Client Referral Sources: Don’t Forget About the Regulations

September 03, 2005

A recent article in Investment Advisor magazine discussed the benefit of using clients as referral sources and the growing practice of using other professionals, such as CPAs and attorneys, to help land clients as well. This article brings to mind the importance of understanding SEC Rule 206(4)-3. (A state registered investment advisor should refer to the state rule on the subject.)

While the SEC does not generally have an issue with using employees or outside sources for client referrals, the Commission has clearly taken the position that a line is crossed upon payment for such referrals. When fees are paid by an SEC registered advisor for client referrals, Rule 206(4)-3 requires a formal agreement between the two parties and disclosures to be provided to the client. The referring party must provide a copy of the advisor firm’s disclosure brochure and a solicitor’s disclosure statement, which must indicate the amount received for the referral. In addition, due diligence must be performed on the referring party to ensure the person or company has not violated any SEC rules as spelled out under Rule 206(4)-3 or has been disqualified from advisor registration.

In addition to the Rule 206(4)-3, SEC registered firms must give attention to state rules as well. The majority of state regulators include the terms solicitor or referral in the definition of investment advisor representative and therefore require the referring party to be licensed as such. This means passing the Series 65 exam, filing a Form U4, paying the licensing fee, and receiving approval by the state; all prior to soliciting the first client for a fee. Some states even require companies that receive solicitor fees to be registered as an investment advisor even though they may provide no other advisory services. In these cases, the referring firm would need to file a Form ADV and other required documents in order to register directly with the state.

Finally, it’s important to consult with the state accounting board or bar association to determine whether a solicitor fee is permissible when working with accountants or lawyers. Special precautions need to be taken for referral arrangements involving ERISA covered accounts or plan fiduciaries. Please see our earlier postings.

If you have specific questions about any solicitor/referral arrangements you have or would like to discuss the rules in more detail, please give us a call.

Posted by Bryan Hill
Labels: Solicitors