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.