Significant Investment Adviser Regulatory Developments in 2024

Alongside the rapid pace of Securities and Exchange Commission (SEC) rulemaking, the SEC and its Staff continue to shape regulatory obligations for investment advisers in 2024 through guidance, alerts, enforcement actions, and other public statements. But private litigants have taken issue with some of this activity, and the SEC’s authority has been challenged, with some measure of success, in federal court. To help you stay current on these developments, this Alert summarizes some of the most notable SEC legal and regulatory developments for investment advisers in 2024 to date and highlights key takeaways. 

• Court Challenges. Perhaps most significantly for private fund advisers, on June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit vacated the SEC’s “Private Fund Adviser Rules,” which the SEC adopted in August 2023. The SEC had until July 22, 2024, to petition to appeal this decision, and it has not done so. For a discussion of this development, please see MoFo’s June 12, 2024 Alert.
• Marketing Rule Enforcement and FAQ. The SEC continues to bring enforcement actions against investment advisers for disseminating hypothetical performance to a general audience. Additionally, recent Risk Alerts published by the Division of Examinations have signaled the Staff’s interest in the solicitation and substantiation requirements of the rule. Based on FAQ guidance, private fund advisers should review their performance advertising to ensure that reported gross and net performance is calculated from the same date, particularly if subscription facilities are used to acquire investments for the private funds.
• Artificial Intelligence. Although the SEC’s proposed rule related to Conflicts of Interest Associated with the Use of Predictive Data Analytics has not been adopted,[1] the SEC’s Staff is scrutinizing investment advisers for perceived “AI-washing.” Investment advisers that use artificial intelligence should be proactive about addressing the fiduciary, marketing, recordkeeping, and other compliance obligations associated with those practices in their policies and procedures.  
• “Off-channel Communications.” The SEC continues to target broker-dealers and investment advisers in its off-channel communications enforcement initiative, recently settling 26 enforcement matters with civil penalties ranging from $400,000 to $50 million.[2] Although many of these and prior actions were brought against broker-dealers and/or their affiliated investment advisers, it has not gone unnoticed that some of these enforcement actions have named investment advisers that are not affiliated with broker-dealers. Investment advisers should consider engaging knowledgeable third parties to review their electronic communications and recordkeeping practices to ensure they are effectively addressing the SEC’s concerns, consistent with evolving best practices. 
• Form PF Amendments. The SEC adopted additional amendments to Form PF on February 8, 2024, marking the third set of amendments to the form in 12 months. Additionally, the Division of Enforcement has apparently launched an investigation into whether advisers subject to Form PF filing obligations are meeting those obligations. Investment advisers should ensure that they understand their responsibilities and should adopt policies and procedures to ensure they make any necessary Form PF filings.

1. Court Challenges to SEC Authority

On June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit vacated the SEC’s Private Fund Adviser Rules, which would have imposed significant audit, reporting, and fee disclosure obligations on investment advisers to certain private funds. To date, the SEC has not appealed the decision. It is not clear whether the SEC will take additional action in response, such as proposing a new rule or seeking to address concepts in the Private Fund Adviser Rules through other means (e.g., through guidance, enforcement actions, or examinations).

On June 28, 2024, and July 1, 2024, the U.S. Supreme Court issued a pair of decisions that will likely increase challenges to SEC and other administrative agency actions.[3] In Loper Bright, the Supreme Court directly overruled a prior Supreme Court case[4] that had established “Chevron deference,” which generally instructed courts to defer to administrative agencies’ interpretations of their respective governing statutes. Following the Loper Bright decision, a court must determine the best meaning of the statute in question and resolve the ambiguity itself, rather than deferring to an agency’s interpretation. Additionally, in Corner Post, the Court held that a claim under the Administrative Procedures Act does not accrue for purposes of the six‑year statute of limitations until the plaintiff is injured by final agency action—not at the time of final agency action, as previously held. Together, these cases will expand investment advisers’ (and other parties’) ability to challenge SEC actions.

Finally, on June 27, 2024, the U.S. Supreme Court held that defendants facing civil penalties for securities fraud in SEC enforcement actions are entitled to a jury trial in federal court, potentially curtailing the SEC’s ability to bring such actions before the SEC’s administrative law judges.[5] For an in-depth analysis of these cases, please see MoFo’s July 1, 2024 Alert and July 3, 2024 Alert.

2. Significant Marketing Rule Developments

A. FAQ Regarding Gross and Net Performance

On February 6, 2024, the Staff published a Marketing Rule[6] FAQ that addresses the calculation of gross and net performance when a private fund adviser uses subscription facilities to acquire investments for its private funds. In the FAQ, the Staff states that an investment adviser violates the Marketing Rule if it presents gross and net performance calculated from different dates, e.g., calculating gross performance from the date that an investment was made with funding from a subscription facility and calculating net performance from the date that investor capital was called to repay the funds borrowed under that subscription facility. The Staff stated that this practice, which it believes is common in the industry, violates the Marketing Rule because the net performance and gross performance are not presented in a format designed to facilitate comparison – i.e., from the same date. The Staff also expressed concerns that calculating net performance from the date when capital is called, rather than the date of the private fund’s acquisition of an investment, may inflate the performance of the private fund. The Staff suggested that even if an advertisement presents both gross and net performance of a private fund from the date when capital is called to repay funds borrowed under a subscription facility, the advertisement should also include net performance calculated from the initial date that the investment was made with the borrowed funds or include disclosures that describe the impact of subscription facilities on the fund’s advertised performance.  

Private fund advisers that use subscription facilities should review their performance calculation practices and, if necessary, update: (1) reported gross and net performance in advertisements to comply with the calculation methodology set forth in the FAQ, and (2) disclosures to describe the calculation methodology and the impact of any subscription facility on the reported performance. Investment advisers should maintain records that substantiate any performance calculations that relate to this FAQ, in addition to all other advertised performance. 

B. Continued Marketing Rule Enforcement

On April 12, 2024, the SEC settled enforcement actions against five registered investment advisers for violations of the Marketing Rule.[7] On August 9, 2024, the SEC settled a similar action against an investment adviser for Marketing Rule violations. These actions represent a continuation of the SEC’s recent Marketing Rule enforcement sweep and demonstrate the SEC’s ongoing commitment to enforcing the rule’s restrictions on hypothetical performance. In each order, the SEC found that the investment adviser had advertised hypothetical performance publicly on its website without adopting and implementing adequate policies and procedures reasonably designed to restrict the dissemination of hypothetical performance to a sophisticated audience.[8] In one order, the SEC found that the investment adviser had also violated the Marketing Rule because it had disseminated advertisements that included inaccurate track records, failed to include necessary disclosures regarding a benchmark comparison, and presented gross performance without net performance.[9] Notably, these advertisements had been created by third-party vendors. The order also found that the investment adviser did not have a written agreement with third-party firms for paid referrals, in violation of the Marketing Rule’s provisions for compensated endorsements. Prior to this order, the SEC’s Marketing Rule enforcement actions generally have not focused on the compensated endorsement requirements, perhaps signaling that increased SEC attention in this area is forthcoming.   

In recent speeches and industry events, senior SEC officials have repeatedly signaled their continued focus on compliance with the Marketing Rule. Investment advisers should continue to expect SEC attention on hypothetical performance and should confirm that their policies and procedures effectively restrict the dissemination of hypothetical performance to a limited audience of sophisticated investors, including any marketing collateral produced or disseminated by third parties. Correcting any issues before the Staff discovers them could help prevent or minimize interest by the SEC’s Enforcement Staff.

C. Division of Examinations Marketing Rule Risk Alert

On April 17, 2024, the SEC’s Division of Examinations published a risk alert (the “Risk Alert”) identifying Marketing Rule observations from recent investment adviser examinations.[10] In the Risk Alert, the Staff identified various deficiencies involving policies and procedures, performance advertising, books and records, and the Marketing Rule’s general prohibitions, many of which largely tracked the rule’s explicit requirements. However, certain of the observed deficiencies involved a more nuanced application of the rule, including advertisements that, for example:

• presented net performance returns reflecting lower fees than those that were offered to the advertisement’s intended audience;[11]
• included benchmark index comparisons but did not define the index or provide sufficient context to enable an understanding of the basis for such comparison or disclose that the benchmark performance did not include the reinvestment of dividends;  
• did not include disclosures in advertisements that provided necessary context, such as indicating that the advertised performance occurred during time periods when most investors would have experienced similar returns, given the performance of the market overall;
• excluded certain investments without providing sufficient information and context, such as investments that were written off as a loss or were lower-performing investments;
• did not disclose the relevant time period for advertised performance or did not disclose whether the returns were calculated for the same time period as other performance information included in the same advertisement; and
• included the performance of only realized investments in the total net return figure and excluded unrealized investments.

Investment advisers should review their marketing practices and consider whether to enhance disclosures in their advertisements, improve marketing review processes, and/or refine their approach to calculating reported performance. 

3. Artificial Intelligence

On March 18, 2024, the SEC settled two enforcement actions with registered investment advisers involving false and misleading claims about their use of artificial intelligence (AI).[12] In each case, the SEC found that the investment adviser had disseminated advertisements (including on its website) stating that it had incorporated AI into various aspects of its advisory business, when in fact it had not. The SEC also found that each investment adviser had failed to adopt and implement adequate written policies and procedures, in violation of the Advisers Act Compliance Rule.[13] In one order, the SEC found that the investment adviser’s compliance manual did not specify a clear advertising review and approval process that would enable the firm’s personnel and consultants to understand their respective roles and responsibilities in that process.[14] In the other order, the SEC found that the investment adviser’s policies and procedures did not include safeguards to ensure that hypothetical performance was only disseminated to a sophisticated audience as required under the Marketing Rule.[15] The SEC also found that the investment adviser had failed to produce records to the SEC substantiating claims made in the relevant advertisements, in violation of the Marketing Rule. 

These actions, in conjunction with other Staff statements, signal increased SEC scrutiny of investment adviser AI practices more generally. The SEC’s Examinations Staff have been requesting information about investment advisers’ AI practices in examinations. Senior SEC officials have also emphasized these two enforcement actions in recent industry events. Notably, at a conference in April 2024, the SEC’s Director of Enforcement, Gurbir Grewal, suggested that the SEC could seek to hold an investment adviser’s Chief Compliance Officer personally liable for the firm’s AI-related violations.[16] Investment advisers should canvas their existing use of AI tools and consider how they are addressing the fiduciary, recordkeeping, marketing, and other compliance obligations related to these practices.  

4. Off-channel Communications

On April 3, 2024, the SEC settled an enforcement action against a standalone registered investment adviser, imposing a $6.5 million civil penalty for the firm’s failure to maintain records of business-related “off-channel communications,” in violation of the Advisers Act Recordkeeping Rule[17] and other provisions of the Advisers Act.[18] On August 14, 2024, the SEC settled enforcement actions with 26 broker-dealers, investment advisers, and dually-registered broker-dealers and investment advisers for similar violations and imposed combined civil penalties of $392.75 million. The SEC’s orders found that the firms had failed to preserve records of numerous business-related communications sent by employees through text messages and/or other unapproved written communications platforms (e.g., WhatsApp). In addition to the Recordkeeping Rule violations, certain of the SEC’s orders found that the investment advisers had failed to implement a system of monitoring reasonably expected to determine whether personnel were following its policies and procedures and failed to supervise its personnel in violation of Section 203(e)(6) of the Advisers Act. The SEC also noted that three of the firms in the August 14th actions received credit for self-reporting and paid reduced civil penalties as a result.   

These actions continue the SEC’s longstanding off-channel communications enforcement efforts, but notably include extension of these enforcement efforts to standalone registered investment advisers. The provision of the recordkeeping rule for broker-dealers cited in the SEC’s actions (Rule 17a-4(b)(4) under the Exchange Act) is similar, but broader than the analogous provision of the recordkeeping rule for investment advisers (Rule 204-2(a)(7) under the Advisers Act). Rule 17a‑4(b)(4) requires broker-dealers to preserve records of all written communications relating to their business as a broker‑dealer, whereas Rule 204-2(a)(7) only requires investment advisers to make and keep records of communications generally relating to recommendations; the receipt, disbursement, or delivery of funds or securities; and the placement or execution of orders. The SEC’s orders do not make this distinction apparent, potentially indicating that the SEC is applying Rule 204-2(a)(7) to a broader scope of communications in these enforcement actions.   

Recent comments from SEC senior officials at industry events indicate that additional enforcement actions against standalone investment advisers for off-channel communications violations are forthcoming. Investment advisers should review the effectiveness of their off-channel communications policies and procedures and ensure compliance by supervised persons. Specifically, an investment adviser should ensure that: (i) its policies and procedures properly scope in the types of records that are required to be preserved under the Recordkeeping Rule and clearly identify authorized and unauthorized channels of communications, including any appropriate exceptions; (ii) it has implemented systems to capture and retain relevant communications; (iii) the CCO and compliance personnel understand these policies and procedures and are sufficiently empowered to enforce them; (iv) it has trained employees on these policies and procedures; and (v) it has enforced these policies and procedures and documented such enforcement.

5. Form PF Updates

On February 8, 2024, the SEC and the Commodity Futures Trading Commission jointly adopted additional amendments to Form PF, the third set of amendments to the form in 12 months.[19] These amendments will require, among other things, that Form PF filers:

• report additional information about themselves and their private funds, including withdrawal and redemption rights, gross asset value and net asset value, inflows and outflows, borrowings and types of creditors, fair value hierarchy, beneficial ownership, and fund performance;
• provide more details regarding hedge fund investment strategies, counterparty exposures, and trading and clearing mechanisms employed by hedge funds; and
• generally provide separate reporting for each component fund of a master-feeder arrangement and parallel fund structure.

Finally, an investment adviser that advises “qualifying hedge funds” (i.e., those with a net asset value of at least $500 million) must report additional information on Form PF about such funds, including details about the operations and strategies of such funds (e.g., investment exposures, borrowing and counterparty exposure, risk metrics, and portfolio liquidity). The compliance date for these amendments is March 12, 2025.

In addition to these Form PF updates, certain industry participants have recently received letters from the SEC’s Division of Enforcement related to an investigation into whether such advisers are complying with their Form PF filing obligations. Investment advisers should ensure that they understand both the current and new triggers for filing Form PF, and implement monitoring and testing to ensure such filings are made when those triggers are reached.

[1] See Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers, SEC Rel. No. IA-6353 (July 26, 2023).

[2] See Twenty-Six Firms to Pay More than $390 Million Combined to Settle SEC’s Charges for Widespread Recordkeeping Failures, U.S. Securities and Exchange Commission (Aug. 14, 2024).

[3] See Loper Bright Enterprises v. Raimondo, No. 22-451 (2024) and Corner Post, Inc. v. Board of Governors of the Federal Reserve System, No. 22-1008 (2024). 

[4] Chevron U.S.A. Inc. v. Natural Resource Defense Council, Inc., 467 U.S. 837 (1984).

[5] See SEC v. Jarkesy, No. 22-859 (2024).

[6] Rule 206(4)-1 under the Advisers Act.

[7] See SEC Charges Five Investment Advisers for Marketing Rule Violations, U.S. Securities and Exchange Commission (Apr. 12, 2024).

[8] The SEC generally believes that hypothetical performance is not appropriate for a mass audience or general circulation given the risks of misleading investors; thus, an investment adviser’s dissemination of hypothetical performance on a publicly available website is inconsistent with the Marketing Rule. See Investment Adviser Marketing, SEC Rel. No. IA-5653, at 220 (Dec. 22, 2021).

[9] See In the Matter of Gea Sphere, LLC, SEC Rel. No. IA-6585 (Apr. 12, 2024).

[10] See Initial Observations Regarding Advisers Act Marketing Rule Compliance, SEC Division of Examinations Risk Alert (Apr. 17, 2024).

[11] It is not clear whether the Staff is suggesting that the investment adviser should have applied a model fee (instead of the actual fee) that corresponded with what the audience would have paid or whether disclosing the difference in fees would have been sufficient. The Marketing Rule provides flexibility to an investment adviser to calculate net performance by deducting “all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant portfolio.” See Rule 206(4)-1(e)(10) under the Advisers Act (emphasis added).

[12] See SEC Charges Two Investment Advisers with Making False and Misleading Statements About Their Use of Artificial Intelligence, U.S. Securities and Exchange Commission (Mar. 18, 2024).

[13] Rule 206(4)-7 under the Advisers Act.

[14] See In the Matter of Delphia (USA), Inc., SEC Rel. No. IA-6573 (Mar. 18, 2024).

[15] See In the Matter of Global Predictions, Inc., SEC Rel. No. IA-6574 (Mar. 18, 2024).

[16] See Isenberg, David, SEC Enforcement Hints at CCO, CISO Liability for AI, Ignites (Apr. 17, 2024).

[17] Rule 204-2 under the Investment Advisers Act of 1940 (the “Advisers Act”).

[18] See In the Matter of Senvest Management, LLC, SEC Rel. No. IA-6581 (Apr. 3, 2024).

[19] In addition to these amendments, the compliance date for certain prior amendments to Form PF passed on June 11, 2024.