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Investment Advisor Advertising: Does the "Testimonial Rule" Apply to Third-party Review Sites?

Earlier this year, the SEC issued welcome guidance on the prohibition against testimonials in advertising by investment advisors and its implications for social media websites. In Guidance Update 2014-4, the SEC’s Division of Investment Management clarified that Registered Investment Advisors are allowed to publish third-party reviews — from sites such as Yelp or Angie’s List — under certain circumstances.

 

Rationale for the Rule

SEC Rule 206(4)-1(a)(1) under the Investment Advisers Act of 1940 prohibits investment advisors (as well as investment advisory representatives) from using testimonials in their advertisements. The rule doesn’t define “testimonial,” but the SEC’s staff has interpreted the term to mean a “statement of a client’s experience with, or endorsement of, an investment advisor.” The rationale behind the rule is that this type of advertising is inherently misleading because it tends to emphasize favorable comments and ignore unfavorable ones.

The SEC generally considers social media reviews to be testimonials within the meaning of the rule. But, as it explains in its Guidance Update, public commentary from independent social media sites doesn’t raise any of the dangers the testimonial rule was designed to prevent, provided specific requirements are met.

Establishing Independence

Generally, investment advisors who invite clients to post public commentaries directly on their websites, blogs, or social media sites, violate the testimonial rule. According to the Guidance Update, however, the rule isn’t applicable if an advisor publishes testimonials from a third-party site that is independent from, and has no material connection to, the advisor.

Among other things, this means that the advisor can’t:

1. Directly or indirectly author or edit the commentary (either in the advisor’s own name or anonymously),

2. Compensate site users for authoring commentary, or

3. Have the ability to affect which commentary is included or how it’s presented.

In addition, the review site must not restrict commentators’ ability to post comments. And it needs to allow visitors to view all public commentary and update new commentary in real time.

Given the need to present the entire comment history, together with realtime updates, an advisor’s “publication” of testimonials is limited to “any form of real-time broadcast through social media or the Internet whether by hyperlinking, posting, live-streaming, tweeting, or forwarding or any similar public dissemination.” It doesn’t include other forms of publication — such as paper, television, or radio — that don’t allow for instantaneous updating or concurrent viewing of all comment history. (Note, however, that these types of advertising may direct consumers to testimonials on an independent social media site.)

Testimonials must be published in chronological or alphabetical order, or in another neutral manner that doesn’t emphasize favorable reviews or downplay unfavorable ones. But this doesn’t prevent the site from allowing users to sort reviews according to criteria they choose, including highest or lowest rating. Also, advisors may publish testimonials from sites that provide an average rating (such as the average number of “stars” on Yelp), provided the rating system is unbiased and neither the advisor nor the site provide any subjective analysis.

Review Your Policies

In light of the SEC’s guidance, investment advisors should review their social media policies to ensure that their advertising activities are in compliance.

Please contact your Untracht Early advisor if you have questions about the testimonial rule.

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