First SEC Enforcement Related to Marketing Rule | Chuck Martin Reacts

Vigilant Insights

Brief Introduction

On Monday, August 21st, the SEC released its first enforcement action related to the new Marketing Rule.

A New York based FinTech Investment Adviser agreed to a cease-and-desist order, a censure, $192,454 in disgorgement/prejudgment interest, and a $850,000 civil penalty.

The charge alleges that this Firm used hypothetical performance metrics in advertisements that were misleading to investors.

What Happened?

According to the SEC:

• From August 2021 to October 2022, the Firm made misleading statements regarding hypothetical performance.
• Certain “annualized” performance results were advertised as high as 2700% for crypto strategy products.
  • Material information was omitted, including the fact that this hypothetical performance assumed that the performance in the first three weeks would continue for an entire year.
  • The Firm failed to have policies and procedures in place showing an attempt to maintain compliance with the Marketing Rule.
• The Firm also made conflicting disclosures to clients about how it custodies crypto assets.
• Disclaimer language implied that clients were waiving causes of action against the Firm, despite those causes being non-waivable.

Vigilant’s Chief Operating Officer, Chuck Martin, Reacts

Chuck Martin gave some insights during an interview with InvestmentNews this week.

He discussed that despite the major missteps made with the use of this projected performance, there are still plenty of lessons to take away from this enforcement.

Chuck emphasized that proper disclosures are essential when Firms advertise hypothetical performance, especially with the retail public.

Important Takeaways

1. A failure to create policies and procedures for the proper evaluation of marketing material in compliance with the Marketing Rule can lead to major compliance failures.
   • A well-trained, independent advertising and marketing review team would likely have caught these mistakes.
   • The SEC clearly states that they are evaluating whether any changes were made to a Firm’s policies and procedures after the adoption of the Marketing Rule.
2. The use of hypothetical performance has strict guidelines and requires accurate disclosure.
   • Omitting material information is a significant compliance failure and likely will be seen as violation of Federal Securities Laws by Regulators.
3. Firms that utilize outside compliance experts will likely do better during investigations.

Vigilant’s Conclusion

This case can be viewed as a potential roadmap to how future Marketing Rule cases and exams may be conducted in the future.

It is important that Firms understand:

1. The importance of adopting and implementing policies and procedures that comply with the New Marketing Rule, especially around hypothetical performance;
2. Be wary about the use of disclosures in endnotes and hyperlinks, ensuring these important disclosures are clear and prominent; and
3. “Fair and Balanced” Standard, is a challenge for many Firms implementing the new marketing rule. This case is one of what we anticipate being many data points that Firms will have to assess the SEC’s interpretation of that standard.

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