Just as some firms are able to grow without advertising, many RIAs do not use solicitors to attract clients. If a firm does have relationships with solicitors, however, it faces a different set of compliance requirements.
A solicitor is any person who, directly or indirectly, solicits clients for, or refers clients to, an RIA. Brokers, bankers, accountants, insurance agents, and attorneys often act as solicitors. In some states, solicitors are required to be registered as IARs.
RIAs 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 ADVs, and they must comply with both SEC and state regulations regarding solicitors. Solicitors and the advisory firms which utilize them must understand the rules.
Rule 206(4)-3 under the Investment Advisers Act establishes requirements governing cash payments to solicitors. This rule permits payment of cash referral fees to individuals and companies recommending prospective clients to an RIA.
Rule 206(4)-3 requires satisfaction of the following four conditions before a cash referral fee is paid:
- The advisor must be registered
- The solicitor is not subject to statutory disqualification
- There is a written agreement between the parties
- Disclosure is made to prospective clients
If an advisor offers personalized advisory services through an affiliated solicitor, this relationship must be disclosed to prospective clients at the time of solicitation, but disclosure of the specific terms of the arrangement is not required. With an unaffiliated solicitor providing personalized advisory services, the solicitor must provide a copy of the RIA’s brochure and a copy of a separate written disclosure document.
Rule 206(4)-3 stipulates a written agreement between the RIA and the solicitor, clearly defining each party’s duties and responsibilities. There must also be a written disclosure document, explaining to prospective clients that the solicitor is working on the adviser’s behalf and is receiving compensation for the referral.
The RIA’s CCO must oversee the solicitor’s activities. If the solicitor is unaffiliated with the advisor, the CCO must exercise due diligence ensuring that the solicitor is acting in compliance with the written agreement. An RIA must make a genuine effort in determining whether the solicitor has complied with their agreement. Furthermore, the RIA must have a reasonable basis for believing that the solicitor is in compliance with the terms of their contract.
Distinctions between Types of Solicitors
An RIA’s compliance obligation depends upon the type of solicitation arrangement the firm is utilizing. Some solicitors provide only impersonal advisory services. Impersonal advisory services are provided solely by means of the following:
- 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
- Any combination of the foregoing services
In addition, a partner, officer, director, or employee of the RIA, 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 RIA. The relationship between the RIA and that person must be disclosed to the client at the time of solicitation or referral. For example, it is becoming increasingly common for CPA firms to start an RIA. An employee of the CPA firm recommending that particular RIA to a client, must disclose their relationship.
Whereas SEC-registered investment advisors are subject to Rule 206(4)-3, most states have implemented the same or a similar regulation. Whether an advisor is SEC or state registered, there are usually stringent disclosure requirements for solicitors who provide more than just impersonal advisory services. In these instances, the written agreement between an RIA and a solicitor must cover all of the aspects of the relationship:
- Describe the solicitation activities engaged in by the solicitor on behalf of the RIA and the compensation to be paid.
- Require the solicitor to comply with the RIA’s instructions, as well as the pertinent provisions of the Investment Advisers Act.
- Require the solicitor, at the time of solicitation, to provide the client with a current copy of the RIA’s written disclosure statement as required by Rule 204-3, as well as a separate written disclosure document.
The separate written disclosure statement furnished by the solicitor to the client must contain the following information:
- The name of the solicitor
- The name of the RIA
- The nature of the relationship, including any affiliation, between the solicitor and the RIA
- A statement that the RIA will be compensating the solicitor for his or her solicitation activities
- The terms of the compensation arrangement
- The cost, if any, to the client above and beyond the advisory fee if attributable to the existence of the solicitation arrangement
Before entering into an advisory contract, an RIA must receive the client’s written acknowledgment that he or she received the firm’s Form ADV or brochure and the solicitor has a written disclosure document. As we will see later in this chapter, the RIA must retain a copy of each acknowledgment as part of the records that must be retained pursuant to Rule 204-2(a)(15).
Must Solicitors Be Registered?
In some states, a solicitor may fall within the definition of IAR. For example, in Oregon, a person who “solicits, offers, or negotiates for the sale of or sells investment advisory services” meets the definition of an IAR. As IARs, solicitors in Oregon are subject to laws applying to individuals employed by or associated with state or SEC-registered investment advisors. Therefore, a state or SEC-registered investment advisor may not employ a solicitor unless the IAR is licensed to the RIA. The RIA is responsible for supervising the solicitor.
Oregon does, however, exclude certain solicitors from the definition of an IAR. A solicitor is not an IAR if the referral fee is a nominal sum, such as a flat fee of $100. On the other hand, if solicitors receive a referral fee that is based on a percentage split of fees to be earned, they do fall within the definition of IAR.
In contrast to Oregon, a solicitor in Florida does not need to be registered as an IAR. The only requirement is that the person may not be subject to a statutory disqualification, such as being barred or suspended by the SEC from associating with an investment advisor.
Books and Records Relating to Solicitors
Rule 204-2(a)(15) under the Investment Advisers Act requires an RIA to create and retain records showing arrangements with solicitors for five years. At the time of solicitation, each prospective client must be given a copy of the RIA’s Form ADV Part 2 disclosure brochure, and a copy of the solicitor’s written disclosure document. The prospective client must acknowledge receipt of this documentation in writing. Furthermore, the RIA must keep a copy of each written agreement and client acknowledgment as part of the records it maintains under Rule 204-2(a)(10).
During a compliance examination, examiners expect to find a written solicitation agreement between the RIA and the solicitor. This document is not usually given to the client. It should contain:
- specific solicitation activities engaged in by the solicitor on behalf of the RIA and the compensation to be received;
- an agreement by the solicitor following the instructions of the RIA and to comply with the provisions of the Investment Advisers Act;
- an agreement by the solicitor to provide prospective clients with a copy of the RIA’s Form ADV, or other disclosure document, at the time of the solicitation;
- an agreement by the solicitor to give the prospective client at the time of solicitation a copy of the solicitor’s separate written disclosure document;
- representation by the solicitor that he or she is not subject to statutory disqualification.
Examiners also expect to see the solicitor’s written disclosure document. One copy goes to the prospective client and a second copy should be given by the RIA to the prospective client when an advisory contract is executed by the parties. This document must disclose:
- the name of the solicitor;
- the name of the RIA;
- a statement that the solicitor is being compensated for referring the client to the RIA;
- the terms of the compensation arrangement between the RIA and the solicitor; and
- whether a client must pay higher fees than would otherwise be charged if there were no payments to a solicitor; and
- the nature of the relationship between the RIA and the solicitor.
Frequently, the solicitor and the RIA are affiliated through common control or ownership.
The Big Picture
RIAs should be on the look-out for situations where they inadvertently use solicitors. For example, some RIAs have considered offering clients a gift card every time they refer a client. Although this type of compensation is not necessarily a cash payment as spelled out by Rule 206(4)-3, it may be viewed as solicitor arrangement if clients are compensated in exchange for referrals. It is far less likely that Rule 206(4)-3 will apply in a situation where an advisor takes a client to lunch or dinner to thank her for a referral.
Examiners want to see specific instructions to the solicitor from the RIA. They also require documentation showing that the firm’s CCO or a designee is monitoring the solicitor’s compliance with the terms of the written agreement. An RIA’s CCO or compliance officer has an affirmative duty to make certain that the solicitor has complied with and continues to comply with the terms of the agreement.
As is so often the case, there can be a disconnect between an RIA’s business model and its Form ADV and policies and procedures. In too many instances, an RIA’s disclosure brochure does not mention that the firm uses solicitors to attract clients. In addition, policies and procedures often do not articulate steps taken by the RIA to comply with the rules relating to solicitors.
Most firms’ policies and procedures incorporate the rules applying to a solicitor working in that jurisdiction. Figure 26-1, shows an example of a firm’s disclosure brochure language with regard to solicitors.
Figure 26-1. Solicitor Disclosure Brochure Language
“We directly compensate non-employee (outside) consultants, individuals, and/or entities (Solicitors) for client referrals. In order to receive a cash referral fee from our firm, Solicitors must comply with the requirements of the jurisdictions in which they operate. If you were referred to our firm by a Solicitor, you should have received a copy of this Disclosure Brochure along with the Solicitor’s disclosure statement at the time of the referral. If you become a client, the Solicitor that referred you to our firm will receive a percentage of the advisory fee you pay our firm for as long as you are a client, or until such time as our agreement with the Solicitor expires. You will not pay additional fees because of this referral arrangement. Referral fees paid to a Solicitor are contingent upon your entering into an advisory agreement with our firm. Therefore, a Solicitor has a financial incentive to recommend our firm to you for advisory services. This creates a conflict of interest; however, you are not obligated to retain our firm for advisory services. Comparable services and/or lower fees may be available through other firms.”
*Used with permission from National Compliance Services, Inc.
The use of solicitors adds to the many compliance obligations owed by RIAs. Investment advisors risk problems if they choose a solicitor who does more harm for the RIA than good.