Titan’s Compliance Challenge: Navigating Hypothetical Performance Under the New Marketing Rule”

Today, the Securities and Exchange Commission unveiled charges against Titan Global Capital Management USA LLC, a FinTech investment firm headquartered in New York. The charges stem from Titan’s deployment of misleading hypothetical investment performance figures in its promotional materials. Alongside this, the SEC highlighted a series of compliance lapses by Titan, encompassing ambiguous disclosures regarding the safeguarding of clients’ cryptocurrency holdings, inappropriate use of “hedge clauses” in contracts, unauthorized client signature application, and a lack of guidelines about crypto trading activities of its staff.

Per the SEC’s documentation, between August 2021 to October 2022, Titan, accessible to retail investors via its mobile application, made several misrepresentative claims on its online platform. A notable instance includes showcasing an “annualized” growth rate of up to 2,700 percent for their Titan Crypto initiative. Such representations were deemed misleading due to the omission of crucial details – such as the assumption that a three-week performance trend would persist throughout a year. Furthermore, Titan allegedly disregarded the December 2020-amended marketing rule by promoting these hypothetical figures without adhering to the Commission’s set protocols.

In addition to these issues, the SEC’s documentation also emphasized that Titan provided inconsistent information about the custody of crypto assets, misused liability disclaimers that could mislead clients into believing they had forfeited certain rights against the company, and despite prior claims, had no established guidelines regarding employee crypto asset trading. Titan’s self-disclosure to the SEC revealed additional lapses, including failing to secure client signatures for specific account activities, leading to agreed settlements on related accusations.

Osman Nawaz, head of the Enforcement’s Complex Financial Instruments Unit, stressed the obligation of investment advisers to provide transparent and accurate information to both potential and current clients. He underscored the amended marketing rule’s accommodation of hypothetical performance metrics, given the advisers adhere to anti-fraud protocols. He added, “Titan’s promotional strategies provided an inaccurate portrayal of some of its investment routes. This development should act as a wake-up call for advisory firms to maintain regulatory adherence.”

While not admitting to or disputing the SEC’s determinations, Titan has agreed to several resolutions: an injunction, official reprimand, and a payment totaling $1,042,454, which encompasses the return of ill-gotten gains, accruing interest, and a civil fine. These funds will be redirected to the impacted clients.

The inquiry was spearheaded by Kelly Rock and Elisabeth Goot, under the supervision of Armita Cohen and Osman Nawaz from the Complex Financial Instruments Unit. The team also received support from Alexander Lefferts from the Enforcement Division’s investigative unit and Ling Yu and Carolyn O’Brien from the Examination Division.

The recent unveiling of the New Marketing Rule case by the SEC underscores the inherent complexities that have always beleaguered Chief Compliance Officers (CCOs), especially concerning the murky waters of hypothetical performance metrics. This particular domain, undeniably, has always been a quandary for even the most seasoned compliance experts. Alongside hypothetical performance, the case elucidates on other significant aspects such as custody considerations, hedge clauses, personal trading, conflicts of interest, and the overarching compliance rule.

Diving deeper into the nuances of the case, it is evident that Titan decided to align with the New Marketing Rule approximately six months post its enactment. However, what stands out glaringly is their oversight in devising a robust framework of policies and procedures that particularly address the deployment of hypothetical performance metrics. As compliance veterans would vouch, marketing hypothetical performance is categorically off-limits unless the requisite compliance protocols and controls, as articulated in the Marketing Rule, are in place.

An additional red flag was Titan’s approach to marketing disclosures. While they linked to certain pivotal disclosures, they apparently omitted incorporating information regarding hypothetical performance within the actual marketing content. The SEC’s contention is twofold here: firstly, the inadequacy of linked disclosures, particularly given that the adviser did not explicitly recommend these pivotal links to their retail investors, and secondly, the overall inefficacy of the disclosures surrounding the hypothetical annualized performance. The extrapolation of a mere three-week cycle for such grandiose claims, without comprehensive disclosures that are fair, balanced, and thorough, was a serious lapse.

Hypothetical performance, given its intrinsic challenges, has historically been a pain point during compliance reviews. From an examiner’s perspective, it is rare to witness hypothetical performance representations that don’t elicit feedback or comments from the examining team. More often than not, these comments are well-merited, especially since there is a slew of underlying assumptions that necessitate proper disclosure. The New Marketing Rule has not simplified this process.

In light of the aforementioned observations, a few critical takeaways emerge (sidelining the non-marketing rule components for this discourse):

1. Rigorous Scrutiny: Every firm needs to rigorously evaluate its performance marketing strategies. It’s not just about what is presented but also about what is implicitly or explicitly left out.

2. Deliberation on Hypothetical Performance: The construction of hypothetical performance must be deliberated upon with care. It’s not just about showcasing optimistic numbers but understanding the underlying assumptions and potential risks.

3. Comprehensive Disclosures: Crafting comprehensive, transparent, and clear disclosures is paramount. These must encapsulate the performance metrics, underlying assumptions, inherent limitations, and any associated risks.

In conclusion, while navigating the regulatory landscape can be intricate and taxing, it is imperative for firms to invest time, resources, and due diligence, especially when it comes to the nuanced realm of hypothetical performance. It not only safeguards them against potential regulatory repercussions but also fortifies trust with their clientele.

Legal Disclaimer

The information provided in this article is for general informational purposes only and should not be construed as legal or tax advice. The content presented is not intended to be a substitute for professional legal, tax, or financial advice, nor should it be relied upon as such. Readers are encouraged to consult with their own attorney, CPA, and tax advisors to obtain specific guidance and advice tailored to their individual circumstances. No responsibility is assumed for any inaccuracies or errors in the information contained herein, and John Montague and Montague Law expressly disclaim any liability for any actions taken or not taken based on the information provided in this article.

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