SEC Risk Alert - Advisors and Soliciting Third-Parties

By: David McNeal, Contributor to My Compliance Blog

Planning to hire a Solicitor?

October 31, 2018. A recent risk alert published by The SEC Office of Compliance Inspections and Examinations (OCIE) identified several frequent violations to the “Cash Solicitation Rule.” 

This article aims to assist investment advisors to identify potential problems and take corrective measures in compliance with federal (and similar state) regulations on client solicitations.

Disclosing your solicitor arrangements

Investment advisors have an obligation to disclose direct (and indirect) financial incentives to solicitors for client referrals.  When Registered Investment Advisers (RIAs) expand their business, they may pay cash referral fees to a third-party that solicits prospective clients on behalf of the firm — but only if the formal “solicitation arrangement” adheres to SEC Rule 206(4)-3 under the Investment Advisers Act of 1940.  

Solicitor Agreement Requirements

All client solicitation arrangements must be documented in a written agreement and include the amount and scope of the referral-based activity.  In addition, the solicitor must provide prospective clients with: (1) a copy of the RIA firm's disclosure document (ADV Part 2A/B Brochure) and (2) a separate solicitor disclosure statement.  Moreover, before establishing a client relationship, the investment advisor must obtain written confirmation that the prospective client received all required documents.  

Improper solicitor procedures are a common discrepancy discovered during regulatory audits.  Advisors should carefully review their referral agreements and their sales activities to ensure compliance with the “Cash Solicitation Rule.”  Federal and State regulators require all firms to make a bona fide effort to ensure the referral agent complies with the solicitation agreement.

OCIE Findings on Solicitations

The SEC Risk Alert titled, “Investment Adviser Compliance Issues Related to the Cash Solicitation Rule” includes the following discrepancies:

#1 – Failure to Disclose Documents

OCIE staff observed advisors, who used third- party solicitors, did not provide disclosure documents to prospective customers.  For those advisors who did send documents, the agreements did not contain all the information required by the Cash Solicitation Rule.

Solicitor disclosure documents must include the exact figures and other terms agreed upon by the advisor and solicitor. The SEC will consider vague or hypothetical language to describe the solicitor’s compensation as a violation of the Rule. 

And lastly, advisors should specify any additional costs the solicited client will be charged besides the advisory fee.

#2 – Failure to Obtain Client Approval

OCIE staff observed that many advisors did not receive a signed and dated client acknowledgment for the receipt of the firm brochure.  

For those who did receive acknowledgements, the attestations were dated after the clients had entered into an investment advisory contract.

#3 – Incomplete or No Solicitation Agreements

OCIE staff noted that some advisors, who paid cash fees to an agent, failed to execute a solicitor agreement whatsoever.  With other cases, the OCIE staff found agreements that did not have the required provisions, such as the following:

Advisors did not include any limits to the allowed activities or instructions for solicitors to perform their duties. Other agreements did not disclose the amount a solicitor would be paid.

And lastly, some advisors did not require solicitors to provide prospective clients with a copy of the adviser brochure and disclosure documents.

#4 – Failure to maintain Solicitor Rule compliance.

OCIE staff observed that some advisors failed to ensure that third-party referral agents were complying with the guidelines in the solicitor agreements.  In this review, the staff also noted that advisors failed to provide any documentation to demonstrate an attempt to maintain compliance with provisions.

The SEC also observed that some advisors failed to meet its fiduciary duties under Sections 206(1) and 206(2) of the Advisers Act.  In this assessment, advisors who recommended service providers to clients, failed to fully and adequately disclose any of its conflicts of interest. 

Summary

The OCIE conducted several audits which provided the basis for this risk alert and for its swift regulatory enforcement actions.  In response to these infractions, some advisors were given the option to amend their disclosure documents, solicitation agreements, compliance policies and procedures, and/or their business practices regarding the Cash Solicitation Rule.

The information is provided in hopes to encourage investment advisors to review their compliance programs and gain more efficient operations.

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