SEC relaxes marketing rule for net performance requirement – McDermott Will & Emery
The US Securities and Exchange Commission’s (SEC) Division of Investment Management recently made updates to its FAQ on Rule 206(4)-1, also known as the Marketing Rule, under the Investment Advisers Act of 1940. The new FAQs allow registered investment advisers to include certain performance metrics in their marketing materials on a gross-only basis. This change is particularly significant for private fund advisers who have struggled with how to present these metrics on a net basis since the Marketing Rule’s compliance deadline in November 2022.
The updated FAQs now permit advisers to showcase the performance of a single investment or group of investments, known as Extracted Performance, and certain portfolio or investment characteristics, such as yield, contribution to return, and volatility, under the umbrella of Portfolio Characteristics, in marketing materials. This shift is a relief for many advisers who have found it challenging to accurately represent these metrics on a net basis, often leading to confusion and potentially misleading results for investors.
To ensure compliance with the newly updated FAQs, advisers should carefully consider how they present Extracted Performance and Portfolio Characteristics in their marketing materials. By aligning their presentations with the conditions outlined in the FAQs and the broader requirements of the Marketing Rule, advisers can avoid potential pitfalls and ensure their marketing materials are both accurate and clear for investors. It may also be necessary for advisers to make updates to their Marketing Rule compliance policies to reflect any changes in their marketing strategies.
One of the key challenges for private fund advisers has been the requirement to present both gross and net performance metrics in a manner that allows for easy comparison. This requirement has proven especially difficult when presenting Extracted Performance, as fund fees and expenses are typically applied at the fund level. While various methodologies have been adopted within the industry to meet this requirement, there have been concerns that the results may be confusing or misleading to investors. The lack of clear guidance from the SEC on this issue further complicated matters for advisers.
Furthermore, there was ambiguity surrounding whether Portfolio Characteristics were considered “performance” for the purposes of the Marketing Rule’s net requirement. The SEC acknowledged the challenges of calculating these characteristics net of fees and expenses and emphasized the importance of presenting both gross and net performance of the total portfolio in a clear and non-misleading manner.
The recent changes outlined in the FAQs now allow investment advisers to present Extracted Performance and Portfolio Characteristics on a gross-only basis under certain conditions. These conditions include clearly identifying that the metrics are calculated on a gross-only basis, presenting both gross and net performance of the total portfolio with equal prominence, and providing adequate accompanying information about how these metrics are calculated. By adhering to these requirements set forth by the SEC, advisers can ensure that prospective investors are accurately informed about the impact of fees and expenses on their returns when evaluating these performance metrics.
