on hypothetical performance were also emphasized by the panelists.
If you’d like to view the video of this panel discussion or any of the other presentations from our annual investment industry update, click here.
If you have any questions about the SEC Marketing Rule or would like to discuss your firm’s needs, please contact Kreischer Miller’s Investment Industry Group.
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