From the May 2008 issue of Boomer Market Advisor • Subscribe!

Caution -- Who's acting on your behalf?

Investment advisors frequently utilize employees or third parties to solicit new clients. Advisors should proceed with caution, however, because they must fully disclose this practice on their Form ADV and must also comply with SEC, as well as state regulations regarding solicitors.

A solicitor is any person who, directly or indirectly, solicits clients for an investment advisor. Brokers, bankers, accountants and attorneys often act as solicitors.

Rule 206(4)-3

Rule 206(4)-3 under the Investment Advisers Act of 1940 governs cash payments to solicitors. The rule states that it shall be unlawful for any investment advisor required to be registered pursuant to Rule 203 of the Act to pay a cash fee to a solicitor with respect to solicitation activities unless:

  • The investment advisor is registered under the Act; and
  • The solicitor meets specified requirements and is not subject to statutory disqualification.

Generally, the cash fee must be paid pursuant to a written agreement to which the advisor is a party. Furthermore, the advisor must keep a copy of each written agreement as part of the records it maintains under Rule 204-2(a)(10).

Distinctions between types of solicitors

The advisor's compliance obligation depends upon the type of solicitation arrangement being utilized. Some solicitors only provide impersonal advisory services. Impersonal advisory services are provided solely by means of:

  • Written materials or oral statements, which do not purport to meet the objectives or needs of the specific client;

  • Statistical information containing no expressions of opinions as to the investment merits of particular securities; or

  • Any combination of the foregoing services.

In addition, a partner, officer, director or employee of the investment advisor may be a solicitor. A solicitor might also be a partner, officer, director or employee of a person who controls, is controlled by, or is under common control of an investment advisor. The relationship between the investment advisor and that person must be disclosed to the client at the time of solicitation or referral.

There are more stringent disclosure requirements for solicitors who don't fall into either of these two categories.

Disclosure requirements

For other types of solicitation arrangements, a higher level of disclosure is necessary. In these instances, the written agreement between the advisor and the solicitor must do all of the following:

  • Describe the solicitation activities to be engaged in by the solicitor on behalf of the investment advisor and the compensation to be paid;

  • Require the solicitor to comply with the advisor's instructions, as well as the Investment Advisers Act;

  • Require the solicitor, at the time of solicitation, to provide the client with a current copy of the advisor's written disclosure statement as required by Rule 204-3, as well as a separate written disclosure document.

  • The advisor's written disclosure statement is its Form ADV Part II or its brochure.

The separate written disclosure statement to be furnished by the solicitor to the client must contain the following information:

  • The name of the solicitor;

  • The name of the advisor;

  • The nature of the relationship, including any affiliation between the solicitor and the investment advisor;

  • A statement that the advisor will be compensating the solicitor for his or her solicitation activities;

  • The terms of the compensation arrangement; and

  • The cost, if any, to the client over and above the advisory fee if attributable to the existence of the solicitation arrangement. Before entering into an advisory contract, the advisor must receive the client's written acknowledgment that he or she received the advisor's Form ADV or brochure and the solicitor's written disclosure document. The advisor must retain a copy of each acknowledgment as part of the records required to be kept under Rule 204-2(a)(15).

    Documentation by itself isn't enough. The advisor must make a bona fide effort to ascertain whether the solicitor has complied with their agreement. Furthermore, the advisor must have a reasonable basis for believing that the solicitor has complied with the terms of their agreement.

    *Questions, Comments, Thoughts? Let's hear it! Please use the form below.
Reprints Discuss this story
This is where the comments go.