currently employ model portfolios in a variety of circumstances.\686\
Instead of limiting the discussion of model portfolios to those managed
alongside portfolios managed for actual investors,\687\ the final rule
will broaden the definition. Model performance will include, but not be
limited to, performance generated by the following types of models: (i)
Those described in the Clover no-action letter where the adviser
applies the same investment strategy to actual investor accounts, but
where the adviser makes slight adjustments to the model (e.g.,
allocation and weighting) to accommodate different investor investment
objectives; (ii) computer generated models; and (iii) those the adviser
creates or purchases from model providers that are not used for actual
investors. After considering comments, we believe it is appropriate for
the final rule to accommodate the use of these variations while
ensuring that advisers consider whether this information is relevant to
the intended audience.\688\
---------------------------------------------------------------------------

    \682\ See 2019 Proposing Release, supra footnote 7, at section
II.A.5 (describing representative performance as including
performance generated by models that adhered to the same investment
strategy as that used by the adviser for actual clients).
    \683\ See, e.g., CFA Institute Comment Letter; IAA Comment
Letter.
    \684\ See final rule 206(4)-1(e)(8)(i). Model performance would
include, among other things, the type of ``model performance''
described in the Clover Letter: Performance results generated by a
``model'' portfolio managed with the same investment philosophy used
by the adviser for actual client accounts and ``consist[ing] of the
same securities'' recommended by the adviser to its clients during
the same time period, ``with variances in specific client objectives
being addressed via the asset allocation process (i.e., the relative
weighting of stocks, bonds, and cash equivalents in each account).''
See Clover Letter. The rule will treat this as hypothetical
performance because, although the ``model'' consists of the same
securities held by several portfolios, the asset allocation process
would result in performance results that were not actually achieved
by any portfolio.
    \685\ See Clover Letter.
    \686\ See SIFMA AMG Comment Letter II; IAA Comment Letter
(discussing ``other types of `model' performance that do not reflect
investment advice actually provided to clients'').
    \687\ See proposed rule 206(4)-1(e)(5).
    \688\ See, e.g., SIFMA AMG Comment Letter II (suggesting that
the Commission recognize that model portfolios are not limited to
the type discussed in the Clover Letter); IAA Comment Letter.

---------------------------------------------------------------------------

    One commenter supported treating model performance as hypothetical
performance,\689\ while some commenters objected because model
performance could reflect the actual performance of a strategy that is
managed in real time.\690\ We understand that model portfolios can be
(but are not always) managed alongside portfolios with investor or
adviser assets and that many investors find model performance helpful.
For instance, model performance may present a nuanced view of how an
adviser would construct a portfolio without the impact of certain
factors, such as the timing of cash flows or investor-specific
restrictions, which may not be relevant to the particular investor.
Model performance also can help an investor assess the adviser's
investment style for new strategies that have not yet been widely
adopted (or adopted at all) by the adviser's investors.
---------------------------------------------------------------------------

    \689\ See CFA Institute Comment Letter (stating that ``paper
portfolios'' should be treated as hypothetical performance).
    \690\ See, e.g., SIFMA AMG Comment Letter II; MMI Comment
Letter.
---------------------------------------------------------------------------

    However, we believe that model performance is appropriately treated
as hypothetical performance because such performance was not achieved
by the actual performance of a portfolio and could mislead investors.
For example, advances in computer technologies have enabled an adviser
to generate hundreds or thousands of potential model portfolios in
addition to the ones it actually offers or manages. An adviser that
generates a large number of model portfolios has an incentive to
advertise only the results of the highest performing models and ignore
others. The adviser could run numerous variations of its investment
strategy, select the most attractive results, and then present those
results as evidence of how well the strategy would have performed under
prior market conditions. Even in cases where an adviser generates only
a single model portfolio, neither investor nor sufficient adviser
assets are at risk, so the adviser can manage that portfolio in a
significantly different manner than if such risk existed. For these
reasons, we believe it is more likely for an investor to be misled
where the investor does not have the resources to scrutinize such
performance and the underlying assumptions used to generate model
portfolio performance. We believe treating model performance as
hypothetical performance under the rule guards against the investor
protection concerns addressed above.
    Some commenters suggested that we consider more flexible treatment
of model performance given that performance generated by certain types
of model portfolios would be less likely to mislead investors.\691\ We
believe that the conditions described below are sufficiently flexible
to allow advisers to tailor their approach based on the intended
audience of the advertisement and the type of hypothetical performance,
including performance generated for different types of model
portfolios. For example, if an adviser believes that model performance
is less likely to mislead the intended audience, the adviser may decide
that less-stringent policies and procedures are required under the
first condition, and that the required disclosures may differ and be
more limited than those required for backtested performance. In
contrast, if an adviser believes that model performance is highly
likely to mislead a particular audience (e.g., it is difficult to
provide disclosure that is sufficiently specific but also
understandable), the adviser could adopt policies and procedures that
eliminate the presentation of that type of model performance to this
investor type in its advertisements or modify the presentation to
satisfy the requirements of the final rule. An adviser would need to
consider the intended audience of the advertisement and the type of
hypothetical performance in order to satisfy the conditions.
---------------------------------------------------------------------------

    \691\ See, e.g., NYC Bar Comment Letter; NRS Comment Letter;
MFA/AIMA Comment Letter I (stating that ``the Commission should
modify the Proposed Advertising Rule to allow investment advisers to
scale the scope of disclosures to the risk profile of the type of
`hypothetical performance' information.'').
---------------------------------------------------------------------------

    Commenters suggested that we consider the impact of this
characterization of hypothetical performance on model providers to wrap
fee accounts and advisers that provide models to other, end-user
advisers for implementation.\692\ We understand that model providers
may not have access to the actual performance data generated after the
end-user adviser implements the model and that the performance data
they have access to may reflect another adviser's fees or adjustments.
Even if model providers had access to such actual performance data, we
believe they would still be subject to the hypothetical performance
provisions because the performance generated would be the performance
of a portfolio managed by the end-user adviser, not the model provider.
However, we believe that model providers would not have difficulty
satisfying the three hypothetical performance provisions. For example,
we anticipate the intended audience for model provider advertisements
often will be end-user advisers or wrap fee program sponsors. Model
providers therefore could adopt simple policies and procedures because
the model provider reasonably believes that the intended audience is
sophisticated and should have the analytical resources and tools
necessary to interpret this type of hypothetical performance. The model
provider could similarly satisfy the rule's disclosure requirements for
hypothetical performance based on the end-user's profile since the
model providers would know that the end-user adviser is a well-informed
investor with analytical tools at his/her disposal.
---------------------------------------------------------------------------

    \692\ See, e.g., SIFMA AMG Comment Letter II; MMI Comment Letter
(stating that model performance is not hypothetical because it
``reflects actual performance of an investment strategy in real-
time''); IAA Comment Letter (stating that ``[m]any advisers serve as
model providers to wrap accounts and other advisers. Such model
providers would not necessarily have the data on the actual
performance of the accounts managed to their models, as they are not
acting directly as advisers to the underlying accounts.''); NYC Bar
Comment Letter.
---------------------------------------------------------------------------

    Backtested Performance. As proposed, the final rule will treat
backtested performance as a type of hypothetical performance. We
proposed to include ``[p]erformance that is backtested by the
application of a strategy to market data from prior periods when the
strategy was not actually used during those periods.'' \693\
---------------------------------------------------------------------------

    \693\ See 2019 Proposing Release, supra footnote 7, at section
II.A.5.c.iv.
---------------------------------------------------------------------------

    One commenter supported broadening the types of backtested
performance that would be subject to the hypothetical performance
provisions.\694\ Other commenters said that we should not treat
backtested performance as a type of hypothetical performance.\695\
---------------------------------------------------------------------------

    \694\ See CFA Institute Comment Letter (stating that proposed
definition of backtested performance would not include ``strategies
that take data from other portfolios managed by the Adviser or
someone else and backtest an asset allocation strategy.'').
    \695\ See, e.g., NYC Bar Comment Letter (stating ``backtested
returns are a conditional analysis of prior data'' and advisers use
this information to stress test investment methodologies that the
advisers intend to use in the future); MMI Comment Letter (stating
``backtested performance figures are not purely hypothetical, but
rather reflect an analysis of actual investment performance based on
certain assumptions'' and that such illustrations ``analyze
historical data'').
---------------------------------------------------------------------------

    We acknowledge that backtested performance may help investors
understand how an investment strategy may have performed in the past if
the strategy had existed or had been applied at that time. In addition,
this type of

performance information may demonstrate how the adviser adjusted its
model to reflect new or changed data sources. While we understand the
potential value of such data to investors, backtested performance
information also has the potential to mislead investors. Because this
performance is calculated after the end of the relevant period, it
allows an adviser to claim credit for investment decisions that may
have been optimized through hindsight, rather than on a forward-looking
application of stated investment methods or criteria and with
investment decisions made in real time and with actual financial risk.
For example, an investment adviser is able to modify its investment
strategy or choice of parameters and assumptions until it can generate
attractive results and then present those as evidence of how its
strategy would have performed in the past.\696\
---------------------------------------------------------------------------

    \696\ See, e.g., David H. Bailey, Jonathan M. Borwein, Marcos
L[oacute]pez de Prado, and Qiji Jim Zhu, Pseudo-Mathematics and
Financial Charlatanism: The Effects of Backtest Overfitting on Out-
of-Sample Performance, 61(5) Notices of the Am. Mathematical
Society, 458, 466 (May 2014), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2308659 (describing the potential to
overfit an investment strategy so that it performs well in-sample
(the simulation over the sample used in the design of the strategy)
but performs poorly out-of-sample (the simulation over a sample not
used in the design of the strategy)).
---------------------------------------------------------------------------

    We believe that backtested performance included in an advertisement
is more likely to be misleading to the extent that the intended
audience does not have the resources and financial expertise to assess
the hypothetical performance presentation. The conditions that the
final rule will impose on displays of hypothetical performance in
advertisements are designed to ensure that advisers present backtested
performance in a manner that is appropriate for the advertisement's
intended audience.
    In response to a commenter's suggestion,\697\ the final rule will
apply to advertisements including presentations of performance that is
backtested by the application of a strategy to data from prior time
periods when the strategy was not actually used during those time
periods, instead of applying only to application of the strategy to
``market'' data from a prior time period. Accordingly, the hypothetical
performance provisions will apply to presentations of both market and
non-market data in advertisements. This change will account for
scenarios where an adviser could backtest performance based on non-
market data (e.g., data from other portfolios managed by the adviser).
We are otherwise adopting this provision as proposed.
---------------------------------------------------------------------------

    \697\ See CFA Institute Comment Letter.
---------------------------------------------------------------------------

    Another commenter asked that we address which disclosures must
accompany specific displays of backtested performance.\698\ In the
spirit of our principles-based approach, we decline to prescribe the
exact disclosure language that should accompany displays of backtested
performance in advertisements.
---------------------------------------------------------------------------

    \698\ See NRS Comment Letter.
---------------------------------------------------------------------------

    Targets and Projections. As proposed, the final rule will treat
presentations of targeted and projected returns in advertisements as
presentations of hypothetical performance. Targeted returns reflect an
investment adviser's aspirational performance goals. Projected returns
reflect an investment adviser's performance estimate, which is often
based on historical data and assumptions. Projected returns are
commonly established through mathematical modeling.\699\
---------------------------------------------------------------------------

    \699\ The final rule does not define ``targeted return'' or
``projected return.'' We believe that these terms have commonly
understood meanings, and we do not intend to narrow or expand
inadvertently the wide variety of returns that may be considered
targets or projections. We generally would consider a target or
projection to be any type of performance that an advertisement
presents as results that could be achieved, are likely to be
achieved, or may be achieved in the future by the investment adviser
with respect to an investor.
---------------------------------------------------------------------------

    Most commenters that addressed this topic opposed the
characterization of targeted returns as hypothetical performance on the
grounds that targeted returns indicate expectations about how a product
or strategy is intended to perform (e.g., how aggressively a strategy
will be managed) as opposed to predictions of performance.\700\ Several
of these commenters agreed that the Commission should continue to treat
projected returns as hypothetical performance.\701\
---------------------------------------------------------------------------

    \700\ See, e.g., Wellington Comment Letter (agreeing that
projected returns have a heightened ability to mislead investors,
but stating that targeted returns can provide useful information
about the risk profile of an investment strategy); Fidelity Comment
Letter; MMI Comment Letter (stating that targeted returns ``are
performance goals that an adviser seeks to achieve with a particular
strategy or product'' while hypothetical returns ``represent a
projection of what returns will or could be based on a series of
assumptions'').
    \701\ See, e.g., CFA Institute Comment Letter; AIC Comment
Letter.
---------------------------------------------------------------------------

    Targets and projections could potentially be presented in such a
manner to raise unrealistic expectations of an advertisement's audience
and thus be misleading, particularly if they use assumptions that are
not reasonably achievable. For example, an advertisement may present
unwarranted claims based on assumptions that are virtually impossible
to occur, such as an assumption that three or four specific industries
will experience decades of uninterrupted growth.
    We recognize, however, that there are some differences between
targeted and projected returns. Targeted returns are aspirational and
may be used as a benchmark or to describe an investment strategy or
objective to measure the success of the strategy.\702\ Projected
returns, on the other hand, use historical data and assumptions to
predict a likely return.\703\ Therefore, targeted returns may not
involve all (or any) of the assumptions and criteria applied to
generate a projection. Still, we do not believe that the difference
between targeted and projected returns is always readily apparent to
recipients of an advertisement. We believe that the presentation of
targeted returns in such context could result in unrealistic
expectations. We continue to believe, therefore, that the presentation
of targets and projections in advertisements should be subject to the
rule's hypothetical performance conditions. The conditions we are
adopting with respect to the use of hypothetical performance are
principles-based, allowing the adviser to tailor the disclosure to the
type of performance used in the advertisement. For example, in the case
of an advertisement that presents targeted returns, which are generally
aspirational in nature and not necessarily based on ``criteria and
assumptions,'' to meet this disclosure requirement an adviser's
disclosure could state that criteria and assumptions were not used.
---------------------------------------------------------------------------

    \702\ See, e.g., CFA Institute Comment Letter.
    \703\ Id.
---------------------------------------------------------------------------

    We believe that providing hypothetical performance in
advertisements only to those investors with the resources and financial
expertise to assess targets or projections will help avoid scenarios
where an investor might be misled into thinking that such performance
is guaranteed. We recognize that some investors want to consider
targeted returns and projected returns (along with these underlying
assumptions) when evaluating investment products, strategies, and
services. For example, based on our staff's outreach and experience, we
understand that financially sophisticated investors in particular may
have specific return targets that they seek to achieve, and their
planning processes may necessarily include reviewing and analyzing the
targets advertised by investment advisers and the information

underlying those targets. Specifically, an analysis of these targets or
projections can inform an investor about an adviser's risk tolerance
when managing a particular strategy. We understand that information
about an adviser's targets or projections also can be useful to an
investor when assessing how the adviser's strategy fits within the
investor's overall portfolio, but advisers must consider the intended
audience when making such presentations in advertisements.
    The rule will apply only to targeted or projected performance
returns ``with respect to any portfolio or to the investment advisory
services with regard to securities offered in the advertisement.''
\704\ This means that projections of general market performance or
economic conditions in an advertisement are not targeted or projected
performance returns subject to the provision on presentation of
hypothetical performance.
---------------------------------------------------------------------------

    \704\ Final rule 206(4)-1(e)(8)(iii).
---------------------------------------------------------------------------

    We did not propose to exclude from the definition of ``hypothetical
performance'' the performance generated by interactive analysis tools.
However, in the proposal, we noted that FINRA permits investment
analysis tools as a limited exception from FINRA's general prohibition
of projections of performance, subject to certain conditions and
disclosures, and we requested comment on whether we should consider
FINRA's approach.\705\ Commenters generally supported an exclusion for
such tools and for adopting FINRA's approach.\706\
---------------------------------------------------------------------------

    \705\ See 2019 Proposing Release, supra footnote 7, at section
II.A.5.c.iv.
    \706\ See, e.g., SIFMA AMG Comment Letter II (stating that
``[i]n the retail setting it is common to use projections that are
based on statistically valid methodologies (e.g., Monte Carlo
simulations) to assist clients and investors in understanding
whether the investment of their current assets will allow them to
meet future goals''); BlackRock Comment Letter (stating that the
rule should provide a safe harbor from the hypothetical performance
provisions for investment analysis tools that comply with FINRA rule
2214); IAA Comment Letter; T. Rowe Price Comment Letter.
---------------------------------------------------------------------------

    As a result, the final rule will exclude the performance generated
by investment analysis tools from the definition of hypothetical
performance and will import a definition of ``investment analysis
tool'' from FINRA Rule 2214 with slight modifications.\707\ FINRA Rule
2214 defines an ``investment analysis tool'' as ``an interactive
technological tool that produces simulations and statistical analyses
that present the likelihood of various investment outcomes if certain
investments are made or certain investment strategies or styles are
undertaken, thereby serving as an additional resource to investors in
the evaluation of the potential risks and returns of investment
choices.'' We will adopt this definition, but will require that a
current or prospective investor must use the tool (i.e., input
information into the tool or provide information to the adviser to
input into the tool).
---------------------------------------------------------------------------

    \707\ FINRA rule 2214 provides a limited exception from FINRA
rule 2210's prohibition on communications that predict or project
performance. While FINRA rule 2210 applies differently to
communications directed to retail versus institutional investors,
our final rule does not have such a bifurcated approach.
---------------------------------------------------------------------------

    Despite the fact that an investment analysis tool is often a
computer-generated model that does not reflect the results of an actual
account, the rule will allow an adviser to present these tools in
advertisements without complying with the conditions applicable to
hypothetical performance.\708\ We do not view these tools as presenting
the same investor risks that model portfolios do because they typically
present information about various investment outcomes based on the
investor's situation and require the investor to interface directly
with the tool. In providing an interactive analysis tool, an adviser
should consider which disclosures are necessary in order to comply with
the general prohibitions of the final marketing rule. For example, to
comply with the first general prohibition, the adviser should neither
imply nor state that the interactive tool, alone, can determine which
securities to buy or sell.
---------------------------------------------------------------------------

    \708\ Under the final rule, general educational communications
that rely on public information and do not reference specific
advisory products or services offered by the adviser would not
qualify as advertisements. See supra section II.A.2.a.v. Educational
presentations of performance that reflect an allocation of assets by
type or class, which we understand investment advisers may use to
inform investors and to educate them about historical trends
regarding asset classes would not be treated as advertisements and
would not be subject to the rule's conditions on the use of
hypothetical performance. For example, the following would not be
considered hypothetical performance under the final rule: A
presentation of performance that illustrates how a portfolio
allocated 60% to equities and 40% to bonds would have performed over
the past 50 years as compared to a portfolio composed of 40%
equities and 60% bonds. Our approach regarding educational
presentations of performance would apply even if the investment
adviser used one of the allocations in managing a strategy being
advertised or illustrated such allocations by reference to relevant
indices or other benchmarks.
---------------------------------------------------------------------------

    The final rule will allow advisers to use interactive analysis
tools, provided that the investment adviser: (1) Provides a description
of the criteria and methodology used, including the investment analysis
tool's limitations and key assumptions; (2) explains that the results
may vary with each use and over time; (3) if applicable, describes the
universe of investments considered in the analysis, explains how the
tool determines which investments to select, discloses if the tool
favors certain investments and, if so, explains the reason for the
selectivity, and states that other investments not considered may have
characteristics similar or superior to those being analyzed; and (4)
discloses that the tool generates outcomes that are hypothetical in
nature.\709\ The fact that an interactive tool uses the same underlying
assumptions does not mean that outputs the tool generates are
advertisements (because the adviser or investor inputs investor-
specific information). We believe that there are adequate investor
protection guardrails in place to allow advisers to provide interactive
analysis tools.\710\
---------------------------------------------------------------------------

    \709\ See final rule 206(4)-1(e)(8)(iv)(A)(4). Such disclosure
could state, for example: ``IMPORTANT: The projections or other
information generated by [name of investment analysis tool]
regarding the likelihood of various investment outcomes are
hypothetical in nature, do not reflect actual investment results and
are not guarantees of future results.''
    \710\ See section 206 of the Advisers Act. See also section
17(a) of the Securities Act, section 10(b) of the Exchange Act (and
rule 10b-5 thereunder), and rule 206(4)-8 under the Advisers Act.
---------------------------------------------------------------------------

    Commenters suggested that we clarify the treatment of broad market
or index-based performance data.\711\ We agree that the use of index-
based data can be informative to investors as a benchmarking tool.\712\
For example, in a scenario where an actual portfolio tracks an index,
information regarding the index's performance can provide useful
information regarding tracking error, sector allocation, and
performance attribution. Accordingly, we believe that an index used as
a performance benchmark in an advertisement would not be hypothetical
performance, unless it is presented as performance that could be
achieved by a portfolio.\713\
---------------------------------------------------------------------------

    \711\ See IAA Comment Letter; CFA Institute Comment Letter
(stating that ``indexes created by the Adviser should be considered
hypothetical performance when the Adviser backtests the index to see
how it would have performed. Other than this case, we do not believe
that benchmarks should be considered hypothetical performance.'').
    \712\ See e.g., IAA Comment Letter; CFA Institute Comment
Letter.
    \713\ See final rule 206(4)-1(e)(8) (defining ``hypothetical
performance'' as ``performance results that were not actually
achieved by any portfolio of the investment adviser''). Although we
would not expect an adviser to comply with the conditions applicable
to hypothetical performance, we would expect the adviser to comply
with the general prohibitions, for instance, by disclosing that the
volatility of the index is materially different from that of the
model or actual performance results with which the index is
compared. Most of the other provisions of the rule would be
irrelevant. For instance, although the conditions on the
presentation of performance would apply, the requirement to show net
performance would be inapplicable because there are no fees or
expenses to deduct from an index. Index information that is provided
for general educational purposes and not, for instance, as a
comparison to the adviser's performance presentation, would not be
considered an advertisement. See supra section II.A.2.a.v.

---------------------------------------------------------------------------

b. Conditions on Presentation of Hypothetical Performance
    Largely as proposed, the final rule will prohibit the presentation
of hypothetical performance in advertisements except under certain
conditions designed to address the potential for hypothetical
performance to mislead investors. First, the adviser must adopt and
implement policies and procedures reasonably designed to ensure that
the hypothetical performance information is relevant to the likely
financial situation and investment objectives of the intended audience
of the advertisement. Second, the adviser must provide sufficient
information to enable the intended audience to understand the criteria
used and assumptions made in calculating such hypothetical performance
(the ``criteria and assumptions''). Third, the adviser must provide
(or, if the intended audience is a private fund investor, provide, or
offer to provide promptly) sufficient information to enable the
intended audience to understand the risks and limitations of using
hypothetical performance in making investment decisions (the ``risk
information'').\714\ For purposes of this discussion, we refer to the
criteria and assumptions and the risk information collectively as the
``underlying information.'' Finally, the final rule does not require an
investment adviser to comply with several conditions applicable to the
presentation of performance information in advertisements, specifically
the requirement to present specific time periods, and the requirements
related to the presentation of related performance, and extracted
performance.\715\
---------------------------------------------------------------------------

    \714\ See final rule 206(4)-1(d)(6)(iii).
    \715\ See id.
---------------------------------------------------------------------------

    Policies and Procedures. In a modification from the proposal, under
the first condition for displaying hypothetical performance information
in advertisements, advisers must adopt and implement policies and
procedures ``reasonably designed to ensure that the hypothetical
performance is relevant to the likely financial situation and
investment objectives'' of the intended audience.\716\ The proposed
condition would have required a higher degree of certainty of the
financial situation and investment objectives of the person to whom the
advertisement is disseminated. Under the final rule, reasonably
designed policies and procedures need not address each recipient's
particular circumstances; rather, the adviser must make a reasonable
judgement about the likely investment objectives and financial
situation of the advertisement's intended audience.
---------------------------------------------------------------------------

    \716\ Final rule 206(4)-1(d)(6)(i).
---------------------------------------------------------------------------

    The final rule will not prescribe the ways in which an adviser may
seek to satisfy the policies and procedures requirement, including how
the adviser will establish that the policies and procedures are
reasonably designed to ensure that the hypothetical performance is
relevant to the likely financial situation and investment objectives of
the intended audience. We have previously used policies and procedures
to establish a defined audience.\717\ We believe that this approach
will provide investment advisers with the flexibility to develop
policies and procedures that best suit their investor base and
operations.
---------------------------------------------------------------------------

    \717\ We have defined ``retail money market fund'' to mean ``a
money market fund that has policies and procedures reasonably
designed to limit all beneficial owners of the fund to natural
persons.'' See 17 CFR 270.2a-7(a)(21); see also Money Market Fund
Reform; Amendments to Form PF, Release No. IA-3879 (July 23, 2014)
[79 FR 47736 (Aug. 14, 2014)], at nn.715-716 and accompanying text.
---------------------------------------------------------------------------

    While one commenter supported the proposed condition,\718\ several
commenters suggested that we eliminate it because it is too subjective
and difficult to implement.\719\ One commenter suggested that the
condition not apply to institutional investors,\720\ while another
commenter stated that the condition imposes a standard so high that an
adviser could not satisfy the standard for retail investors.\721\
Another commenter suggested that we clarify that the proposed condition
would not require an adviser to have knowledge of the specific
individual circumstances or financial condition of each investor
receiving hypothetical performance from the adviser.\722\
---------------------------------------------------------------------------

    \718\ See Consumer Federation Comment Letter.
    \719\ See, e.g., MMI Comment Letter (stating this condition
would be difficult, if not impossible, to satisfy for an
advertisement that would be disseminated to a large number of
people); SIFMA AMG Comment Letter II; Wellington Comment Letter.
    \720\ See Credit Suisse Comment Letter.
    \721\ See CFA Institute Comment Letter.
    \722\ See Comment Letter of Flexible Plan Investments, Ltd. on
proposed advertising rule (Feb. 10, 2020) (``Flexible Plan
Investments Comment Letter II'') (noting that the relevancy
requirement would be difficult to administer because ``[i]t will be
dependent on knowing in many cases the exact person to whom the use
of (sic) hypothetical performance is being delivered.'').
---------------------------------------------------------------------------

    We continue to believe that this condition, as modified, will
ensure that advisers provide advertisements containing relevant
hypothetical performance to the appropriate audience without creating
unnecessary compliance burdens. In response to commenters' concerns,
however, the final rule will specify that the policies and procedures
must be reasonably designed to ensure that hypothetical performance is
relevant to the likely financial situation and investment objectives of
the intended audience. We added the qualifier ``likely'' to clarify
that an adviser is not required to know the actual financial situation
or investment objectives of each investor that receives hypothetical
performance. We also replaced the word ``person'' with ``intended
audience'' to clarify that advisers can comply with this condition, as
well as the other conditions related to hypothetical performance, by
grouping investors into categories or types, and to emphasize that an
investor might not be a natural person. We believe that these changes
will ease the compliance burdens commenters identified.
    This condition is designed to help ensure that an adviser provides
advertisements containing hypothetical performance information only to
those investors with the resources and financial expertise.
Hypothetical performance may not be relevant to the likely financial
situation and investment objectives of and may be misleading for
investors that do not have the resources and financial expertise. For
example, analysis of hypothetical performance may require tools and/or
other data to assess the impact of assumptions driving hypothetical
performance, such as factor or other performance attribution, fee
compounding, or the probability of various outcomes. Without being able
to subject hypothetical performance to additional analysis, this
information could tell an investor little about an investment adviser's
process or other information relevant to a decision to hire the
adviser. Instead, providing hypothetical performance to an investor
that does not have access to the resources and financial expertise
needed to assess the hypothetical performance and underlying
information could mislead the investor to believe something about the
adviser's experience or ability that is unwarranted. We believe that
advisers generally would not be able to include hypothetical
performance in advertisements directed to a mass audience or intended
for general circulation. In that case, because the advertisement would
be available to mass audiences, an adviser generally could not form any
expectations about

their financial situation or investment objectives.
    The adviser's past experiences with particular types of investors
should lead the adviser to design reasonable policies and procedures
that distinguish among investor types and whether hypothetical
performance is relevant to the likely financial situation and
investment objectives of an audience composed of that type. Such
policies and procedures could distinguish investor types on the basis
of criteria, such as previous investments with the adviser, net worth
or investing experience if that information is available to the
adviser, certain regulatory defined categories (e.g., qualified
purchasers or qualified clients), or whether the intended audience
includes only natural persons or only institutions.
    An adviser could determine that certain hypothetical performance
presentations are relevant to the likely financial situation and
investment objectives of certain types of investors based on routine
requests from those types of investors in the past. For example, an
adviser, based on its past experience, might be able to reasonably
conclude that hypothetical performance would be relevant to investors
who meet certain financial sophistication standards such as qualified
client \723\ or qualified purchaser.\724\ The adviser could explain in
its policies and procedures why it believes that hypothetical
performance is relevant for this intended audience. In addition, an
adviser's policies and procedures should address how the adviser's
dissemination of the advertisement would seek to be limited to that
audience. As discussed above, hypothetical performance directed to mass
audiences generally will not be able to meet this standard.
---------------------------------------------------------------------------

    \723\ See rule 205-3(d)(1) under the Act.
    \724\ See section 2(a)(51) of the Investment Company Act.
---------------------------------------------------------------------------

    One commenter expressed concerns that this condition would pose a
compliance challenge for advisers to private funds because they do not
have insight into potential investors, especially prior to the time
when subscription documents are disseminated.\725\ Because an adviser's
policies and procedures should be informed by its prior experience with
certain investor types, an adviser that plans to advise a private fund
can develop policies and procedures that take into account its
experience advising a prior private fund for which it raised money from
investors. That experience might indicate that investors in the vehicle
valued a particular type of hypothetical performance because, for
example, the investors used it to assess the adviser's strategy and
investment process. Similarly, an adviser could determine, based on its
experience, that hypothetical performance is not relevant to the likely
financial situation and investment objectives of certain investors and
reflect such determination in its policies and procedures. New advisers
that do not have prior client experiences to inform their determination
of the intended audience can rely on other resources, including
information they have gathered from potential investors (e.g.,
questionnaires, surveys, or conversations) and academic research, to
help identify the intended audience in connection with the three
hypothetical performance conditions.\726\
---------------------------------------------------------------------------

    \725\ See Ropes & Gray Comment Letter.
    \726\ Advisers may already be required to comply with similar
provisions under other regulatory regimes that also require advisers
to consider the recipient when disseminating communications. See,
e.g., FINRA rule 2210(d)(1)(E) (``Members must consider the nature
of the audience to which the communication will be directed and must
provide details and explanations appropriate to the audience.'');
Global Investment Performance Standards (GIPS) for Firms (2020),
Provision 1.A.11; GIPS Standards Handbook for Firms (Nov. 2020),
Discussion of Provision 1.A.11.
---------------------------------------------------------------------------

    One commenter expressed concern that this condition would
effectively restrict hypothetical performance only to a sub-set of
investors with the financial and analytical resources to analyze such
performance even if an investor outside of this sub-set specifically
requested the information.\727\ As noted above, we believe that it is
appropriate to apply the hypothetical performance conditions to
communications that otherwise meet the definition of advertisement,
even if they take place in one-on-one settings due to the potential for
such information to mislead investors. However, advisers would still be
able to provide investors with interactive financial analysis tools
without subjecting those tools to the hypothetical performance
conditions.
---------------------------------------------------------------------------

    \727\ See CFA Institute Comment Letter (suggesting that ``an
[a]dviser could consider hypothetical performance to be relevant to
the financial situation and investment objectives of the person if
the person has expressed interest in the strategy or the [a]dviser
has determined it is an appropriate strategy for the investor based
on their (sic) investment needs'').
---------------------------------------------------------------------------

    Criteria and Assumptions. The second condition for the presentation
of hypothetical performance will require the adviser to provide
sufficient information to enable the intended audience to understand
the criteria used and assumptions made in calculating the hypothetical
performance.\728\ The rule does not prescribe any particular
methodology or calculation for the different categories of hypothetical
performance, just as it does not prescribe methodologies or
calculations for actual performance. Instead, advisers must provide the
information about criteria and assumptions so that the intended
audience can understand how the hypothetical performance was
calculated. We are adopting the second condition largely as proposed,
except that we are replacing the phrase ``such person'' with ``the
intended audience'' for consistency with the first condition, as
discussed above. In addition, and in response to one commenter's
concerns,\729\ we are clarifying that the adviser is responsible for
providing sufficient information as we agree that it would not be
workable to require advisers to have a precise understanding of exactly
what each investor needs in order to allow that investor to understand
the calculations and assumptions underlying the hypothetical
performance.\730\
---------------------------------------------------------------------------

    \728\ See final rule 206(4)-1(d)(6)(ii). We would consider any
calculation information provided alongside the hypothetical
performance to be a part of the advertisement and therefore subject
to the books and records rule. See infra section II.I.
    \729\ See Flexible Plan Investments Comment Letter II.
    \730\ This obligation would be similar to an adviser's
obligation to provide full and fair disclosure to its clients of all
material facts relating to the advisory relationship and of
conflicts of interest. See Fiduciary Interpretation, supra footnote
8888, at n.70 (stating that institutional clients, as compared to
retail clients, generally have a greater capacity and more resources
to analyze and understand complex conflicts and their
ramifications).
---------------------------------------------------------------------------

    Several commenters expressed concern that this condition would
require advisers to disclose proprietary or confidential information
\731\ due to the statement in the proposal that this condition may
require advisers to provide the ``methodology used in calculating and
generating the hypothetical performance.'' \732\ To clarify, we do not
expect advisers to disclose proprietary or confidential information to
satisfy this condition. We expect that a general description of the
methodology used would be sufficient information for an investor to
understand how it was generated.
---------------------------------------------------------------------------

    \731\ See, e.g., Withers Bergman Comment Letter; MFA/AIMA
Comment Letter I; Resolute Comment Letter.
    \732\ See 2019 Proposing Release, supra footnote 7, at section
II.A.5.c.iv.
---------------------------------------------------------------------------

    Under the final rule, the condition will not require an adviser to
provide information that would be necessary to allow the intended
audience to replicate the performance (e.g., information that is
confidential or proprietary). With

respect to assumptions, investment advisers should provide information
that includes any assumptions on which the hypothetical performance
rests--e.g., in the case of targeted or projected returns, the
adviser's view of the likelihood of a given event occurring.
    Commenters suggested that we not require advisers to disclose the
extent to which hypothetical performance is based on the likelihood of
an event occurring because this would require advisers to make
speculative statements.\733\ Yet, commenters agreed that an adviser
should disclose the assumptions it has made.\734\
---------------------------------------------------------------------------

    \733\ See, e.g., NYC Bar Comment Letter; AIC Comment Letter.
    \734\ See, e.g., NYC Bar Comment Letter; AIC Comment Letter
(stating that the requirements of the second condition are
``consistent with market practice'' but that advisers should not be
required to state the likelihood that a given event would occur).
---------------------------------------------------------------------------

    It is our view that assumptions underlying hypothetical performance
should be interpreted to include assumptions that future events will
occur. We believe that hypothetical performance, by its nature,
contains a speculative element; therefore, requiring advisers to
disclose the assumptions that informed a model aligns with the types of
restrictions we seek to place on performance presentation that have a
high potential to mislead investors. We believe advisers should provide
this information so that the intended audience is able to determine, in
part, how much value to attribute to the hypothetical performance.
Without information regarding criteria and assumptions, we believe that
such performance would be misleading even to an investor with the
resources and financial expertise to evaluate it.
    Risk Information. The final rule will require the adviser to
provide--or, if the intended audience is a private fund investor, to
provide, or offer to provide promptly--sufficient information to enable
the intended audience to understand the risks and limitations of using
the hypothetical performance in the advertisement in making investment
decisions.\735\
---------------------------------------------------------------------------

    \735\ See final rule 206(4)-1(d)(6)(iii).
---------------------------------------------------------------------------

    Commenters generally supported this condition.\736\ However, one
commenter suggested that we add a reasonableness component in order to
provide more flexibility, requiring advisers to provide reasonably
sufficient information.\737\ We do not believe this change is necessary
as we believe that advisers' consideration of the intended audience
will provide advisers with flexibility and alleviate some of the
burdens imposed by these conditions. In a change from the proposal, we
replaced ``Non-Retail Person'' with ``an investor in a private fund''
in order to align with broader changes to the rule (i.e., to dispense
with the distinction between Retail and Non-Retail Persons).\738\ As
explained above, we also replaced references to ``such person'' with
``the intended audience.'' After considering comments,\739\ the final
rule will not require advisers to provide private fund investors with
information on the risks and limitations of using the advertised
hypothetical performance. Instead, advisers can merely offer to
promptly provide such information.
---------------------------------------------------------------------------

    \736\ See CFA Institute Comment Letter; Withers Bergman Comment
Letter.
    \737\ See Flexible Plan Investments Comment Letter II.
    \738\ See proposed rule 206(4)-1(c)(1)(v)(C) (requiring an
adviser to ``[p]rovide[ ] (or, if such person is a non-retail
person, provide[ ] or offer[ ] to provide promptly) sufficient
information to enable such person to understand the risks and
limitations of using such hypothetical performance in making
investment decisions.'').
    \739\ See, e.g., Ropes & Gray Comment Letter; IAA Comment
Letter; AIC Comment Letter.
---------------------------------------------------------------------------

    With respect to risks and limitations, investment advisers should
provide information that would apply to both hypothetical performance
generally and to the specific hypothetical performance presented--e.g.,
if applicable, that hypothetical performance reflects certain
assumptions but that the adviser generated dozens of other, varying
performance results applying different assumptions. Risk information
should also include any known reasons why the hypothetical performance
might differ from actual performance of a portfolio--e.g., that the
hypothetical performance does not reflect cash flows into or out of the
portfolio. This risk information will, in part, enable the intended
audience to understand how much value to attribute to the hypothetical
performance in deciding whether to hire or retain the investment
adviser or invest in a private fund managed by the adviser. An adviser
should tailor its risk information to its intended audience.
    In addition, any communication that is an advertisement under the
first prong of the definition of advertisement, and that includes
hypothetical performance, will be required to comply with the general
prohibitions.\740\ As a result, the rule will prohibit advisers from
presenting hypothetical performance in such advertisements in a
materially misleading way. For example, we would view an advertisement
as including an untrue statement of material fact if the advertised
hypothetical performance reflected the application of rules, criteria,
assumptions, or general methodologies that were materially different
from those stated or applied in the underlying information of such
hypothetical performance. Also, we would view it as materially
misleading for an advertisement to present hypothetical performance
that discusses any potential benefits resulting from the adviser's
methods of operation without providing fair and balanced discussion of
any associated material risks or material limitations associated with
the potential benefits.\741\ Similarly, an adviser can meets its
obligation with respect to an advertisement presenting hypothetical
performance that includes an offer to promptly provide risk information
to a private fund investor if the adviser makes reasonable efforts to
promptly provide such information upon the investor's request.
---------------------------------------------------------------------------

    \740\ See supra section II.B.
    \741\ See final rule 206(4)-1(a)(4).
---------------------------------------------------------------------------

F. Portability of Performance, Testimonials, Endorsements, Third-Party
Ratings, and Specific Investment Advice

    Among the performance results that an investment adviser may seek
to advertise are those of groups of investments or accounts for which
the adviser, its personnel, or its predecessor investment adviser firms
have provided investment advice in the past as or at a different
entity. In some cases, an investment adviser may seek to advertise the
performance results of portfolios managed by the investment adviser
before it was spun out from another adviser. Alternatively, an adviser
may seek to advertise performance achieved by its investment personnel
when they were employed by another investment adviser. This may occur,
for example, when a portfolio management team leaves one advisory firm
and joins another advisory firm or begins its own firm. Predecessor
performance results may be directly relevant to an audience when the
advertisement offers services to be provided by the personnel
responsible for the predecessor performance, even when the personnel
did not work for the adviser disseminating the advertisement (the
``advertising adviser'') during the period for which performance is
being advertised.\742\
---------------------------------------------------------------------------

    \742\ The term ``predecessor performance'' is defined in final
rule 206(4)-1(e) and refers to all situations where an investment
adviser presents investment performance achieved by a group of
investments consisting of an account or a private fund that was not
advised by the investment adviser at all times during the period
shown.
---------------------------------------------------------------------------

    We believe that the presentation of predecessor performance can
mislead

investors, especially, for example, when: (i) The team that was
primarily responsible for the predecessor performance is different from
the team whose advisory services are being offered in the
advertisement, (ii) an individual who played a significant part in
achieving the predecessor performance is not a member of the
advertising adviser's investment team,\743\ (iii) the adviser that
generated the performance underwent a restructuring, reorganization, or
sale,\744\ or (iv) an advertising adviser does not clearly disclose
that the performance was achieved at a different entity.
---------------------------------------------------------------------------

    \743\ See, e.g., Fiduciary Management Associates, Inc., SEC
Staff No-Action Letter (Feb. 2, 1984) (``Fiduciary Management
Letter'').
    \744\ See, e.g., South State Bank, SEC Staff No-Action Letter
(May 8, 2018) (``South State Bank Letter'') (the staff stated that
it would not recommend enforcement action based on representations
designed to ensure advisory clients would not be misled if clients
attributed the predecessor adviser's performance to the advertising
adviser, including, for example, that it would operate in the same
manner and under the same brand name as the predecessor adviser).
---------------------------------------------------------------------------

    We have previously identified characteristics of a restructuring,
sale, or reorganization (collectively, ``reorganization'') that likely
support a finding that an adviser's business continued to exist where:
There was a substantial and direct business nexus between the successor
and predecessor advisers; the reorganization was not designed to
eliminate substantial liabilities and/or spin off personnel; and, if
applicable, the successor adviser assumed substantially all of the
assets and liabilities of the predecessor adviser.\745\ Under the final
rule, we would consider similar factors when analyzing the extent to
which an advertising adviser must treat a predecessor adviser's
performance as predecessor performance. For example, we do not believe
that a change of brand name, without additional differences between the
advisory entity before and after the restructuring, would render its
past performance as ``predecessor performance.'' Likewise, a mere
change in the form of legal organization (e.g., from a corporation to
limited liability company) or a change in ownership of the adviser
would likely not raise the concerns described in this section.
---------------------------------------------------------------------------

    \745\ See Registration of Successors to Broker-Dealers and
Investment Advisers, Release No. IA-1357 (Dec. 28, 1992) [58 FR 7-01
(Jan. 4, 1993)].
---------------------------------------------------------------------------

    In the proposal, we considered whether applying the rule's general
prohibitions and the more specific performance advertising restrictions
would sufficiently alleviate our concerns,\746\ or whether specific
rule provisions would more appropriately address those concerns.\747\
For example, we questioned whether the untrue or misleading implication
general prohibition would prevent the display of predecessor
performance containing an untrue or misleading implication about a
material fact relating to the advertising adviser. As another example,
we stated that, depending on the circumstances, predecessor performance
results that exclude accounts managed in a substantially similar manner
at the predecessor firm may be misleading and implicate the proposed
general prohibitions in the rule. We stated that such presentations
could result in the inclusion or exclusion of performance results in a
manner that is neither accurate nor fair and balanced. Accordingly, we
requested comment on whether the advertising rule should include
additional provisions on the presentation of predecessor performance
results, and we specifically asked about the approach our staff has
taken in providing guidance on this issue under the current rule.\748\
---------------------------------------------------------------------------

    \746\ See proposed rule 206(4)-1(a) and (c).
    \747\ For the discussion that follows, see generally 2019
Proposing Release, supra footnote 7, at section II.A.6.
    \748\ See Horizon Asset Management, LLC, SEC Staff No-Action
Letter (Sept. 13, 1996) (``Horizon Letter''); Great Lakes Advisers,
Inc., SEC Staff No-Action Letter (Apr. 3, 1992) (``Great Lakes
Letter''); Fiduciary Management Letter; South State Bank Letter. We
requested comment on a number of the issues raised by predecessor
performance. See 2019 Proposing Release, supra footnote 7, at
section II.A.6.
---------------------------------------------------------------------------

    Some commenters supported the addition of a provision on this
topic, urging us to address predecessor performance in the final
rule.\749\ Two commenters supported the approach our staff took in its
no-action letters and suggested we adopt a rule that would draw from
those requirements, with minor modifications.\750\ In light of these
comments, we believe that placing explicit guardrails on displays of
predecessor performance will increase investor protection, in addition
to the general prohibitions. Moreover, we expect that clarifying our
views on positions taken by our staff over the years will promote
consistency of practices among advisory firms and thereby level the
playing field.
---------------------------------------------------------------------------

    \749\ See IAA Comment Letter; CFA Institute Comment Letter
(supporting specific provisions on predecessor performance, but
suggesting compliance with GIPS standards); Fried Frank Comment
Letter (stating that the final rule should explicitly address
predecessor performance and supporting a ``principles-based,
disclosure-driven approach'' that has a similar framework as the
proposed approach to hypothetical performance); Comment Letter of
SIFMA (Supplemental) (June 5, 2020) (``SIFMA Supplemental Comment
Letter'').
    \750\ See IAA Comment Letter; SIFMA Supplemental Comment Letter.
---------------------------------------------------------------------------

    Investments advisers will be prohibited from displaying predecessor
performance in an advertisement, unless the following requirements are
satisfied:
    (A) The person or persons who were primarily responsible for
achieving the prior performance results manage accounts at the
advertising adviser;
    (B) the accounts managed at the predecessor investment adviser are
sufficiently similar to the accounts managed at the advertising adviser
that the performance results would provide relevant information to
investors;
    (C) all accounts that were managed in a substantially similar
manner are advertised unless the exclusion of any such account would
not result in materially higher performance and the exclusion of any
account does not alter the presentation of any prescribed time periods;
and
    (D) the advertisement clearly and prominently includes all relevant
disclosures, including that the performance results were from accounts
managed at another entity.\751\
---------------------------------------------------------------------------

    \751\ See final rule 206(4)-1(d)(7)(iv); see also 2019 Proposing
Release, supra footnote 7, at sections II.A.5.c.ii and II.A.6.
---------------------------------------------------------------------------

    In addition to applying these specific provisions, advisers should
consider the extent to which other provisions of the advertising rule,
such as the general prohibitions (including those pertaining to the
fair and balanced presentation of information), apply to any display of
predecessor performance.
    Primarily Responsible. In order to present predecessor performance
in an advertisement, the person or persons who were primarily
responsible for achieving the prior performance results while employed
at the predecessor firm must manage accounts at the advertising
adviser.\752\ We believe that the ``primarily responsible'' requirement
will help place critical guardrails on the use of predecessor
performance and will require advisers to focus on the role that the
individual played in producing the performance (e.g., the extent of the
person's decision-making authority or influence). Advisers should
consider the substantive responsibilities of those who are responsible
for generating the performance at issue and, where more than one
individual is primarily

responsible for making investment decisions, whether a substantial
identity of the group responsible for achieving the prior performance
have moved over to the advertising adviser. We anticipate that this
principles-based approach will address scenarios where a committee
makes the investment decisions and where a single person is responsible
for investment decisions. Where a committee managed the group of
investments at the predecessor firm, a committee comprising a
substantial identity of the membership must manage the portfolios at
the advertising adviser.\753\
---------------------------------------------------------------------------

    \752\ See final rule 206(4)-1(d)(7)(i). Our staff has applied a
similar principle when considering the presentation of predecessor
performance. See Horizon Letter (stating that the staff would not
find a display of predecessor performance to be in and of itself
misleading based on several representations, including that ``the
person or persons who manage accounts at the adviser were also those
primarily responsible for achieving the prior performance
results'').
    \753\ Our staff applied a similar principle when considering
investment teams or committees. See Great Lakes Letter, at n.4
(staff declined to take a no-action position where only one person
from a three-person committee transferred from the predecessor
adviser to the advertising adviser and where the other two
individuals played a significant role stating that, ``at a minimum,
there would have to be a substantial identity of personnel among the
predecessor's and successor's committees.''); Horizon Letter (staff
stated that it would not recommend enforcement action under rule
206(4)-1 where one individual was primarily responsible for
achieving performance results at the predecessor firm and, upon
joining the advertising adviser, would be a member of a three-person
committee. The individual would still have final decision-making
authority and the other committee members would only advise the sole
decision-maker.).
---------------------------------------------------------------------------

    A person or group of persons is ``primarily responsible'' for
achieving prior performance results if the person makes or the group
makes investment decisions.\754\ Where more than one person is involved
in making investment decisions, advisers should consider the authority
and influence that each person has in making investment decisions.\755\
---------------------------------------------------------------------------

    \754\ Commenters generally supported applying guardrails to
displays of predecessor performance based on existing staff no-
action letters and industry best practices. See IAA Comment Letter
(citing Horizon Letter, South State Bank Letter, Great Lakes Letter,
Fiduciary Management Letter, and Conway Asset Management, Inc., SEC
Staff No-Action Letter (Jan. 27, 1989)); Fried Frank Comment Letter;
SIFMA Supplemental Comment Letter.
    \755\ See 2019 Proposing Release, supra footnote 7, at section
II.A.6. (stating that it may be difficult to attach relative
significance to the role played by each group member where an
adviser selects portfolio securities by consensus or committee
decision-making). See also Great Lakes Letter; Horizon Letter.
Commenters generally supported the positon our staff has taken in
no-action letters on predecessor performance where a committee makes
investment decisions. See, e.g., IAA Comment Letter (suggesting that
the final rule require that ``substantially all of the investment
decision-makers who manage accounts at the adviser are those
primarily responsible for achieving the prior performance
results'').
---------------------------------------------------------------------------

    Sufficiently similar accounts. Under the final rule, an advertising
adviser may not present predecessor performance in an advertisement
unless the accounts managed at the predecessor and advertising advisers
are ``sufficiently similar'' in order to ensure the investor receives
relevant information.\756\ Prior staff letters took no-action positions
with accounts that were ``so similar'' to the advertised accounts.\757\
We believe that the language in the final rule provides advisers
appropriate flexibility in displaying predecessor performance and would
not result in investor confusion.
---------------------------------------------------------------------------

    \756\ See final rule 206(4)-1(d)(7)(ii). Our staff applied a
similar principle when considering whether displays of predecessor
performance would be relevant to investors. See Horizon Letter
(stating that the staff would not find a display of predecessor
performance to be in and of itself misleading based on several
representations, including that ``the accounts managed at the
predecessor entity are so similar to the accounts currently under
management that the performance results would provide relevant
information to prospective clients'').
    \757\ See IAA Comment Letter (suggesting that the Commission
require the accounts to be ``sufficiently similar'' instead of ``so
similar'').
---------------------------------------------------------------------------

    Managed in a substantially similar manner. Under the final rule, an
investment adviser using predecessor performance in an advertisement
will be required to display all accounts that were managed in a
``substantially similar manner'' at the predecessor adviser, unless
excluding any account would not result in materially higher performance
and the exclusion of any account does not alter the presentation of any
applicable time periods required by the rule.\758\ This condition
mirrors the related performance provisions of the final rule, which
requires investment advisers to include all related portfolios and only
permits an adviser to exclude a related portfolio if performance would
not be materially higher and if the exclusion of any related portfolio
does not alter the presentation of any applicable time periods required
by the rule.\759\ Accounts that are managed in a substantially similar
manner are those with substantially similar investment policies,
objectives, and strategies.\760\ As a result, advisers can use the same
approach for determining the scope of the accounts that are managed in
a substantially similar manner as they use to determine which accounts
are related portfolios for purposes of displaying related performance.
---------------------------------------------------------------------------

    \758\ See final rule 206(4)-1(d)(7)(iii). Our staff applied a
similar principle when considering whether displays of predecessor
performance would be relevant to investors. See Horizon Letter
(stating that the staff would not find a display of predecessor
performance to be in and of itself misleading based on several
representations, including that ``all accounts that were managed in
a substantially similar manner are advertised unless the exclusion
of any such account would not result in materially higher
performance''); IAA Comment Letter (supporting this provision).
    \759\ See final rule 206(4)-1(d)(4); 2019 Proposing Release,
supra footnote 7, at section II.A.5.c.ii, n.279.
    \760\ See final rule 206(4)-1(e)(15). Our staff has stated that
it would not recommend enforcement action if advisers present
predecessor performance where the adviser presents the composite
performance of all of the predecessor firm's accounts that had the
same investment objectives and were managed using the same
investment strategies that the adviser will manage at the new firm.
See Horizon Letter.
---------------------------------------------------------------------------

    An adviser that chooses to display predecessor performance
information in an advertisement must consider the related performance
requirements of the final rule. For example, if an adviser includes
predecessor performance and the advertising adviser manages accounts
that are related portfolios to those groups of investments depicted in
the predecessor performance, then the advertising adviser must include
these related portfolios in its performance display.\761\
---------------------------------------------------------------------------

    \761\ In presenting such performance, advisers should also
consider the general prohibitions and other performance advertising
provisions of the final rule.
---------------------------------------------------------------------------

    Relevant disclosures. The final rule will require an adviser to
clearly and prominently include all relevant disclosures and indicate
that the performance results were from accounts managed at another
entity.\762\ While what disclosures are ``relevant'' will depend on the
facts and circumstances, we agree with a commenter's suggestion that
the fact that the performance was generated from accounts managed at
another entity will always be relevant. Accordingly, the final rule
will explicitly require this disclosure.\763\ Additionally, advisers
should consider what disclosures would be appropriate to comply with
the other provisions of the final rule, such as the general
prohibitions.
---------------------------------------------------------------------------

    \762\ See final rule 206(4)-1(d)(7)(iv). Our staff applied a
similar principle when considering whether displays of predecessor
performance would be relevant to investors. See Horizon Letter
(stating that the staff would not find a display of predecessor
performance to be in and of itself misleading based on several
representations, including that ``the advertisement includes all
relevant disclosures, including that the performance results were
from accounts managed at another entity.''). Disclosures that are
subject to a clear and prominent standard under final rule 206(4)-1
should be included within the advertisement. See supra footnote 286.
    \763\ See IAA Comment Letter (suggesting the addition of
``including that the performance results were from accounts managed
at another entity'' to the rule text).
---------------------------------------------------------------------------

    Our amendments to the books and records rule will require an
adviser to retain records to support the performance presented.\764\ We
believe that, in order to avoid misleading presentations of predecessor

performance, an adviser must have access to the books and records
underlying the performance.\765\ We have applied this concept more
generally under the final rule, which will also require that an adviser
have a reasonable basis for believing that it will be able to
substantiate (upon demand by the Commission) all material statements of
fact contained in an advertisement.\766\
---------------------------------------------------------------------------

    \764\ See final rule 204-2(a)(16). See also Great Lakes Letter
(stating that rule 204-2(a)(16) applies to a successor's use of a
predecessor's performance data).
    \765\ Our staff took this approach in stating that it would not
recommend enforcement action under section 206 of the Advisers Act
or the current advertising rule if an advertising adviser presents
performance results achieved at another firm based on several
representations, including that the advertising adviser would keep
the books and records of the predecessor firm that are necessary to
substantiate the performance results in accordance with rule 204-
2(a)(16). See Horizon Letter; see also Great Lakes Letter, at n.3
(stating that rule 204-2(a)(16) ``applies also to a successor's use
of a predecessor's performance data''). We understand that
investment advisers who consider this staff no-action letter
currently keep copies of all advertisements containing performance
data and all documents necessary to form the basis of those
calculations.
    \766\ See final rule 206(4)-1(a)(2).
---------------------------------------------------------------------------

    Certain commenters that addressed this aspect of the proposal
requested that we preserve flexibility for the types of records that
support predecessor performance,\767\ while another commenter disagreed
that flexibility was appropriate and suggested permitting predecessor
performance only where the records required under rule 204-2 were
available.\768\ Without supporting information, we are concerned about
the accuracy of such performance displays and that such information
could be misleading. We do not believe that an advertising adviser
could recreate performance based on a sampling of investor statements
and/or display performance from a prior firm because we are concerned
that such an approach has a heightened risk of cherry picking
performance. Allowing a sampling of information to support performance
displays is inconsistent with our general approach to require advisers
to display all applicable performance (e.g., related performance) to
mitigate these cherry-picking concerns.
---------------------------------------------------------------------------

    \767\ See SIFMA AMG Comment Letter II; IAA Comment Letter
(stating that an adviser should be permitted to substantiate
performance using publicly available information and audit or
verification statements); MarketCounsel Comment Letter (noting that
the books and records of the predecessor firm are often unavailable
due to contractual or privacy restrictions and suggesting that the
Commission permit advertising advisers to recreate performance based
on a sampling of client statements and/or display performance from a
prior firm in a scenario where the advertising adviser has a copy of
the advertisement and where the prior firm was subject to the books
and records rule).
    \768\ See CFA Institute Comment Letter (stating that alternative
books and records requirements should not be an option for
predecessor performance because verification reports will not
satisfy the books and records requirements in most cases, nor would
performance information that has been subject to a financial
statement audit).
---------------------------------------------------------------------------

    Because the final rule addresses the portability of adviser
performance, our staff will withdraw several no-action letters our
staff has issued on this topic.\769\ However, other related letters
will not be withdrawn in connection with this rulemaking since they
address different activity than the activity covered by our final rule
text on predecessor performance. Those letters address topics including
an adviser's use of performance generated by predecessor accounts
(e.g., separate accounts or private funds) in RIC advertisements and
filings \770\ and the establishment of pools in order to generate
performance track records.\771\ These letters generally address the use
of performance from predecessor accounts (i.e., where the same adviser
uses performance generated by one investment vehicle in an
advertisement for another product) rather than performance of a
predecessor advisory firm.\772\
---------------------------------------------------------------------------

    \769\ See infra section II.J.
    \770\ See, e.g., MassMutual Institutional Funds, SEC Staff No-
Action Letter (Sept. 28, 1995); Nicholas-Applegate, SEC Staff No-
Action Letter (Aug. 6, 1996); Growth Stock Outlook Trust Inc., SEC
Staff No-Action Letter (Apr. 15, 1986).
    \771\ See Dr. William Greene, SEC Staff No-Action Letter (Feb.
3, 1997).
    \772\ See, e.g., Salomon Brothers Asset Management Inc., SEC
Staff No-Action Letter (July 23, 1999). See also, Jennison
Associates LLC, SEC Staff No-Action Letter (July 6, 2000).
---------------------------------------------------------------------------

    Although we requested comment on the portability of testimonials,
endorsements, third-party ratings, and specific investment advice,\773\
commenters did not address these topics. To the extent that
testimonials, endorsements, third-party ratings, and specific
investment advice contain performance from a predecessor firm, the
general prohibitions apply to such testimonials, endorsements, and
third-party ratings. We do not believe we need to address their
portability specifically as the general prohibitions, depending on the
facts and circumstances, will have the effect of prohibiting advisers
from presenting misleading information to investors by using outdated
testimonials, endorsements, and third-party ratings.
---------------------------------------------------------------------------

    \773\ See 2019 Proposing Release, supra footnote 7, at section
II.A.6.
---------------------------------------------------------------------------

G. Review and Approval of Advertisements

    The final rule will not require investment advisers to review and
approve their advertisements prior to dissemination, unlike the
proposal. The proposed advertising rule would have required an adviser
to have an advertisement reviewed and approved for consistency with the
requirements of the proposed rule by a designated employee before
disseminating the advertisement, except in certain circumstances.\774\
We proposed this requirement because we believed it might reduce the
likelihood of advisers violating the proposed rule. We believed it was
important that investment advisers implement a process designed to
promote compliance with the proposed rule's requirements. We also
proposed to require that advisers create and maintain a written record
of the review and approval of the advertisement, which would have
allowed our examination staff to better review adviser compliance with
the rule.
---------------------------------------------------------------------------

    \774\ See proposed rule 206(4)-1(d).
---------------------------------------------------------------------------

    Many commenters opposed this requirement or suggested modifications
to it. Commenters expressed concern that it would impose a significant
compliance burden on advisers, especially smaller firms.\775\ Many
commenters also argued that such a requirement would be duplicative of
the compliance rule, pointing out that most advisers already have
implemented policies and procedures to review advertisements for
accuracy prior to dissemination.\776\ Other commenters stated that an
inflexible review and approval requirement covering nearly all
advertisements would impair an adviser's ability to communicate timely
with clients, resulting in poor client service or slow responses during
periods of market volatility.\777\ Commenters claimed that the
proposal, which did not exclude one-on-one communications from the
definition of advertisement, would effectively require advisers to
screen all communications to assess whether a communication would
constitute an advertisement subject to the review and approval
requirement, or met one of the requirement's exceptions.\778\
Consequently, some of these commenters suggested that if we adopt this
requirement, the final rule should expand the exceptions to include,
for example, responses to questions that contain pre-approved template
language, advertisements to Non-Retail

Persons, and interactive social media content.\779\
---------------------------------------------------------------------------

    \775\ See, e.g., FPA Comment Letter; MFA/AIMA Comment Letter I.
    \776\ See, e.g., SBIA Commenter Letter; SIFMA AMG Comment Letter
I.
    \777\ See, e.g., Commonwealth Comment Letter.
    \778\ See, e.g., NSCP Comment Letter; SIFMA AMG Comment Letter
I.
    \779\ See, e.g., MFA/AIMA Comment Letter I; MMI Comment Letter;
ICE Comment Letter.
---------------------------------------------------------------------------

    After considering these comments, we are not adopting the proposed
internal review and approval requirement. Instead, we believe an
adviser's existing obligations under the compliance rule will allow an
adviser to tailor its compliance program to its own advertising
practices to prevent violations from occurring, detect violations that
have occurred, and correct promptly any violations that have
occurred.\780\ In adopting the compliance rule, the Commission stated
that investment advisers should adopt policies and procedures that
address ``. . . the accuracy of disclosures made to investors, clients,
and regulators, including account statements and advertisements.''
\781\ We believe for these compliance policies and procedures to be
effective, they should include objective and testable means reasonably
designed to prevent violations of the final rule in the advertisements
the adviser disseminates.
---------------------------------------------------------------------------

    \780\ See Compliance Program Adopting Release, supra footnote
371, at 74716. Rule 206(4)-7 makes it unlawful for an investment
adviser to provide investment advice unless the adviser has adopted
and implemented written policies and procedures reasonably designed
to prevent violations of the Advisers Act and rules that the
Commission has adopted under the Act, which will include final rule
206(4)-1 and its specific requirements. See rule 206(4)-7(a). Rule
206(4)-7 also requires investment advisers to review, no less than
annually, the adequacy of the policies and procedures and the
effectiveness of their implementation, and to designate who is
responsible for administering the policies and procedures adopted
under the rule. See id. at (b)-(c).
    \781\ See Compliance Program Adopting Release, supra footnote
371, at 74716.
---------------------------------------------------------------------------

    Advisers can establish such an objective and testable compliance
policies and procedures through a variety of tools. For example,
internal pre-review and approval of advertisements could serve as an
effective component of an adviser's compliance program. Other effective
methods to prevent issues could include reviewing a sample of
advertisements based on risk or pre-approving templates. Effective
methods to detect and correct promptly violations and adjust practices
to prevent future violations might include spot-checking advertisements
and periodic reviews.\782\ Commenters confirmed our understanding that
the internal policies and procedures of many advisers currently require
some level of review for advertisements, although not pre-review of
every advertisement.\783\ Advisers should also consider the extent to
which reasonably designed policies and procedures should involve
training on the requirements and prohibitions of the advertising rule
for any employee(s) involved in the creation, review, or dissemination
of adviser advertisements.
---------------------------------------------------------------------------

    \782\ See Compliance Program Adopting Release, supra footnote
371, at 74716. If advisers indirectly market or solicit through
third parties, they should consider how to tailor policies and
procedures according to the risks posed by those third parties
making statements that constitute advertisements under the rule. See
supra section II.C.3.
    \783\ See, e.g., SBIA Comment Letter; SIFMA AMG Comment Letter I
(stating that advisers' compliances programs currently include
upfront reviews of templates, spot-checking or sampling
advertisements after dissemination, or a risk-based approach
depending on the type of advertisement).
---------------------------------------------------------------------------

    In addition, consistent with the Commission's examination
authority, upon request, advisers must promptly provide information
about their compliance policies and procedures and any records that
document implementation of those policies and procedures to us and our
staff.\784\ The Commission's ability to collect information in a timely
fashion through its examination authority, and evaluate such
information for compliance with the Federal securities laws, is
essential to our mission of protecting investors and our securities
markets.\785\ Indeed, the prompt production of records to the
Commission is central to our mission of protecting investors, and is
imperative to an effective and efficient examination program.\786\
---------------------------------------------------------------------------

    \784\ See 15 U.S.C. 80b-4 (section 204 of the Investment
Advisers Act) (providing the Commission with examination authority
over ``all records'' of an investment adviser); see rule 204-2(g)(2)
(requiring prompt production of records); see rule 204-2(a)(17)
(requiring investment advisers to make and keep records of their
policies and procedures formulated pursuant to rule 206(4)-7).
    \785\ See, e.g., 15 U.S.C. 80b-4 (section 204 of the Investment
Advisers Act) (providing the Commission with examination authority);
see also 17 CFR 275.204-2 (rule 204-2 under the Investment Advisers
Act) (Commission books and records rules).
    \786\ See, e.g., Electronic Recordkeeping by Investment
Companies and Investment Advisers, Release No. IA-1945 (May 24,
2001) [66 FR 29224 (May 30, 2001)] (explaining that the ``continuing
accessibility and integrity of fund and adviser records are critical
to the fulfillment of our oversight responsibilities,'' and noting
the Commission's expectation that a fund or adviser would be
permitted to delay furnishing electronically stored records for more
than 24 hours only in ``unusual circumstances.'').
---------------------------------------------------------------------------

    In connection with the proposed review and approval requirement, we
also proposed to require investment advisers to maintain a copy of all
written approvals of advertisements by designated employees.\787\ As we
are not adopting the proposed pre-use approval requirement, we are also
not adopting this associated recordkeeping requirement.
---------------------------------------------------------------------------

    \787\ See proposed rule 204-2(a)(11)(iii).
---------------------------------------------------------------------------

H. Amendments to Form ADV

    We are adopting, largely as proposed, amendments to Item 5 of Form
ADV Part 1A to improve information available to the Commission and the
public about advisers' marketing practices. Item 5 currently requires
an adviser to provide information about its advisory business.\788\ We
proposed to add a subsection L (``Marketing Activities'') to require
information about an adviser's use in its advertisements of performance
results, testimonials, endorsements, third-party ratings, and
references to its specific investment advice.
---------------------------------------------------------------------------

    \788\ Exempt reporting advisers (that are not also registering
with any state securities authority) are not required to complete
Item 5 of Part 1A. Accordingly, subsection L of Item 5 of Part 1A
will not be required for such advisers. See, e.g., Instruction 3 to
Form ADV: General Instructions (``How is Form ADV organized'').
Exempt reporting advisers will not be subject to the final rule. See
supra footnote 21.
---------------------------------------------------------------------------

    Several commenters supported the proposed additions to Form
ADV,\789\ while others questioned their usefulness.\790\ Some
commenters suggested removing the question regarding whether an
adviser's performance results were verified, arguing that it could
disadvantage smaller advisers or could provide investors with a false
assurance of accuracy.\791\ Other commenters suggested that we include
questions about an adviser's use of other types of performance, such as
predecessor performance,\792\ or specific types of hypothetical
performance.\793\ One commenter opposed including questions regarding
the amount or range of compensation paid for testimonials,
endorsements, or third-party ratings, arguing that this could be
commercially sensitive information.\794\ Others suggested technical
improvements to the proposed section. For example, one commenter
requested that we clarify how frequently advisers must update responses
to Item 5.L.\795\ Another commenter requested that we define
advertisement and other relevant terms

of Item 5.L in the Form ADV Glossary.\796\
---------------------------------------------------------------------------

    \789\ See CFA Institute Comment Letter; NRS Comment Letter;
NAPFA Comment Letter.
    \790\ See, e.g., SIFMA AMG Comment Letter I.
    \791\ See, e.g., JG Advisory Comment Letter; Pickard Djinis
Comment Letter.
    \792\ See CFA Institute Comment Letter.
    \793\ See NRS Comment Letter (suggesting that Form ADV
specifically request that an adviser disclose whether its
advertisements include backtested performance or projected or
targeted returns).
    \794\ See SIFMA AMG Comment Letter I.
    \795\ See NRS Comment Letter.
    \796\ See Pickard Djinis Comment Letter.
---------------------------------------------------------------------------

    After considering the comments, we are adopting new subsection L to
Item 5 of Form ADV with slight modifications to the ordering and
content of the subsection versus the proposal. We are also amending the
Form ADV Glossary to incorporate the final rule's definitions for
``advertisement,'' ``endorsement,'' ``hypothetical performance,''
``testimonial,'' ``third-party rating,'' and ``predecessor
performance.'' Because new subsection L is included under Item 5 of
Form ADV, advisers will be required to update responses to these
questions in their annual updating amendment only.\797\ We continue to
believe that this new information will be useful for staff in reviewing
an adviser's compliance with the final rule, including the restrictions
and conditions on advisers' use in advertisements of performance
presentations and third-party statements.
---------------------------------------------------------------------------

    \797\ See Instruction 4 to Form ADV: General Instructions
(``When am I required to update my Form ADV?'').
---------------------------------------------------------------------------

    First, we are combining several proposed questions into Item
5.L(1), which will require an adviser to state whether any of its
advertisements include performance results, a reference to specific
investment advice, testimonials, endorsements, or third-party
ratings.\798\ Unlike under the proposal, this item will require an
adviser to address separately whether its advertisements include
testimonials, endorsements, and third-party ratings. We believe that
requiring advisers to address each separately will provide more
specific and useful information to our staff regarding whether an
adviser engages in these marketing practices. We are not including the
proposed related question that would have asked whether the performance
results in Item 5.L(1) were reviewed or verified, as proposed. We agree
with commenters that ``verification'' may inappropriately suggest an
assurance of accuracy to investors, and disadvantage smaller advisers
that may not obtain third-party reviews of their performance
results.\799\
---------------------------------------------------------------------------

    \798\ The question will exclude testimonials and endorsements
given by certain affiliated persons of the adviser that satisfy rule
206(4)-1(b)(4)(ii).
    \799\ See JG Advisory Comment Letter; CFA Institute Comment
Letter.
---------------------------------------------------------------------------

    As proposed, we are requiring an adviser to state whether the
adviser pays or otherwise provides cash or non-cash compensation,
directly or indirectly, in connection with the use of testimonials,
endorsements, or third-party ratings.\800\ This question will only
require `yes' or `no' responses, and will not require additional
information about the amount or range of compensation provided to avoid
the disclosure of potentially sensitive information as suggested by one
commenter.\801\
---------------------------------------------------------------------------

    \800\ This question will appear in Item 5.L(2), but had been
proposed as Item 5.L(4).
    \801\ See SIFMA AMG Comment Letter I.
---------------------------------------------------------------------------

    Third, unlike under our proposal, we are adding items requiring an
adviser to state whether any of its advertisements include hypothetical
performance and predecessor performance, respectively. We agree with
commenters' suggestions that this information could be useful for our
staff preparing for examinations, especially considering that
hypothetical performance can pose a heightened risk of misleading
investors.\802\ Additionally, as explained above, the final rule
specifically addresses when advisers can include predecessor
performance in advertisements.\803\ Responses regarding predecessor
performance will enable our examination staff to better assess
compliance with this new provision of the rule.
---------------------------------------------------------------------------

    \802\ See, e.g., CFA Institute Comment Letter; NRS Comment
Letter.
    \803\ See supra section II.F.
---------------------------------------------------------------------------

I. Recordkeeping

    We are adopting amendments to the books and records rule, largely
as proposed, to reflect the final rule and to help further the
Commission's inspection and enforcement capabilities. Investment
advisers must make and keep records of all advertisements they
disseminate, and certain alternative methods for complying with this
provision are available for oral advertisements, including oral
testimonials and oral endorsements.\804\ If an adviser provides an
advertisement orally, the adviser may, instead of recording and
retaining the advertisement, retain a copy of any written or recorded
materials used by the adviser in connection with the oral
advertisement.\805\ If an adviser's advertisement includes a
compensated oral testimonial or endorsement, the adviser may, instead
of recording and retaining the advertisement, make and keep a record of
the disclosures provided to investors.\806\ Further, if an adviser's
disclosures with respect to a testimonial or endorsement are not
included in the advertisement, then the adviser must retain copies of
such disclosures provided to investors.\807\
---------------------------------------------------------------------------

    \804\ See final rule 204-2(a)(11)(i)(A).
    \805\ See final rule 204-2(a)(11)(i)(A)(1).
    \806\ See final rule 204-2(a)(11)(i)(A)(2).
    \807\ See final rule 204-2(a)(11)(i)(A) and (15)(i).
---------------------------------------------------------------------------

    Commenters generally disagreed with this expansion of the books and
records rule, which currently only requires advisers to retain
advertisements sent to ten or more persons. According to commenters,
advisory firms of all sizes would face compliance challenges,
especially smaller advisers, if required to maintain all
advertisements.\808\ We believe, however, that this change is necessary
to conform the books and records rule to the definition of
advertisement and is designed to ensure advisers comply with the
requirements in the final rule.\809\ Our decision to narrow the
proposed definition of advertisement by excluding one-on-one
communications from the first prong of the definition (other than most
communications that include hypothetical performance) will lessen any
burden imposed by the associated recordkeeping obligations.
---------------------------------------------------------------------------

    \808\ See JG Advisory Comment Letter; NAPFA Comment Letter; FPA
Comment Letter.
    \809\ See also NRS Comment Letter (stating that ``most advisers
have developed procedures requiring the retention of all written
communications, so that individuals within the firm do not have the
discretion to determine whether or not a particular communication is
required under rule 204-2(a)(7).''). As proposed, we are not
changing the requirement that advisers keep a record of
communications other than advertisements (e.g., notices, circulars,
newspaper articles, investment letters, and bulletins) that the
investment adviser disseminates, directly or indirectly, to ten or
more persons.
---------------------------------------------------------------------------

    One commenter asked us to clarify that electronic mail (``email'')
archives are an acceptable method of maintaining records of
advertisements that are disseminated to investors, and we agree.\810\
The final rule does not prescribe or prohibit any particular method of
maintaining records. Rather, it requires the adviser to maintain and
preserve these records ``in an easily accessible place for a period of
not less than five years, the first two years in an appropriate office
of the investment adviser, from the end of the fiscal year during which
the investment adviser last published or otherwise disseminated,
directly or indirectly, the . . . advertisement.'' \811\ We believe it
would be permissible for an adviser to store records using email
archives (including in cloud storage or with a third-party vendor),
provided that the adviser can promptly produce records in accordance
with the recordkeeping rule \812\ and statements of the
Commission.\813\
---------------------------------------------------------------------------

    \810\ See JG Advisory Comment Letter.
    \811\ Final rule 204-2(e)(3)(i). This provision has not been
amended from the current rule.
    \812\ See final rule 204-2(g)(2)(ii). This provision has not
been amended from the current rule.
    \813\ See Amendments to the Timing Requirements for Filing
Reports on Form N-PORT, Release No. IC-33384 (Feb. 27, 2019) [84 FR
7980 (Mar. 6, 2019)] (interim final rule), at n.44. See also JG
Advisory Comment Letter (suggesting that the Commission clarify that
email archives are an acceptable method of recordkeeping in certain
contexts).

---------------------------------------------------------------------------

    The current recordkeeping rule requires advisers to retain
originals of all written communications received and copies sent by the
adviser relating to the performance or rate of return of any or all
managed accounts or securities recommendations.\814\ As proposed, the
final rule will amend the current rule to also require advisers to
maintain written communications relating to the performance or rate of
return of any portfolios (as defined in the final marketing rule).\815\
---------------------------------------------------------------------------

    \814\ See current rule 204-2(a)(7)(iv).
    \815\ See final rule 204-2(a)(7)(iv).
---------------------------------------------------------------------------

    The current recordkeeping rule requires advisers to retain all
accounts, books, internal working papers, and other documents necessary
to form the basis for or demonstrate the calculation of the performance
or rate of return of any or all managed accounts or securities
recommendations in any advertisement.\816\ As proposed, the final rule
will amend the current rule to also require advisers to maintain
accounts, books, internal working papers, and other documents necessary
to form the basis for or demonstrate the calculation of the performance
or rate of return of any portfolios (as defined in the final marketing
rule).\817\ In addition, the supporting records of investment advisers
that display hypothetical performance must include copies of all
information provided or offered pursuant to the hypothetical
performance provisions of the final rule.\818\ These changes are
designed to help to facilitate the Commission's inspection and
enforcement capabilities.
---------------------------------------------------------------------------

    \816\ See current rule 204-2(a)(16).
    \817\ See final rule 204-2(a)(16). See also Recordkeeping by
Investment Advisers, Release No. IA-1135 (Aug. 17, 1988) [53 FR
32033 (Aug. 23, 1988)] (describing as ``supporting records'' the
documents necessary to form the basis for performance information in
advertisements that are required under rule 204-2(a)(16)).
    \818\ See final rule 206(4)-1(d)(6), which will prohibit
hypothetical performance in an advertisement except under certain
conditions, including a requirement that the investment adviser
provides (or offers to provide promptly to a recipient that is a
private fund investor) sufficient information to enable the intended
audience to understand the risks and limitations of using such
hypothetical performance in making investment decisions. Any such
supplemental information that is required by final rule 206(4)-1 to
be a part of the advertisement is subject to the books and records
rule. See final rule 204-2(a)(16).
---------------------------------------------------------------------------

    In a change from the proposal, the final rule will require advisers
to maintain documentation of communications relating to predecessor
performance.\819\ This change complements the predecessor performance
provisions of the final rule and will help ensure that advertising
advisers retain appropriate documentation to substantiate displays of
predecessor performance. One commenter noted that advisers often have
difficulty complying with the books and records requirements in
connection with predecessor performance.\820\ For the reasons discussed
above, we decline to provide additional flexibility.\821\
---------------------------------------------------------------------------

    \819\ See proposed rule 204-2(a)(7)(iv). See also 2019 Proposing
Release, supra footnote 7, at sections II.A.6. and II.C. (requesting
comment about whether to amend the books and records rule to address
the substantiation of performance results from a predecessor firm
and whether the Commission should amend the rule to address
specifically other provisions of the proposed advertising rule).
    \820\ See SIFMA AMG Comment Letter II.
    \821\ See supra section I.F.
---------------------------------------------------------------------------

    In a change from the proposal, we will require advisers to make and
keep a record of who the ``intended audience'' is pursuant to the
hypothetical performance and model fee provisions of the final
marketing rule.\822\ Our examination staff may choose to review the
adviser's policies and procedures (for displaying hypothetical
performance) against the records retained in connection with this new
recordkeeping provision when determining whether the adviser satisfied
the hypothetical performance policies and procedures condition. Also,
we believe this additional requirement will assist our examination
staff in confirming that advisers are appropriately considering the
target audience when preparing and disseminating net performance and
hypothetical performance.
---------------------------------------------------------------------------

    \822\ See final rule 204-2(a)(19). See also final rule 206(4)-
1(d)(6) and (e)(10)(ii)(B).
---------------------------------------------------------------------------

    We proposed to require investment advisers to maintain a copy of
all written approvals of advertisements by designated employees in
order to track a corresponding proposed provision of the advertising
rule relating to a review and approval process.\823\ Since we are not
adopting the provision of the proposed advertising rule relating to
review and approval, we are not adopting the corresponding proposed
recordkeeping requirement. As discussed above, we are persuaded by
commenters who asserted that an adviser's own policies and procedures
would provide an effective compliance mechanism.\824\
---------------------------------------------------------------------------

    \823\ See proposed rule 204-2(a)(11)(iii).
    \824\ See, e.g., NRS Comment Letter.
---------------------------------------------------------------------------

    The combination of the current solicitation rule and current
advertising rule into a single marketing rule resulted in additional
changes to the books and records rule. We are adopting, as proposed,
changes to the books and records rule in order to correspond to the
marketing rule's provisions that address testimonials and endorsements.
The rule will require investment advisers to make and keep any
communication or other document related to the investment adviser's
determination that it has a reasonable basis for believing that a
testimonial or endorsement complies with rule 206(4)-1 and that a
third-party rating complies with rule 206(4)-1(c)(1).\825\ We are not
adopting amendments to the books and records rule that would
specifically reference the adviser's obligation to retain the written
agreements with promoters \826\ because such a provision would be
duplicative of the current books and records rule.\827\
---------------------------------------------------------------------------

    \825\ See final rule 204-2(a)(15)(ii).
    \826\ See final rule 206(4)-1(b)(2)(ii).
    \827\ Advisers are already required to retain the written
agreement pursuant to current rule 204-2(a)(10).
---------------------------------------------------------------------------

    We did not receive any comments on the proposed amendments to the
recordkeeping rule provisions that corresponded to the proposed
amendments to the solicitation rule. For the reasons discussed in the
proposal regarding amendments to the solicitation rule, we are
retaining the current recordkeeping rule's requirement for investment
advisers to keep a record of the disclosures delivered to investors,
which now apply to testimonials, endorsements, and third-party ratings.
However, we are adjusting the wording to correspond to changes to the
final marketing rule that permit either the investment adviser or the
promoter to provide the disclosure. Further, in a change from the
current solicitation rule, the final marketing rule will not require a
promoter to provide an investor with the adviser's brochure.
Accordingly, as proposed, we will remove the corresponding books and
records requirement as no longer relevant or necessary.
    As discussed above, in a change from the proposed amendments to the
solicitation rule, the final rule contains a partial exemption (from
the disclosure requirements associated with testimonials and
endorsements in the final rule) for an adviser's affiliated personnel.
The amended recordkeeping rule will now contain a corresponding
requirement for advisers that rely on the exemption to keep a record of
the names of all affiliated personnel and document their affiliates'
status at the time the

investment adviser disseminates the testimonial or endorsement.\828\
---------------------------------------------------------------------------

    \828\ See final rule 204-2(a)(15)(iii).
---------------------------------------------------------------------------

    Finally, we are adopting, as proposed, the requirement that an
adviser retain a copy of any questionnaire or survey used in the
preparation of a third-party rating included or appearing in any
advertisement.\829\ Commenters expressed concerns about not being able
to obtain a copy of the questionnaire or survey.\830\ As discussed
above, we recognize this concern and the rule will require an adviser
to retain a copy of this material only in the event the adviser obtains
a copy of the questionnaire or survey (i.e., an adviser would not be
required to obtain a copy of the questionnaire or survey in order to
comply with rule 206(4)-1 or rule 204-2).
---------------------------------------------------------------------------

    \829\ See final rule 204-2(a)(11)(ii).
    \830\ See, e.g., Blackrock Comment Letter; AIC Comment Letter.
---------------------------------------------------------------------------

J. Existing Staff No-Action Letters

    Staff in the Division of Investment Management reviewed certain of
our staff's no-action letters that addresses the application of the
advertising and solicitation rules to determine whether any such
letters should be withdrawn in connection with the adoption of the
marketing rule. Because we are rescinding the solicitation rule, the
staff no-action letters that address that rule will be nullified.\831\
Additionally, pursuant to the staff's review, the staff will be
withdrawing the staff's remaining no-action letters and other staff
guidance, or portions thereof, as of the compliance date of the final
rules.\832\ A few commenters supported this approach, suggesting that
the final rule should either supersede or incorporate every
letter.\833\ Other commenters requested that certain no-action letters
not be withdrawn that were issued to solicitors who would otherwise be
subject to the rule's disqualification provisions.\834\ These
commenters alternatively requested that the Commission grandfather such
solicitation arrangements if these letters are withdrawn.
---------------------------------------------------------------------------

    \831\ The order granting exemptive relief under rule 206(4)-3 is
also terminated. See In the Matter of Blackrock, Investment Advisers
Release Nos. 2971 (Jan. 4, 2010) [75 FR 1421 (Jan. 11, 2010)]
(application) and 2988 (Feb. 26, 2010) (order) (stating that ``the
Applicant will rely on the Order only for so long as the Cash
Solicitation Rule in effect as of the date of the Order is
operative.'').
    \832\ A list of the letters to be withdrawn will be available on
the Commission's website.
    \833\ IAA Comment Letter; Mercer Comment Letter.
    \834\ See, e.g., SIFMA AMG Comment Letter II; Mercer Comment
Letter; Stansberry Comment Letter.
---------------------------------------------------------------------------

    Based on the staff's review, we understand that some solicitors may
continue to conduct solicitation activity consistent with the
conditions stated in certain of the solicitor disqualification letters
identified below.\835\ The majority of these letters, however, pertain
to events that occurred more than ten years prior to the effective date
of the marketing rule and thus would not be disqualifying events under
the marketing rule.\836\ The nullification of these solicitation
disqualification letters will not have an impact on the relevant
solicitor's eligibility under the rule. For the minority of the
solicitor disqualification letters that involve events that occurred
within the rule's ten-year lookback period, however, nullification of
these letters could trigger disqualification under the marketing rule
for that underlying event. To avoid this result, we understand that the
staff will take a no-action position with respect to the events in
those letters to prevent those solicitors from being deemed
disqualified under the marketing rule. This position is designed
primarily to assist the phase-out of these letters as of the compliance
date of the final rule.\837\
---------------------------------------------------------------------------

    \835\ See also, Stansberry Comment Letter.
    \836\ See final rule 206(4)-1(e)(4).
    \837\ We believe that the need for this position will likely be
temporary since the events covered by these letters, over time, will
fall outside the ten-year lookback period for purposes of
disqualification under the rule.
---------------------------------------------------------------------------

K. Transition Period and Compliance Date

    The final rule will provide an eighteen-month transition period
between the effective date of the rule and the compliance date. While
we had proposed a one-year transition period, two commenters requested
a longer transition period to prepare for the new rule's
requirements.\838\ One of these commenters argued that a two-year
transition period would be more appropriate given the compliance burden
of implementing the proposed review and approval requirement.\839\ We
did not adopt the proposed pre-review and approval requirement;
nevertheless, we appreciate commenters' concerns. Accordingly, the
compliance date will be eighteen months following the effective date of
the rules. Any advertisements disseminated on or after the compliance
date by advisers registered or required to be registered with the
Commission would be subject to the new marketing rule.
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    \838\ See FPA Comment Letter; MFA/AIMA Comment Letter I.
    \839\ See MFA/AIMA Comment Letter I.
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    The compliance date for the amended recordkeeping rule will also
provide an eighteen-month transition date from the effective date of
the rule. Advisers filing Form ADV after a similar eighteen-month
transition period from the effective date of the rule will be required
to complete the amended form. Importantly, Form ADV does not require an
adviser to update responses to Item 5 promptly by filing an other-than-
annual amendment, and if an adviser submits an other-than-annual
amendment, the adviser is not required to update its response to Item 5
even if the response has become inaccurate.\840\ Therefore, each
adviser is only responsible for filing an amended form that includes
responses to the amended questions in Item 5 in its next annual
updating amendment that is filed after the eighteen-month transition
period.
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    \840\ See Form ADV General Instruction 4.
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L. Other Matters

    Pursuant to the Congressional Review Act,\841\ the Office of
Information and Regulatory Affairs has designated this rule a ``major
rule'' as defined by 5 U.S.C. 804(2). If any of the provisions of these
rules, or the application thereof to any person or circumstance, is
held to be invalid, such invalidity shall not affect other provisions
or application of such provisions to other persons or circumstances
that can be given effect without the invalid provision or application.
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    \841\ 5 U.S.C. 801 et seq.
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III. Economic Analysis

A. Introduction

    We are mindful of the costs imposed by, and the benefits obtained
from, our rules. Whenever we engage in rulemaking and are required to
consider or determine whether an action is necessary or appropriate in
the public interest, section 202(c) of the Advisers Act requires the
Commission to consider, in addition to the protection of investors,
whether the action would promote efficiency, competition, and capital
formation. The following analysis considers, in detail, the potential
economic effects that may result from the final rule, including the
benefits and costs to market participants as well as the broader
implications of the final rule for efficiency, competition, and capital
formation. Where possible, the Commission quantifies the likely
economic effects of the final rule; however, the Commission is unable
to quantify certain economic effects because it lacks the information
necessary to provide estimates or ranges. In some cases, quantification
is particularly challenging due to the number of assumptions that would
be

required to forecast how investment advisers would respond to the new
conditions of the final rule, and how those responses would in turn
affect the broader market for investment advice and the investors'
participation in this market. Nevertheless, as described more fully
below, the Commission is providing both a qualitative assessment and,
where feasible, a quantified estimate of the economic effects.
    In large part, the scope of these costs and benefits is determined
by the scope of the rule's definition of advertisement. The final
rule's definition includes many of the types of communications subject
to the current advertising rule. The final rule, however, will
expressly apply the protections of the rule to investors in private
funds, and advisers will now incur costs related to these
communications, to the extent that their current practices differ from
the final rule. In addition, the definition's scope has been expanded
to include communications made by promoters, including cash-compensated
promoters, who were previously subject to the cash solicitation rule,
and non-cash-compensated promoters who were not. Some of these affected
promoters whose communications will be newly defined as advertisements
may also be registered broker-dealers whose communications may be
subject to other regulatory requirements governing communications and
advertisements, including those under the Exchange Act, the rules
promulgated thereunder (including Regulation BI), and FINRA rules
(including FINRA rule 2210). The final rule's application to promoters
that are registered broker-dealers relating to endorsements to private
fund investors may create some overlap in regulation to the extent
regulatory requirements under the Exchange Act and FINRA rules apply to
their promotional activities. This may create burdens on these
promoters to the extent their compliance with these other regulatory
requirements does not fully satisfy the final rule. However, both the
costs and benefits of the testimonial and endorsement requirements will
be mitigated by the exclusions from the endorsement requirements that
will apply to these registered broker-dealers.
    Other aspects of the final rule will also yield costs and benefits,
such as the final rule's general prohibitions on certain marketing
practices. The impact of these changes are generally limited to the
extent that communications are subject to similar restrictions under
the current advertising rule, the current solicitation rule, and the
general anti-fraud provisions of the securities laws, and the extent to
which the final rule's prohibitions conform to current market
practices. The impact is more pronounced with respect to communications
newly subject to the definition of an advertisement and not previously
subject to the solicitation rule--particularly to communications by
solicitors who are not cash-compensated. In addition, the rules and
rescission of existing no-action letters may increase certainty because
advisers who choose to advertise will be able to follow the
requirements of the final rules rather than various no-action letters,
which could ultimately reduce compliance costs. Conversely, to the
extent that the specificity of the rules prompts some advisers to
devote greater resources to ensure compliance obligations under the
final rules, the requirements of the rules may impose greater costs on
such funds and advisers. Changes in costs of compliance for advisers
ultimately could affect investors to the extent that any changes in
costs would be passed down to them in the form of changed fund
operating expenses or higher advisory fees.
    In addition, the rule will (i) permit investment advisers to use
certain features in an advertisement, such as testimonials and
endorsements, subject to certain conditions, such as disclosing
information that would help investors evaluate the advertisement, and
(ii) prohibit third-party ratings and investment adviser performance in
advertisements unless they comply with certain conditions. The ability
to use testimonials and endorsements will likely have a less pronounced
impact on advisers that are currently complying with the solicitation
rule because this aspect of the marketing rule is drawn from the
current solicitation rule. The impact of restrictions in the marketing
rule related to the use of performance advertising is likely similar on
advisers currently subject to the advertising or solicitation rule
because this aspect of the final rule permits certain activity that is
not permissible under either current rule. If an adviser that is
subject to the current advertising rule is implementing practices
similar to those of the recipients of staff letters with respect to
performance advertising, the impact of this new aspect of the final
rule may be less pronounced for these advisers as compared to the
impact on other advisers to the extent that there are some similarities
between the final rule and the staff letters.
    The Commission is also adopting amendments to Form ADV that are
designed to provide additional information regarding advisers'
marketing practices, and amendments to the Advisers Act books and
records rule to correspond to the features of the marketing rule. The
final rule reflects market developments since 1961 and 1979, when rules
206(4)-1 and 206(4)-3, respectively, were adopted, as well as practices
addressed in staff no-action letters. These market developments include
advances in communication technology and marketing practices that did
not exist at the time the rules were adopted and may fall outside of
the scope of the current rules.

B. Broad Economic Considerations

    While we discuss investment advisers' many diverse marketing
methods and practices in detail later, here we discuss the broad
economic considerations that frame our economic analysis of the final
rule and describe the relevant structural features of the market for
investment advice and its relationship to marketing of advisory
services and private funds. Key to this framework is the problem that