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Regulation and Compliance > State Regulation

Required: Referral Fee Compliance

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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

3) The advisor obtain (and maintain for recordkeeping purposes) written proof that the solicitor discharged his/her/its delivery obligations (i.e., a signed and dated document from the prospective client acknowledging receipt of both the advisor’s brochure and the solicitor’s written disclosure statement). The best way to satisfy this requirement is to require that the solicitor provide to the advisor a copy of the solicitor disclosure statement executed by the prospective client that also acknowledges the prospective client’s receipt of the advisor’s brochure.

In addition, the advisor must have a reasonable belief that the solicitor continues to: (a) qualify to serve under applicable state and/or federal securities laws (i.e., does not have any disqualifying disciplinary history as discussed under the Rule); and (b) discharge his/her/its obligations under the Rule (i.e., the reason for the definitive signed and dated solicitor disclosure statement from the prospective client acknowledging receipt of both the advisor’s brochure and the solicitor’s written disclosure statement).

To buttress support for the advisor’s compliance with these requirements, for years we have added supplemental steps for our clients to consider so that an SEC challenge to the validity of the process can be fended off: (1) a corresponding client acknowledgment in the advisory agreement (Please Note: the SEC has challenged whether this paragraph on its own will be sufficient to confirm the client’s acknowledgment that the solicitor discharged its obligations); and, (2) an ongoing solicitor review process to confirm continued compliance.

State requirements. Because laws regulating solicitors differ on a state-by-state basis, it is important that advisors, before engaging solicitors in or for a particular state, first determine if any corresponding filing, registration, and/or qualification requirements are applicable to the advisor and/or the solicitor. Why? If a firm engages a solicitor in a state that requires that solicitor to be registered, it is the advisor that will suffer the regulatory consequences, including potential disciplinary proceedings and corresponding fines, for what’s required to be disclosed on Form ADV.

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York and Philadelphia that represents investment advisors, financial planners, BDs, CPA firms, registered reps and investment companies, and is a regular contributor to Investment Advisor. He can be reached at [email protected].


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