Advertising Algorithm Trading Results Guide

The Marketing Rule Revolution for Algorithm Trading

The SEC's Marketing Rule (Rule 206(4)-1), which became effective in November 2022, fundamentally transformed how investment advisers can advertise their performance. For algorithmic trading platforms, robo-advisers, and quantitative investment managers, this rule presents both opportunities and landmines.

In my practice advising algorithmic trading platforms, I see a consistent pattern: marketing teams eager to showcase impressive backtests and performance statistics, but compliance teams terrified of SEC enforcement. The Marketing Rule replaced decades-old prohibitions with a principles-based framework that permits performance advertising if done correctly.

The challenge is that "correctly" requires navigating complex requirements around gross vs. net returns, time-weighted vs. dollar-weighted calculations, model vs. actual performance, and comprehensive disclosure obligations. A single misstep can trigger SEC enforcement action with penalties ranging from hundreds of thousands to millions of dollars.

Performance Advertising Standards Under the Marketing Rule

The Marketing Rule establishes a general prohibition on false or misleading statements, with specific requirements for performance advertising. Understanding these foundational standards is critical before diving into technical calculation requirements.

The General Prohibition

Rule 206(4)-1(a)(1) prohibits any advertisement that:

• Includes any untrue statement of material fact
• Omits material facts necessary to make the statements made not misleading
• Would reasonably be likely to cause an untrue or misleading inference

What Constitutes "Performance Advertising"

The Marketing Rule defines "performance advertising" broadly to include any direct or indirect presentation of returns, profitability, or investment success. This encompasses:

• Specific returns (e.g., "Our algorithm returned 25% last year")
• Comparisons to benchmarks (e.g., "We beat the S&P 500 by 5%")
• Model or backtested returns
• Hypothetical performance projections
• Predecessor performance (track records from prior firms)
• Testimonials that discuss results or performance
• Third-party ratings that incorporate performance

Mandatory Performance Advertising Requirements

When you present performance, the Marketing Rule requires:

SEC Marketing Rule Application to Trading Platforms

The Marketing Rule applies differently depending on your platform's regulatory status and how you present performance. Understanding these distinctions is essential for compliance.

Who is Subject to the Marketing Rule?

The Marketing Rule applies to SEC-registered investment advisers and exempt reporting advisers. This includes:

• Registered Investment Advisers: Fully subject to all provisions
• Exempt Reporting Advisers: Subject to the general anti-fraud provisions but not specific performance requirements
• State-Registered Advisers: May be subject to similar state rules
• Broker-Dealers: Subject to separate FINRA rules, not the Marketing Rule

Platform-Specific Applications

Robo-Advisers

Robo-advisers face unique challenges because they typically manage many similar but distinct portfolios. Key considerations:

• Cannot cherry-pick best-performing accounts for advertising
• Must show performance for representative accounts or composites
• Model portfolios must comply with hypothetical performance rules
• Account minimums and eligibility criteria affect what constitutes a "similar" account

Algorithm Trading Platforms (SaaS Model)

Platforms that provide algorithms but don't manage client assets face special scrutiny:

• Platform returns vs. user returns must be distinguished
• User testimonials about returns trigger testimonial disclosure rules
• Aggregate user performance claims require substantiation
• Backtests are considered model performance requiring specific disclosures

Discretionary Algorithmic Managers

Managers who use algorithms to make discretionary investment decisions for client accounts:

• Can advertise actual client returns with proper disclosures
• Must include all accounts in composites, not just successful ones
• Cannot advertise pre-launch backtests without hypothetical performance disclosures
• Changes to algorithms may require performance recalculation

Gross vs Net Returns: Calculation and Disclosure Requirements

One of the most frequently violated provisions of the Marketing Rule is the requirement to present net returns alongside gross returns. Understanding how to properly calculate and present both is essential.

Why Net Returns Matter

Gross returns (before fees) can dramatically overstate what clients actually realize. For example, a strategy with 12% gross returns but 2% annual fees delivers only 10% net returns. Over time, this difference compounds significantly:

Net Return Calculation Requirements

The Marketing Rule requires net returns to reflect deduction of:

• Advisory Fees: All investment advisory fees charged
• Performance Fees: Any carried interest or performance-based compensation
• Management Fees: For fund structures, management fees

Net returns do NOT need to deduct:

• Custodial fees (unless you select the custodian)
• Transaction costs (unless you operate as a wrap fee program)
• Subscription fees for platform access (if separate from advisory fees)

Presentation Requirements

When presenting performance, you must:

• Show net returns with at least equal prominence to gross returns
• Use the same time periods for both gross and net
• Clearly label which is gross and which is net
• Disclose the fee structure used to calculate net returns
• Explain any assumptions about fees (e.g., "assuming highest fee tier")

Time-Weighted vs Dollar-Weighted Returns

The choice between time-weighted return (TWR) and dollar-weighted return (DWR, also called money-weighted or internal rate of return) significantly impacts reported performance. The Marketing Rule requires disclosure of which method you use and why it's appropriate.

Time-Weighted Return (TWR)

TWR measures the compound rate of growth by removing the effect of cash flows. It's calculated by:

1. Breaking the measurement period into sub-periods at each cash flow
2. Calculating the return for each sub-period
3. Linking the sub-period returns geometrically

Dollar-Weighted Return (DWR)

DWR (IRR) measures the actual return experienced by the investor, accounting for the timing and size of cash flows. It's the discount rate that makes the net present value of all cash flows equal to zero.

When to Use Each Method

Why This Matters for Algorithm Trading

The choice between TWR and DWR can dramatically affect reported performance when cash flows are large relative to account size or poorly timed:

Marketing Rule Compliance Requirements

Whichever method you choose, you must:

• Disclose which method is used (TWR or DWR)
• Explain why that method is appropriate for your strategy
• Use the same method consistently across all time periods
• If showing both, explain the differences between them
• Maintain documentation of calculations and methodology

Cherry-Picking Prohibition and Related-Performance Rules

One of the most significant aspects of the Marketing Rule is its prohibition on cherry-picking performance. You cannot show only your best results while hiding poor performance.

What Constitutes Cherry-Picking

The SEC considers cherry-picking to include:

• Showing only top-performing accounts while omitting similar accounts
• Selecting favorable time periods that exclude poor performance
• Highlighting best-performing strategies while hiding unsuccessful ones
• Using a subset of accounts without clearly explaining the selection criteria
• Advertising only accounts that are still clients (survivorship bias)

The "Related Performance" Requirement

Rule 206(4)-1(a)(5) requires that any advertisement including performance results for a subset of investments must provide (or offer to provide):

• Performance results for all related portfolios
• An explanation of criteria used to select the subset shown
• If performance is for extracted investments, an explanation of how the subset was determined

Creating Compliant Composites

To avoid cherry-picking violations, algorithmic trading platforms typically create composites. A composite groups together all accounts managed according to the same strategy. Requirements:

Algorithmic Trading Platform Specific Issues

User-Controlled vs. Discretionary Accounts

Many algorithmic platforms allow users to customize settings or override signals. This creates challenges:

• You cannot advertise aggregate user returns if users control execution
• If users can modify algorithm parameters, their results are not your "performance"
• Discretionary overlay by users breaks the composite
• You must distinguish between algorithm performance and user performance

Backtests as Cherry-Picked Performance

Backtests inherently involve cherry-picking because you selected which historical period to test. Additional disclosures required:

• Acknowledge the backtest period was selected and may not be representative
• Disclose if multiple backtests were run and only favorable ones are shown
• Explain any optimization or parameter selection process
• Highlight that actual performance in the selected period may have differed

Model vs Actual Performance Distinctions

The Marketing Rule draws critical distinctions between actual performance (real client returns) and model performance (backtests, hypothetical returns, or model portfolios not actually managed). The requirements differ significantly.

Definitions

Actual Performance

Performance of real portfolios managed for actual clients, including:

• Individual client account performance
• Composite performance of multiple client accounts
• Fund performance (if the fund is actually managed)
• Proprietary account performance (if managed the same as client accounts)

Hypothetical Performance

Performance results that were not actually achieved by any client portfolio, including:

• Backtested results
• Forward-looking projections
• Model portfolios not actually managed
• Pro forma results
• Performance of indices or benchmarks you don't actually replicate

Additional Requirements for Hypothetical Performance

Rule 206(4)-1(d)(6) imposes specific requirements when presenting hypothetical performance:

1. Policies and Procedures: Must adopt and implement written policies addressing:
   • Criteria for using hypothetical performance
   • Methods for determining relevant assumptions and inputs
   • Process for reviewing hypothetical performance for accuracy
2. Disclosure of Material Assumptions: Must provide sufficient information for investors to understand:
   • Criteria used and assumptions made in calculating performance
   • Any material limitations of the presentation
   • Factors that materially affect the results shown
3. Supplemental Performance: If showing hypothetical performance for a period when you also have actual performance, you must present the actual performance with equal or greater prominence

Model Portfolios: A Special Case

Model portfolios present particular challenges because they may be actual (if you manage accounts that track the model) or hypothetical (if the model is just a recommendation). The classification matters:

Transitioning from Model to Actual Performance

When launching a new algorithm, you often start with backtested results and then accumulate actual performance. Compliance during this transition requires:

• Clear labeling of which periods are hypothetical vs. actual
• Visual distinction (different colors, shading, or clear labels)
• Disclosure of the transition date
• Explanation of any methodology differences between backtest and live trading
• Once you have actual performance, it must be shown with at least equal prominence

Fee Disclosure Requirements in Performance Advertising

Beyond the requirement to show net returns, the Marketing Rule imposes comprehensive disclosure obligations about fees when presenting performance. These disclosures ensure investors understand what they would actually pay.

What Fee Information Must Be Disclosed

When presenting performance, you must disclose:

• Fee Schedule: The specific fees used to calculate net performance
• Fee Assumptions: If using hypothetical fees, what assumptions were made
• Fee Components: Breakdown of advisory fees, performance fees, management fees, etc.
• Fee Variability: If fees vary among clients, which tier or average was used
• Fee Changes: Any material changes to fee structure during the performance period
• Excluded Fees: Which fees are not reflected in net performance (e.g., custody, transaction costs)

Common Fee Disclosure Scenarios

Scenario 1: Single Fee Tier

If all clients pay the same advisory fee:

Scenario 2: Tiered Fee Structure

If fees vary based on account size or other factors:

Scenario 3: Performance-Based Fees

If you charge performance fees or carried interest:

Scenario 4: Subscription Model + Advisory Fees

For platforms charging both subscription fees and advisory fees:

Transaction Cost Disclosure

The Marketing Rule does not require deduction of transaction costs from net performance (except for wrap fee programs), but you must disclose this fact if transaction costs are material:

Fee Disclosure Format Requirements

Fee disclosures must be:

• Proximate: Located near the performance presentation, not buried in footnotes
• Clear: Written in plain language understandable to a retail investor
• Comprehensive: Covering all material fee information
• Accessible: If performance is in a video/audio format, fee disclosure must also be presented in the same medium

Testimonial and Endorsement Rules

The Marketing Rule fundamentally changed testimonial rules for investment advisers, moving from an effective prohibition to a disclosure-based regime. For algorithmic trading platforms that often rely on user testimonials, understanding these rules is critical.

Testimonials vs. Endorsements

The Marketing Rule distinguishes between these two categories:

Disclosure Requirements for Testimonials

Rule 206(4)-1(b) requires specific disclosures for testimonials:

• Client Status: Disclose that the person providing the testimonial is a current client or investor
• Compensation: Disclose if the client was compensated for the testimonial (cash, fee discounts, free services, etc.)
• Material Conflicts: Disclose any material conflicts of interest arising from the relationship
• Performance Disclaimers: If testimonial discusses performance, include standard performance disclaimers

Disclosure Requirements for Endorsements

Endorsements have more extensive requirements, especially if the endorser is compensated:

• Compensation Disclosure: Clear and prominent disclosure of material terms of compensation arrangement
• Non-Client Status: Disclose if the endorser is not a client
• Written Agreement: Required for cash compensation over $1,000 during preceding 12 months, including:
  • Scope of agreed-upon activities
  • Terms of compensation
  • Agreement to comply with the Marketing Rule
• Oversight: You must have a reasonable basis to believe the endorser is complying with the agreement
• Disqualification: Cannot use endorsers who are "bad actors" under the rule

The "Bad Actor" Disqualification

You cannot compensate promoters (endorsers) who are subject to certain disqualifying events, including:

• Criminal convictions related to investment-related activity
• Court injunctions or restraining orders related to investment activity
• Final SEC orders imposing certain sanctions
• CFTC orders related to fraud or registration violations
• Suspensions or expulsions from SRO membership

Social Media Testimonials and Endorsements

Applying these rules to social media requires special attention:

Compliant Testimonial Examples

Social Media Compliance for Trading Results

Social media presents unique challenges for advertising trading results due to character limits, format constraints, and the informal nature of platforms. However, the Marketing Rule fully applies to social media communications.

Platform-Specific Challenges

Twitter/X (280 character limit)

Compliance strategies:

• Use thread format to include full disclosures in follow-up tweets
• Link to full performance presentation on your website
• Pin a disclosure tweet to your profile
• Consider whether you can include required disclosures in 280 chars (often you cannot)
• If you cannot include adequate disclosures, don't post performance on Twitter

Instagram/TikTok (Visual emphasis)

Compliance strategies:

• Include disclosures in on-screen text, not just video description
• Make disclosures visible for sufficient duration (3+ seconds)
• Use verbal disclosures in addition to text overlays
• Remember that Stories/temporary content still must comply
• Archive all content for record-keeping requirements

LinkedIn (Professional context)

Compliance strategies:

• More space available for disclosures
• Professional audience may not excuse lack of disclosures
• Company page posts require same compliance as website content
• Personal posts by employees about the firm may be attributable to the firm

Common Social Media Violations

Best Practices for Social Media Performance Advertising

1. Default to NOT posting specific performance on character-limited platforms - If you can't include all required disclosures, don't post performance
2. Create a dedicated performance landing page - Use social media to drive traffic to a compliant webpage rather than trying to fit disclosures in posts
3. Use "teaser" content without specifics - General statements like "Strong month for our momentum strategy" instead of specific returns
4. Implement pre-approval workflow - All performance-related posts must be reviewed by compliance before posting
5. Maintain archives - Social media archiving systems must capture all posts including deleted content
6. Train all employees - Personal social media accounts discussing the firm may be attributable to the firm

Common Violations and Enforcement Actions

Understanding how the SEC enforces the Marketing Rule provides critical guidance on compliance priorities. Here are the most common violations and recent enforcement actions.

Most Common Marketing Rule Violations

Recent Enforcement Actions

SEC Examination Priorities for Performance Advertising

Based on recent examination findings, the SEC focuses on:

• Net performance presentation: Verifying net returns are shown with equal prominence
• Composite construction: Reviewing inclusion criteria and testing for cherry-picking
• Hypothetical performance policies: Examining written policies for backtests and models
• Fee disclosures: Confirming fee information is proximate and comprehensive
• Performance calculation support: Testing that reported performance can be verified from books and records
• Testimonial compliance: Checking for required disclosures on client testimonials
• Social media monitoring: Reviewing social media posts for undisclosed performance claims

Compliant Advertisement Examples

The following examples demonstrate compliant approaches to common algorithmic trading advertising scenarios.

Example 1: Algorithm Performance with Actual Track Record

Example 2: Backtest Results for New Algorithm

Example 3: Model Portfolio Performance

Performance Advertising Disclosure Checklist

Best Practices and Recommendations

Technology Solutions for Compliance

Algorithmic trading platforms should consider implementing:

• Performance Calculation Software: Automated systems that calculate returns according to standardized methodologies (GIPS-compliant tools)
• Composite Management Systems: Tools that automatically include/exclude accounts based on documented criteria
• Marketing Material Management: Workflow systems requiring compliance approval before publication
• Social Media Archiving: Real-time capture of all social media posts including deleted content
• Disclosure Management: Centralized system maintaining current approved disclosures

When to Seek Legal Counsel

Consult with securities counsel when:

• Launching a new algorithm and determining how to present backtests
• Receiving SEC examination request letters asking about performance advertising
• Planning to use influencer marketing or paid endorsements
• Migrating from a prior firm and wanting to use predecessor performance
• Dealing with accounts that deviate from your standard strategy
• Creating new model portfolios or investment strategies
• Unsure whether your platform is subject to the Marketing Rule