Misrepresentations in Hypothetical Performance Leads to SEC’s First Marketing Rule Enforcement Case

  

Misrepresentations in Hypothetical Performance Leads to SEC’s First Marketing Rule Enforcement Case

FAQs, Risk Alerts, and press releases can provide valuable insight into the SEC’s thought process on rule language, maybe even more so than the rule itself. On August 21, 2023, the SEC announced its first violation of 206(4)-1 The Marketing Rule, in a case that also touches other hot button industry items. The SEC found that Titan Global Capital Management USA LLC (Titan), used misleading hypothetical performance metrics in advertisements, and had several other compliance failures, leading to fines totaling $192,454 in disgorgement and an $850,000 civil penalty for affected clients. From August 2021 to October 2022, Titan made misleading statements on their website regarding the Advisor’s hypothetical performance. These statements included annualized performance yielding a high mark of 2,700% for their crypto strategy. These results did not disclose material information, such as the fact that the annualized projections assumed performance based on the first three weeks of the strategies performance data, nor taking into light economic/market conditions, or other applicable risk factors. AdvisorAssist has engaged with Sean P. Gilligan CFA, CPA, CIPM, Managing Partner of Longs Peak Advisory Services, as an industry expert and provider of guidance with GIPS compliance and investment performance measurement, analysis, and reporting to comment on some key data points of this case:

“Periods less than a year should never be annualized. This has always been a requirement under the GIPS standards, but even without being a GIPS compliant Advisor, I think most SEC examiners would have considered this to be misleading - even prior to the new Marketing Rule. Then you add in such a volatile and risky asset like crypto, where repeating a return earned over 3 week period for an entire year, would not be a likely scenario.”

Furthermore, Titan failed to adopt and implement the required policies and procedures regarding the Marketing Rule:

“Having policies and procedures to determine who can receive hypothetical performance is one of the key updates made clear in the new marketing rule.” said Gilligan, “When working with firms that want to use hypothetical performance, we always emphasize the importance of having these policies and to limit the distribution to only those that can reasonably be expected to understand what they are presenting.”

AdvisorAssist has guided on the importance of a retrospective review of Advisor’s active client communications in our recent blog post, and stressed how regulatory examinations are focused on components of the Marketing Rule by providing sample request letters to clients.

As a reminder, an Advisor should treat any form of communication to Clients that is designed to solicit or maintain advisory service (“Client Communications”) as covered by regulations under Securities Laws. This includes written communications on a one-to-one basis to existing, or prospective, advisory Clients designed to offer advisory services, or maintain the existing Client, are subject to the general prohibitions under the Marketing Rule.

In conjunction with adopting applicable policies and procedures, as Mr. Gilligan stated above, it is imperative that the discloses for all client communications all relevant criteria used and assumptions made in calculating the hypothetical performance, and discloses sufficient information to allow the intended audience to understand the risks and limitations associated with hypothetical performance.

AdvisorAssist can support you with questions you may have regarding your current performance advertising and/or Marketing Rule policies and procedures. Please contact us today!

Posted in: