The saying goes, referrals are the lifeblood of any business. Indeed, all business owners, robo-advisory firms included, strive to provide a level of value and service to their customers such that those customers in turn become advocates and solicitors of the business. Unfortunately, word of mouth referrals alone are not usually enough. Your firm may choose to engage third parties to solicit new clients. Traditionally, these third parties include the likes of broker-dealers, banks, accountants, and attorneys. While these third-party arrangements are important for any investment adviser, for robo-advisory firms, these arrangements may carry added significance. For example, your firm may engage in a cash referral program whereby existing clients are encouraged to refer new potential clients in exchange for waiving advisory fees, or simply depositing cash into the client’s account. Another example might involve an arrangement to have a link to your firm’s website appear on a third-party website. While these arrangements may be sound from a business standpoint, from a compliance perspective they can be problematic.
Unlike a traditional brick and mortar advisory firm, your firm likely doesn’t have direct client engagement. Moreover, your firm’s business model may rely on a higher volume of clients with lower individual account sizes. Therefore, having a dedicated third-party solicitation network may be key to a healthy client pipeline. However, before you rush to set up a referral program, you should consider what compliance steps are necessary.
If any of these third-party arrangements involve your firm paying for client solicitation, your firm must comply with both state and federal requirements. Individual state requirements related to solicitation agreements focus on licensing requirements. We previously covered this topic in our Individual Licensing Requirements Post, and highly encourage you to review it.
Federally, Rule 206(4)-3 (the “Solicitation Rule”) under the Investment Advisers Act of 1940 outlines specific disclosure and delivery requirements with respect to solicitation. Under the Solicitation Rule, an advisory firm can only pay a referral fee to a third party pursuant to a written agreement with that party. The agreement must describe the specific activities to be undertaken by the third party and the compensation to be received for those activities. The Solicitation Rule also requires that the third party, at the time of solicitation, provide to the potential client a copy of the adviser’s brochure along with a separate document that discloses the details of the solicitation arrangement. This separate disclosure document must be signed by the potential client and returned to the third party, and ultimately delivered to the adviser before the prospect can become a client. Your firm also has a duty under the Solicitation Rule to make a bona fide effort to ensure that the third-party solicitor has complied with these requirements.
While this process may seem onerous, you may find that the potential benefits of third-party solicitation far outweigh the compliance burdens. As always, our recommendation is to involve a compliance professional early in the process.
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