US Regulation: SEC permits advisers to provide past specific recommendations in response to unsolicited requests

This article by New York-based law firm Tannenbaum Helpern
Syracuse & Hirschtritt LLP clarifies the SEC's position with regard to
unsolicited requests for information.


On March 1, 2004, the Division of Investment Management of the
Securities and Exchange Commission (the "SEC") clarified its view on
the application of Rule 206(4)-1 of the Investment Advisers Act of
1940, as amended (the "Advisers Act") in a letter to the Investment
Counsel Association of America, Inc. 2


The SEC staff stated that the act of providing past specific
recommendations by a registered investment adviser in response to
an unsolicited request of a client, prospective client or consultant is
not an advertisement within the meaning of Rule 206(4)-1(b) of the
Advisers Act.


Moreover, the SEC staff stated that a registered investment adviser
responding to an unsolicited request by a client, prospective client or
consultant for specific information about the adviser's past specific
recommendation would not be prohibited to do so by Rule 206(4)-
1(a)(2) of the Advisers Act provided that the adviser did not directly or
indirectly solicit the client, prospective client or consultant to make the
request.


Furthermore, the SEC stated that a written communication by a
registered investment adviser to its existing clients generally would
not be an advertisement within the meaning of Rule 206(4)-1(b) of the
Advisers Act merely because it discusses the adviser's past specific
recommendations concerning securities that are or were recently held
by each of those clients provided that such communications are not
designed to offer advisory services.


The ICAAI Letter is a significant clarification of the advertising rules
under the Advisers Act that recognizes the flow of information in the
market and the services an adviser provides to its clients in the
normal course of business.


Providing Past Specific Recommendations to Clients,
Prospective Clients and Consultants


Registered investment advisers are subject to a number of
restrictions with respect to advertisement. 3


Under Rule 206(4)-1(a)(2) of the Advisers Act, it is fraudulent if an
adviser publishes, circulates, or distributes any advertisement that
refers directly or indirectly to the adviser's past specific
recommendations that were or would have been profitable to any
person.


This general prohibition on advertisements that contain past specific
recommendation stems from the SEC's concern that an adviser could
"cherry-pick" its profitable recommendations and omit unprofitable
recommendations. Nevertheless, an adviser could advertise its past
specific recommendations provided that certain conditions are
satisfied as described under Rule 206(4)-1(a)(2)(A) and (B) of the
Advisers Act. 4


Among the key conditions is that an adviser must furnish a list of all
recommendations made by such adviser during the pertinent time
period.


Quite often, current clients, prospective clients and consultants
contact a registered investment adviser to request information about
the adviser. Such requests should be expected as part of the due
diligence process prospective clients and consultants conduct and as
a form of monitoring by current clients. Until the ICCAI Letter,
advisers have been constrained in their ability to furnish information
about their past specific recommendations because of the danger of
violating the advertising rules and in particular Rule 206(4)-1(a)(2) of
the Advisers Act. According to the SEC staff in the ICCAI Letter, an
adviser that does no more than respond via a written communication
to an unsolicited request by a client, prospective client or consultant
for specific information about the adviser's past specific
recommendations is not an "advertisement."


As such, an adviser can provide past specific recommendations in
response to unsolicited requests by prospective clients, current
clients or consultants without having to comply with the onerous
conditions set forth under Rule 206(4)-1(a)(2)(A) and (B) of the
Advisers Act because such acts do not constitute advertisement. 5


As a consequence, information about an adviser's past specific
recommendations can now be more freely disseminated. For
example, according to the SEC staff, it would be permissible for an
adviser to provide information about its past specific
recommendations to a consultant requesting information on behalf of
several of its own clients.


Note that a critical requirement is that the request must be
"unsolicited." According to the SEC staff, a solicited request would be
the result of "any affirmative effort by an investment adviser that is
intended or designed to induce a client, prospective client or
consultant to request the adviser to provide past specific
recommendations or an advertisement indicating that the adviser is
willing to provide past specific recommendations upon request." 6


Written Communications to Current Clients that Contain Past
Specific Recommendations


In practice, registered investment advisers periodically distribute
written communications to their existing clients about the
performance of their accounts, and the SEC staff recognizes that this
is a normal part of the adviser's advisory services. Accordingly, in the
ICAAI Letter, the SEC staff is giving comfort to advisers that sending
written communications to their existing clients would not be
considered to be advertisement within the meaning of Rule 206(4)-
1(b) merely because the written communication discusses the
adviser's past specific recommendations concerning securities that
were or are recently held by the client.


The SEC staff cautions that if past specific recommendations are
presented in a manner that suggests an offer of advisory services,
then such communications would be considered to be
advertisement. 7


As such, advisers must remain conscientious of the restrictions on
advertising when drafting reports and statements to existing clients so
as not to violate applicable provisions under the Advisers Act. 8


Recap


To recap, a registered investment adviser can now provide written
materials about its past specific recommendations in response to
inquiries from current clients, prospective clients, and consultants
provided that certain conditions are met:


•The request is from a current client, a prospective client or a
consultant;
•The request for past specific information is unsolicited;
•The response does no more than provide past specific
recommendations of the adviser; and
•The response is not designed to offer advisory services.


Furthermore, written communications by a registered investment
adviser to its existing clients that discuss the adviser's past specific
recommendations would not be considered to be advertisement
provided that certain conditions are met:


•The written communications is directed towards current clients;
•The past specific recommendations concern securities that are or
were recently held by each of those clients; and
•The written communications are not designed to offer advisory
services.


While a registered investment adviser can take comfort in the issue of
past specific recommendations, in general an adviser's written
communications that are advertisement in nature should be drafted
carefully and reviewed by counsel to ensure that such written
communications are within the proscriptions of the advertisement
rules.


Also, registered investment advisers that operate hedge funds should
note that the ICAAI Letter does not relax any of the restrictions on
general advertisement and general solicitation applicable to hedge
funds.


Overall, the SEC staff's response in the ICAAI Letter is a significant
step in the promotion of greater transparency in the market.


Notes:


1 This memorandum provides general information on the subject
matter described, and it should not be relied on for legal advice on
any matter, which may turn on specific facts. You should seek
specific legal advice before acting with regard to the subjects treated
here.


2 Division of Investment Management of the Securities and Exchange
Commission, Letter to Investment Counsel Association of Americas,
Inc., dated March 1, 2004 ("ICAAI Letter").


3 Rule 206(4)-1(b) of the Advisers Act defines "advertisement" to
include: any notice, circular, letter or other written communication
addressed to more than one person, or any notice or other
announcement in any publication or by radio or television, which
offers (1) any analysis, report, or publication concerning securities, or
(2) any graph, chart formula or other devise to be used in making any
determination as to when to buy or sell any security, or which security
to buy or sell, or (3) any other investment advisory service with regard
to securities.


4 Rule 206(4)-1(a)(2)(A) and (B) of the Advisers Act provides that the
prohibition against including past specific recommendations that were
or would have been profitable does not apply if the advisement
includes or offers to furnish a list of all recommendations made by the
adviser and includes the following information: (1) the name of each
security recommended; (2) the date and nature of each
recommendation (e.g. whether to buy, sell or hold); (3) the market
price at the time of the recommendation; (4) the price of the security
when the recommendation was to be acted upon; (5) the market price
of each such security at the most recent practicable date; and (6) a
disclaimer regarding the profitability of recommendations in the
future.


5 Although an adviser may now respond to unsolicited requests
regarding past specific recommendations without complying with Rule
206(4)-1(a)(2)(A) and (B) of the Advisers Act, an adviser's written
communications must still comply with the general anti-fraud
provisions under Sections 206(1) and (2) of the Advisers Act.


6 ICAAI Letter, note 1.


7 For example, a letter written by an adviser that discussed its past
specific performance recommendations concerning securities not
held or not recently held by some of the clients to whom the letter
was directed would suggest that a purpose of the communication was
to promote the advisory services of the adviser and thus may
constitute an advertisement and be prohibited by Rule 206(4)-1(a)(2)
of the Advisers Act. See ICAAI Letter.


8 See Rule 206(4)-1(a) and Sections 206(1) and (2) of the Advisers
Act.


 
 
 
 

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