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Singing An Investment Adviser’s Praises

United States Securities and Exchange Commission decisions and reports (book spines).
photo courtesy PeakPx

Advertising is such a pervasive part of American life that you may not realize the ways in which certain businesses can’t advertise to you. One of these rules may be about to vanish, opening the door to a new sort of ad in your feeds and on your screens.

Since 1961, the U.S. Securities and Exchange Commission has forbidden investment advisers to use testimonials in advertisements. Consumers are well acquainted with this sort of ad in other industries. A celebrity (or, these days, an influencer) tells you how much they love a given product or service. The existing rule presupposes that testimonial ads are especially dangerous when it comes to managing money. In fact, when the rule was first created, the SEC argued that testimonials are misleading “by their very nature.” Consumers can’t learn much if a celebrity, who many not even be a client, endorses a particular adviser – but the endorser’s clout may unduly sway someone anyway.

The testimonial rule does not apply solely to well-known public figures. An adviser also cannot highlight a noncelebrity client’s glowing review in advertising materials while ignoring unfavorable reviews. The SEC broadly bans advisers from advertising in ways that are fraudulent, deceptive or manipulative. It has long ruled that testimonials, whether from clients or third parties, fall under this prohibition.

The rule against testimonials may be on its way out, however. The SEC is exploring an approach to advertising more like the one used by the Financial Industry Regulatory Authority (FINRA). FINRA allows broker-dealers to use testimonials as long as they abide by certain restrictions and make certain disclosures. These include noting that the testimonial is paid (if it is), specifying whether the person giving the testimonial is a client, and noting that the testimonial is no guarantee of future performance.

The main factor driving the SEC’s potential change to the rules: social media. Advisers have had to tread carefully in this area for years. Back in 2014, the SEC issued updated guidance to try to make it clearer what behavior was permitted and what was not. For example, reviews on sites like Yelp or Angie’s List are not under the adviser’s control. Both good and bad reviews display equally, with no mechanism for the adviser to remove the bad ones. So while an adviser cannot quote a positive Yelp review in isolation, the adviser can urge prospective clients to visit the full set of reviews on Yelp. Generally, advisers are not responsible for things third parties choose to say about them online, at least to the extent the adviser can’t control the platform where they say it.

However, the 2014 guidance left a lot of gray areas for investment advisers. If an adviser sets up a professional Facebook page and clients or associates “like” it in order to receive updates, is that a testimonial? Generally not. But if a client likes a post about the firm itself, depending on the post’s content, the interaction might draw more regulatory scrutiny. Similarly, many advisers have fully turned off LinkedIn’s endorsement feature to avoid potentially triggering the testimonial rule. As The Wall Street Journal reported, enforcement has sometimes seemed oddly specific or inconsistent. The founder of American Century Investments, formerly known as Twentieth Century Investors, said that the SEC tried to force the company to change its logo from an ascending rocket to a descending one. (The agency later backed down.)

The SEC’s proposed changes won’t be final until next year, and there is time for the commission to incorporate public feedback. The specific wording of the new rules could change as a result. But potentially lifting the testimonial ban has both pros and cons.

While I understand the SEC is looking for ways to reduce the regulatory burden on investment advisers, the testimonial rule was one I always thought made a lot of sense. Any investment adviser who is pushing especially hard to get it rolled back immediately raises red flags, or should, with potential clients. Investment advisers sell something much more important than hamburgers or clothing. If I buy a burger that tastes bad or a T-shirt that falls apart after I wear it a few times, life goes on. A client who signs up with a shady adviser based on misleading information can suffer irreparable harm.

That said, the SEC’s efforts to clear up some of the gray areas created by new technology are admirable. Many honest investment advisers play it safe when judging whether the SEC considers Facebook likes or LinkedIn endorsements to be out-of-bounds. Technology will inevitably continue to evolve, and the SEC should also evolve by weighing in on cases that are not clear-cut based on existing rules. Some testimonials may simply not carry enough weight to matter. After all, how much do you care what pages your Facebook friends like?

While there is reason to be wary of overly lax testimonial rules, the industry may self-regulate even in the absence of a bright line from the SEC. A few years ago, the Jumpstart Our Business Startups (JOBS) Act removed an advertising ban for hedge funds, yet no avalanche of hedge fund commercials followed. As a 2013 article for The New Yorker explained, there were a variety of other factors holding the funds back. Hedge funds are only open to a certain class of investors, which means broadly aimed ads are not cost-effective. And certain firms may have been wary of appearing desperate. While hedge funds and registered investment advisers are different in some important ways, the hedge fund example suggests that just because investment advisers are allowed to advertise more aggressively doesn’t mean they inevitably will.

Are you likely to see your favorite athlete or musician encouraging you to sign up with a particular investment adviser? I think it is too soon to say. But if such testimonial ads do arrive, remember to stay skeptical and do your own research before taking a celebrity’s word for it.

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