Compliance Solutions for Investment Advisers

FAQs — Solicitors & Referrals

 

What is the definition of solicitor?

Solicitor means any person who, directly or indirectly, solicits any client  for, or refers any client to, an investment adviser.

What is the cash referral fee rule?

Rule 206(4)-3 under the Advisers Act (e.g., the cash referral fee rule) generally prohibits an SEC-registered investment adviser from paying a cash fee, directly or indirectly, to a third party (a “solicitor”) for referring clients to the adviser unless the arrangement complies with a number of conditions.

What are the basic requirements of the cash referral fee rule?

Pursuant to Rule 206(4)-3, a cash fee cannot be paid directly or indirectly to a solicitor unless three basic conditions are met:

  1. The investment adviser must be registered;
  2. The fee must be paid pursuant to a written agreement between the solicitor and the investment adviser; and
  3. No payment is made to a disqualified person.

What information must be included in the agreement between an investment adviser and the solicitor?

The written agreement must set forth the following information:

  • The scope of the solicitor’s activities;
  • A covenant (e.g., undertaking) by the solicitor to perform such activities consistent with instructions of the investment adviser and in compliance with the Investment Advisers Act of 1940 and associated rules; and
  • A covenant by the solicitor to provide the client with a copy of the investment adviser’s Form ADV Part 2A and a separate written solicitor disclosure document.

What information must be included in the separate written solicitor disclosure document that a third-party solicitor must provide a client?

The solicitor’s written disclosure document must contain the following information:

  • The name of the solicitor;
  • The name of the investment adviser;
  • The nature of the relationship, including any affiliation, between the solicitor and the investment adviser;
  • A statement that the solicitor will be compensated for their solicitation services by the investment adviser;
  • The terms of such compensation arrangement, including a description of the compensation paid or to be paid to the solicitor; and
  • The additional amount that will be charged to the solicited client’s investment advisory fee and the differential attributable to the solicitor arrangement.

Can the solicitor’s disclosure document be incorporated into another document such as the Form ADV Part 2A?

The SEC staff has refused to grant no-action relief on proposals that the solicitor’s disclosure document be incorporated in other documents, rather than be set forth in a “separate written disclosure statement” as literally called for by the cash referral fee rule.

Can the investment adviser, as opposed to the solicitor, deliver the required documents (e.g., Form ADV Part 2A and the solicitor’s written disclosure document)?

The SEC staff has, by no-action letter, permitted an investment adviser (in lieu of the solicitor) to deliver copies of the their Form ADV Part 2A and the solicitor’s separate written disclosure document to prospective clients.

Who is considered a disqualified person?

An investment adviser is prohibited from paying solicitation fees to any person subject to any of the following:

  • An individual barred or suspended by the SEC under Section 203(f) of the Act from associating with an investment adviser;
  • An individual convicted within the previous ten years of any felony or misdemeanor involving conduct described in Section 203(e)(2)(A) through (D) of the Act;
  • An individual who has been found by the SEC to have engaged, or has been convicted of engaging, in any of the conduct specified in paragraphs (1), (5) or (6) of Section 203(e) of the Act; or
  • An individual that is subject to an order, judgment or decree described in Section 203(e)(4) of the Act.

Is a solicitor required to be registered as an investment adviser or investment adviser representative?

Actually, the SEC does not require a solicitor to be registered in any of these capacities. However, because the majority of state securities regulations define the solicitation or referral of investment advisory clients as an investment advisory activity, they require the registration of the solicitor as an investment adviser or investment adviser representative.

Are there any exceptions to the state-level requirement that a solicitor must be registered?

Yes. Some states provide an exception for the solicitation activities of attorneys, CPAs and surprisingly, engineers, if such solicitation activity is incidental to their primary business.  In other words, if a lawyer refers a client to an investment adviser once in a while and receives a referral fee that would probably be okay. But anyone contemplating using this exception should check the specific regulations of their state because some states assert that the mere fact that a client was referred makes it not incidental.

Does the solicitor have to be registered with the investment advisory firm that is receiving the referrals?

No. The solicitor does not have to be registered with the advisory firm receiving the referrals.

Are there any other situations where an investment adviser may pay a cash referral fee?

There are two alternative scenarios where an adviser may pay a cash referral fee. The first is with respect to solicitation activities for the provision of impersonal advisory services only. The second is when the solicitor is an associated person of the advisory firm.

What are considered impersonal advisory services?

Impersonal advisory services means investment advisory services provided solely by means of (i) written materials or oral statements which do not purport to meet the objectives or needs of the specific client, (ii) statistical information containing no expressions of opinions as to the investment merits of particular securities, or (iii) any combination of the foregoing services.

What is the associated person exception to the cash referral fee rule requirements?

An adviser may pay solicitation fees with respect to personal advisory services if the solicitor is a partner, officer, director, or employee of either the investment adviser or a person that controls, is controlled by, or is under common control with the investment adviser, and the solicitor’s association with the investment adviser is disclosed to the client at the time of the solicitation.

Is an investment adviser required to supervise solicitors?

While an investment adviser is not required to supervise the solicitation activities of the solicitor as if the solicitor were one of its own employees, an adviser is required to make a bona fide effort to ascertain whether the solicitor is in compliance with the terms of the agreement and to have a reasonable basis for believing that the solicitor is in fact in compliance.

Where are the disclosure requirements with respect to a solicitation arrangement?

An investment adviser must disclose the existence of a solicitation arrangement in Item 5.B(6) and Item 8.H of Form ADV Part 1 and in Item 14 of Form ADV Part 2A.

What does Item 14 of Form ADV Part 2A require?

An adviser must disclose whether the adviser or a related person directly or indirectly compensates any person who is not one of their supervised persons for client referrals.  The adviser must also describe the relationship and the compensation paid to the solicitor.

What are the record keeping requirements under the cash referral fee rule?

Advisers Act Rule 204-2 requires investment advisers to keep copies of the following material pertaining to solicitors and referrals:

  • The separate written disclosure document required to be furnished by the solicitor to the client (e.g., the Solicitor’s Written Disclosure Document).
  • Copies of the investment adviser’s disclosure documents (e.g., Form ADV Part 2A) delivered to the solicited client by the solicitor.

 

Important Information

The information contained in this Frequently Asked Questions is only a summary and is not intended to be a comprehensive analysis of the rules and regulations applicable to registered investment advisers. It is not intended to constitute legal or compliance consulting advice or apply to any one investment adviser’s particular situation. For more information, please see our Terms of Use.

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