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SEC: RIAs Should be Required to Maintain all Performance Information

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Written by: RIA in a Box

On May 20, 2015, the Securities and Exchange Commission (SEC) issued a press release announcing the proposal of new regulatory rules that would apply to registered investment adviser (RIA) firms registered at the federal level. Previously, we noted that the proposal makes it evident that the SEC is reviewing the outsourced RIA Chief Compliance Officer (CCO) model and that the SEC would also like RIA firms to be required to disclose social media addresses. In this post, we take a closer look at the SEC’s proposed amendments to the Investment Advisers Act Rule 204-2 that would require investment advisers to maintain records of the calculation of investment performance information that is distributed to any single person.

In regards to maintaining books and records related to the distribution of investment performance information, the Investment Advisers Act Rule 204-2(a)(16) currently reads:

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All accounts, books, internal working papers, and any other records or documents that are necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any notice, circular, advertisement, newspaper article, investment letter, bulletin or other communication that the investment adviser circulates or distributes, directly or indirectly, to 10 or more persons (other than persons connected with such investment adviser); provided, however, that, with respect to the performance of managed accounts, the retention of all account statements, if they reflect all debits, credits, and other transactions in a client’s account for the period of the statement, and all worksheets necessary to demonstrate the calculation of the performance or rate of return of all managed accounts shall be deemed to satisfy the requirements of this paragraph.

Thus, presently, RIA firms registered with the SEC are generally required to maintain performance information that is distributed to 10 or more persons. In its new proposal, the SEC is requesting the following rule changes to be made:

Rule 204-2(a)(16) currently requires advisers that are registered or required to be registered with us to maintain records supporting performance claims in communications that are distributed or circulated to ten or more persons. Although it has been our staff’s experience that investment advisers routinely make and preserve communications containing performance information and records to support the performance claims, the books and records rule requires such records only when the communication is distributed to ten or more persons. We are proposing to amend rule 204-2(a)(16) by removing the ten or more persons condition and replacing it with “any person.” Accordingly, advisers would be required to maintain the materials listed in rule 204-2(a)(16) that demonstrate the calculation of the performance or rate of return in any communication that the adviser circulates or distributes, directly or indirectly, to any person. The veracity of performance information is important regardless of whether it is a personalized client communication or in an advertisement sent to ten or more persons. 

In addition, the SEC is also proposing a rule change to Rule 204-2(a)(7):

Rule 204-2(a)(7) currently requires advisers that are registered or required to be registered with us to maintain certain categories of written communications received and copies of written communications sent by such advisers. We are proposing to amend rule 204-2(a)(7) to require advisers to also maintain originals of all written communications received and copies of written communications sent by an investment adviser relating to the performance or rate of return of any or all managed accounts or securities recommendations. We believe these records would be useful in examining and evaluating adviser performance claims. A recent enforcement action demonstrated to us the disadvantages of not requiring investment advisers to maintain records forming the basis of performance calculations or performance communications sent to individuals.

The SEC’s rationale behind these proposed rule changes includes:

  • Whether performance information is distributed to one or many investors, accuracy is important.
  • This would not be an overly burdensome rule change as most investment advisory firms already maintain such information.
  • It would provide the examination staff with additional tools to enforce cases of fraudulent advertising.
  • Investors would benefit as the frequency of cases related to fraudulent advertising may decline.
     

The SEC does also acknowledge that this rule change could discourage RIA firms “from creating and communicating custom performance information to individual clients, who would then lose the benefit of having that information available to them.” However, the agency believes this is unlikely. 

In addition, the SEC notes that individual advisory firm “compliance costs also would vary depending on the degree to which performance figure determination and the record keeping process is automated…” Thus, it’s possible that this rule proposal could lead to additional advisory firms purchasing automated portfolio management and reporting technology solutions such as Rushmore Advisor Services.

If your advisory firm is debating whether to advertise investment performance, the SEC staff no-action letter issued on October 28, 1986 to Clover Capital Management provides great insight into what is and is not acceptable at the federal level. As RIA compliance consultants, we recommend that investment advisory firms exercise extreme caution when it comes to performance advertising regardless of whether marketing to one or many investors. We also strongly encourage the Chief Compliance Officer (CCO) of each RIA firm to take a few minutes to review the firm’s current advertising procedures to ensure it is staying in compliance with all relevant SEC or state statutes. In general, performance marketing is likely to increase a firm’s audit risk and can greatly lengthen the examination process..

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