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Effective Expert Witnesses – December 4, 2019

Libby Hall: Hi everybody. I’m Libby Hall, your host for today’s podcast. Selecting the right expert witness can affect the duration and outcome of your case. Today, I’m joined by Oyster Consulting’s General Counsel Patrick Dennis and Consultant Andy Favret, who will be discussing the typical industry cases they’ve been a part of and how to be an effective expert witness. 

Libby Hall: Patrick is one of Oyster Consulting’s founders and he frequently acts as an expert witness on a variety of financial services industry topics. Patrick has been in the securities industry for 30 years. He previously worked for the SEC’s Division of Enforcement, and was also General Counsel for Wachovia Securities and Banc One Securities. Andy also has over 30 years of experience in the industry. Prior to working at Oyster, Andy served as Regional Chief Counsel in the FINRA South Region, and Andy has provided expert witness services in FINRA and JAMS arbitrations and civil and criminal court proceedings. With that, Patrick, I’ll hand it over to you. 

Patrick Dennis: Thanks. Andy, I know you and I testified about a number of different things, somewhat different. Tell me a little bit about some of the areas that you’ve testified about. 

Andy Favret: I’ve primarily been hired as an expert in FINRA rules and regulations and, to some extent, on SEC rules and even some state rules. Typically the most common things I’ve been asked to opine on have been interpretations of federal rules on suitability and supervision. Those are sort of the bread and butter topics that I’ve seen in securities litigation and arbitration. But I’ve been surprised at how many other somewhat more obscure rules are called into play and those have been included FINRA rules involving membership agreements, obligations of firms to disclose accurately on forms U4 and U5, debt security markups  anything typically that would enable a fact finder to gain information that might not otherwise be available to them. 

Patrick Dennis: Before we move on, I know you’ve done a lot of work on the variable annuity stuff, and that was one of the areas of expertise you had when you were at FINRA. Have you testified about variable annuity issues? I know we’ve talked to a number of firms about that, but I don’t know whether you’ve testified about that yet. 

Andy Favret: I have had an opportunity to testify in one case about that. I’ve actually been retained in two others. One, which is still pending, to talk about the evolution of the variable annuity suitability rule, and because that’s a more complex type of instrument, it has been the type of area that both lawyers and arbitration panels do need expert testimony. And so you’re right, that has been one that I’ve found that I’ve been able to add some benefit to. 

Patrick Dennis: I know I’ve testified about a number of the similar things that you have  suitability and supervision, and things like that. But I’ve also ended up testifying a lot about investment advisory issues: both requirements, the obligations, due diligence required of an investment advisor, and recommending hedge fund investments, and some things like that. I’ve also done a lot of work on the role of investment advisors versus clearing firms, and testified a lot about margin and margin issues that seem to pop up a lot, both on the clearing firm side of course, and then on the investment advisory side. But I’ve had some pretty obscure, investment advisory issues as well, including one in which the guy wanted to do principal trades in an investment advisory account, which created some issues. You can do it, but you have to do a bunch of work in advance. And they have testified about (Form) U5 and issues and concerns about that, and firms’ obligations, and things like that. But Andy, tell me a little bit about your thoughts on the role, on your role as an expert when you’re retained. What are they looking for and what do you think you provide? 

Andy Favret: Well, at the outset, what you’re looking at primarily are documents, and typically there’s sort of a document dump, but the beginning of an engagement, where you’re reviewing statement of claim and the answers and exhibits that are going to go into the case, you typically are gonna look at a firm’s written supervisory procedures or aspects of it. So, at the outset and most commonly, you’re reviewing a lot of documents. But I’ve been surprised at how far beyond just document review the scope of engagement may go very often. We’re called upon to provide assistance to the lawyers litigating the case for purposes of trial preparation. They want to bounce ideas off you, they want you to review copies of pre-hearing submissions briefs. They want to talk about witnesses and ways to approach their examination of witnesses, both your own and witnesses from the other side. So, a lot of the role goes beyond just document review and providing the actual expert opinion and includes as well, assistance in trial preparation, which is very rewarding and often extends into the hearing itself. Where during the conduct of the hearing, you’re huddling with the lawyers and really discussing strategy on a day-by-day basis. 

Patrick Dennis: Yeah, I think my experience is the same. It’s interesting. It sort of runs the gamut from being very much involved, including strategy and feeding questions when the other side’s expert is testifying to figuring out who the right people are to testify. Other stuff we want to try and get in and stuff we want to leave out. I get involved in a lot of those. And it’s interesting because I’m talking to somebody right now about a case that’s about a year away in federal court in Boston. I have done a bunch of federal court cases. I’ve done some state court cases, a lot of FINRA. And you know, it’s interesting because sometimes you’ll get called a year in advance or so to testify, and there’s a lot that needs to be done. In other cases it seems like you’re getting called at the eve of the 20-day exchange on a FINRA arbitration, or sometimes even after the 20-day exchange because they’ve gotten the witness list for the other side, and they’re thinking about you as a rebuttal witness. So it really kind of varies a lot in terms of how much lead time we get, how quickly we need to be able to review the documents, and things like that. But what’s your experience been? 

Andy Favret: My experience is very much the same. I’d like to go back to one thing you said when you talked about our role. I’ve also had a recent experience where the lawyers for the client wanted me to sit down with the client and advise them as to the whether or not they should settle the case. In other words, prior to the hearing, whether they had a good case, whether it made sense to settle, not how strong their case was. So you may have situations where you’re dealing directly with a client and basically providing the advice. But getting back to your discussion about time considerations, there’s a real discrepancy. There’s a lot of hurry up and wait, where you get documents provided, as you said, sometimes 20 days out, when there’s a sudden need for an expert and the retention agreements put into place. 

Andy Favret: Other times you might find with a continuance or a postponement that a lot of the work that you’ve done hurriedly before the hearing, then it gets put off three or four months. And you’re really in a situation where you’ve got to keep good notes so that when you go back three months later to readdress particular issues, you’ve got the notes in front of you and it’s relatively easy to refresh yourself. You don’t want to be in a situation where you have to start all over again, so you’ve got to be a quick study in this kind of engagement because documents come in, and suddenly lawyers are frantic to have you take a look at something if they’ve got a deadline approaching. But you’ve also got to recognize the fact that sometimes things are going to be postponed and put off. Neither of those are situations you really have a lot of control over. You just have to be as adaptable as possible. 

Patrick Dennis: Right. You know, it sort of reminds me of the fact that you and I aren’t the only ones that do this for Oyster. We’ve got a couple of other folks that do a lot of expert testimony and, and one is Bill Reilly in Florida. Bill was with the state of Florida Financial Services Division for 30 years, and has been with us seven or eight years now. He does a lot of testifying on a lot of state issues and a lot of broker-dealer examination issues, because he ran the training program for broker-dealer examiners for NASSA for a big part of the 30 years he was there, and they still call on him to come in and run that training. So that’s one issue that we get calls on a lot. The other thing is Evan Rosser, who was at FINRA as well. 

Patrick Dennis: Evan was there for 20 plus years, and sort of the liaison between the exam staff and the Enforcement Division, and has some unique insights into FINRA and those kinds of issues. One of the things that has come is the rates and what we charge, and what experts charge. I agree with you. I’ve talked about the fact that we think that a lot of times experts are considered a luxury. They’re sort of on top of all the other money that’s getting spent in litigation. So, I know we’re sensitive to costs, we’re sensitive to rates, we try and work with folks and are flexible. What are your thoughts on that? 

Andy Favret: Well, we have all sorts of different clients, and some of them are big operations that don’t think twice about hiring an array of experts to litigate an important case. But others are smaller clients, where costs are very much the sensitive issue. And I’m certainly aware in my dealings with these clients that there are instances where the retention of an expert is viewed as something of a luxury. Sometimes it’s one of the costs that are incurred in the weeks leading up to a hearing. They’re sensitive to spending extra money, not withstanding the fact that they recognize the importance of having the expert there. So we do have to be cost conscious, especially with certain of our clients. We’ve got to be efficient because you want to make sure you’re not spending too much time going over documents that may not be important to a hearing. 

Andy Favret: I’ve found it’s very helpful to talk to counsel to make sure that the documents and the time that I’m spending is useful for a hearing, and not just sort of make-work, because we don’t want to spend the client’s money unnecessarily. That being said, we recognize the importance of being thoroughly prepared when you go into a hearing because there’s nothing more important to the client than having an expert who is, in fact, up to speed on both the facts of the case and the law involved in the case. So we’re thorough. We try to be very well prepared, but at the same time, we understand that we don’t want to be spinning our wheels reviewing materials that ultimately may not be necessary. It’s interesting you bring up Bill Reilly in your discussion of our experts. There have been at least two instances that I’ve had in the midst of an engagement where an issue of Florida state law has come up either during or hearing or leading up to a hearing. 

Andy Favret: I’ve been able to pick up the phone to Bill and get a resolution of that issue quickly. He’s very well rehearsed on Florida state regulations, and it’s great that at Oyster we have a deep bench of other experts that you can call on in the middle of an engagement to get additional advice. I’ll tell the client that  I’ll say, “I’ve got a colleague that can help us out on this. Do you want me to put in a call?” Invariably they say yes, and, as I said, in at least two instances, Bill particularly has really come through. 

Patrick Dennis: One of the things that I think we ought to talk about, because I think it’s critically important as an expert, is that you have to come off as being credible. You have to have integrity, meaning you don’t testify about things you don’t know or you don’t get out over your skis as they say, because you’re arguing too far over your skis to help reach some opinion that somebody wants. That’s not our job. Our job is to make sure that we’re solid on the testimony and information we’re providing. I think that that’s critically important, that we maintain our integrity. I’ve been lucky enough that most of the folks that I’ve testified for have said that I am very, very credible, and I think part of that is because if I don’t know something I say, “I don’t know it.” If it’s something I’m not comfortable with, I don’t try and stretch the limits of my knowledge or my experience. I think that’s critically important. And I will say, this has happened a number of times, where folks have called us and we don’t really have the right expert. People have been kind of shocked that I’ve called people back or, sent them an email and say I’m not sure I’m the right person, but you might want to try this person or that person or other folks that I’ve met in my career that I think could testify and could do a good job for you. People appreciate that. I think I’ve gotten a number of calls from folks that they’re surprised that I will do that, but it’s more important that we maintain our reputation and our integrity and help people find somebody. They’ll come back and they’ll talk to us again if they have a need again. 

Andy Favret:
I very much agree, Patrick, on the credibility issue, especially you and I, as former regulators, I think that’s the one thing we have in our favor as an expert testifying before fact-finders. There have been instances where I’ve testified or given an opinion on four items, but not on the fifth. I’ll very candidly say, “No, that’s not something I’m really prepared to testify about.” Or, even in some instances after discussions with counsel, we’ll give testimony that works in some fashion against our client because you want to come out Foursquare in terms of integrity and credibility. I think that very much helps you in front of an arbitration panel or a judge or a jury where you can be 95% in favor of the client. But if 5% say, “Yeah, there was a problem there,” and be skillful enough to sort of talk your way around it without losing credibility and without casting any aspersions on your clients. So I agree and I think especially for us as former regulators, that rings even more true that we want to be in a position where our integrity is unquestioned. 

Patrick Dennis: I agree completely. I think that’s critically important both for our own personal reputations as experts, and for the reputation of Oyster. With that, Andy, thanks for your time and I really appreciate your thoughts. Hopefully folks can use this to learn a little bit about Oyster and about what we do as expert witnesses, and about expert witnesses in general, in terms of what folks should be looking for when they’re looking to hire an expert. So with that, thanks very much. 

Libby Hall: Thanks again for listening to the Oyster Stew podcast. Don’t forget to subscribe so we can help you make the best decisions for your firm. If you’re struggling with a topic and you’d like us to do a podcast on it, or you’d like a free consultation, please reach out to us at (804) 965-5400 or visit our website at www.oysterllc.com. 


Advertising Rule Part 2 – November 15, 2019

Molly Bryson:  Welcome back everyone to the second of our two-part podcast series talking about the SEC proposed advertising rule changes. I’m Molly Bryson, and today with me are Bill Reilly and Michelle Craft. We’ll discuss the pertinent SEC enforcement actions and how Reg BI will impact advertising and marketing practices. Bill’s been with Oyster for seven years. Prior to that, Bill was a state of Florida regulator for 30 years. He has deep experience with broker-dealer and investment advisor compliance programs, and frequently acts as an expert witness. Michelle Craft has been with Oyster for eight years, and in the financial services industry for 24 years. She has held various roles from Registration Analyst to Chief Compliance Officer for regional and national broker dealers as well as investment advisors. So let’s get started. Bill, could you start us off?

Bill Reilly:  Yes, I’d be glad to. What I did in researching for this presentation, is I went ahead and looked for the last couple of years at SEC enforcement actions and came up with three that I thought were noteworthy of speaking about. The first of the cases I’m going to talk about our robo advisors, and the reason that I chose those is, number one, robo advisors is a type of advisor that has been looked at substantially over the last couple of years by the Commission. The violations that were found for these robo advisors are also going to be found in your more standard type of investment advisor. But the first case I want to talk about is that the SEC found that a robo advisor with over $11 billion in assets under management made false statements about tax loss harvesting strategy, offered to clients. What the firm did was, it disclosed to clients employing it’s tax loss harvesting strategy, and the strategy was the selling of securities at a loss to offset capital gains tax liabilities. And, the firm would monitor all client accounts for any transactions that might trigger a wash sale. And of course, a wash sale occurs when it’s security is sold at a loss, but the same security is also purchased within 30 days before or after the sale. The losses from the wash sales are not recognized for tax purposes. But what the SEC found was that the investment advisor, it’s system failed to monitor for wash sales over a period of more than three years, during the time of this three years, while sales occurred in at least 31% of accounts enrolled in the firm’s tax loss harvesting strategy. The firm said it was going to offer a service and it never held it’s part of the bargain. The SEC also found that the investment advisor improperly retweeted client testimonials without necessary disclosures, paid bloggers for client referrals without the required disclosure and documentation to comply with the Solicitors Rule, and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws. As a result of these issues, the SEC fined the investment advisor $250,000 for violating the anti-fraud advertising compliance and some other provisions of the Investment Advisers Act of 1940. This case that I just talked about, and the case I’m going to talk about, were actions brought in 2018.

Bill Reilly:  In the second case, the SEC found that the investment advisor, which had approximately $81 million in assets under management, made a series of misleading statements about it’s investment performance. What the commission found was that from 2016 until mid-2017, the investment advisor posted on its website and social media comparisons of the investment performance of the investment advisor with those of two other robo advisors, or competitors. By doing this, the SEC stated that the performance comparisons were misleading because the advisor included less than 4% of his clients’ accounts, and those 4% had higher-than-average returns; the investment advisor compared this with rates of return that were not based on a competitor’s actual trading models.

Bill Reilly: The SEC also found that the advisor failed to maintain required documentation, and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws. They also found that the advisor violated the anti-fraud advertising compliance and books and records provision of the Adviser’s Act. These are somewhat fairly common types of violations that we find on the in the advisor area.

Bill Reilly:  The last case I want to talk about is an action brought by the Commission against 13 investment advisors. Now, this action was brought in 2016, but I still think it’s very appropriate, based upon the number of advisors named and some of the violations. In this case, the SEC brought action against 13 investment advisory firms, found they violated securities laws by spreading the false claims made by an investment management firm about its flagship product. As a result of an investment sweep, the Commission found the 13 firms accepted and negligently relied upon claims by the registered investment advisor, that one of its strategies for investing in exchange traded funds had outperformed the S&P Index for several years. The firms repeated many of the investment advisors’ claims, while recommending the investment to their own clients. This is the important part of the action: recommending the investment to their own clients without obtaining sufficient documentation to substantiate information being advertised. And basically, through this enforcement process, the advisor admitted in an SEC enforcement case that what was purportedly it’s real historical track record was only back tested performance that turned out to be substantially inflated. As a result of this, I thought that there was a quote that was provided by the commission relating to this activity. Let me go ahead and read the quote:

“When an investment advisor echos another firm’s performance claims in its own advertisements, it must verify the information first, rather than merely accept it as fact. These advisors negligently pass many of the investment advisors’ claims onto their own clients, who were consequently relying on false and misleading information when making investment decisions. I think the point to be gained here is that you cannot take information provided to you – you must actually take the steps to verify to the best of your ability, and confirm data that you are publishing and providing to your own clients.

Molly Bryson: In addition to the proposed Advertising Rule changes, the June 30th, 2020 Reg BI implementation date is looming. CCOs and marketing and compliance teams will be extremely busy reviewing the potentially thousands of marketing and advertising pieces which may be produced against these new requirements. Michelle, what will the Reg BI implementation mean for firms with regard to advertising?

Michelle Craft: So, when we think about the Reg BI impact to firms, we see that there’s going to be potentially a larger impact to our broker-dealer firms. And specifically, as we talk about advertising here today, the titles that are being used by registered representatives of broker-dealers. So it’s important to note that if an individual is referring to themselves as a Financial Advisor currently, and they are only registered with a broker-dealer, they do not maintain any kind of license with a registered investment advisor. They are going to be prohibited from using the word “Advisor” in their title. So, no longer can they be referred to as a Financial Advisor. And there’s probably, I would say, 80% or more of the individuals in the industry using that term even if they are only broker-dealer registered. So that’s going to require firms to take a look at their approved titles that can be used by individuals, and potentially come up with new titles.

Michelle Craft:  There’s nothing in the rule that states that you can only call yourself a registered representative if you are solely broker-dealer licensed. But, the rule is really intended to target the clients’ understanding of the services that they’re being provided. So if you’re calling yourself a Financial Advisor, there’s an assumption that you could be providing those services as a registered investment advisor, or a representative of an investment advisory firm. Again, people are going to need to start taking a look at business cards, stationary, email signatures. If your firm website has bio bio pages where you’ve listed an individual and their title, that could potentially need to be updated. A social media page where you’re listing your name and title; or any flyer, brochure, seminar material. Basically, any kind of advertising or communication that’s personalized to the representative themselves, if it includes the words Financial Advisor and they are solely registered with a FINRA firm as a registered representative, they cannot represent themselves as a Financial Advisor.

Michelle Craft: Now I will mention that if you’re a dually registered individuals, so you are registered with FINRA as well as being registered with a registered investment advisory firm, then you can still use the Financial Advisor title. Similarly, if you are registered solely with a registered investment advisory firm, you can still use the title Financial Advisor. Dually registered firms and or individuals, and solely registered investment advisor representatives, can still use Financial Advisor. If you are broker-dealer licensed only – so Series 7 licensed only as an agent through FINRA, you may no longer use the Financial Advisor title. They may choose to use “wealth advisor” or “financial consultant.” There’s a variety of different titles that those individuals can still use. Certainly there’s registered representative, which is the term that’s typically used as reference from a regulatory standpoint to delineate the difference between a broker-dealer representative and an IA representative.

Michelle Craft:  But it’s up to firms to make a decision as to what titles they will allow moving forward. We recommend that once you’ve determined what titles would be allowed for individuals that are solely-registered within with a broker-dealer, communicate that information to your supervisory principals, to those individuals that are reviewing materials to look for instances where individuals are still using Financial Advisor. And remember, this role does go into effect in June of 2020. So for firms that have mass amounts of advertising materials (I have worked myself with firms that have issued 4,000 pieces of advertising in a year), it may be a piece of advertising that is then approved, but then it’s tailored to fit the individual that’s issuing the material. You need to clearly make sure that you’ve communicated with your associates the changes in titles. Make sure that your supervisors are looking for it so it doesn’t sneak through. Update your policies and procedures to make sure that you have specifically addressed what titles can be used depending on the types of registrations held. So, I see that as one of the biggest impacts from an advertising perspective, as it relates to the Reg BI rule, which again goes into effect in June of 2020.

Molly Bryson:   Okay, thanks Michelle and Bill. There’ll be a lot for folks to do in the upcoming months and, of course, Oyster is ready to help. Oysters experts can assess your firm’s marketing and advertising materials against the Reg BI requirements and the proposed rule changes. Our team is also well-prepared to assist with other aspects of your Reg BI implementation. If you have any questions about anything we’ve discussed today, or if you have a topic you’d like to hear in future Oysters Stew podcasts, please feel free to call us at (804) 965-5400 or visit our website at www.oysterllc.com.


Advertising Rule Part 1 – November 20. 2019

Molly Bryson:  Hello everyone. I’m Molly Bryson, your host for today’s podcast, Part 1 of a two-part series talking about the SEC’s proposed advertising rule changes. Today we’re discussing the difference between the current rule and proposed changes. Next week, in Part 2, we will talk about pertinent enforcement cases and the impact of Reg BI on marketing and advertising. I’m joined today by Oyster Associate Director, Bill Rielly and Senior Consultant Michelle Craft. Bill’s been with Oyster for seven years. Prior to that, Bill was a state of Florida regulator for 30 years. He has deep experience with broker dealer and investment advisor compliance programs and frequently acts as an expert witness. Michelle Craft has been with Oyster for eight years and in the financial services industry for 24 years. She has held various roles from Registration Analyst to Chief Compliance Officer for regional and national broker dealers as well as investment advisors. So let’s get started. Bill, could you start us off?

Bill Reilly:  The current SEC Rule 206 of the Investment Adviser Act defines an advertisement as: any notice, circular, letter or written communication addressed to more than one person; or any notice or other announcement in any publication by radio or television, which offers any analysis, report, publication, concerning securities or which is to be used in making any determination as to whether or not to buy/sell any security, or what security to buy or sell; any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell a security; or which security to buy or sell. And lastly, any other investment advisory services with regard to securities. Now, one of the things that’s important to point out here is that there is an industry standard for advertisements. And that standard is that an advertisement may not contain any untrue statement of material fact or which is otherwise false or misleading. In essence, all advertisements must be fair and balanced.

Michelle Craft: That’s correct. So on November 4th of 2019 the SEC did publish, the proposed changes to the advertising rule. This is going to be the largest change in the advertising rules, or any change to the advertising roles since 1961. We discussed here internally that many of the people who are currently in the financial securities industry weren’t even born when this rule was originally written. So this is a big change. It helps to address the technology advances that we’ve had over the years and how the industry as a whole has evolved since 1961. So one of the biggest changes is the actual definition of advertisement. So it’s now going to be more broadly defined as any communication that’s disseminated by any means, by or on behalf of an investment advisor, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors, in a pooled investment vehicle that’s advised by the advisor. Now, there are a couple exclusions to the definition when we talk about any communication disseminated by any means. They do specifically exclude from the definition of advertisement oral communications that are not broadcasted, responses to certain unsolicited requests for specified information, any other sales material, that may be within the scope of another commission rule and any information that is contained in a statutory or regulatory notice or filing or other communication. And that would include things like the ADV Part 2 brochure because that’s a regulatory filing, well, required filing or notice that would not fall under the definition of an advertisement.

Michelle Craft:  Now, under the proposed rules, the general prohibitions do remain the same. So you can’t make any false or misleading statements, omissions of material fact. You can’t have any unsubstantiated claims. You have to provide a balanced presentation. You can’t talk about the benefits and not also talk about the risks, including or excluding any performance results or other performance information or time periods in a manner that is not, again, balanced or fair; and any other information that they would otherwise deem to be materially misleading. It seems like basic common sense, but ultimately those are the general prohibitions. I think something that we’d like to do is kind of look at the risk alert that was issued back in 2017 by the SEC that really targeted what were the areas of advertising that were most frequently identified as advisers violating the advertising rules and kind of comparing contrast how the proposed rules are being addressed. So when we look at what the violations were in the past and what the issues were that were as a result of the former advertising rule, and then kind of looking forward at how the proposed rule is intending to address some of those areas. So I’m going to toss it back to Bill to kind of kick us off on some of the different areas that we want to address: current role versus proposed role.

Bill Reilly:  Yes. Thank you Michelle. And one of the things that, again, I’m going to talk about is the current rule, and we’ll talk about their proposals and we’ll move forward from there. But one of the first areas that was discussed in the 2017 risk alert, was advertising concerns that the Commission had regarding Registered Investment Advisors presenting performance results without deducting advisory fees. And, of course, the regulation requires that the performance results must be net of fees. Another area that the SEC talked about was that the Registered Investment Advisors compared results for a benchmark but did not include disclosures regarding the limitations of such comparisons. An example of that is the advertised strategy material different from that of the benchmark. It’s very important to make sure that all of that information is included and analyzed. And one other, one last area under the current rules for a misleading performance results is that the advisor included hypothetical and backtested performance results without explaining how these returns were derived. Again, one of the things that we’ve talked about are full and fair disclosure – disclosure of the good, disclosure of positive and disclosure of the risks. In many of these situations, these performance results did not present both sides of the equation.

Michelle Craft:  Okay. So again, when we think about what the proposed rule states, they’ve kind of broken it down into a couple of categories. You have some performance information in general – they have defined there are certain prohibitions or would be certain prohibitions. Number one, gross performance results. Unless it is provided with a schedule of fees and expenses deducted to calculate net performance, you cannot use gross performance, unless you are providing that schedule of fees and expenses deducted to calculate net performance. Where before you basically were told that you could only do net performance, now they’re saying that you can potentially provide gross performance, but only if it isn’t accompanied by that schedule of fees and expenses that would allow someone to calculate the net performance. In addition, no statement that the calculation or presentation of performance results have been approved or reviewed by the Commission.

Michelle Craft:  We keep in mind that there are many places where the Commission does not, not allow us to make a statement that it has been reviewed, approved, or endorsed by the commission. Think about your Form ADV Part 2 disclosures. That is a statement that you have to make in your ADV. If you state that you are a Registered Investment Advisor, you must make the statement that the Commission has not reviewed or approved, and is not endorsing your Registered Investment Advisor. In addition, performance results with fewer then all of your portfolios was substantially different investment policies, objectives or strategies as those being offered or promoted in the advertisement, with a limited number of exceptions, would also be prohibited. Performance results of a subset of investments that were extracted from a portfolio, unless it provides or offers to provide, promptly the performance reviews of all investments in that portfolio would also be prohibited.

Michelle Craft:  When we think about hypothetical performance, unless the advisor has adopted and implemented policies and procedures that are designed to ensure that the performance is relevant to the financial situation and the investment objective of the recipient, and the advisor provided certain information underlying the hypothetical performance. So again, the hypothetical performance has to be relevant and it has to describe why it is relevant to the information that you’re providing. If it’s an advertisement that’s targeted towards a retail audience, additional protections would also be provided. They wouldn’t require that the presentation, the net of fees alongside any growth performance. So again, we talked about the general prohibitions that gross performance would not be allowed, unless you provided a schedule of fees and expenses that would give you the ability to deduct and calculate the net performance. If it’s targeted towards a retail audience, you would be required to present net of fees along with any presentation, gross of performance. Requiring that the presentation of any performance results in any portfolio or certain composition aggregations for the one-year, five-year and 10-year period. So they’ve gotten very specific in that you have to provide it for specific time periods as well. And again, that is for advertisements targeted to retail investors.

Bill Reilly:  Okay, well let’s, let’s talk for a few minutes about some other provisions that were, that are in these release. And one of them is cherry picking of profitable stocks elections under the proposal. Now, one of the things that all of us are familiar with are cherry picking. It’s the generally used in review of client accounts, and it’s placing favorable transactions into certain preferred accounts. So that itself is a general definition cherry picking. But in the definition of cherry picking of their profitable selections under the proposed rule, in a lot of situations the RIAs included only profitable stock selections in their recommendations and presentations, client newsletters, on their website. And the advisor failed to furnish a list of all recommendations made by such investment advisors during the proceeding year. In essence, what we’re talking about here is taking the good information, highlighting that and not presenting a balanced approach by providing the not so favorable recommendation.

Bill Reilly:  So a very, very serious problem there. The next section we want to talk about is misleading selection or recommendations. And what the Commission found is that advisors disclose past specific recommendations that may have been misleading because they included only certain and not all recommendations in order to illustrate an investment strategy. Again, one of the things is that all advertisements must be fair and balanced and when you’re not providing the positive information and either not providing or downplaying the “not so positive” or negative aspect of the recommendations, the Commission is going to come in and question those activities. And also the OCIE staff observed that advertisements may not have been consistent with these representations. A good example of this is disclosing that specific recommendations did not represent all securities purchased, sold or recommended to clients during that period, and discussing an advertisement to profits realized by specific recommendations.

Bill Reilly:  Again, fair and balanced advertisement disclosed the positive information, but also it’s necessary to provide the downside and the risks associated with any type of recommendations. The next area that we want to talk about, is compliance policies and procedures. Just like a lot of other areas, the Commission requires firms to have policies and procedures relating to advertisements. One of the things that the Commission found is that advisors did not have or did not implement policies and procedures concerning the following issues. First issue: the process for reviewing and approving advertising materials prior to their publication or dissemination. Many firms will have a pre-approval policy in place. The next one was, when using composites determined in the parameters for which accounts were included or excluded from performance calculations. I think in many situations there was positive information presented at the expense of some negative information. And the last is confirming the accuracy of performance results in compliance with the advertising rules. Now, we’re going to turn it back to Michelle. She’s going to address a little bit about the policies and procedures under the proposed regulation.

Michelle Craft:  Thanks Bill. So under the proposed rule, similar for those of you that are FINRA registered firms or dual-registered firms, FINRA has said for a long time that you had to have pre-review and approval of communications with the public or advertising; that they had to be reviewed by a designated principal prior to the distribution or dissemination of any advertising material. The proposed rule follows suit with that and is going to require Registered Investment Advisors to have an internal pre-use review and approval process. All communications, all advertisements would have to be previously reviewed and approved by the designated employee. So, unlike on the FINRA side, you would have a series 24, Series 910 principal that would be responsible for reviewing and approving advertisements or communications with the public prior to dissemination. They don’t have that same designation of the individual on the Registered Investment Advisory side, but nonetheless the firm will need to designate an individual that is responsible for reviewing and approving prior to dissemination of any advertisement.

Michelle Craft:  Now, there are a couple of exceptions to when it will not be subject to that prior review and approval standard. That is for communications that are disseminated solely to one individual or household, or single investor in a pooled investment vehicle, or in the case that it’s a live oral communication, that’s broadcasted on the radio, television, the internet or, or some other similar medium. And obviously, because it’s broadcasted live, it can’t be reviewed and approved prior to dissemination. So those would be the only two instances. Moving forward, if the proposed rule was approved as currently written, you would not need prior review and approval of an advertisement.

Bill Reilly:  Okay. Let’s go back and talk about the current rule and the misleading use of third party rankings or awards. A Couple of things that the Commission found during their reviews was that advisers advertised accolades that have been obtained by submitting potentially false or misleading information. The applications for such accolades that advisors published were marketing materials that referenced outdated rankings, advertisements that refer to the IRAs’ high rankings, and various publications were issued several years prior where the rankings were no longer applicable. It’s very important that information that is provided to clients is current as opposed to, in some situations, it’s indicated from information that may have been several years old. Also, advisers published potentially misleading advertisements that did not disclose irrelevant selection criteria for the awards or rankings, or who conducted the survey. Again, fair, balanced, and transparent are general observations that are made about advertising.

Bill Reilly:  And lastly, the Commission found that IAs failed to disclose the fact that they had paid a fee to participate. The Commission found that investment advisors failed to disclose the fact that they had paid a fee to participate in or distribute the results of the survey. Anytime we’re talking about monies or services being paid or exchanged, it’s important for that information to be, to be disclosed. And in many situations, the payment of these monies and so forth might actually even be discouraged from being utilized in this use of their party rankings. Michelle….

Michelle Craft:  So under the proposed rules, they will allow the use of third party rankings. They are going to require that there be specified disclosures and there has to be certain criteria included in those disclosures when pertaining to the preparation of the rating or ranking or accolade. So, similar to what Bill was just mentioning, all of those little highlighted areas that the SEC picked apart, those are the specific disclosures that you’re going to need to include. So they’re going to allow them, you need to state whether or not you were paid a fee or that you paid a fee to circulate the survey. You need to substantiate what was the criteria for earning the accolade, what is the calculation and or methodology for the rating being granted. So now all of that information is clearly spelled out in the proposed rule – that you have to clearly define how did you obtain it, what was the criteria for obtaining it? What is the methodology of any rating that’s being used? And if you’ve earned an award or you have paid any money to circulate the results of that survey, all of that information has to be there.

Bill Reilly:  And the last area that we’re going to talk about under the 2017 release is dealing with testimonials. One of the things that the Commission found is that Registered Investment Advisors presented statements of clients attesting to the RIA’s services or endorsing the RIA, that may be prohibited under the testimonials. And what we’re talking about here are client endorsements published on websites, social media pages, reprints or third party articles, or pitch books. I think this is one area that is going to be a major change on the proposed rules that Michelle’s going to talk about in a second, that will allow certain types of testimonials to be provided by Registered Investment Advisors. So Michelle, why don’t you talk about that?

Michelle Craft:  Yes, that is correct. So again, this is another one of those areas where the SEC has looked at FINRA rules. So FINRA would allow a broker-dealer to post a testimonial or to have an endorsement posted on a public website or on a social media page. The one caveat to the FINRA rule is that if you paid the individual for the testimonial for it to make any kind of endorsement, that information has to be disclosed. So under the proposed SEC advertising rules, this will follow suit. They are going to allow testimonials; however, it is going to be subject to those specified disclosures, including whether the person that is giving the testimonial or the endorsement is a client and whether or not compensation had been provided by or on behalf of the advisor for that testimonial and or endorsement.

Michelle Craft:  And again, I think as Bill mentioned, one of the biggest areas we expect this to be impacted on is… as we know, advisors are using LinkedIn. LinkedIn has that section out there where you can endorse and/or provide some sort of recommendation, based on the services that you’ve received from that advisor. That’s an area that many firms have just completely said, “You need to turn that off on your LinkedIn account so that someone can’t inadvertently put information out there that would be in violation of the rule.” So that is an area I think that will have a potentially large impact for some firms if they allow people to turn that function back on. They can have their clients now provide a testimony, a testimonial, and or endorsement out on LinkedIn. They’ll still want to monitor, obviously, what is being posted there, and they may choose to still not allow it. But certainly under the proposed rule, if it is approved as written, it would allow for testimonials.

Molly Bryson:  Thanks Michelle and Bill. Well, I think we covered a great deal about the differences between the current advertising rule and the proposed changes. Be sure to tune in next week as we talk about SEC enforcement actions and how Reg BI will impact marketing and advertising. I think a lot of people are going to be very busy in the upcoming months. If you have any questions about anything we’ve discussed today or if you have a topic you’d like to hear in a future Oyster Stew podcast, please feel free to call us at (804) 965-5400 or visit us at www.oysterllc.com

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