Poor Compliance With Cash Solicitation Rule Prompts OCIE Risk Alert

Faced with various compliance issues related to the ‘cash solicitation rule’, the Staff issued a risk alert to inform market participants and help advisers update their policies accordingly. The rule prohibits advisers from paying a cash fee, directly or indirectly, to any person who solicits clients for them, unless the arrangement complies with certain conditions. Among those conditions is that the cash fee must be paid pursuant to a written solicitation agreement to which the adviser is a party. In addition, the solicitor must not be a person subject to certain disqualifications set forth in the rule.   

If the solicitor is a third party, there are additional requirements:

• The solicitation agreement must describe the solicitation activities and compensation to be received;
  
  
• The solicitation agreement must require the solicitor to provide the prospective client with the adviser’s brochure, and a disclosure document outlining the solicitor’s financial interest in the potential transaction;
  
  
• Before or at the time of entering into an agreement with the client, the adviser must receive a signed and dated acknowledgement that the client received the brochure and the disclosure statement; and
  
  
• The adviser must make a genuine effort to confirm the solicitor complied with the solicitation agreement.

The Staff observed compliance issues with each of these items, as follows:

• Solicitor disclosure: Some prospective clients did not receive the disclosure documents, or received incomplete documents. For instance, some documents omitted the nature of the relationship between the solicitor and adviser, as well as the terms of the compensation arrangement between the adviser and the solicitor. Some descriptions of the compensation terms were criticized for being “vague or hypothetical.” Disclosure documents also did not specify the additional solicitation cost charged to the client.
  
  
• Client acknowledgements: The signed and dated client acknowledgement was sometimes not received by the adviser on a timely basis. In other instances, the acknowledgement was not dated, or dated after the clients entered into the investment advisory contract.
  
  
• Solicitation agreements: The Staff found some advisers that paid cash fees to a solicitor without the required written agreement, or used agreements that were missing the following provisions:
  • an undertaking by the solicitor to follow the adviser’s instructions,
  • a description of the solicitor’s activities and compensation, and
  • an obligation for the solicitor to provide the prospective client with the adviser brochure and solicitor disclosure document.
    
    
• Bona fide efforts to confirm solicitor compliance: Some advisers were unable to explain what measures they took to ensure compliance with solicitation agreements.

Some advisers involved in the review have amended their disclosure documents and solicitation agreements (or have undertaken to review their policies for improved compliance), and the Staff encouraged other advisers to review their compliance programs.

The requirements in securities legislation, although often detailed and prescriptive, also include broad principles for which the judgment of compliance officers is especially important. Although compliance tools such as checklists are helpful, this risk alert is a reminder that good compliance also depends on a clear understanding of the level of detail which is appropriate in disclosure, or the level of inquiry which qualifies as a “bona fide effort.” Advisers should consider reviewing their policies and practices as needed, based on the Staff’s guidance.