Advertising Pitfalls Every Alts Sponsor Should Know About

I’m the compliance guy at a managing broker-dealer focused on alternative investments.

In my tenure, our firm has reviewed about 2,000 offerings, processed around 30,000 investments, and reviewed close to 10,000 pieces of communications with the public, often referred to as advertising, supporting more than $5B in equity and debt investments. Largely, our transactions are for syndicated, tax-advantaged commercial real estate offerings; but we also have 40 Act Fund sponsors and other non-listed public offerings such as Regulation A and non-traded REITs.

Our experience onboarding more than 100 clients over the past decade has been that once an offering is structured, its memorandum or offering circular prepared, and the issuer or sponsor believes that it’s time to get the show on the road—advertising review and approval accounts for most of the delay to market.

Below are two common scenarios we’ve seen and some considerations sponsors should be aware of to help keep the process running smoothly.

Scenario 1:

A successful institutional fund sponsor seeks high net worth investors. An issuer, with years of experience raising funds utilizing the 3a-4 exemption, seeks to expand its distribution model by syndicating a fund. The strategy involves creating a national accounts team, engaging wholesalers, and pitching to independent broker-dealers (IBDs) and registered investment advisors (RIAs). In order to pay its sales team a “commission”, they must be affiliated with a broker-dealer who pays the registered folks their production compensation. One of the consequences of pursuing this strategy is that the SEC’s anti-fraud communication rules (you must tell the truth, you can’t be misleading, and you can’t omit material facts) are now also subject to FINRA’s Rule 2210—the advertising rule.

Scenario 2:

A successful regional real estate developer wants to take on larger projects. Similar desire, different point of origin. This developer has a track record as a real estate developer utilizing a well-established network of investors known to the company, but now seeks to engage in larger development projects and has exceeded the capacity of his friends and family network. His strategy is to create a fund and to distribute it through the IBD and RIA channel. For this sponsor, most of what it takes to engage this channel is going to be a new adventure. It’s not cheap, it takes tenacity, and it’s not linear forward progress. PPMs drafted by securities counsel, third-party sponsor reports and offering diligence reports are likely new requirements. And, the sponsor will either be hiring or engaging wholesaling personnel.

In both examples, how the sponsor communicates about itself, and how it communicates about its investment offering must meet the FINRA content standard.

The strategy to expand the distribution network requires registered representatives affiliated with a FINRA member. Registered folks can’t distribute non-compliant communications.

Well, they can, but that creates a bad outcome for everyone.

The content standard in FINRA Rule 2210 that creates considerable friction is the one that prohibits a projected return to the investor for an investment in advertising material. To some, it’s counterintuitive. A projected return takes many forms: internal rate of return, cash on cash multiple, distribution rate, annual return, etc. The regional developer says, “Wait a minute, all of my competitors project returns, how can I compete if I can’t provide an investor the same information?”

It’s also an objection by an asset manager who has never had issue with a projected return. It’s part of the asset manager’s DNA to provide that type of information; it’s the reason an investor chooses their fund and it is not prohibited in advertising until a FINRA registered entity or person distributes the advertising. In both examples, the distribution by the issuer’s or sponsor’s registered representatives to the IBD and RIA channel, or from the distribution partner to their investors, are in violation of FINRA’s Rule 2210.

There are no workarounds. It’s prohibited. You can’t show your work, list your assumptions, add a disclosure or fix it...it is prohibited.

It is appropriate for the issuer or sponsor to include a projection in the offering’s PPM or offering circular—unless that inclusion looks like advertising or is prepared by a FINRA member. Even though FINRA generally takes the position that an issuer-prepared PPM or offering circular is not subject to FINRA’s communication with the public rule, that’s not always true. Based on a subjective evaluation, the member must determine if all or a portion of the PPM could be considered advertising, i.e. does it have pictures, color, glossy paper or generally look like a marketing piece, rather than a document? If so, that portion of the PPM is considered advertising subject to FINRA’s content standards and must be reviewed and approved prior to use.

That is the rule, subject to enforcement, and as a sponsor or issuer, it truly is not to your advantage for your distribution partner to bend the rules.

A year or so ago, FINRA amended its Rule 5123. The rule now requires that all advertising used to solicit investors by a member firm must be submitted to FINRA’s Corporate Finance Department within fifteen days of the private offering’s first sale. No registered firm or person wants to receive a FINRA information request about content used to promote an offering. Good firms won’t take the chance by allowing its affiliated reps to use non-compliant material on the assumption that FINRA won’t see it.

Other Advertising Pitfalls and Considerations

There are other FINRA content standard attributes that can be frustrating to those not familiar with securities communications, but important to be aware of.

• Testimonials – Are they paid, and if so, is that communicated?
• Claims – Are they the belief of the issuer, or is there reputable, independent and publicly sourced confirmation? Is the source cited and is it timely? Is it less than 12 months old?
• Past Results – Are previous offerings and outcomes used? If so, are they just the good ones, or considered to be cherry picking? Or is a complete list presented? The content standard requires all or none.
• Exaggeration – Phrases like “the best, largest, first, only, etc”. This type of language must be tempered.
• Balance – Most issuers have high confidence in the outcome of their endeavors, but those outcomes are not guaranteed. In fact, the outcome may be quite the opposite from what the issuer expects. Does the advertising piece give a balanced picture of the potential upside of success as well as the downside of less than success?
• Comparisons – These are especially hard. An exhaustive list is required of all attributes of each in the comparison and each must be clearly explained.
• Required Disclosures – FINRA considers alternative investments to be speculative and generally illiquid. Does the piece point that out to the investor so that they may make an objective investment decision? That is considered material information and must be included.
• Unwarranted Claims – Is the inclusion of some broad market metric unwarranted? Does it apply directly to the offering or is it general information about the market overall? If it’s general in nature, it is also likely to be unwarranted and may not be used without clear disclosure that it is general information and may not be correlated with the specific offering.

*Certainly each bullet point is deserving of its own topical article and this is in no way intended to be a comprehensive and fully illustrative list.

One way sponsors can avoid these pitfalls is by working with a partner with extensive experience in this area and is consultative in their approach. As they say, ten years of experience can’t be had in ten minutes. Compliant regulatory advertising is a “facts and circumstances” review of the piece in relation to the offering or sponsor that it portrays. Good broker-dealers will have a library of voluntary FINRA advertising submissions that give basis for their feedback and coaching as new content is developed and submitted for approval.

I believe that responsible distribution partners expect compliant advertising material to be presented by the sponsor or issuer. Compliant material portraying a worthy sponsor and its worthy offering is better received by the independent broker-dealer and registered investment advisor. It can then be used confidently to create distribution relationships in preference to sponsors and offerings with materials that lack appropriate rigor.

And good distribution relationships can be mutually beneficial.