A prospective client receives a marketing brochure from an investment adviser (IA) firm. The brochure prominently features a chart illustrating hypothetical investment growth over the past 10 years, assuming a consistent 8% annual return. The brochure does not include any disclosure about the hypothetical nature of the returns or that past performance is not indicative of future results. This omission is most problematic because it:
- AConstitutes an unregistered offering of securities.
- BCreates an unreasonable expectation of investment performance.
- CSuggests the IA is also a broker-dealer.
- DFails to meet minimum capital requirements for the IA.
Show answer & explanationAnswer & explanation
Correct answer: B. Creates an unreasonable expectation of investment performance.
Hypothetical illustrations, especially when projecting returns, must always be accompanied by clear disclosures that they are hypothetical, do not represent actual performance, and that past performance (or hypothetical past performance) does not guarantee future results. Failing to do so creates an unreasonable and misleading expectation for potential investors.
Why the other options are wrong
- A. The scenario describes marketing, not an offering of a specific security.
- C. The content of the brochure does not imply the IA is also a broker-dealer.
- D. Minimum capital requirements are unrelated to the content of a marketing brochure.
Hypothetical Performance Disclosures
When using hypothetical performance illustrations in marketing materials, investment advisers must prominently disclose that the results are hypothetical, do not represent actual performance, and are not indicative of future results.
- Required for all hypothetical illustrations.
- Must state 'hypothetical' clearly.
- Must state 'not actual performance'.
- Must state 'past performance not indicative of future results'.
Memory trick: IA marketing needs disclosures, like a road needs clear signs.