SEC Loosens Ruling On Fund Solicitation Fees

The SEC has clarified its position on the "Cash Solicitation Rule" saying that a registered investment adviser may compensate a person for soliciting investors for, or referring investors to his or her investment fund.

Usually, under the rule, it is illegal for an investment adviser to pay a cash fee, directly or indirectly, as the "Cash Solicitation Rule" only applies to solicitations of “clients.”

But the SEC has taken the position that solicitations of investors for investment funds should not fall ito that category. The determination of whether the cash payment is being made solely to compensate that person for soliciting or referring investors will depend on the facts and circumstances of each particular case.

The SEC also warned that "Despite the additional guidance provided by the interpretative letter, investment advisers will need to continue to be mindful of potential traps for the unwary when entering into solicitation agreements."



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Original Release

SEC Clarifies Application of Cash Solicitation Rule to Payments by Investment Advisers

In a July 15, 2008 interpretative letter, the SEC staff clarified that Rule 206(4)-3 (the “Cash Solicitation Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”) does not apply to a registered investment adviser’s cash payments to a person solely to compensate that person for soliciting investors for, or referring investors to, an investment pool managed by the adviser.

The Cash Solicitation Rule makes it unlawful for a registered investment adviser to pay a cash fee, directly or indirectly, to a solicitor unless the payments are made in compliance with conditions specified in the Cash Solicitation Rule. As the Cash Solicitation Rule only applies to solicitations of “clients,” the SEC has taken the position that solicitations of investors for investment funds should not fall within the purview of the Cash Solicitation Rule. This position is consistent with statements recently made by the U.S. Court of Appeals for the District of Columbia Circuit in Goldstein, et al. v. Securities and Exchange Commission, which vacated as arbitrary the SEC’s requirement that investment advisers count the shareholders, limited partners, members or beneficiaries of the pools as “clients.”

The SEC staff indicated that the determination of whether a registered investment adviser's cash payment to a person is being made solely to compensate that person for soliciting investors for, or referring investors to, an investment pool managed by the adviser will depend upon all of the facts and circumstances of the particular case. The most pertinent facts and circumstances generally will be those relating to the nature of the arrangement between the soliciting/referring person and the investment adviser, the nature of the relationship between the investment adviser and the solicited/referred person, and the purpose of the adviser's cash payment to the soliciting/referring person.

The SEC staff stated that the Cash Solicitation Rule would not apply to a registered adviser'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 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 solely for referring the other persons to the adviser as investors or as prospective investors in one or more of the investment pools managed by the adviser. In contrast, the Cash Solicitation Rule would 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.

Despite the additional guidance provided by the interpretative letter, investment advisers will need to continue to be mindful of potential traps for the unwary when entering into solicitation agreements. For example, a person's receipt of cash compensation from an investment adviser of an investment pool for soliciting investors may result in the person being considered a “broker” under Section 3(a)(4) of the Securities Exchange Act of 1934. Also, although a solicitor will not be required to provide prospective investors with the investment adviser's written disclosure statement specified in Rule 204-3 under the Advisers Act if the Cash Solicitation Rule does not apply to the relevant solicitation arrangement, the solicitor may generally be required by Section 206 of the Advisers Act to disclose to prospective investors material facts relating to conflicts of interest arising from the solicitation agreement.