SEC Breaks Silence on New Marketing Rule’s Net Performance Requirements

The SEC staff has issued FAQs related to Rule 206(4)-1, as amended under the Investment Advisers Act (the “Marketing Rule”), suggesting that the net/gross rule could consist of returns on a single investment. Clarifies that it applies to some extracted performance. This addresses one of the many ambiguities in the Marketing Rules that are in effect from November 4, 2022.

Background

The Marketing Rule codified the SEC staff’s long-standing position that prohibits the presentation of gross performance in advertising unless the advertisement also presents net performance. Marketing rules also require that extracted performance, such as investment group performance (such as those representing a single strategy drawn from a multi-strategy fund), be presented net of costs when presented at total costs. doing. Net performance should be displayed at least as prominently as gross performance and displayed in a format designed to facilitate comparison.

However, the rule text was unclear as to whether individual investment returns were considered performance or “extracted performance”. Additionally, it was not (and remains) unclear how fund-level expenses should be attributed to individual investments.

Staff FAQ

The Staff FAQ notes that presenting the performance of one investment in a private fund is a form of performance extracted under marketing rules, and that the gross performance of that investment must accompany the net performance of the investment. clarified. Therefore, advertising materials showing gross performance in case studies, or including investment returns for lists of individual portfolio positions, even when presented alongside fund-level investment performance on a net basis, do not represent the respective net returns. should be displayed.

To show the net performance of individual investments, a method should be adopted that attributes the fund’s fees and expenses to portfolio holdings and derives their respective imputed returns. We understand that there are various types of pro forma calculation methods that private fund advisors employ to implement this net his performance requirements. One common approach is to apply a uniform “haircut” to each investment in the portfolio. Hereby, the difference between the portfolio’s gross and net performance on the relevant measurement date is used to reduce the gross return of individual investments.

Advisors deriving net performance should be aware that results may be deemed misleading under the Marketing Rules or other provisions of Rule 10b-5 under the Securities Exchange Act of 1934. The assumptions made in the above simplistic way are that investments are held for the entire period over which performance is measured (although they may not have been) and that certain investments have associated fees and expenses. It didn’t (although it might have in some cases). Other assumptions must be made if the fund has multiple classes or portfolios and holds investments but incurs different fees or expenses.

This guidance is new, and as such industry standards related to how and how to present such net performance continue to develop and consequently require compliance policies and procedures to be adopted. Moreover, SEC examiners have not yet said what methodology they consider acceptable. Please contact your private fund group partner for more information on the amended marketing rules.

SEC breaks silence on new marketing rule’s net performance requirements

The content of this article is intended to provide a general guide on the subject. You should seek professional advice for your particular situation.