SEC Marketing Rule: How does it affect composites?

The SEC Marketing Rule presents many opportunities for firms to streamline performance and composite reporting. However, firms face the challenges of managing many composites, tight deadlines to produce information, and manual or spreadsheet-driven processes across multiple facets and regions of the business. How can firms use composites when advertising related, hypothetical and representative account performance?

Using composites when advertising performance

True or False? The SEC Marketing Rule now requires advisors to use composites when advertising performance.

Answer: Although the rule doesn’t explicitly require composites, it does necessitate advisors who want to advertise performance to maintain composites.

The rule addresses the concept of related performance. This is defined as the performance results of one or more related portfolios which meet a stated criterion and present that performance on a portfolio-by-portfolio basis, or as an aggregate of all portfolios in a composite.

Related portfolios have similar investment objectives, strategies and policies as the services you advertise in your performance. Therefore, when you present related performance, the rule requires the inclusion of all related portfolios – unless excluding certain portfolios won’t produce results materially higher than the results of presenting all related portfolios.

Addressing time requirements in GIPS^® composite reports

Most firms view the GIPS^® Report as a standard disclosure document. Even before the SEC Marketing Rule, the deck included many of the expected disclosures regulators would want to see in describing performance, calculations, and composites. By including the prescribed time period advisors can ensure the report is included in all presentations, which covers all the bases.

The GIPS^® standards gives firms 12 months to update GIPS^® Reports. The majority of advisors include the prescribed time periods in their GIPS^® Report in some way. Generally, advisors want to be able to include the GIPS^® Report as a standalone document and the prescribed time periods are therefore included in the GIPS^® Report.

However, a key challenge to the time requirements is the need to update prescribed time periods one month after the calendar year ends, or by the end of January 2024. This is a challenge for firms who produce many GIPS^® Reports. It’s possible they can be produced during the first quarter, however not all GIPS^® statistics and elements required in the GIPS^® Report can be updated by the end of January.

In response, firms are either updating prescribed time periods and other statistics within the GIPS^® Report within a few months or weeks later. Another option is to make sure there’s another page within the marketing deck which includes a prescribed time period, notating the update schedule. As long as the supplemental page is included with the GIPS^® Report, the firm has its basis covered.

In addition, many firms are no longer waiting for their verification. They now realize the need for internal controls to update reports, conduct a review process, validate results, and alleviate the pressure on the verifier. Generally, firms want to update them as quickly as the information becomes available and feasible, rather than waiting for verification.

Dealing with hypothetical and representative account performance

Any materials containing hypothetical performance are considered advertisements under the SEC Marketing Rule. In addition, the rule views advertisements as materials distributed to more than one party. Even if you’re using the information just once, it’s still considered an advertisement subject to the rule.

The SEC has also expanded the definition of hypothetical performance. In addition to model and back-tested results, it includes targets and projections, which many firms may not have previously regarded as hypothetical. This means firms will need to create policies and procedures around the dissemination of this information and know who the recipients will be, to ensure they can understand it.

Advisors cannot, therefore, feature hypothetical performance information on websites or other platforms where it’ll be broadly distributed, or viewed by individuals who may not understand it. Some firms have taken it as far as no longer broadly marketing their hypothetical performance results or stopping the use of hypothetical performance with their clients and prospects altogether.

Elevating performance standards

There are many good reasons to become GIPS^® compliant or implement GIPS^® requirements as client demands and regulatory mandates amplify in the years ahead. For starters, firms who are GIPS^® compliant may be in a better position to meet the SEC Marketing Rule’s advertising performance requirements. To thrive in this shifting landscape, firms need to create meaningful composites that are essential in the fair presentation, consistency and comparability of performance over time and among firms.

GIPS^®️ is a registered trademark owned by CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

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