More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
Client referrals are arguably the lifeblood of the financial services industry, and understandably so. They are perhaps the greatest compliment a financial professional can receive, and it sure beats a random LinkedIn endorsement from that guy you had a fleeting interaction with at a conference five years ago.
Some financial professions, particularly investment advisors, are so keen on client referrals that they are willing to pay for the privilege of receiving them. If you are an investment advisor paying for client referrals, or even another individual (CPA, attorney, registered rep, Joe the Plumber) receiving payments from an investment advisor for client referrals (i.e., a solicitor), make Rule 206(4)-3 of the Investment Advisers Act of 1940 (the “Act”) your new best friend.
First of all, “payments” for purposes of this article and Rule 206(4)-3 means cash payments. Non-cash payments to solicitors are outside the scope of Rule 206(4)-3, but suffice it to say there are plenty of important disclosure and fiduciary considerations for non-cash payments like directed brokerage as well.
With that in mind, Rule 206(4)-3 makes an important distinction between solicitors that are somehow affiliated with the investment advisor and those that are not. The latter category of independent solicitors is what triggers the bulk of the regulatory burden imposed by Rule 206(4)-3, which is outlined specifically in Rule 206(4)-3(a)(2)(iii) and 206(4)-3(b) but described in plain English below:
- The investment advisor and the solicitor must have a written agreement between them that:
- Describes the solicitation activities and the money changing hands
- Subjects the solicitor to the investment advisor’s instructions and to the Act
- Requires the solicitor to deliver to the referred client the investment advisor’s Form ADV Part 2 and a separate solicitor’s written disclosure document (described below)
- The investment advisor must receive from the client a signed and dated acknowledgement of receipt of its Form ADV Part 2 and separate solicitor’s written disclosure document as delivered by the solicitor
- The investment advisor must make a “bona fide effort” to confirm the solicitor’s adherence to the agreement (i.e., perform due diligence)
What is this “separate solicitor’s written disclosure” that must be given to the client, you ask? Luckily, Rule 206(4)-3(b) itemizes the requirements quite clearly and succinctly. Basically, the disclosure must identify the solicitor, the investment advisor, the relationship and money changing hands between the two, and any additional solicitor-related fees the client will be paying.
All solicitors, regardless of whether they are somehow affiliated or independent, must be party to a written agreement of some kind with the investment advisor. In addition, both affiliated and independent solicitors cannot be…’sketchy,’ for lack of a better term. Generally speaking, sketchy solicitors are those that are subject to certain SEC orders, judgments or decrees, have been convicted of certain felonies or misdemeanors within the last decade, or have been found by the SEC to have engaged in certain egregious conduct (see Rule 206(4)-3(a)(1)(ii) for exact details).
Finally, and perhaps most importantly, both investment advisors and solicitors need to consult state laws applicable to where they are conducting business. Why? Because many states consider solicitors to be de-facto investment advisers or investment advisor representatives, thus requiring registration as such. Though each state has its own specific laws in this regard, NASAA’s Investment Adviser FAQ points out that the Uniform Securities Act (upon which many state securities laws are modeled) includes anyone “who solicits, offers, or negotiates for the sale of or sells investment advisory services” within the definition of investment advisor representative.
As always, recordkeeping is of utmost importance. Investment advisors must keep copies of any solicitors agreements, separate solicitor’s written disclosure documents, and client receipt acknowledgements. It would also bode well to document the requisite due diligence an investment advisor performs on its solicitors, and periodically monitor for solicitors that fall into the ‘sketchy’ category described above.
Cash for clients is an industry norm that is not likely to go away any time soon, but there are plenty of ‘T’s to be crossed and ‘I’s to be dotted to comply with both federal and state law.