Are You Ready for the New SEC Advertising Rule? | Video Podcast
Articles by: Richey May, Jul 29, 2021
The new advertising rules coming down from the SEC, which are updates to the Investment Advisers Act, modernize marketing standards in the alternative investments industry. In our latest video podcast, Jennifer Csaszar, Chief Growth Officer and Justin Schleifer, President & Co-Founder of Aspect Advisors sit down to discuss how funds can stay in compliance with these rules.
Their discussion covers:
- The new advertising rule & it’s implications
- Regulatory environment expectations
- Differences to consider for crypto funds vs. traditional hedge funds
- Common questions and pitfalls to avoid to keep your fund in compliance
Thank you for joining the discussion and a big thank you to our host, Richey May. I’m Jennifer Csaszar, the Chief Growth Officer at Aspect Advisors, and with me today is Justin Schleifer, our President and Co-Founder. Aspect Advisors is a regulatory compliance firm. We have many types of clients exempt reporting advisors, registered investment advisors, from fintech companies to hedge funds, private equity and venture capital clients. We offer a customized approach to every client engagement and build compliance programs and specific policies and procedures to support their type of business. Many of our clients are pioneers in their asset class and have been adding digital assets to their portfolio. One interesting regulatory update is the new advertising role that went into effect. Justin, can you provide us with an overview of the role?
Sure. And thank you, Jennifer, and thank you, Richey May for having us on the podcast today with the advertising rule that’s coming into effect. There’s really a lot of changes that are happening, but a lot of it is also just trying to bring things into the modern era and codify a lot of things that had previously existed in no action letters or regulatory interpretations. So the main things that people get to do now are focus on new advertising avenues, social media platforms, the ability to actually use things like testimonials or endorsements, either from customers or from third parties who might be a worthwhile advertising partner. Celebrities, for instance, that might be able to get in on the opportunity to talk about a product or service, whereas previously they wouldn’t have been allowed to do so. A lot of firms are still waiting for the actual implementation date, which is the, you know, middle to end of next year before they’re allowed to actually or before they’re required, rather to get into compliance with the new regulations. But in the meantime, a lot of firms are trying to be proactive and switch into the new regime right now, especially firms that are just launching or who want to push the envelope a little bit more from an advertising perspective, and they’re allowed to start using the new rules right now. So a lot of firms we’re finding are being able to take advantage of that and get out in front and be able to use some of these new rules to their advantage and really create some really interesting marketing programs and advertising, you know, protocols around what they’re trying to do together.
Who does this rule apply to?
Well, largely. It’s really just the SCC registered advisors at this point. There are obviously going to be some firms that are at the state level or smaller about one or, you know, smaller advisors that really want to try to take advantage of it soon, too. But everyone needs to understand it’s really just for a SEC registered advisors right now. If you’re an SEC exempt reporting advisor, it would still apply to you as well. But if you’re a state registered advisor, you can’t really do much with it yet. We do expect, just like with most rules, the states are probably going to take their time. See how this plays out at the federal level. See how firms are using it, how it works for them, how it doesn’t before they start to implement some of their own rules. But it’s probably going to be a little while before the states try to catch up and implement something like that. Realistically, it’s important to remember that some of these changes are coming into play that have been historically understood, you know, from a from an interpretation and regulatory understanding type perspective where, for instance, you know, advisors have been able to use back tested or hypothetical performance, know they’ve been able to have some kind of online social media type presence. And so those types of things are still going to exist at the state level. But as people want to be able to upgrade, try to use some of the newer things like testimonials, for instance, that’s not going to be allowed at the state level until they individually start to, you know, bring in some of those new concepts into their rules. So in the short term, it’s definitely going to be important for state advisors to make sure that they’re still, you know, following their own individual state rules. Don’t just take this new federal regime as something that you can start plugging into right away. But I know in some of our conversations with clients, there’s always a discussion around, Well, how quickly can I get to be registered or if I’m launching now, can I start out as an SEC registered firm? And when you’re having discussions like that, especially around the ability to use new advertising methods, you know, the ability to use testimonials, endorsements, build referral networks and a new and exciting way. That’s something that a lot of firms are really eager to to get to use right away. And it is going to push them in some of their conversations with us or with their legal counsel to figure out what are some avenues to be with the SEC sooner than later so that they can do some of this stuff and not have to worry about waiting for the states to catch up on some of that.
Does this new rule apply to digital assets differently than traditional fund managers?
That’s a great question, and I think realistically, you know, the rules are going to apply the same to everyone. The especially interesting piece about how it works with digital asset managers is largely around what their use cases look like relative to some of the more traditional traditional alternatives, as I like to jokingly call them these days. Even putting, you know, hedge funds or private equity, and that sort of that similar category of, you know, traditional alternatives people looking to to really push the envelope as far as their asset classes. Looking at the digital assets and things like that, it ends up being a little bit more involved based on, again, the methods of communication that they like to use. And so some of those managers definitely like to be able to, just like other people, you know, have the concept of testimonials or endorsements available to them. Certainly, you know, if you have celebrities or other influential people that are invested in your fund or like what your services or your product, you want to have them be able to talk about it and incorporate that into some of your materials or some of your your website or or, you know, videos or get them on in interviews, things like that now that you can do that with the new advertising rule. It is interesting, especially for digital assets, where they’re trying to still educate and inform the public and get people interested in it, where I think some of the more traditional asset classes, you know, you don’t really rely as much or they don’t need to rely as much, maybe on getting some people who have influence into the conversation. But otherwise, it’s really about the channels that people are using. And so with these new rules, people have the ability to have a much clearer understanding of how the regulators are going to look at concepts around advertising on the internet, through your website, through social media channels and through different methods of communication, either with prospective investors or prospective customers or communications with your vendors or other third parties. And so the digital asset managers tend to be people who are very tech savvy and like to be able to push the boundaries on what they can be using, how they can use it, how they can communicate with people. And I think that ends up being where the rules end up getting a little bit murkier and a little bit grayer as far as how they apply to some of these new technology solutions that people are using.
You mentioned some social media and using testimonials and endorsements, are there specific implications for private fund managers?
Yeah, definitely. I think one of the main new adjustments in the rule that’s coming out these days as it relates to private fund managers is now even though, you know, for the longest time, say your investors are not your clients, your fund is your client. Now, a lot of the new advertising rules kind of look through the fund to the investors and say, Well, anything that you’re going to be providing to an investor is really the same as providing it to a client of the firm. And that way, you have to be able to provide reasonable disclosures. It does allow you to then use investors treating them as your customers for the purpose of a testimonial or something so you can have an investor, provide commentary or an endorsement or some kind of a quote for you if you want to about their experience with the fund. And so that’s really the main. The main difference these days is that previously you didn’t really have to treat investors as if they were your clients or your customers from an advertising standpoint. And now you do, which means that all of the materials you’d put together from a marketing DAC or investor updates, quarterly letters, things like that all have to now go through the advertising lens and filter and ideally have a compliance officer, review it and sign off on it before it gets sent out, whether that’s either to prospective investors or to your current investor base. Anything that could be sent to current investors that could be construed as trying to retain investors and keep them invested is also considered marketing and advertising material at this point.
So how do firms stay compliant then, when using all these new technologies?
It’s a really good question, too, and you know, the technology largely depends on which firms using it, how they’re using it, and how they’re interacting with other people, whether they’re it’s third parties or just internally uses the biggest things. You know, it all starts out, obviously with, you know, we go from written communications, you know, buy, buy paper and pen, exclusively getting into emails and figuring out how do we surveil and retain email and electronic communications. And now we just have different forms of electronic communications that add new challenges to this to the spectrum, right? It, you know, goes from things like chat, messaging, you know, people use Slack a lot these days or. Similar types of services, those all need to be able to be retained archived surveilled, just like any other type of electronic communication. People now spreading out into other forms of chat and messaging. People like to be able to text with their customers or using slack externally with vendors or third parties, or in some cases, with customers. A really popular one these days, especially in the digital asset community, Telegram and WhatsApp are really big because people like to be able to communicate in an encrypted way. You know, be able to communicate with people who may be overseas and not have to worry about paying for those communications or something, and they are private. So those are things where, you know, the privacy in some of those use cases end up going counter to the compliance obligations and what we’re supposed to be able to do and how we’re supposed to be able to monitor things. So in a lot of those cases, it’s a matter of getting people to understand that, yes, there’s business use cases. We can absolutely use them and we understand how important they are to being able to continue to be at the front of the industry and being able to make good investments and communicate with people well. But there’s always a balance of what has to happen from the compliance side. And we still need to be able to monitor everything, document everything, surveil it, do some testing. And so sometimes that’s a matter of bringing in a third party vendor to be able to to, you know, monitor and keep track of all that stuff. And sometimes, depending on how tech savvy the client is, we’re able to work on things internally and figure out a system so that we can store and track it and review it all together. So can you give us some common questions that we typically get from digital asset clients? Sure. You know, I think the the main things for for digital asset clients are is that the regulation is still unclear and being written. And so we are largely providing guidance based on everything that we know about the traditional financial space and how we think it’s going to apply or how it should apply to the modern and digital asset space. And largely, we go with a framework and we, you know, fortunately, we have great clients who have a similar mindset of really wanting to be in the area of best practices, taking their responsibilities as fiduciary really seriously. And if you do that, everything sort of flows from it. So taking concepts that you have in a traditional asset management space, looking at your conflicts of interest, making sure that your employees are acting ethically and in the best interests of the clients, right? Starting from there, it ends up being, you know, a lot easier to be able to hone down onto some of the issues and think about them in this new context. So around conflicts of interest and you know, the employee activities a lot of times in the traditional space or even traditional alternatives, as I said before, hedge funds and things like that, you look around employee trading. What kinds of investment activities they’re allowed to do similar to the activities of the fund or the advisor? And it’s also the same type of concept in the digital asset space RB, allowing employees to invest in those types of same opportunities. Can they invest in different opportunities, things like staking and yield farming, where people might just sort of take for granted that there or think they can take for granted that there isn’t a lot of responsibility around that there can be conflicts of interest associated with how you participate in those activities as an individual versus how the firm or the fund might do it. And that could impact your customers, your investors. So those are some examples, you know, at a high level of really what we’re we’re thinking through with people, you know, building out their procedures in general around their internal controls. Cybersecurity is another big issue that even though it affects everybody, digital asset managers have a heightened responsibility, especially because their custody tends to be a little bit more complicated than traditional managers. They end up having, you know, sometimes more of a self custody solution, which you know, we help with people too is not always the most regulatory friendly, but at least if you have a good idea, you document it well and you have really good security protocols. That is a really important step for digital asset managers, maybe a little bit more so than the traditional managers.
Thank you. And do you see any major changes on the horizon for the crypto regulatory landscape? Changes on the horizon?
That’s what everyone always wants to know, right? And I mean, the the good thing is, from my perspective, you know, we have an SEC chairman now who who really cares about the crypto industry and about developing it properly. And you know, the SEC has signaled that. Even, you know, verbally, they want to try to do their best to not thwart this industry as it gets going. It’s pretty clear that the digital assets space is going to be very important and and really, you know, we fully believe it’s the future of the financial industry and of a lot of technology in the world in general. And so, you know, we we definitely see the FCC trying to be supportive of that. The interesting thing is that as we usually find with the FCC, sometimes they don’t always end up getting regulation right the first time. So what we’re hoping for and what we’re seeing is they are still having conversations with people in the space. They are trying to fill out what the right things are. That makes sense. And what we’re expecting is that at the end of the day, the SEC is probably going to end up putting in rules that are very similar to what we’re currently seeing with more traditional financial assets, just with incorporating more modern terminology and more modern concepts associated with it. So we’re really not expecting them to reinvent the wheel with a lot of things. That’s why, you know, we try to always focus on the fundamentals of, you know, conflicts of interest, good controls, understanding exactly what you’re trying to do, documenting out your thought process around things because ultimately we feel like those same types of concepts are going to still rule the day when the when the FCC ends up coming out with actual regulations. But some of these more modern concepts, you know, again, just to go back to things like staking, participating in governance. You know what? What is a decentralized entity in the context of, you know, a company or being able to participate in, you know, control types of activities? What is control mean? And the concept of, you know, the context of a decentralized exchange or a decentralized protocol. Those are the things I think the SEC’s and a be struggling the most with. And whether some of those things fit the more traditional definition of a security. So for me, you know, personally what? I’d love to see two things I’d love to see a more modernized definition of security that makes it a little bit easier to tell when some of these things fit or not. And if and absent a more modern definition of security, a new category entirely that would be able to sort of fall under the SEC’s purview, hopefully, rather than the NFA or CFTC. And if the SEC comes up with a separate category, I still expect it to have a lot of the same requirements around securities, but again, with maybe some different definitions or glossary items that that make a little bit more sense in this context. And the second thing that I would really love to see is a little bit less from the FCC, but more from the IRS, which is just adjustments on the, you know, the tax requirements around being able to use cryptocurrencies in daily life and in payments. I think that’s going to be the next step in really being able to unlock a lot of use cases in the industry.
Justin, thank you again for your time. Richey May thank you for hosting. Feel free to reach out to Justin or myself with any further questions.
Absolutely. Thank you so much, everybody for joining today. I definitely enjoy speaking about these things. So feel free to drop us a line anytime. Happy to talk about the advertising rule, digital assets or really anything else on your mind from a compliance perspective.