Some investors may not realize that the person who the investor thinks of as his or her investment adviser is actually a solicitor for another business who is paid a cash fee to bring in clients. Investors who are working with an adviser who uses a solicitor may be paying higher fees because of the solicitor arrangement. Often times, the investor receives no additional services in exchange for paying higher fees. In other cases, the relationship between the investment adviser and solicitor is hidden or unclear, or the investment adviser and solicitor wear multiple hats, providing investment advice and receiving payments for bringing in new clients.
Investment advisers who must register under the Investment Advisers Act of 1940 (“Advisers Act”) are generally prohibited from paying a cash fee, either directly or indirectly, to a person who acts as a finder or runner, soliciting clients for the adviser. However, a complex rule, 17 CFR Section 275.206(4)-3, provides an exception to the general prohibition against an adviser paying a solicitor to bring in clients. This rule says that it is unlawful for an investment adviser required to be registered under section 203 of the Advisers Act to pay a cash fee to a solicitor with respect to solicitation activities unless a long list of requirements are met. Among others, the requirements include: i) that the adviser be registered under the Advisers Act; ii) the cash fee is paid pursuant to a written agreement to which the adviser is a party; iii) the adviser must keep a copy of the written agreement; iv) the written agreement must describe the solicitation activities and the compensation to be received for them; v) the solicitor, at the time of any solicitation activities for which compensation is paid or to be paid by the investment adviser, provide the investor with specific disclosures; and vi) the investment adviser must receive from the client, before or at the time of entering into an advisory contract with the client, a signed acknowledgment of the investment adviser’s written disclosure statement and the solicitor’s written disclosure statement.
The SEC’s Office of Compliance Inspection and Examinations (“OCIE”) published a risk alert in October 2018 about compliance issues related to cash solicitations. The OCIE identified some of the most frequent deficiencies that its staff found regarding the cash solicitation rule, 17 CFR Section 275.206(4)-3. The frequent deficiencies include that advisers paid cash fees to a solicitor without a solicitation agreement, missing disclosure documents, incomplete disclosures, and missing client acknowledgments. The OCIE staff also observed advisers who did not make a bona fide effort to determine whether solicitors complied with solicitation agreements. Any one of these deficiencies means that the adviser and solicitor may have violated the prohibition against paying or receiving a cash fee for soliciting clients.