Legal Update: Breaking News: Advisers Can Answer Their Mail! Investment Management Group. SEC Staff Issues Guidance on Advertising Rule

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1 Investment Management Group Legal Update: If you have questions or would like additional information on the material presented herein, please contact: George F. Magera or Frederick C. Leech Investment Management Group C. Grant Anderson G. Andrew Bonnewell Byron F. Bowman Andrew P. Cross Gregory P. Dulski John D. Johnson Timothy S. Johnson Gail C. Jones Lisa D. McAnany Daniel M. Miller Kary A. Moore Donald J. Myers Jay S. Neuman Alicia G. Powell Michael B. Richman Leslie K. Ross Kimberly L. Sachse Victor R. Siclari Nelson W. Winter Todd P. Zerega or the Reed Smith attorney with whom you regularly work. This text is presented for informational purposes and is not intended to constitute legal advice. Reed Smith refers to Reed Smith LLP, a limited liability partnership formed in the state of Delaware. Reed Smith LLP All Rights Reserved. Breaking News: Advisers Can Answer Their Mail! SEC Staff Issues Guidance on Advertising Rule In a no-action letter issued on March 1, 2004 (the March 1 Letter ), the U.S. Securities and Exchange Commission ( SEC ) staff confirmed that registered investment advisers may answer their mail! Specifically, the SEC staff clarified that an adviser may respond in writing to unsolicited requests for specific information about the adviser s past specific recommendations by clients, prospective clients and consultants without the written response being considered an advertisement under Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended ( Advisers Act ). 1 The SEC staff also provided other useful clarifications regarding the staff s views on the application of Rule 206(4)-1 in the context of past specific recommendations. What is an advertisement? Basics you need to know. Under Rule 206(4)-1, an advertisement includes: any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which, in either case, offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula or other device to be used in making any determination as to when to buy or sell any security or which security to buy or sell, or (3) any other investment advisory service with regard to securities. LONDON NEW YORK LOS ANGELES SAN FRANCISCO WASHINGTON, D.C. PHILADELPHIA PITTSBURGH OAKLAND PRINCETON NORTHERN VA WILMINGTON NEWARK MIDLANDS, U.K. CENTURY CITY RICHMOND HARRISBURG WESTLAKE VILLAGE r e e d s m i t h. c o m

2 According to the SEC staff, whether any particular communication - or series of communications - constitutes an advertisement under Rule 206(4)-1(b)...depends upon all of the facts and circumstances. For example, the SEC staff indicated in the March 1 Letter that a letter written by an adviser that discussed its past specific recommendations concerning securities not held or not recently held by some of the clients to whom the letter was directed would suggest that a purpose of the communication was to promote the advisory services of the adviser and may constitute an advertisement, which may be prohibited under Rule 206(4)-1(a)(2) under the Advisers Act. 2 In contrast, the SEC staff indicated that, in general, written communications by advisers to their existing clients about the performance of the securities in their accounts are not offers of investment advisory services but are part of the adviser s advisory services. When is a communication discussing past specific recommendations not an advertisement? What you can provide to your clients in writing. In the March 1 Letter, the SEC staff clarified that an adviser may respond in writing to unsolicited requests for specific information about the adviser s past specific recommendations by clients, prospective clients and consultants without the written response being considered an advertisement under Rule 206(4)-1. The SEC staff also indicated that the same conclusion would apply: if an adviser provided the same information to one consultant requesting the information on behalf of several clients; if an adviser provided the same information to several consultants; or to the provision of client testimonials by an investment adviser, so long as, in each case, the information or testimonial was provided in response to a specific, unsolicited request for the information or testimonials. The SEC staff emphasized that the specific request must be unsolicited. An adviser cannot directly or indirectly solicit a request for information regarding past specific recommendations. For example, an adviser cannot: make an affirmative effort that is intended or designed to induce a client, prospective client or consultant to request the adviser to provide past specific recommendations; or advertise that the adviser is willing to provide past specific recommendations upon request

3 The SEC staff indicated that it would view requests resulting from the above activities to be solicited requests, not unsolicited requests. 3 In the March 1 Letter, the SEC staff also expressed its belief that a written communication by an investment adviser to its existing clients generally would not be an advertisement under Rule 206(4)-1 merely because it discusses the adviser s past specific recommendations concerning the securities that are or were recently held by those clients. The SEC staff noted, however, that if the context suggests that the purpose of the communication is to offer advisory services, the SEC staff would conclude that the communication was an advertisement. What impact does the SEC staff s guidance have? How it affects your business. The SEC staff s guidance clarifies when an adviser may respond in writing to unsolicited requests for specific information about the adviser s past specific recommendations by clients, prospective clients and consultants without the written response being considered an advertisement under Rule 206(4)-1. The SEC staff s guidance does not change the requirements of Rule 206(4)-1 as they apply to an adviser s responsibilities when presenting past specific recommendations within an advertisement, including the type of information that may be considered to be past specific recommendations. If a communication is an advertisement, and the advertisement contains past specific recommendations, Rule 206(4)-1 requires that the advertisement either comply with Rule 206(4)-1(a)(2) or with SEC staff guidance issued in a series of no-action letters. Under Rule 206(4)-1(a)(2), a registered investment adviser may not, directly or indirectly, publish, circulate or distribute any advertisement that refers, directly or indirectly, to past specific recommendations of the adviser which were or would have been profitable to any person. This prohibition caused many advisers not to publish any past specific recommendations (profitable or otherwise). An adviser may use an advertisement that sets out or offers to furnish a list of all recommendations made by the adviser within the immediately preceding period of not less than one year if such advertisement, and such list if it is furnished separately: state the name of each such security recommended, the date and nature of each such recommendation (e.g., whether to buy, sell or hold), the market price at that time, the price at which the recommendation was to be acted upon, and the market price of each such security as of the most recent practicable date, and - 3 -

4 contain the following cautionary legend on the first page thereof in print or type as large as the largest print or type used in the body or text thereof: it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. 4 Under the SEC no-action letters on Rule 206(4)-1(a)(2), the SEC staff advised: Rule 206(4)-1(a)(2) applies only to past, not current, recommendations; Whether a recommendation is current depends on the facts and circumstances; An advertisement distributed after an adviser ceases recommending any of the securities listed may be prohibited under Rule 206(4)- 1(a)(2); and An advertisement indicating that any current recommendation listed was recommended by the adviser in the past may be prohibited under Rule 206(4)-1(a)(2). 5 Finally, as the SEC staff reminded advisers in the March 1 Letter, all communications by advisers to clients, prospective clients and consultants, including advertisements, remain subject to Section 206(1) and (2) under the Advisers Act, and must be truthful, accurate, balanced and not misleading. How can Reed Smith help you? Lawyers within the Investment Adviser Group ( IAG ) within Reed Smith s Investment Management Group routinely assist registered investment advisers and mutual funds with advertising issues under the Advisers Act, the Investment Company Act of 1940 and NASD Regulations. Reed Smith also has expertise in federal and state advertising laws generally. Reed Smith can assist you with your advertising questions and needs. * * * * * * * 1. The SEC staff issued the no-action letter in response to a request by the Investment Counsel Association of America, Inc. for guidance concerning Rule 206(4)-1 under the Adviser s Act. See Investment Counsel Association of America (pub. avail. Mar. 1, 2004); see also m-2001.pdf. 2. In support of its statement, the SEC staff cited Franklin Management, Inc. (pub. avail. Dec. 10, 1998) (permitting distribution of quarterly report identifying and discussing some, but not all, of securities bought, sold or held by the adviser for investment accounts to existing and prospective advisory clients)

5 For other relevant no-action letters, see, e.g., Munder Capital Management (pub. avail. May 17, 1996) (provision of portfolio transaction information via the Internet determined not to be an advertisement for advisory services where information reflected only services provided to specific funds and not services provided to adviser's other clients); and Kurtz Capital Management (pub. Avail. Jan. 18, 1988) (distribution of a reprint of an unbiased third-party news article containing past specific recommendations determined not to be subject to Rule 206(4)-1). 3. Cf. Rule 15a-6 under the Securities Exchange Act of See also Securities Exchange Act Release No (July 11, 1989). 4. Under Rule 206(4)-1(a), a registered investment adviser may not, directly or indirectly, publish, circulate or distribute any advertisement (1) that refers, directly or indirectly, to any testimonial of any kind concerning the adviser or concerning any advice, analysis, report or other service rendered by the adviser; (2) that represents, directly or indirectly, that any graph, chart, formula or other device being offered can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; or that represents, directly or indirectly, that any graph, chart, formula or other device being offered will assist any person in making his own decisions as to which securities to buy or sell, or when to buy or sell them, without prominently disclosing in such advertisement the limitations thereof and the difficulties with respect to its use; (3) that contains any statement to the effect that any report, analysis, or other service will be furnished free or without charge, unless such report, analysis or other service actually is or will be furnished entirely free and without any condition or obligation, directly or indirectly; or (4) that contains any untrue statement of a material fact, or which is otherwise false or misleading. 5. See footnote 2, supra. By George F. Magera. Mr. Magera is a partner with Reed Smith s Investment Management Group