As discussed in a previous blog posting, investment advisers must comply with Rule 206(4)-3 (the “Rule”) of the Investment Advisers Act of 1940 when using solicitors. Notably, in July 2008, the SEC issued a no-action letter (the “Letter”) which provided additional guidance to Rule 206(4)-3’s applicability. In this Letter, the SEC stated that Rule 206(4)-3 generally does not apply to a RIA’s cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, a private fund managed by the adviser. In support of this interpretation, the SEC noted that:
- Neither the Rule’s Proposing Release nor the Adopting Release contained any statement directly or indirectly suggesting that it would apply to RIAs’ cash payments to others solely to compensate them for soliciting investors for investment pools managed by the advisers;
- The Rule is designed so as to clearly apply to solicitations and referrals in which the solicited or referred persons might ultimately enter into investment advisory contracts with the investment adviser, yet private fund investors do not typically enter into investment advisory contracts with the investment advisers of the pools; and
- The Rule’s use of the terms “client” and “prospective client,” rather than “investor” or “prospective investor,” also strongly suggests that the Rule was intended to apply to solicitations and referrals in which the solicited or referred persons might ultimately enter into investment advisory contracts with the investment adviser.
Whether a RIA’s cash payment to a person is being made solely to compensate that person for soliciting investors for an investment pool managed by the adviser will depend upon all surrounding facts and circumstances. For example, the Rule would not appear to apply to a RIA’s cash payment to a person for referring other persons to the adviser where the adviser manages only investment pools and is not seeking to enter into advisory relationships with other persons. In contrast, the Rule would appear to apply if the adviser manages or seeks to manage investment pools and individual accounts, is seeking to enter into investment advisory relationships with other persons, and the adviser’s cash payment, under the adviser’s arrangement with the referring person, compensates the referring person for referring the other persons as prospective advisory clients.
For more information, please contact Brent Cunningham, Associate, at (619) 298-2880 or at firstname.lastname@example.org.