News & Events

Performance and Advertising – A Practical Guide for Hedge Funds in the Post Registration Era

On 23 June 2006, the US Court of Appeals for the D.C. Circuit vacated the rule, which required hedge fund managers to register with the Securities and Exchange Commission (SEC). As a result, hedge fund managers are no longer required to register with the SEC, nor are they subject to SEC compliance inspections and examinations. However, the court’s ruling does not affect the SEC’s authority to investigate and bring enforcement actions against hedge fund managers, regardless of whether they are registered, for violating the anti-fraud provisions of the Investment Advisers Act of 1940 (the “Advisers Act”).

The purpose of the anti-fraud provisions of the Advisers Act, particularly Section 206, is to prohibit hedge fund managers from misleading investors by engaging in fraudulent, deceptive, or manipulative activities. The anti-fraud provisions are broadly written and cover the calculation of performance information and the dissemination of marketing or advertising materials. Accordingly, hedge fund managers, registered or not, must still ensure that their advertisements do not violate the anti-fraud provisions.

Advertisements and Marketing Materials

An advertisement is defined as an offer of investment advisory services regarding securities, which is communicated or addressed to more than one person, or made in any publication or by radio or television. Although the Advisers Act does not explicitly cover one-on-one presentations, it is a violation of the anti-fraud provisions to mislead investors regardless of the context. The SEC has recently brought a number of enforcement actions against hedge fund managers under the anti-fraud provisions for misleading potential investors. For example, the SEC has brought enforcement actions under Sections 206(1) and (2) against hedge fund managers for disseminating advertisements that exaggerated performance, improperly valued assets, did not disclose conflicts of interest, falsified or fabricated statements or other information, or misrepresented the trading methodology used by the hedge fund manager. SEC enforcement actions may result in cease-and-desist orders, disgorgement of fees, fines, and civil penalties. Moreover, a hedge fund manager’s investors may bring a claim against the hedge fund manager under the applicable state anti-fraud statutes.

In order to assist hedge fund managers with the preparation of their advertising or marketing material, we have set forth below several factors that hedge fund managers should consider when preparing these materials. They are intended to give hedge fund managers a general idea of the types of information that should or should not be included in a hedge fund manager’s client communications. This overview is not intended to address all advertising practices nor is it intended to cover all factors that the SEC may consider when determining whether an advertisement violates the provisions of the Advisers Act.

Guidance for Preparing Advertisements

Generally, a hedge fund manager’s advertisement should accurately state all information and contain prominent disclosures (ie, not in the footnotes) of the following, if applicable:

  • the effect of material economic and/or market conditions on the investment results;

  • whether the investment results reflect any re-investment of dividends, interest, or other earnings;

  • whether the investment results reflect the deduction of advisory fees, brokerage or other commissions, or any other expenses charged to the client;

  • that past performance does not guarantee future results;

  • all material facts regarding any comparison with an index; or

  • all material conditions, objectives, or investment strategies used to obtain the investment results.

If actual performance results are used, the advertisement should prominently disclose the following, if applicable:

  • that the results portrayed only relate to a select group of clients, the basis for the selection of these clients, and the effect of this practice on the results portrayed, if material;

  • the material changes in the conditions, objectives, and/or investment strategies of the investment portfolio during the period portrayed and the effect of the changes;

  • that a portion of the investment portfolio’s securities or strategies do not relate, or only partially relate, to the hedge fund manager’s current services; or

  • that the hedge fund manager’s clients had investment results that were materially different from the results portrayed in the investment portfolio.

In addition, a hedge fund manager’s advertisement should not:

  • contain a testimonial (ie, a statement of a client’s experience with or endorsement of a hedge fund manager) regarding the hedge fund manager or the hedge fund manager’s advice, analysis, report, or other services;

  • refer to any past specific recommendations that were or would have been profitable (unless the hedge fund manager provides or offers to provide a list of all recommendations made within the one-year period preceding the advertisements), the information relevant to the recommendation (eg, the name of the security recommended; whether to buy, sell, or hold; the gain or loss on the recommendation; etc.), and a statement, in a font size as large as the largest font size used in the relevant text, which states “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”;

  • represent that any graph, chart, formula or other device offered could be used to make a trading decision, without prominently disclosing the limitations and/or difficulties with respect to its use;

  • state that a report, analysis, or service is free when it is not;

  • contain any untrue statement of material fact or be false or misleading; or

  • make a claim about potential profit without mentioning the possibility of loss.

No-Action Letters

Hedge fund managers seeking additional guidance should review the SEC’s “no-action letters” pertaining to advertisements. No-action letters are issued by the staff of the SEC and provide assurances that the staff will not recommend enforcement action against the inquirer based on the specific facts of the inquiry. The hedge fund industry often uses these letters as an indication of the SEC’s position regarding particular matters. The most prominent no-action letter regarding performance and advertising was issued on 28 October 1986 to Clover Capital Management. Other important no-action letters regarding performance and advertising include, the 24 August 1987 no-action letter issued to Investment Company Institute, and the 23 September 1988 no-action letter also issued to Investment Company Institute.

A hedge fund manager may request a no-action letter from the SEC. However, hedge fund managers should think long and hard before approaching the SEC with an idea for an advertisement or the presentation for performance that could later be found to have violated the anti-fraud provisions of the Advisers Act. Hedge fund managers should familiarize themselves with the content of these letters.

Valuation of Assets

If a hedge fund manager’s communications to investors and potential investors contain performance information, such performance information must accurately reflect the valuation of the fund’s underlying assets. The SEC has brought numerous enforcement actions under Section 206 against hedge fund managers, alleging that their advertisements were improper or misleading because they contained an overvaluation of fund assets. Examples of recent SEC enforcement actions include the enforcement action against CMG Capital Management Group, which advertised average annual returns of up to 36% despite incurring us $7.8 million in trading losses, as well as the enforcement action against K.L. Group LLC, which advertised a 125% return despite substantial trading losses. The valuation of certain assets, particularly illiquid assets, can be difficult because there are no clear guidelines available nor any consistency within the hedge fund industry with respect to how such assets should be valued.

In order to assist a hedge fund manager with the preparation of advertisements that contain performance information, we have set forth below general guidelines that hedge fund managers should follow with respect to valuation issues. They are intended to give hedge fund managers a general idea of the types of valuation issues that should be considered with respect to advertisements and is not intended to address all valuation issues. Hedge fund managers generally should:

  • establish valuation methodology in writing and disclose such methodology to investors;

  • apply their valuation methodology consistently among each investor;

  • use only reputable dealers and rely on more than one source, if they value their assets based on dealer quotes;

  • keep any records related to the valuation of its assets, particularly if such records were prepared by third parties; and

  • take into account all relevant information that may affect the price of its assets, such as the assets’ relative liquidity.

In addition, hedge fund managers of funds of funds should determine how the underlying funds value their assets. If the fund of funds manager knows that an underlying fund is improperly valuing its assets, it will likely violate the anti-fraud provisions if it advertises the underlying fund’s performance without fully disclosing the underlying fund’s valuation practices.

Record Keeping

Although hedge fund managers who are not registered with the SEC are not technically required to comply with the record keeping provisions of Rule 204-2, hedge fund managers follow such record keeping requirements as much as possible. Incomplete or inaccurate record keeping could give rise to a SEC enforcement action alleging violations of other provisions of the Advisers Act, particularly the anti-fraud provisions. Generally, Rule 204-2 requires hedge fund managers to keep all records that formed the basis for any calculation or claim of performance made to investors. The type of records that must be kept will vary depending on the circumstances, however, the SEC has generally found that a hedge fund manager’s account statements alone are not sufficient for purposes of substantiating its performance. These records should be kept for at least five years from the date of the communication.


Hedge fund managers should not become complacent now that they are not required to register with the SEC nor subject to compliance examinations. With all of the scrutiny hedge funds have recently received, it is unlikely that SEC enforcement actions against hedge funds will diminish. In fact, now that the anti-fraud provisions of the Advisers Act are the SEC’s primary enforcement tool, we recommend that hedge fund managers take the necessary precautions to avoid any indication of fraudulent conduct. Thus, hedge fund managers, whether registered or not, should closely and diligently monitor and evaluate their advertisements to ensure that they do not violate the anti-fraud provisions of the Advisers Act.


Pillsbury Winthrop Shaw Pittman LLP represents hedge fund sponsors and advisers, prime brokers, and administrators through its 16 offices, located in global centers for capital markets, finance, energy, and technology.