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In May of 2021, the US Securities and Exchange Commission’s “Marketing Rule” went into effect, modernizing advertising and cash solicitation rules for investment advisors. Organizations have had 18 months to comply with the new rules and regulations, which have officially become enforced beginning November 4, 2022. Those seeking a smooth transition must understand the amendment’s effects on investment advisors and private fund managers, and the potential implications on management liability insurance.
The “Marketing Rule” updates the predecessor "Advertising” (Rule 206(4)-1 and Cash Solicitation (Rule 206(4)-3) Rules as a codification under Rule 206(4)-1; as a part of the Investment Advisers Act of 1940. The modernized rule is intended to more closely regulate advisors’ marketing communications and use principles-based prohibitions that will be applicable to all advertisements. One of Its most striking changes is the definition of advertisement. Under the new rule, advertising now takes on two prongs — The first part generally includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The second prong now generally expands advertisements to mean: Endorsements and testimonials, social media comments, or nonwritten communications like pre-recorded videos, etc., for which the adviser receives compensation. Compensation can include cash and non-cash compensation paid directly or indirectly to the adviser.
Per the SEC, new rules mandate that advertisements may not:
This revision of the Investment Advisers Act enables the SEC to better regulate today’s more modern and technologically advanced environment where social media and other platforms have allowed businesses to skirt regulations such as those involving endorsements. Prior to the update, an amendment to the marketing rulebook had not been updated for decades. Meanwhile, technological progress allowed advisors to disclose information, endorsements, and testimonials through third-party online platforms without violating solicitation regulations. The SEC is also expanding existing oversight to be more stringent categorizing fraud and misrepresentation – seeking to ensure an organization is not saying anything that may be considered misleading or inaccurate.
While the overhaul may seem to be about policing, it serves more as a necessary update. Fixing issues brought on by technological advancement while also trying to anticipate future problems, this amendment protects both sophisticated and non-sophisticated investors from deception.
Management Liability underwriters will expect organizations to be fully compliant with the new rules and regulations and will seek evidence that senior management has updated its compliance program accordingly.
Only time will tell how premiums will be impacted by the new requirements in the long term. We can, though, anticipate a new basis on which investors have to make claims for omission of information, or materially misleading statements which they purport caused them a loss in investor value. At a minimum, defense costs incurred in the defense of these new allegations may begin to impact insurance companies’ premium charge. However, these lawsuits will provide a learning opportunity for organizations -- allowing them to strengthen their own ecosystem to protect from litigation.
As this new regulatory environment becomes set in stone, it is imperative for organizations to look at their D&O insurance policies to make sure that they are covered in the event of misrepresentation allegations. It is imperative to have robust exceptions to the fraud exclusions with severability built in, as well as conforming the definition of Investment Advisory Services to include “marketing, and solicitation”.
Additional ways to prepare for the “Marketing Rule”:
Change is never easy, but quickly getting in step with a new regulatory environment mitigates risks and possible litigation. Follow the Risk Strategies blog to stay up to date on initial impressions and reactions as the regulatory transition sets in.
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Connect with the Risk Strategies Management Liability team at MLPG@risk-strategies.com