On November 4, 2019, the U.S. Securities and Exchange Commission (SEC) proposed amendments to rules governing investment adviser advertisements and payment to solicitors under the Investment Advisers Act. The comment period for both rulemakings is expected to close in January 2020. In this client alert, we summarize the proposed amendments to the solicitation rule (Rule 206(4)-3). A separate alert, SEC To Overhaul Investment Adviser Advertising Rule, covers the advertising rule proposal.
As background, the solicitor rule requires that an adviser paying a firm or individual to solicit clients to take specific steps in engaging and monitoring the solicitor. Among other things, the adviser must confirm that the solicitor is not disqualified from serving in the role, require a written engagement with the solicitor, and require that the solicitor disclose specific information to the prospective clients.
Key elements of the current proposal are:
The current rule defines a “solicitor” as “any person who, directly or indirectly, solicits any client for, or refers any client to, an investment adviser.”
The proposal would expand on this in the following ways:
The proposed rule largely maintains the current exemption from the rule for affiliated or in-house solicitors so long as that relationship between the solicitor and the adviser is “readily apparent” to the prospect. The proposed rule also largely maintains the current exemption for solicitation of impersonal investment services. (The rule’s disqualification terms still apply to these otherwise exempt solicitors.)
The proposed disclosure requirements largely track the current rule. Solicitors would be required to disclose the name of the adviser, name of the solicitor, a description of the relationship between them, the terms of any compensation to be received by the solicitor, and any potential material conflicts of interest for the solicitor. The rule also would require disclosure of any additional cost to the prospect as a result of the solicitation. Only the requirement to disclose potential material conflicts of interest would be wholly new.
The new rule would keep the requirement that the disclosure package should be “separate” from other information received by the prospect in connection with the advisory relationship. Unlike in the current rule, the SEC proposes that the disclosure could be made either by the solicitor or the adviser. The proposed rule also would provide more flexibility as to the timing of when the disclosure is made. The proposal specifically recognizes that disclosures might be made in electronic means including through chat and “pop-up” messages.
The proposal also would eliminate the longstanding requirement that the solicitor deliver the adviser’s Form ADV brochure to prospects. This addresses the redundancy of current practice in which the same brochure may be provided by both solicitor and adviser.
Finally, while the current rule requires that an adviser must make a bona fide effort to confirm compliance with the rule’s requirements by a solicitor, including obtaining a signed and dated acknowledgment of receipt of the disclosures from each solicited client, the proposal would substitute a general “reasonable belief” standard (i.e., that the adviser takes steps sufficient to give it a reasonable belief that the solicitor is meeting the requirements).
Advisers are prohibited from engaging solicitors that have committed various kinds of bad acts (generally referred to in this context as disqualifications). Such a disqualification would apply at the time of solicitation. As proposed, if disqualification arises subsequent to solicitation, payments could continue to be made to a solicitor for its past solicitation activity.
The proposed new disqualification terms generally are as follows:
The SEC proposes a one-year transition period from the effective date of the rule to full implementation. Advisers would be permitted to rely on the amended rule during the period after the effective date but before the compliance date.
Regarding disqualification, the SEC proposes a form of grandfathering in which a solicitor that would be disqualified solely as a result of the expanded definition of disqualifying events will be disqualified only for new disqualifying events occurring after the rule’s adoption. The SEC also indicates that it is open to other types of transition rules associated with new disqualification terms.
The proposal generally would ease operational burdens associated with the solicitor rule and will be viewed as a welcome modernization for many. The proposed changes would be less welcome for firms covered by new terms of the rule, such as advisers using solicitors only to solicit private fund investors or paying only non-cash compensation (both of which are exempt under the current rule). Updates to the disqualification rules also would require care for both advisers and solicitors.