In addition to making disclosures to the state administrator during the registration process, broker-dealers and investment advisers are required to make ongoing disclosures to their clients. We’ll cover three categories of these disclosures in this chapter:
In the previous chapter, we discussed the various fees broker-dealers charge outside of commissions, markups, and markdowns. Those are disclosed in fee schedules that must be made available to customers. The North American Securities Administrators Association (NASAA) offers a model fee disclosure template that most broker-dealers utilize. This information must be made available to customers, and most broker-dealers include them in account applications and on their websites.
The most important disclosures made by an investment adviser are typically presented in the brochure. Let’s refresh ourselves on the three important sections of this disclosure document:
The primary purpose of each is to ensure clients are informed about the person they entrust their money with. Not only do these documents disclose the specifics related to products and services offered, but the client also has access to the history of the firm and its investment adviser representatives (IARs). If the adviser has a checkered past or is employing an IAR with a criminal record, this information can be gathered from the brochure.
NASAA disclosure-related rules also regulate solicitors, sometimes referred to as promoters. Let’s first take a look at NASAA’s definition of a solicitor:
“Solicitor” means any individual, person, or entity who, directly or indirectly, receives a cash fee or any other economic benefit for soliciting, referring, offering or otherwise negotiating for the sale or selling of investment advisory services to clients on behalf of an investment adviser.
In a nutshell, a solicitor is any person that is compensated to connect potential clients with advisers. While a solicitor could be an employee of the adviser, they could also be a separate third party. For example, an individual with a marketing background networks in their city and finds prospective clients for an adviser.
This type of arrangement is legal and ethical as long as certain protocols are followed and disclosures are made. The rules governing solicitors of state-registered advisers require the solicitor:
Be registered as an IAR
This one is pretty simple - the solicitor must be registered as an IAR of the firm they solicit business for.
Not be subject to a statutory disqualification
Promoters are treated just like financial professionals. If they have a checkered past, they cannot solicit on behalf of an adviser. We learned about statutory disqualifications in a previous chapter, but these are past actions or punishments that prevent a person from gaining registration (effectively barring them from the industry). Let’s review what qualifies as one:
Maintains a written agreement with the adviser
Solicitor-related regulations require the adviser and the promoter to create a written agreement between both parties. Additionally, the adviser is responsible for maintaining the agreement in their records, which could be requested by the state administrator. The agreement must describe the following:
Must deliver brochures
During the solicitation of any prospective client, the solicitor is required to deliver two brochures. Form ADV Part 2A, which is the adviser’s brochure, must be delivered in writing to the potential client. Additionally, a solicitor’s brochure must be created and delivered in writing as well. The required disclosures in this document include:
**Obtains signed receipt of brochures from a prospective client **
In addition to providing both the adviser’s and solicitor’s brochures, the promoter is required to obtain a signed receipt from the prospective client that simply affirms both disclosures were received. The investment adviser is required to maintain the signed receipt in their records.
Prior to 2020, solicitor rules for federal-covered advisers were essentially the same as those at the state level. In 2020, the Securities and Exchange Commission (SEC) finalized a new rule that simplified how solicitors were regulated. You’ll notice a few similarities in these requirements:
The solicitor must disclose the following:
Additionally, these rules must be followed:
*Essentially the same items that must be in the agreement between a state-registered adviser and their solicitor (discussed above) are the same here.
Last, the solicitor may not*:
*Although these prohibitions are specifically for solicitors of federal-covered advisers, you can assume the same applies at the state level.
You may have noticed two big omissions for federal-covered advisors compared to the state-based solicitor rule. First, federal-covered solicitors are not required to be registered as IARs. Second, there is no brochure delivery requirement for promoters. Given the adviser must provide the brochure to the client, the SEC felt forcing the solicitor to deliver it was redundant. As discussed above, the promoter must make disclosures at the time of solicitation. The SEC rule specifically states the disclosures must be made “clearly and prominently,” but does not explicitly require them to be put in writing.
Securities rules and regulations have continually pushed for further transparency in relation to investment advice. One particular concern for regulators is how an IAR’s personal securities holding may influence their recommendations to clients. For example, let’s assume an IAR personally owns stock in a thinly traded company. Knowing added demand for the security will result in its market price rising, they recommend it to a number of their clients even when it may not be totally suitable for their situation. Obviously, this would be a problem.
Rules applicable to both federal-covered and state-registered advisers have been recently created and implemented to prevent this type of behavior. Employees of advisers (typically IARs) with access to certain nonpublic information must continually disclose their personal securities holdings to their compliance departments. Let’s go through the details.
These disclosure rules only apply to access persons.
As stated above, most, if not all IARs of a registered adviser will qualify as an access person. These roles require access to client accounts, portfolio holdings, and details related to recommendations. To attain the transparency discussed above, securities regulators require access persons to fully disclose their personal holdings and transactions to their employing firms. This allows compliance officers to cross-reference recommendations made to clients against their personal investing activity. These two reports must be filed by access persons regularly:
Holdings reports
A holdings report provides a detailed view of an access person’s personal portfolio. This report will include:
The timing of the filing of the holdings report also must be known. It must be filed:
Transaction reports
These reports contain exactly what you would expect - transactions. In particular, the following must be disclosed:
Transaction reports must be filed no later than 30 days after the end of the quarter in which the transactions occurred.
Securities regulators provide three exceptions to the required filings of holdings and transaction reports. In particular, no filing is required for:
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