Davis Polk & Wardwell Newsflash

SEC Issues Interpretative Letter Regarding the Cash Solicitation Rule

July 17, 2008

On July 15, 2008, the SEC staff issued an interpretative letter clarifying that Rule 206(4)-3 (the "Cash Solicitation Rule" or the “Rule”), promulgated pursuant to the Investment Advisers Act of 1940 (the “Advisers Act”), generally does not apply to a cash payment paid by an investment adviser to a person (a "solicitor") if the payment is solely to compensate that solicitor for referring investors to, or soliciting investors for, a privately-offered investment fund managed by the adviser (such as a fund that is exempt under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940).

The Cash Solicitation Rule prohibits an investment adviser that is required to be registered from paying any solicitor a cash fee, directly or indirectly, with respect to solicitation activities unless the requirements of the Rule are met.  The request for clarification was prompted by the uncertainty caused by informal oral statements of members of the SEC staff (made after the Goldstein decision) that the Cash Solicitation Rule would not apply to the solicitation of investors to private investment funds (on the basis that the Rule applies to the solicitation of clients, and investors are not clients of the adviser for purposes of the Rule), while certain prior no-action letters suggested that the Rule should apply in such a case.  The SEC staff indicated that the question of whether the Cash Solicitation Rule applies in a particular case must be evaluated in light of the particular facts and circumstances, and it would view, as relevant to the analysis, the nature of the arrangement and the relationship between the solicitor and the investment adviser and the purpose of the cash payment.  The letter provided two examples.  First, the Cash Solicitation Rule would not apply to a registered adviser's cash payment to a solicitor in exchange for the solicitation or referral of investors or prospective investors to one or more investment funds managed by the adviser if the adviser only manages investment funds and is not seeking to establish investment advisory relationships (i.e., individual accounts) with other persons.  In contrast, the letter indicated that the Cash Solicitation Rule would appear to apply if an adviser manages, or seeks to manage, investment funds and individual accounts, is seeking to enter into advisory relationships with other persons (i.e., is seeking advisory clients) and makes a cash payment under an arrangement with a solicitor to compensate the solicitor for referring persons as prospective advisory clients.

The SEC staff noted that a solicitor, depending on the facts, may be acting as an investment adviser within the meaning of Section 202(a)(11) of the Advisers Act, and therefore, even if the Cash Solicitation Rule does not apply, would generally have an obligation under Section 206 thereunder to disclose material conflicts of interest to the persons being solicited or referred.  Thus, the letter suggests that a solicitor may continue to have an obligation to disclose the arrangement and the cash payment to such persons.  The letter does not address whether solicitors who refer investors to investment funds are required to be registered as broker-dealers or registered representatives of broker-dealers.

A summary of this interpretative letter will be included in the next issue of our Investment Management Regulatory Update.

See a copy of the letter.

If you have any questions regarding this newsflash, please call your Davis Polk contact.

Davis Polk & Wardwell