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Dec 03, 2018

OCIE Highlights Investment Adviser Compliance Issues Related to the Cash Solicitation Rule

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Background

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”).[1] 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:

  • The fee must be payable pursuant to a written agreement that:
    • describes the solicitation activities and the compensation arrangements;
    • requires the solicitor to agree to comply with the adviser’s instructions and the Advisers Act (and the investment adviser must make a bona fide effort to determine that the solicitor has complied with the agreement, and have a reasonable basis to believe the solicitor has done so); and
    • requires the solicitor to provide to prospective clients the adviser’s Form ADV brochure and a separate disclosure document regarding the solicitation arrangements (as described below).
  • The solicitor must not have committed certain acts of malfeasance or otherwise be subject to certain disciplinary events, as more particularly described in the Rule.
  • The adviser must receive from the client, prior to or upon entering into an advisory contract with the client, a signed and dated acknowledgement of receipt of the adviser’s Form ADV brochure and the solicitor’s disclosure statement, which disclosure statement must include:
    • the names of the adviser and solicitor, as well as the nature of their relationship (including any affiliation);
    • a statement that the solicitor will be compensated by the adviser for its solicitation services, as well as the terms of such compensation; and
    • the amount, if any, to be charged to the client for such solicitation activities.

OCIE Findings

OCIE described common deficiencies it found among advisers involving the Rule. Notable examples include:

  • Lack of a solicitation agreement or an agreement without all of the specific terms prescribed by the Rule;
  • Solicitors not providing (or providing an inadequate) solicitor disclosure document to prospective clients (e.g., the terms of compensation are not described or described only in a vague or hypothetical way);
  • Advisers not timely receiving a signed and dated client acknowledgment (i.e. prior to the advisory contract being entered into); and
  • Advisers not making efforts to confirm solicitor compliance with the solicitation agreement.

Compliance Take-Aways

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.[2] 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.

脚注

[1]   National Exam Program Risk Alert, Investment Adviser Compliance Issues Related to the Cash Solicitation Rule (Oct. 31, 2018), Investment Adviser Compliance Issues. 
[2]  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).

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