Dec 03, 2018
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In a new Risk Alert, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) highlighted common compliance issues involving Rule 206(4)-3 under the U.S. Investment Advisers Act of 1940, as amended, otherwise known as the “Cash Solicitation Rule” (the “Rule”). The Rule provides that investment advisers registered under the Advisers Act (or required to be registered) cannot pay a cash fee to any person who solicits clients unless the adviser meets several conditions. When an unaffiliated third party acts as solicitor, such conditions include the following:
OCIE described common deficiencies it found among advisers involving the Rule. Notable examples include:
In light of OCIE’s clear focus on the specifics of the Cash Solicitation Rule, Advisers should review their compliance policies and procedures, as well as actual practices and relevant documentation, and make modifications as necessary to help ensure compliance with the Rule.
Application of the Cash Solicitation Rule to Fund Investors and Managed Accounts
Though not specifically mentioned in the Risk Alert, we note that the Rule does not technically apply to cash payments made by a registered adviser to a solicitor solely to compensate the solicitor for soliciting investors for an investment pool (i.e., fund) managed by the adviser. Given the inherent conflict of interest involved, however, the prudent approach (and typical market practice) is for advisers to follow the general spirit of the Rule. For example, advisers should require that a solicitor clearly disclose to its prospective fund investors that it will be compensated by the adviser for any investment by such investors.
Importantly, the Rule does fully apply with respect to clients entering into a managed account relationship with the adviser. In our experience, many solicitation arrangements are silent or flexible in terms of the investment structure for prospective investors, and some have long tail provisions pursuant to which payments could be required for a managed account relationship established many years after an initial fund investment. As such, it would be wise to build the full requirements of the Rule into any solicitation agreement that allows for the possibility that a solicitor could be paid for a future managed account relationship.
Other Securities Law Considerations for Solicitation Agreements
An investment adviser retaining a solicitor, whether to assist with finding direct advisory clients or fund investors, should also require the solicitor to represent and warrant that it will comply with applicable securities law registration and licensing requirements. In particular, a solicitor’s receipt of transaction-based compensation for the sale of fund interests necessitates confirmation and/or analysis of the broker-dealer status and registration obligations of the solicitor. Additionally, an adviser hiring a solicitor to assist with a private offering of fund interests must be mindful of the solicitor’s status as a covered person under Rule 506(d) of Regulation D under the Securities Act, and should be sure to include evergreen “bad actor” representations from the solicitor in the solicitation agreement.
 National Exam Program Risk Alert, Investment Adviser Compliance Issues Related to the Cash Solicitation Rule (Oct. 31, 2018), Investment Adviser Compliance Issues.
 Mayer Brown LLP, SEC No-Action Letter (July 28, 2008). See also Goldstein, et al. v. Securities and Exchange Commission 451 F.3d 873 (D.C. Cir. 2006).