Navigating Model Fees and Net Performance in Investment Advertising Compliance

Navigating Model Fees and Net Performance in Investment Advertising Compliance

Navigating Model Fees and Net Performance in Investment Advertising Compliance

Investment advisers face complex rules when advertising portfolio performance, especially regarding how fees are presented. A key question is whether advisers can show net performance based on actual fees charged historically when the fees expected to be charged to prospective clients are higher. This issue touches on Rule 206(4)-1(a), often called the marketing rule, which governs how advisers communicate performance to avoid misleading investors.

Understanding how to properly use model fees and actual fees in advertising is essential for compliance and maintaining trust. This post explains the regulatory framework, highlights practical examples, and offers guidance on navigating these requirements effectively.

Clear view of investment performance reports on a desk

What the Marketing Rule Says About Net Performance

The marketing rule defines net performance as the return of a portfolio after deducting fees and expenses. It includes two scenarios:

• Performance after deducting actual fees clients have paid.

• Performance after deducting a model fee, which is a hypothetical fee representing what clients are expected to pay.

  
  

The rule aims to ensure that performance advertisements are not misleading by clearly reflecting the costs investors will bear.

Why Fees Matter in Performance Advertising

Fees directly affect investment returns. If an adviser advertises net performance based on lower historical fees but expects to charge higher fees going forward, the advertised returns may overstate what new clients will experience. This discrepancy can mislead investors about potential outcomes.

The Role of Model Fees According to Footnote 590

Footnote 590 of the marketing rule’s adopting release specifically addresses this issue. It states:

• If the anticipated fees for the intended audience are higher than the actual fees historically charged, advisers must use a model fee reflecting the anticipated fees when presenting net performance.

• This requirement prevents advisers from showing inflated net returns that do not reflect the fees new clients will pay.

  
  

Common Misinterpretations

Some advisers interpret this footnote as a strict ban on using actual fees when anticipated fees are higher. However, the SEC clarifies that the rule provides flexibility and advisers should consider the facts and circumstances of each advertisement.

Applying the Rule in Practice

When to Use Actual Fees

• If the fees historically charged closely match or exceed the fees expected to be charged to new clients, using actual fees to calculate net performance is appropriate.

• Actual fees give a precise picture of what past clients paid and the returns they received.

  
  

When to Use Model Fees

• If the anticipated fees are higher than historical fees, advisers should present net performance using a model fee that reflects the higher anticipated fees.

• This approach ensures that prospective clients see a realistic estimate of returns after fees they are likely to pay.

  
  

Examples to Illustrate Fee Presentation

Example 1: Actual Fees Match Anticipated Fees

An adviser charged clients a 1% annual fee over the past three years. The adviser plans to charge new clients the same 1%. Advertising net performance using actual fees is consistent with the rule because the fees align.

Example 2: Anticipated Fees Are Higher Than Actual Fees

An adviser historically charged 0.75% fees but plans to charge new clients 1.25%. Showing net performance based on 0.75% fees would overstate returns. The adviser must use a model fee of 1.25% to calculate net performance for advertising.

Balancing Transparency and Compliance

Advisers should clearly disclose how net performance is calculated, including:

• Whether actual or model fees were used.

• The fee rates applied.

• Any assumptions behind model fees.

  
  

Clear disclosures help investors understand the basis of performance figures and reduce the risk of misleading advertising.

Practical Tips for Advisers

• Review fee structures regularly to ensure advertising reflects current or anticipated fees.

• Use model fees when fees change or vary significantly across client groups.

• Document decisions on fee presentation and disclosures for compliance records.

• Consult legal or compliance experts when uncertain about specific advertisements.

• Avoid presenting only gross performance without fee deductions, as this can mislead investors.

  
  

Summary

Advertising net performance requires careful attention to fee presentation. The marketing rule allows advisers to use actual fees or model fees but requires model fees when anticipated fees exceed historical fees. This ensures investors receive a realistic view of returns after fees.

Advisers should evaluate each advertisement’s facts and circumstances, use clear disclosures, and maintain transparency to comply with Rule 206(4)-1(a). Doing so builds trust and helps investors make informed decisions.