SEC’s Marketing Rule – Strategies for CLO Managers

Background

In December 2020, the Securities and Exchange Commission (“SEC”) adopted changes to Rule 206(4)-1 under the Investment Advisers Act to modernize the regulatory framework for investment advisers’ advertising and marketing practices.¹ This amended “Marketing Rule” replaces the previous advertising and cash solicitation rules that were applicable to investment advisers, and is accompanied by a wholesale withdrawal of prior no-action letters and other staff guidance.

The Marketing Rule became effective on November 4, 2022 (the “Compliance Date”). As described in more detail in our article at Eleven “Top of Mind” Questions and Misconceptions Surrounding the New Marketing Rule and our video tutorials at The New SEC Marketing Rule—Planning Your Transition, advisers have confronted many issues and questions with respect to the Marketing Rule.

Effect on CLO Managers and Proposed Strategies for Compliance

While the Marketing Rule primarily targets advisers of traditional private equity and hedge funds, collateralized loan obligation (“CLO”) managers, because they are SEC-registered investment advisers, fall within the scope of the Marketing Rule.

The SEC has recommended that all investment advisers should consider whether they need to update or revise their written policies and procedures to ensure they are reasonably designed to prevent violations of the Marketing Rule.²  As such, CLO managers are taking steps to ensure compliance with the new rule.

The Marketing Rule requires CLO managers to have a reasonable belief that they will be able to substantiate material statements of fact in their “advertisements,” which includes certain written materials disseminated by, and oral statements made by, CLO placement agents to potential investors in the marketing process. For some CLO managers, this “substantiation requirement” may well require a significant increase in the amount of effort that goes into preparing, reviewing, and approving marketing (and potentially some offering) documents that constitute covered “advertisements.”

CLO managers will also need to ensure that the requirements of the Marketing Rule covering the solicitation activities of their placement agents are met. To that end, we note the following best practices:

• CLO managers should negotiate with their placement agents mutually acceptable steps that will permit CLO managers to form a good faith belief that the placement agents’ activities comply with “endorsements” provisions of the Marketing Rule. One way to facilitate compliance that is gaining popularity in the market is for placement agents to represent and warrant in engagement letters that all relevant marketing materials provided to investors will include or be accompanied by clear and prominent disclosure of the material conflicts of interest resulting from the engagement of the placement agent by the CLO manager.
• Such disclosure provided by the placement agent to investors should inform investors that the placement agent will earn a fee in connection with the CLO transaction and therefore has an incentive to endorse the manager and close the CLO transaction.
• The CLO manager should obtain a representation from the placement agent that it is an SEC-registered broker-dealer and is not an “ineligible person” subject to a disqualifying SEC action or disqualifying event under the Marketing Rule.
• It is also helpful for the placement agent to agree to assist the CLO manager in complying with the Marketing Rule by sharing information reasonably requested by the CLO manager from time to time for this purpose.

In summary, although a certain amount of diligence is required, in most cases this new obligation should be able to fit within the existing relationships between CLO managers and their placement agents. While there is no-one-size-fits-all approach, CLO managers should focus on confirming that their placement agents understand their Marketing Rule compliance responsibilities and that the CLO managers’ personnel have the opportunity to obtain information and other comfort sufficient to allow them to establish a reasonable belief that the agents’ activities will not cause a violation of the Marketing Rule.

¹ Final Rule: Investment Adviser Marketing (sec.gov).

² SEC Risk Alert (September 19, 2022) exams-risk-alert-marketing-rule.pdf (sec.gov).