Under Rule 206(4)-3, adopted by the U.S. Securities and Exchange Commission pursuant to the Investment Advisers Act of 1940 (and under a number of parallel state securities laws or regulations), an investment adviser may compensate a cash solicitor who is not otherwise connected to the advisory firm for soliciting and referring prospective clients to the adviser. The Rule relies upon a number of procedural and disclosure provisions incorporated in the rule to protect investors. However, for firms covered by the new Department of Labor Fiduciary Duty Rule that use such solicitors to locate and refer clients, there is a very significant impact that has to be considered. Under appropriate circumstances, this could include anything from a huge company pension plan to a 401(k) roll-over account of an individual’s defined benefit or defined contribution plan, among others.
Under the new rule, people and entities providing investment advice will be deemed to be a “fiduciary” subject to very extensive provisions of the rule. Under the rule, recommending an investment adviser or soliciting prospective clients for an adviser is deemed to be the giving of investment advice, and causes the party giving that advice to fall into the definition of a fiduciary. That could result in a firm asking to be hired by a client to be deemed a fiduciary even before they enter into a relationship. That clearly is unworkable. To address this, the rule has an exception that allows an adviser to solicit prospective clients for itself without becoming a fiduciary during the solicitation process. This reflects the view that a prospective client who is being solicited will recognize that someone saying “hire me” is acting in the firm’s interest. The built-in bias is self-evident.
So what is the problem? The key to the exemption is that the solicitation is being done by the person or firm for itself. An independent cash solicitor under the rule is not soliciting for himself or herself. The person is soliciting the prospective client for another entity – the advisory firm. This solicitation would appear to fall outside the scope of the “hire me” exception. When (or if) the DOL rule takes effect next year, an independent solicitor should consider establishing a more formal relationship with a firm for which he or she solicits. And investment advisory firms would have to consider whether and how they may continue to use cash solicitors if the firm seeks prospective clients covered under the new DOL rule.