RIA Compliance Blog
The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) periodically issues “Risk Alerts” highlighting common deficiencies encountered by its staff during routine investment adviser compliance exams. These Risk Alerts serve the dual purpose of providing advisers with both useful insight into the results of recent OCIE examination activity as well as advance warning of areas that OCIE may be paying closer attention to in the future. Accordingly, a recent Risk Alert issued by OCIE details the most common deficiencies the staff has cited relating to Rule 206(4)-3 (the “Cash Solicitation Rule” or “Rule”) under the Investment Advisers Act of 1940. See National Exam Program Risk Alert, Investment Adviser Compliance Issues Related to the Cash Solicitation Rule (Oct. 31, 2018).
By way of background, the Cash Solicitation Rule prohibits SEC-registered investment advisers from paying a cash fee, directly or indirectly, to any person who solicits clients for the adviser unless the arrangement complies with a number of conditions specified in the Rule, including that the fee must be paid pursuant to a written agreement to which the adviser is a party. Notably, the Rule discerns between solicitors that are affiliated with the registered adviser versus those that are not, setting-up more comprehensive requirements for the latter third-party solicitors. For example, third-party solicitors must provide potential clients with both a copy of the adviser’s Form ADV Part II (or other applicable brochure) and a separate written solicitor’s disclosure document containing specific data about the solicitation arrangement—including the terms of the solicitor’s compensation. Moreover, with respect to third-party arrangements, the Rule obliges advisers to: (i) collect a signed and dated acknowledgment from every potential solicited client that such client has in fact received the adviser’s brochure and the solicitor’s disclosure document; and (ii) make a “bona fide effort” to ascertain whether the solicitor has complied with its duties under the Rule.
In this context, OCIE cited the following as the most noteworthy deficiency areas encountered by its front-line examiners:
- Solicitor Disclosure Documents. OCIE referenced examples of advisers dealing with third-party solicitors lacking solicitor disclosure documents entirely or disseminating faulty or incomplete documents. For example, OCIE cited documents that failed to contain the terms of the compensation arrangement between the adviser and the solicitor. In this regard, OCIE stressed the need to describe the “actual compensation terms agreed to,” and not “vague or hypothetical terms” paraphrasing them. Additionally, OCIE reiterated the Rule’s requirement that any incremental solicitation cost being passed on to the solicited client be fully disclosed.
- Client Acknowledgements. OCIE staff observed advisers that did not timely receive a signed and dated client acknowledgement evidencing receipt of the adviser’s brochure and the solicitor’s disclosure document. In some cases, the acknowledgements were undated or dated after the date on which the prospect became a client.
- Solicitation Agreements. The staff found cases of advisers that paid cash fees to a solicitor without any solicitation agreement in place, as well as cases of agreements containing faulty language or missing mandated terms.
- The Bona Fide Effort. OCIE noted advisers that did not make the required bona fide effort to verify whether solicitors complied with the solicitation agreement. For example, OCIE staff observed advisers that were unable to describe any efforts they took to confirm compliance with existing solicitation agreements.
In a footnote, OCIE cited a recent enforcement action by the SEC brought against an adviser for violations of the Cash Solicitation Rule as a reminder of the potential ramifications of non-compliance. Accordingly, we recommend that all SEC-registered advisers take heed of the staff’s admonishment that “advisers should review their practices and policies to ensure compliance with the Cash Solicitation Rule.”
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