Remember that time you started a new relationship, and at the beginning, you thought it was ok not to disclose your previous relationships? Then as things became serious, you were afraid to bring up the past, deciding that technically since it wasn’t an issue over the years – why start disclosing now? Until your current partner discovers that you dated one of their colleagues! Your tactic? Deny, deny, deny.
You’re probably wondering how this is relevant in the world of Investment Advisers. That scenario sums up the case with Cetera Investment Advisers and PrimeVest Financial Services, Inc., who failed in requiring solicitors to disclose their relationships and hid behind a no-action letter, resulting in a fine of $185,000.
Why is Disclosure Important?
As with many items related to Investment-Advisers or Broker-Dealers, there’s a rule for that. The Investment Advisers Act requires a firm to disclose its relationships with solicitors.
Rule 206(4) of the Adviser Act, and Rule 206(4)-3 thereunder, prohibit an investment Adviser from paying a cash fee, directly or indirectly, to a solicitor with respect to solicitation activities unless they meet the appropriate requirements.
If you’re an IA or BD, you need to:
- Enter into a written agreement with each solicitor
- Require the solicitor to provide each prospective client a copy of the Adviser’s ADV
- Require the solicitor to provide each prospective client a separate disclosure document
The disclosure document must contain, among other things:
- The name of the solicitor
- The nature of the solicitor relationship
- A statement that the solicitor will be compensated for their services to the adviser
- The terms of the solicitor’s compensation, including a brief description of the compensation
Ignoring the Issue Doesn’t Make it Go Away
In 2006, the OCIE examined PrimeVest, a dually registered Investment Adviser and Broker-Dealer, and informed them in their deficiency letter that they were providing insufficient disclosures to advisory clients regarding their solicitor relationship with banks. In 2007, PrimeVest amended their networking agreements to no longer require prospective clients to receive a disclosure regarding their solicitor relationships.
In 2010, when Cetera acquired PrimeVest, they assumed responsibility for the networking agreements. They also continued their practice of not requiring banks to provide the appropriate disclosures to prospective advisory clients.
Cetera paid 350 banks and credit unions to solicit investment advisory clients for them. These banks and credit unions operated under networking agreements under which each bank and credit union would refer anyone seeking investment advisory services to Cetera. In exchange, the solicitors would receive a portion of any investment advisory fees Cetera received from these clients.
Cetera never required the banks to provide a separate disclosure statement to the clients detailing the relationship between the solicitors and Cetera. Cetera also knew in advance that what they were doing violated the Advisers Act, as the prior deficiency letter in PrimeVest’s examination informed them of this error.
A Chance to Come Clean
In 2014, Cetera was examined by the SEC, and they were informed of the disclosure deficiencies yet again. Cetera refused to require the disclosures, citing a 1991 no-action letter that Cetera interpreted incorrectly.
Cetera continued to violate the adviser’s act, incorrectly believing themselves protected by the no-action letter. The SEC rejected the interpretation of the no-action letter. It found that Cetera had willfully violated the Advisers Act, stating that “Cetera’s clients were not informed of the extent of the banks’ financial interest in the clients’ choice of Cetera as an investment adviser and did not have all of the information that would enable them to evaluate the solicitor’s recommendation.”
The SEC issued a cease and desist order against Cetera, censured them, and fined them $185,000 in civil penalties.
If you have questions about your duty to disclosure your solicitor relationships, or if you need help understanding a no-action letter, please reach out to the Red Oak team. No matter what stage of the relationship, we’re here to help with your needs.
About Red Oak Compliance Solutions
Red Oak Compliance Solutions is the global advertising review software of choice in the financial services industry. It is a comprehensive suite of SEC 17A-4 compliant features that are 100% books and records compliant and provides clients with 35% faster approvals and 70% fewer touches or better. We also offer Smart Review(SM), which solves for the storage and maintenance of disclosures, helping firms reduce risk, decrease review times, and increase the speed of distribution of marketing materials. Smart Registration(SM) automates the licensing and registration management process to help reduce regulatory risk and time spent on manual processes. Overall, Red Oak allows firms to minimize risk, reduce costs, and increase compliance review process effectiveness and efficiencies.