Highlights of Investment Adviser Advertising and Marketing

1. Highlights of Investment Adviser Advertising and Marketing FIRMA National Training Conference April 9, 2008 Orlando, FL • Chris Hardy • Partner • Ascendant Compliance Management, Inc.

2. Investment Adviser Advertising • Definition • Rules and Guidelines • SEC interpretations • Recordkeeping • SEC Examinations

3. Definition of an Advertisement • “Any written communication addressed to more than one person” that offers investment advisory services related to securities • Broadest definition includes any communication designed to attract new clients or maintain existing clients • Includes electronic and broadcast advertisements

4. What Is Not an Advertisement? • Oral communications • Customized RFP responses, letters or e-mails (not sent to more than one person) • Personal account information sent to a client • Still possible to violate Section 206 antifraud provision

5. Investment Adviser Advertising • Specific Guidance • Section 206 (general antifraud provision of Advisers Act) • Rule 206(4)-1 (SEC advertising rule) • No-Action Letters • SEC inspections and enforcement actions • Rules focus solely on disclosure, not calculation of performance

6. SEC Advertisements • General Antifraud Rule • Applicable to both registered and unregistered investment advisers • Perennially one of the top SEC exam deficiencies “[It is] unlawful to engage in any act, practice or course of conduct which is fraudulent, deceptive or manipulative.”

7. SEC Advertisements • Specific prohibitions applicable to registered investment advisers: • Testimonials • Third Party Reports • Partial Client Lists • Past specific recommendations • Charts/Formulas • Claim of free service unless it really is

8. SEC Advertisements • General Prohibitions: • Anti-Fraud Provision Depends On • Form • Content • Inferences that may be drawn by reader • Client sophistication

9. SEC Performance Advertising • Guiding Principals: • Investment performance is false or misleading if: • it implies, or a reader would infer, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts • Comply with investment performance presentation guidelines • Clover Capital series of No-Action Letters

10. Clover Capital No-Action Letter • Actual and Model Results • Disclose the effect of market conditions • Disclose relevant facts in comparison to index • Must be net of fees • Must disclose reinvestment of income/dividends • Disclose the possibility of a loss • Disclose material conditions, objectives, or strategies used

11. Clover Capital No-Action Letter • Model Performance Results • Disclose prominently the limitations inherent in model results • Disclose, if applicable, material changes in the conditions, objectives, or investment strategies of the model portfolio during the period portrayed and the effect of those changes • Disclose, if applicable, that the securities or strategies reflected in the model do not relate, or relate only partially, to services currently offered • Disclose, if applicable, that the adviser's clients had investment results were materially different from those portrayed in the model

12. Clover Capital No-Action Letter • Actual Results • Disclose prominently, if applicable, that the results portrayed relate only to a select group of the adviser's clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.

13. Clover Capital Exceptions • Exceptions to Net of Fees • Gross of fees performance • Sophistication of prospect • Must always be shown after transaction costs • Private, one-on-one meeting • Ability to ask questions and negotiate advisory fees

14. Clover Capital Exceptions • “One-on-One” Presentations must disclose: • Performance does not reflect deduction of advisory fees • The client’s return will be reduced by advisory and other expenses the client may incur in the management of its investment advisory account • Advisory fees are disclosed in Form ADV Part II • A representative example (table, chart, graph or narrative) showing the effect advisory fees, compounded over years, could have on the value of a portfolio

15. Clover Capital Exceptions • Net vs. Gross of Fees Presentation • Model advisory fees • Side-by-side gross and net • Multi-manager accounts • Model fees • Permissible to use highest fee charged to client in strategy

16. “Backtested” Performance • Use of theoretical performance developed by applying a particular investment strategy (typically, a quantitative or formula-based strategy) to historical financial data • Viewed as highly suspect as the adviser can run the backtested model again and again until it gets the results it wants. • Does not involve market risk

17. “Backtested” Performance • In addition to Clover requirements, disclose, at an absolute minimum: • That the adviser only began offering the given service after the performance period depicted by the advertisement • That the results do not represent the results of actual trading but were achieved by means of the retroactive application of a model designed with the benefit of hindsight • All material economic and market factors that might have had an impact on the adviser’s decision-making when using the model to manage actual client accounts;

18. Portability of Performance • Permitted if following conditions are met: • The person who manages accounts at the successor adviser was also primarily responsible for achieving prior performance • The accounts managed at predecessor are so similar to the accounts currently under management that the performance results would provide relevant information to prospective clients of the successor adviser • All accounts that were managed in a substantially similar manner are advertised unless exclusion of any account would not result in materially higher performance • Advertisement includes all relevant disclosures, including that performance results were from accounts managed at another entity.

19. Investment Advisor Advertisements • Article Reprints • Permitted, if comply with Advertising Rules • Can’t be false or misleading • Edit problematic statements • Use legends and footnotes to • Correct inaccuracies • Update information • Fill in gaps (e.g., provide net performance if article discusses only gross)

20. Past Specific Recommendations • SEC concerns re “cherry picking” • Exclusion from Advertising Rule prohibition if advertisement: • Offers to furnish list of all recommendations made by adviser within previous 12 month period • States • name of each security recommended • date and nature of each recommendation • market price of the security at time of recommendation • price at which the recommendation was to be acted on • the market price of each security as of the most recent practicable date • Discloses that “It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities in this list”

21. Holdings Lists – “Top Ten” • Permissible, but adviser must: • use objective, non-performance based criteria in selecting securities • use same selection criteria for each quarter for each investment category • Ensure report does not discuss extent to which the investments were, or were not, profitable

22. Investment Advisor Advertisements • Recordkeeping • Client communications and distribution lists • Copies of all written communication • Advertisements and Recommendations • All advertisements sent to more than 10 recipients • Document basis of all recommendations • Document basis of all claims • Retention Periods

23. Investment Advisor Advertisements • Performance Recordkeeping • Records to support performance calculations • Necessary to form the basis for or demonstrate the calculation of the performance • Internal account statements and worksheets • Prepared contemporaneously • Third party records to substantiate claims • Necessary to support performance: • In articles • From prior firm

24. SEC Advertising and GIPS • How to avoid false claims of compliance: • Educate marketing staff on appropriate presentation usage • Understand the limitations of verification • Take GIPS compliance seriously • Comply with all guidance statements • Review all applicable Q&A on CFA Institute website

25. SEC Exams • Recurring Problems: • Cherry picking • Comparing performance to inappropriate index • Representing model or back tested strategy as actual performance • Portability of performance • Submission of misleading information to publications or consultants • Inaccurate assets under management • False GIPS compliance claims

26. Chris Hardy Tel: (860) 435-2255 chardy@ascendantcompliance.com www.ascendantcompliance.com Questions?