"May an investment adviser registered with the United States Securities and Exchange Commission (“SEC”) pay a third-party (non-employee) to solicit or refer new investment advisory clients?
Yes, an SEC registered investment adviser firm may pay cash referral fees to a third-party (non-employee) that solicits investment adviser clients on behalf of the registered investment adviser firm only if such a solicitor arrangement is in compliance with SEC Rule 206(4)-3 under the Investment Advisers Act of 1940.
What are the basic regulatory requirements for a solicitor referral arrangement between an SEC registered investment adviser and a third-party (non-employee)?
Under SEC Rule 206(4)-3, a solicitor referral arrangement between the investment adviser and third-party (non-employee) solicitor must be in writing, which needs to include provisions related to the following: (a) the scope of the solicitor's activities; (b) a covenant 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 (c) 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.
What information must be included in the separate written solicitor disclosure that the third-party solicitor must provide a client?
As outlined by SEC Rule 206(4)-3, the separate written solicitor disclosure must include the following information:
The name of the solicitor;
The name of the investment adviser;
The nature of the relationship between the solicitor and investment adviser;
A statement that the solicitor will be compensated by the investment adviser for the referral;
The terms of such compensation arrangement including a description of the fees paid or to be paid to the solicitor; and
The additional amount that will be charged to the investment advisory fee and the differential attributable to such a solicitor arrangement.
Can the third-party solicitor’s referral fee be paid from the investment advisory fee charged by the registered investment adviser?
Yes, the investment advisor firm can pay a portion of the ongoing investment advisory fee charged to the client each billing period as long as such payments are consistent with the Form ADV and separate written solicitor disclosure given to the client and in accordance with the requirements of SEC Rule 206(4)-3.
Does a third-party solicitor have to be registered as an investment adviser or investment adviser representative?
The Investment Advisers Act of 1940 and the associated SEC rules do not require the solicitor to register as an investment adviser as long as the solicitor’s activities are strictly limited to merely referring clients to a registered investment adviser in compliance with SEC Rule 206(4)-3. However, the majority of state securities regulators define the solicitation or referral of investment advisory clients as an investment advisory activity requiring the registration of the solicitor as an investment adviser or investment adviser representative. A registered investment adviser considering a solicitor arrangement should verify whether the intended solicitor’s activity is included under the state securities regulator’s definition of an investment adviser representative.
If a state securities regulator requires an individual to be registered as an investment adviser representative in order to solicit investment advisory clients in a third-party capacity, does the solicitor have to be an investment adviser representative under the investment advisor firm receiving such referrals?
No, the referring solicitor required to be registered as investment adviser representative does not usually have to be registered under the investment adviser firm receiving the referrals.
Are there individuals that cannot serve as a solicitor on behalf of a registered investment adviser under SEC Rule 206(4)-3?
Individuals subject to a statutory disqualification under Section 203 of the Investment Advisers Act of 1940 (“Act”) cannot be paid a solicitor referral fee. Such a statutory disqualification would include 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.
Can a solicitor provide investment advice to a client about a security and/or the securities market?
If a solicitor is not registered as an investment adviser or investment adviser representative with the applicable securities regulators, then the solicitor may not provide invest advice about a security or the securities market to a prospective or existing client. Moreover, an unregistered solicitor cannot provide advice to a client regarding a client’s investment objective or an investment adviser’s investment strategy or performance.
A solicitor that is registered as an investment adviser or investment adviser representative can provide advice about a security and/or the securities market to a prospective or existing client.
Is a solicitor required to provide a client with a separate written solicitor disclosure when the registered investment adviser firm gives impersonal advisory services?
No, a solicitor is not required to provide a client with a separate written solicitor disclosure when the registered investment adviser firm only provides investment advisory services that are not personalized to the specific client or otherwise purports to meet the objectives or needs of the specific client.
Should there be a specific disclosure within the Form ADV if a registered investment adviser pays a referral fee to a third-party solicitor?
Yes, if a registered investment adviser firm pays a third-party solicitor for referrals, there are several disclosures that need to be made in the Form ADV. The number of third-party solicitors used by the registered investment adviser needs to be indicated in response to Item 5.B(6) of the Form ADV Part 1. In Form ADV Part 2A, Item 14.B Client Referrals and Other Compensation, "If you or a related person directly or indirectly compensates any person who is not your supervised person for client referrals, describe the arrangement and the compensation."
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