As I lecture at compliance-related events throughout the country, it continues to surprise me that solicitor (referral fee) arrangements are too often misunderstood. Given both enhanced Securities and Exchange Commission and state scrutiny over these arrangements, careful attention is required.
Under a solicitor arrangement, an advisor engages an individual or an entity to introduce prospective clients to the advisor in return for compensation, generally a portion of the fee that the advisor receives from the introduced client. To the extent that an advisory firm seeks to establish and/or continue referral arrangements with a solicitor (individual or an entity), it must ensure that it does so consistent with applicable SEC (if the firm is SEC registered) and corresponding state law requirements.
The latter is too often overlooked at the potential peril of the advisor. For both regulatory and liability protection purposes, the roles and obligations of the parties should be set forth in a well-defined solicitation agreement, certain terms of which will differ depending upon the identity of the solicitor (i.e., an individual, another investment advisor, a broker-dealer, etc.).
Federal (SEC) requirements. Under Rule 206(4)-3 of the Advisers Act, the advisory firm that engages the solicitor must comply (and confirm that the solicitor complies) with certain express requirements. Specifically, the Rule requires that:
1) There is a written agreement between the advisor and the solicitor setting forth certain terms and conditions of the referral arrangement;
2) At the time that the solicitor introduces the prospective client to the advisor, the solicitor (not the advisor) must provide the prospective client with: (a) a copy of the advisor’s brochure as set forth on Part 2A of Form ADV; and (b) a separate written disclosure document containing certain information pertaining to the solicitation arrangement, including a description of the compensation (i.e., the amount/percentage) to be paid by the advisor to the solicitor; and