FYI: OCIE has issued a Risk Alert outlining common deficiencies found under the Cash Solicitation Rule (Rule 206(4)-3). Subject to few exceptions, the Cash Solicitation Rule applies whenever an IA pays cash to any solicitor with respect to solicitation activities. A “solicitor” is any person who, directly or indirectly, solicits any client for, or refers any client to, an IA. This covers the IA’s own personnel, as well as third-party solicitors.
Personnel Solicitors. It is not uncommon for the rule to be missed altogether by IAs who use their own personnel (partners, officers, directors and employees of the IA or its affiliates) as solicitors, for example, paying them bonuses or a cut of the client’s fees for bringing in new clients. “We don’t use solicitors” is a common refrain heard in these circumstances, even though the IA’s own personnel CAN BE solicitors under the definitions applicable in the rule. When a solicitor is the IA’s own personnel, the rule requires that the cash fee be paid pursuant to a written agreement to which the IA is a party. In addition, the status of the solicitor as a partner, officer, director or employee of the IA or its affiliate must also be disclosed to the client at the time of the solicitation or referral.
Third-Party Solicitors. The rule’s requirements are even broader when the solicitor is not the IA’s own personnel, but rather a third party. This is where the Risk Alert places its focus. In addition to requiring a written agreement to which the IA is a party, the written agreement with a third-party solicitor must:
(1) describe the solicitation activities to be engaged in by the solicitor and the compensation to be received therefor;
(2) contain an undertaking by the solicitor to perform its duties under the agreement in a manner consistent with the instructions of the IA and applicable law; and
(3) require that the solicitor, at the time of any solicitation activities for which compensation is paid or to be paid, provide the client with a current copy of the IA’s Firm Brochure (Form ADV, Part 2A) AND a separate written disclosure document describing:
–The name of the solicitor;
–The name of the IA;
–The nature of the relationship, including any affiliation, between the solicitor and the IA;
–A statement that the solicitor will be compensated for its solicitation services by the IA;
–The terms of the compensation arrangement, including a description of the compensation paid or to be paid to the solicitor; and
–Any amount for the cost of obtaining the account the client will be charged in addition to the advisory fee, and any differential among clients with respect to the amount or level of advisory fees charged by the IA if the differential is attributable to the existence of the solicitation arrangement.
For third-party solicitation arrangements, the IA must also timely receive from the client a signed and dated acknowledgment of receipt of the IA’s Firm Brochure and the solicitor’s written disclosure document. (These acknowledgments must be preserved under the Advisers Act books and records rules.) The IA must also make a bona fide effort to ascertain whether the solicitor has complied with the solicitation agreement, and have a reasonable basis for believing that the solicitor has complied.
Violations. The Risk Alert indicates circumstances have been found where IAs have missed one or more of virtually every one of these rule requirements.
OCIE also observed IA conduct that could implicate other provisions of the Advisers Act, for example, IAs that recommended service providers to clients in exchange for client referrals without full and fair disclosure of the conflicts of interest, potentially in violation of the IA’s fiduciary duty under Sections 206(1) and 206(2).
In light of this Risk Alert, IAs would be wise to review their personnel and third-party solicitation arrangements for compliance with applicable requirements, focusing in particular on the deficiencies identified in the Risk Alert.
* * *