Hypothetical Performance Restrictions

You can include hypothetical performance in an SEC “advertisement” only if you have written policies and procedures that make the hypothetical results relevant to the intended audience’s likely financial situation and objectives, and you deliver the information and risk context that audience needs to interpret it. Treat this as a gating control: no hypothetical performance goes out until audience fit, assumptions support, and required disclosures are documented. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Key takeaways:

• Hypothetical performance is permitted only with policies and procedures that ensure relevance to the intended audience. (17 CFR § 275.206(4)-1(d)(4))
• Operationalize this with an “audience qualification + content substantiation + disclosure package” workflow tied to approvals and recordkeeping. (17 CFR § 275.206(4)-1)
• Your highest risk is broad distribution (mass audiences) and weak documentation of assumptions, limitations, and why the audience can reasonably evaluate the information. (17 CFR § 275.206(4)-1)

“HYPOTHETICAL PERFORMANCE” under the SEC Marketing Rule is a high-scrutiny claim category because it can look precise while depending on assumptions the viewer may not understand. The restriction in 17 CFR § 275.206(4)-1(d)(4) is simple to state but easy to fail in practice: you must adopt and implement policies and procedures reasonably designed to ensure the hypothetical performance you present is relevant to the likely financial situation and objectives of the intended audience. (17 CFR § 275.206(4)-1(d)(4))

For a CCO or GRC lead, the fastest way to operationalize this requirement is to stop treating it like “just another disclosure.” Build a repeatable gate that ties (1) who the audience is and why they are a fit, (2) what the hypothetical performance is (model, backtested, targeted/projected) and the assumptions behind it, and (3) what the audience needs to interpret it responsibly. Your marketing review process should force the business to prove relevance before publication, and your books-and-records package should allow an examiner to re-run your logic after the fact. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Regulatory text

Text (excerpt): “An advertisement may not include hypothetical performance unless the adviser adopts and implements policies and procedures reasonably designed to ensure that it is relevant to the likely financial situation and objectives of the intended audience.” (17 CFR § 275.206(4)-1(d)(4))

What the operator must do:
You need a documented, consistently followed control framework that (a) defines what counts as hypothetical performance, (b) defines and restricts the intended audience, and (c) requires a relevance determination before distribution. The practical standard is “reasonably designed,” so your controls must match your products, strategies, and distribution channels, not a generic checklist. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Plain-English interpretation (what this requirement is trying to prevent)

Hypothetical performance can mislead if a recipient cannot evaluate the assumptions, limitations, and risks. The rule does not flatly ban model/backtested/targeted returns. It requires you to present them only where the audience is likely able to understand and where the information is relevant to that audience’s circumstances and objectives. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

A workable internal translation:

• If you can’t define the audience, you can’t use hypothetical performance.
• If you can’t explain the assumptions and limitations in a way the audience can understand, you can’t use hypothetical performance.
• If distribution can spill into a mass audience, treat it as prohibited until you redesign the channel or the content. (17 CFR § 275.206(4)-1(d)(4))

Who it applies to (entity + operational context)

Covered entities: Registered investment advisers and advisers engaged in marketing activities subject to the SEC Marketing Rule; fund managers marketing advisory services/strategies through “advertisements” as defined by the rule. (17 CFR § 275.206(4)-1)

Where it shows up operationally:

• Pitch decks and DDQs with model, backtested, or projected results
• One-pagers and strategy profiles with targeted returns
• Website “performance” pages and factsheets
• RFP responses and consultant databases if they are advertisements under the rule’s definition
• Social posts or videos that reference projected results or targets (high risk because of distribution breadth) (17 CFR § 275.206(4)-1)

What you actually need to do (step-by-step)

Below is a practical workflow you can drop into your marketing review SOP. The goal is a gated release: hypothetical performance is permitted only after the file shows relevance, support, and disclosures.

Step 1: Classify the content as “hypothetical performance”

Create a short classification standard in policy and in your review form. Treat these as hypothetical performance:

• Model performance (model portfolios, paper portfolios)
• Backtested performance (simulated results based on historical data)
• Targeted/projected performance (targets, projections, expected returns) (17 CFR § 275.206(4)-1)

Control: Marketing/legal/compliance must tag the material “HP” (hypothetical performance) in your content repository to trigger the extra controls and retention package. (17 CFR § 275.206(4)-1(d)(4))

Step 2: Define the “intended audience” and block mass distribution

Your procedures should require an affirmative answer to: Who exactly will receive this? Then harden distribution so the content does not drift.

Minimum operational requirements:

• Identify audience type (for example: institutional consultant, ERISA plan fiduciary, high-net-worth prospect under specific onboarding stage, existing client with strategy mandate).
• Define audience access method (secure portal, one-to-one email, data room, controlled consultant platform).
• Prohibit posting hypothetical performance to public webpages or channels that cannot reasonably restrict access, unless you can still satisfy relevance and other Marketing Rule conditions for that channel. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Practical gating questions (build into your review form):

• Is the recipient known and documented (named firm/contact or authenticated user)?
• Do we have a record of the recipient’s investment objectives/constraints, or a reasonable proxy (e.g., consultant mandate profile)?
• Can this be forwarded externally without controls (PDF forwarding risk)? If yes, add a cover page restricting redistribution and use controlled delivery where feasible.

Step 3: Document “relevance to the likely financial situation and objectives”

This is the core requirement. Your file needs a relevance memo (short is fine) that links the hypothetical performance to the audience.

Relevance memo (one-page template):

• Audience description (who, sophistication, decision role)
• Known/likely objectives (return target, risk tolerance proxy, time horizon, liquidity needs, benchmark context)
• Why the hypothetical performance is relevant to those objectives
• What would make it not relevant (guardrails: minimum horizon, volatility limits, leverage constraints, drawdown tolerance, liquidity profile) (17 CFR § 275.206(4)-1(d)(4))

Make it operational: Require the business owner (PM, product specialist, IR) to complete it; compliance reviews and either approves or returns with required changes.

Step 4: Provide sufficient information on criteria and assumptions

Your procedures should require that the audience can understand how results were produced. The exact content varies, but your standard should force the basics:

• Time period and data source description
• Key model rules (rebalancing logic, transaction cost assumptions, fees treatment)
• Material constraints (position limits, liquidity constraints, leverage, shorting)
• Benchmark selection rationale if shown
• For projections/targets: what the target represents and what it is not (17 CFR § 275.206(4)-1)

Artifact: “Hypothetical Performance Methodology Appendix” attached to the deck or included as an exhibit in the data room.

Step 5: Add tailored risk disclosures (not generic boilerplate)

Your disclosures should be specific to why hypothetical performance can diverge from real results and what the audience should not infer. Require at least:

• Statement that results are hypothetical and have inherent limitations
• Key drivers of divergence (model assumptions, lack of live trading frictions, changing market regimes, implementation constraints)
• Material risks of the strategy relevant to the audience (concentration, liquidity, derivatives, leverage, volatility) (17 CFR § 275.206(4)-1)

Control: Disclosures must be version-controlled and tied to the specific hypothetical exhibit (so a deck update triggers a disclosure review).

Step 6: Route approvals and lock distribution

Build an approval chain that matches your risk:

• Content owner attests to assumptions and audience
• Performance/analytics owner attests to calculation inputs and reproducibility
• Compliance approves for Marketing Rule alignment
• Final PDF is locked and stored; distribution happens through approved channels only (17 CFR § 275.206(4)-1(d)(4))

Where Daydream fits naturally: Many teams fail on consistency: audience gating, version control, and artifacts scattered across email. Daydream can centralize the hypothetical performance approval workflow, enforce required fields (audience fit, assumptions, disclosures), and produce an exam-ready evidence packet tied to each distribution event.

Required evidence and artifacts to retain

Treat this as your “exam binder” checklist for each item containing hypothetical performance:

1. Final approved advertisement (deck/factsheet/DDQ response) with version/date.
2. Hypothetical Performance Classification (tag + rationale).
3. Audience definition + access controls (distribution list, portal access logs, consultant platform details, or CRM notes supporting intended audience).
4. Relevance memo tied to the audience and the specific hypothetical exhibit. (17 CFR § 275.206(4)-1(d)(4))
5. Methodology/assumptions appendix (inputs, rules, fee treatment, limitations). (17 CFR § 275.206(4)-1)
6. Risk disclosure language as delivered with the piece. (17 CFR § 275.206(4)-1)
7. Approvals record (who approved, when, what changed).
8. Source data and calculation support sufficient for internal reproduction (owned by performance/finance as appropriate).

Common exam/audit questions and hangups

Expect reviewers to test whether your process is real, not aspirational. Common lines of questioning:

• Show me your policies and procedures for hypothetical performance. (17 CFR § 275.206(4)-1(d)(4))
• For this deck, who was the intended audience and how did you determine relevance? Produce the documentation.
• How do you prevent this from being delivered to a mass audience (public website, social, broad email blasts)?
• What assumptions drive the results, and where are they disclosed to the recipient?
• Who signs off on the calculations, and can you reproduce them from retained records? (17 CFR § 275.206(4)-1)

Frequent implementation mistakes (and how to avoid them)

1. “Institutional” as the only audience definition.
   Fix: Require a concrete audience profile plus distribution controls and a relevance memo tied to objectives. (17 CFR § 275.206(4)-1(d)(4))

2. Posting backtests in public materials.
   Fix: Treat uncontrolled channels as prohibited for hypothetical performance unless you redesign access and can still satisfy the requirement for the intended audience. (17 CFR § 275.206(4)-1(d)(4))

3. Assumptions buried in an internal spreadsheet, not shared with recipients.
   Fix: Attach a methodology appendix or incorporate assumptions directly in the piece. (17 CFR § 275.206(4)-1)

4. Boilerplate risk disclosure that ignores the strategy’s actual drivers.
   Fix: Maintain a disclosure library with strategy-specific modules and require tailoring in the review. (17 CFR § 275.206(4)-1)

5. No linkage between approvals and the exact version distributed.
   Fix: Version-control PDFs, store the “final as sent,” and log distribution events.

Enforcement context and risk implications

No public enforcement cases were provided in the source catalog for this requirement, so this page does not list specific cases. The practical risk remains high because hypothetical performance sits in a rule subsection that exam teams can test directly from your marketing files and distribution logs. The most defensible posture is to make hypothetical performance a controlled activity with visible gates, documented relevance, and reproducible support. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Practical 30/60/90-day execution plan

Use phases to move quickly without waiting for a perfect policy rewrite.

First 30 days (Immediate stabilization)

• Inventory all materials and channels where hypothetical performance appears or could appear (pitch decks, factsheets, website, DDQs). (17 CFR § 275.206(4)-1)
• Put an interim hold on new hypothetical performance releases outside controlled distribution.
• Publish a short interim SOP: classification, audience gating, required attachments, and approval routing. (17 CFR § 275.206(4)-1(d)(4))
• Build the one-page relevance memo template and a methodology appendix template.

Next 60 days (Operational hardening)

• Update formal policies and procedures to codify the gate and responsibilities. (17 CFR § 275.206(4)-1(d)(4))
• Implement distribution controls (portal, authenticated access, controlled mailing lists, standardized cover language).
• Create a disclosure library: general hypothetical limitations + strategy-specific risk modules. (17 CFR § 275.206(4)-1)
• Stand up an evidence repository by advertisement version (Daydream or your existing GRC/content system).

Next 90 days (Testing + audit readiness)

• Run a QA test: pick recent ads with hypothetical performance and confirm you can produce the full evidence pack within a short turnaround.
• Train IR, product, and marketing on “what triggers HP controls” and “what will get rejected.”
• Add ongoing monitoring: periodic sampling of outbound materials and website scans for stray hypothetical claims. (17 CFR § 275.206(4)-1(d)(4))

Frequently Asked Questions

Does “hypothetical performance” include targeted returns in a pitch deck?

Yes, targeted or projected returns fall under the plain-language summary of hypothetical performance and should trigger the relevance policies and procedures. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

Can we show backtested results on our public website if we add a big disclaimer?

A disclaimer does not replace the requirement to ensure relevance to the intended audience, and public webpages are hard to square with a defined, controlled audience. Treat public distribution as high risk and redesign access or remove the hypothetical performance. (17 CFR § 275.206(4)-1(d)(4))

What does “reasonably designed” mean for policies and procedures here?

Your controls should match how you actually market: the strategies you offer, the sophistication of your recipients, and the channels you use. Examiners will look for consistent execution and evidence, not just policy language. (17 CFR § 275.206(4)-1(d)(4))

Do we need to provide the full calculation model to prospects?

The rule language in this prompt focuses on relevance, and the summary also expects sufficient information for the audience to understand criteria and assumptions. A methodology appendix is usually a better practice than handing over the full model, unless your audience and negotiation require deeper transparency. (17 CFR § 275.206(4)-1)

Who should own approval of hypothetical performance materials?

Compliance should approve against the Marketing Rule requirements, but performance/finance should attest to calculation inputs and reproducibility, and the business should attest to audience fit. Separate attestations reduce single-point-of-failure risk. (17 CFR § 275.206(4)-1(d)(4); 17 CFR § 275.206(4)-1)

What evidence will save the most time in an exam?

A complete, version-locked file per advertisement that includes the relevance memo, the assumptions/methodology exhibit, the disclosures as delivered, and distribution/audience controls. If those are in one place (for example, Daydream), you avoid reconstructing intent from email. (17 CFR § 275.206(4)-1(d)(4))