investment adviser--consciously or unconsciously--to render advice
which was not disinterested.'').
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    Our proposal would newly require that the solicitor disclosure
specifically include any potential material conflicts of interest of
the solicitor resulting from the investment adviser's relationship with
the solicitor and/or the compensation arrangement. Therefore, in
addition to stating the facts that give the solicitor an incentive to
solicit the adviser (e.g., that the solicitor is compensated, the terms
and description of the compensation, and the relationship between the
solicitor and the adviser), the solicitor disclosure would also state
that such incentives present a conflict of interest for the solicitor.
We believe that this addition would enhance the solicitor disclosure by
directly stating that there is a conflict of interest. It would alert
the investor of the relevant conflict of interest in the solicitation
arrangement at the time of solicitation or, in the case of a mass
communication, as soon as practicable thereafter.\385\
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    \385\ Information about an adviser's conflict of interest is
required to be disclosed in the adviser's brochure, which is
provided to the client prior to entering into an investment advisory
relationship with the adviser. See supra footnote 373 (referencing
the Form ADV brochure required disclosures about compensated
referral arrangements, including with respect to conflicts of
interests). We believe it is important to state the solicitor's
conflict of interest in the solicitor disclosure.
---------------------------------------------------------------------------

    For example, when advisers direct brokerage as compensation for
solicitation, it presents a conflict of interest for the
solicitor.\386\ The solicitor's conflict is present to varying degrees
in many types of directed brokerage referral arrangements, such as when
the solicitation is contingent upon a specified amount (e.g., certain
thresholds) of directed brokerage, and when the broker-dealer more
generally considers the receipt of directed brokerage as the primary
factor or one of many factors that motivate it to refer investors to an
adviser. Similarly, a solicitor associated with a commercial bank may
refer investors in exchange for the adviser's referral of other
investors to the firm's banking services, which is also a conflict of
interest for the solicitor.
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    \386\ The Commission adopted changes to an adviser's brochure in
2010 to require additional disclosure about the practice of using
directed brokerage, including disclosure about the conflicts of
interest it creates. See 2010 Form ADV Amendments Release, supra
footnote 34, at n.143 and accompanying text (new required disclosure
included that the adviser may have an incentive to select or
recommend a broker-dealer based on its interest in receiving client
referrals, rather than on its clients' interest in receiving most
favorable execution).
---------------------------------------------------------------------------

    Other types of solicitation relationships between solicitors and
advisers can also create conflicts of interest for the solicitor that
would need to be disclosed under the proposed solicitor disclosure. For
example, a broker-dealer that is a solicitor may refer investors to
advisers that compensate it for the referrals by recommending the
solicitor's proprietary investment products or products that have
revenue sharing or other pecuniary arrangements with the
solicitor.\387\ This solicitation arrangement would be a conflict of
interest for the solicitor that would be required to be disclosed in
the solicitor disclosure.
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    \387\ See also Regulation Best Interest Release, supra footnote
359, at text accompanying nn.193-194 (discussing the Commission's
view that ``Regulation Best Interest should apply broadly to
recommendations of securities transactions and investment strategies
involving securities.'').
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    Our proposal would also require disclosure of the amount of any
additional cost to the investor as a result of solicitation.\388\ This
provision would revise the current rule's requirement that the
solicitor state whether the client will pay a specific fee to the
adviser in addition to the advisory fee, and

whether the client will pay higher advisory fees than other clients
(and the difference in such fees) because the client was referred by
the solicitor.\389\ We believe that it is important for investors to
understand whether they will bear any additional costs as a result of
the solicitation. For investors that are advisory clients, the
additional cost could be that they will pay a higher investment
advisory fee. In such case, the solicitor disclosure would need to say
so and state the amount of such additional fee. For investors that are
private fund investors, we request comment below on whether investors
would indirectly incur any additional costs as a result of the
adviser's use of a solicitor, such as through the adviser charging the
private fund a higher fee than another private fund it manages without
using a solicitor and whether the solicitor disclosure should state
such additional amounts, if applicable. In some contexts, there may not
be any differences in fees to the investor. In directed brokerage
arrangements, for example, the adviser's duty to seek best execution
should mitigate against the risk that the directed brokerage
arrangement would result in higher execution costs for the investor,
but the rule would still require disclosure of the magnitude of any
increased costs such as increased commissions (or higher custodian
fees) as a result of the solicitation.
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    \388\ See proposed rule 206(4)-3(a)(1)(iii)(F).
    \389\ Rule 206(4)-3(b)(6) (requiring disclosure of ``[t]he
amount, if any, for the cost of obtaining his account the client
will be charged in addition to the advisory fee, and the
differential, if any, among clients with respect to the amount or
level of advisory fees charged by the investment adviser if such
differential is attributable to the existence of any arrangement
pursuant to which the investment adviser has agreed to compensate
the solicitor for soliciting clients for, or referring clients to,
the investment adviser'').
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    In addition, we are proposing a modification to the timing of the
delivery of the solicitor disclosure for solicitations that are
conducted through mass communications. Mass communications include
communications that appear to be personalized to a single investor (and
nominally addressed to only one person), but are actually widely
disseminated to multiple investors, as well as impersonal outreach to
large numbers of persons.\390\ In these cases, we are proposing to
permit the solicitor disclosure to be delivered at the time of
solicitation or as soon as reasonably practicable thereafter, because
it may not be practicable to deliver the solicitor disclosure at the
time of initial solicitation.\391\ Under the proposed rule, we would
view delivery of the solicitor disclosure to be made be as soon as
reasonably practicable after the time of a mass solicitation if it is
provided promptly after the investor expresses an initial interest in
the adviser's services.\392\ If the adviser, rather than the solicitor,
has agreed to deliver the disclosure, we would view ``as soon as
reasonably practicable thereafter'' as being at the time the investor
first reaches out in any manner to the adviser in response to the
solicitation. We believe that this modification for mass communications
would continue to promote investor protection, while providing firms
with greater flexibility in meeting the rule's requirements.
---------------------------------------------------------------------------

    \390\ See supra footnote 88, and accompanying text (discussing
template presentations and mass mailings).
    \391\ From time to time, solicitors that make their initial
contact with prospective clients through mass mailings have asked
whether they can forgo delivery of the solicitor's disclosure
statement and the adviser's brochure until recipients of the mass
mailings indicate preliminary interest by returning a reply card or
telephoning the solicitor's call center. See, e.g., E.F. Hutton &
Company, Inc., SEC Staff No-Action Letter (Sept. 21, 1987) (``Hutton
Letter''); AMA Investment Advisers, Inc., SEC Staff No-Action Letter
(Oct. 28, 1993) (``AMA Letter''); and Moneta Group Investment
Advisers, Inc., SEC Staff No-Action Letter (Oct. 12, 1993) (``Moneta
Letter'').
    \392\ Commission staff has stated that it would not recommend
enforcement action to the Commission under rule 206(4)-3 if a
registered investment adviser, rather than its solicitor, delivers
the solicitor disclosure, provided the adviser meets several other
conditions. See, e.g., Hutton Letter; AMA Letter; Moneta Letter, id.
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    We request comment on our proposal to revise the rule's solicitor
disclosure requirement.
     Should we require a solicitor disclosure be delivered to
investors at the time of any solicitation activities (or in the case of
a mass communication, as soon as reasonably practicable thereafter)? If
not, when should the solicitor disclosure be delivered to investors?
     Should we remove the current requirement that the
solicitor disclosure be ``written''? Why or why not?
     Do commenters agree with the proposal to require the
solicitor disclosure be separate disclosure? If not, what
requirement(s) would make the presentation of solicitor disclosure
salient and impactful? Should we include a specific requirement that if
the solicitor delivers multiple communications to the investor, the
solicitor disclosure must be presented first so that it is clearly and
prominently disclosed? Are there any practical issues that arise with
the requirement to deliver the solicitor disclosure separately in the
context of delivery through electronic media or other forms of
delivery? If so, what are they and how should we treat them?
     Do solicitors employ mass communications to solicit
investors, and if so, what types of mass communications? For example,
do solicitors send mass mailing via the postal service or electronic
mail delivery? Do they provide mass communications in the form of
compensated blog posts referring investors to an adviser?
     Do commenters agree that for solicitors that make their
initial contact to investors by mass communications, delivery of the
solicitor disclosure should be permitted to occur at, or as soon as
reasonably practicable after, the time of the solicitation? Why or why
not? Do commenters believe that solicitor disclosure provided promptly
after the investor expresses an initial interest in the adviser's
services would be effectively timed disclosure for investors solicited
by mass communications? Would it provide such investor the necessary
tools at an appropriate time to evaluate any potential bias on the part
of the solicitor? Why or why not? In order for an adviser to deliver
the solicitor disclosure at the time the investor first reaches out to
the adviser in response to a solicitation made by mass communication,
would it be clear to the adviser when the investor makes such contact?
     If delivery of the solicitor disclosure is made as soon as
reasonably practicable after the time of solicitation, should we
require that the mass communication include a statement alerting the
investor of the solicitor disclosure to come? Why or why not? What
disclosure, if any, would be sufficient to alert the investor of the
disclosure to come?
     Are there specific types of mass communications that
require similar, or different, treatment under the rule? For example,
some solicitors may provide a mass communication in the form of a
compensated blog post referring investors to an adviser. Should these
solicitors be required to provide the solicitor disclosures at the time
of solicitation (i.e., as part of their blog posts)? Or, should we
permit such a solicitor or the adviser engaging the solicitor to
provide the solicitor disclosure when an investor clicks through the
solicitor's blog post to learn more information about the adviser? By
what other methods could disclosure be provided, for mass
communications, to ensure that the disclosure is provided at the time
of solicitation or as soon as reasonably practicable thereafter?
     Should the solicitor disclosure include more, or fewer,
disclosures? If so, which disclosures should be

omitted, or what disclosures should we add, and why? For example,
should the solicitor disclosure require additional information about
the nature of the relationship between the adviser and the solicitor,
or about compensation?
     Do commenters agree that we should include the proposed
additional disclosure requiring a statement of any potential material
conflicts of interest resulting from the investment adviser's
relationship with the solicitor and/or the compensation arrangement?
Why or why not? Or should it be sufficient for the disclosure to state
the relationship between the solicitor and the adviser (including any
affiliation), and the terms of such compensation arrangement, including
a description of the compensation paid or to be paid to the solicitor?
Would the proposed additional disclosure requirement result in
disclosure that is too lengthy? If so, how should we ensure that the
conflict of interest in the solicitation relationship is effectively
conveyed to the investor?
     Should we include an exception to the proposed disclosure
requirement when the solicitor itself is registered with the Commission
as an investment adviser and discloses the relevant conflicts of
interest concerning the compensation for solicitation in its brochure
and/or brochure supplements? In such a case would it be sufficient for
the solicitor disclosure to briefly disclose that there is cash or non-
cash compensation for the solicitation, and to state that the details
of that compensation and any conflicts it creates are described in the
brochure and/or brochure supplement?
     Should we include an exception to the proposed disclosure
requirement when the solicitor itself is registered with the Commission
as a broker-dealer and discloses the relevant conflicts of interest
concerning the compensation for solicitation under the Commission's
regulations, such as under Regulation Best Interest or Form CRS
Relationship Summary? In such a case would it be sufficient for the
solicitor disclosure to briefly disclose that there is a cash or non-
cash compensation for the solicitation, and to state that the details
of that compensation and any conflicts it creates are described in Form
CRS or where applicable pursuant to Regulation Best Interest?
     In addition to the solicitor disclosure, should we require
the solicitor or the adviser to deliver to the investor, at the time of
solicitation, the adviser's Form CRS relationship summary, which would
inform the investor about, among other things, the types of customer
relationships and services provided? Why or why not?
     Should we continue to require that the solicitor
disclosure describe the terms of the compensation arrangement,
including a description of the compensation paid or to be paid to the
solicitor? Why or why not? Should we require a different disclosure for
cash or for non-cash compensation? Why or why not, and if so, what
disclosure requirement should apply for cash or for non-cash
compensation?
     Should we explicitly require that the solicitor disclose
any compensation it receives indirectly? Why or why not?
     Should we, as proposed, replace the current rule's
requirements that the solicitor disclosure include whether the client
will pay a specific fee to the adviser and whether the client will pay
higher advisory fees because the client was referred by the solicitor,
with the requirement that the solicitor disclosure include the amount
of any additional cost to the investor as a result of solicitation?
Would such a proposed requirement result in disclosure that would
effectively inform the investor of any increased costs to it as a
result of the solicitation? What direct or indirect additional costs to
investors that are private fund investors would be included in this
disclosure?
     Would private fund investors indirectly incur any
additional costs as a result of the adviser's use of a solicitor, such
as through the adviser charging the private fund a higher fee than
another private fund it manages without using a solicitor? Why or why
not? If so, should the solicitor disclosure state such additional
amounts, if applicable?
     Do commenters agree with the proposal that either the
solicitor or the adviser could deliver the solicitor disclosure (as
long as the contract designates the responsible party) at the time of
the solicitation or, in the case of a mass communication, as soon as
reasonably practical thereafter? Alternatively, should we continue to
require the solicitor to deliver the disclosure? Why or why not, and if
so, should we require that the adviser deliver a disclosure template to
the solicitor, as a means reasonably designed to ensure that the
solicitor has all of the information required to be disclosed (e.g.,
the solicitor may be unaware of the amount of additional costs to the
investor as a result of solicitation)? Why or why not?
5. Written Agreement
    The proposed rule would require that the investment adviser's
compensation to the solicitor be made pursuant to a written agreement
with the solicitor, as is required under the current rule.\393\ The
written agreement would be required to: (i) Describe with specificity
the solicitation activities of the solicitor and the terms of the
compensation for the solicitation activities; (ii) require that the
solicitor perform its solicitation activities in accordance with
sections 206(1), (2), and (4) of the Act; and (iii) as discussed above,
require and designate the solicitor or the adviser to provide the
investor, at the time of any solicitation activities or, in the case of
a mass communication, as soon as reasonably practicable thereafter,
with a separate disclosure meeting the conditions of the rule.\394\
While these requirements are similar to the requirements of the current
rule, we are proposing to eliminate some of the current written
agreement requirements, i.e., the requirement that the solicitor
deliver the adviser's brochure, and the requirement that the solicitor
undertake to perform its duties consistent with the instructions of the
adviser.\395\ Our proposal would also modify the current requirement
that the written agreement contain an undertaking by the solicitor to
perform his duties under the agreement in a manner consistent with the
provisions of the Act and the rules thereunder, replacing it with the
requirement that the solicitor agree to perform its solicitation
activities in accordance with sections 206(1), (2), and (4) of the Act.
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    \393\ Proposed rule 206(4)-3(a)(1); rule 206(4)-3(a)(iii)(A).
Under our proposal, the written agreement requirement would not
apply with respect to solicitation activities by the adviser's in-
house personnel and certain affiliated persons or for the
solicitation of impersonal investment advice. See infra section
II.B.7.
    \394\ See supra section II.B.4.
    \395\ See rule 206(4)-3(a)(2)(iii)(A)(3) (requiring that the
written agreement ``requires that the solicitor, at the time of any
solicitation activities for which compensation is paid or to be paid
by the investment adviser, provide the client with a current copy of
the investment adviser's written disclosure statement required by
[Sec.  275.204-3] of this chapter (`brochure rule'). . .''); rule
206(4)-3(a)(2)(iii)(A)(2) (requiring that the written agreement
``contains an undertaking by the solicitor to perform his duties
under the agreement in a manner consistent with the instructions of
the investment adviser and the provisions of the Act and the rules
thereunder'').
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    We continue to believe the written agreement requirement is
appropriate for unaffiliated solicitors.\396\ Although an investment
adviser may not be able to exercise control over a third party in the
same manner as it could control its own employee, having the contours
of the solicitation relationship spelled out in the written agreement
between the

adviser and solicitor would establish some degree of control over
aspects of the arrangement. The current rule achieves this by requiring
that the solicitor agree to perform its duties consistent with the
instructions of the adviser.\397\ We believe this requirement could be
difficult or impractical to implement in a number of contexts, however,
such as when advisers enter into solicitation agreements with many
different solicitors or the solicitor is a much larger institution than
the adviser. Instead, under our proposal, the solicitor would be
required to meet the specific requirements of the written agreement,
including the solicitor's agreement to perform its solicitation
activities in a manner consistent with sections 206(1), (2), and (4) of
the Act.
---------------------------------------------------------------------------

    \396\ See supra footnote 393 (referencing the proposed exemption
from the written agreement requirement for certain solicitation
arrangements).
    \397\ Rule 206(4)-3(a)(2)(iii)(A).
---------------------------------------------------------------------------

    Our proposed rule would eliminate the current rule's written
agreement requirement that the solicitor deliver to clients a copy of
the adviser's Form ADV brochure. We are proposing this change because
the current requirement is duplicative of an adviser's delivery
requirement under rule 204-3, the Act's brochure rule. Under the
brochure rule, an adviser must provide its prospective clients with a
current firm brochure before or at the time it enters into an advisory
contract with them.\398\ The same year we adopted the cash solicitation
rule, we adopted for the first time the Form ADV brochure and rule 204-
3.\399\ We stated that the solicitor's delivery of the adviser's
brochure could satisfy the investment adviser's obligation to deliver
it under rule 204-3.\400\ However, to the extent both the adviser and
the solicitor deliver the adviser's brochure, clients may find this
disclosure confusing or overwhelming, and it also could undermine
disclosure effectiveness by taking away the spotlight from the conflict
of interest disclosure.
---------------------------------------------------------------------------

    \398\ Rule 204-3. The rule does not require advisers to deliver
brochures to certain advisory clients receiving only impersonal
investment advice for which the adviser charges less than $500 per
year, or to clients that are RICs or BDCs provided that the advisory
contract with such a company meets the requirements of section 15(c)
of the Investment Company Act.
    \399\ See 1979 Adopting Release, supra footnote 27, at n.14 and
accompanying text.
    \400\ See id. We stated that the solicitor's delivery of the
brochure ``will be useful to clients and will not impose an undue
burden upon solicitors or investment advisers'' and that
``[f]urthermore, delivery of a brochure by the solicitor will, in
most cases, satisfy the investment adviser's obligation to deliver a
brochure to the client under Rule 204-3.'' Id.
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    In addition, since 1979, we have significantly amended the form and
content of the brochure to better correspond to advisers' businesses
and to be more accessible to investors.\401\ Many advisers with
multiple types of advisory services have developed different versions
of their brochures for each type of service. The adviser is in the best
position to ensure that the correct version of the brochure is
delivered to the client.
---------------------------------------------------------------------------

    \401\ See 2010 Form ADV Amendments Release, supra footnote 34,
at section I. In the past, Form ADV Part 2 had required advisers to
respond to a series of multiple-choice and fill-in-the-blank
questions organized in a ``check-the-box'' format, supplemented in
some cases with brief narrative responses. Advisers had the option
of providing information required by Part 2 in an entirely narrative
format, but few had done so. Form ADV Part 2 currently requires the
``brochure,'' which contains 18 narrative disclosure items about the
advisory firm, and the ``brochure supplement,'' which contains
information about certain advisory personnel on whom clients rely
for investment advice.
---------------------------------------------------------------------------

    We believe that our proposed solicitor disclosure and written
agreement requirements would be adaptable to different types of
solicitation arrangements, including refer-a-friend programs and other
solicitation arrangements that may involve smaller amounts of
compensation, to the extent advisers could not take advantage of the
proposed de minimis exemption. Under refer-a-friend arrangements,
current investors may solicit multiple investors for their adviser
through social media or other electronic communications.\402\ The
adviser and solicitor could employ electronic media and communications
to satisfy the rule's written agreement and disclosure requirements
(e.g., by entering into the required written agreement electronically).
Solicitors could also provide the required concise disclosure in a
format appropriate for the nature of the relationship, such as
electronically via pop-ups or other electronic means.
---------------------------------------------------------------------------

    \402\ Refer-a-friend solicitation arrangements can often involve
small amount of compensation, such as the adviser paying $10.00 to a
current client for each client the current client solicits to enter
into an investment advisory relationship with the adviser (some such
solicitation arrangements are contingent upon the solicited client
successfully entering into an investment advisory relationship with
the adviser; others are not). Such compensation can also be, for
example, free or lower-fee investment advisory services for a
defined period of time, investment adviser subscription services,
and gift cards.
---------------------------------------------------------------------------

    We request comment on the proposed written agreement requirement.
     Should the adviser be required to enter into written
agreements with solicitors who are engaged in solicitation activities
(subject to certain exemptions such as for in-house solicitors,
discussed infra section II.B.7)?
     Should the written agreement include more, or fewer,
specific requirements? If so, what requirements should be added and/or
what requirements should be removed, and why?
     Should we retain the current rule's written agreement
requirement that the solicitor undertake to perform its duties
consistent with the instructions of the adviser? Why or why not? Should
the written agreement require that the solicitor perform its
solicitation activities in accordance with sections 206(1), (2), and
(4) of the Act, rather than more generally in accordance with the
provisions of the Act and the rules thereunder? Why or why not? Or, are
there other provisions of the Act and the rules thereunder that we
should add to the solicitor's required undertakings? If so, what are
they, and why?
     Should we require that the agreement include a provision
under which the solicitor agrees to provide relevant books and records
to the Commission or the adviser upon request?
     Should we retain the current rule's written agreement
requirement for solicitors to deliver the adviser's brochure, in light
of the adviser's brochure delivery requirement? Why or why not?
     Are there instances where an adviser would enter into a
written solicitation agreement with an individual rather than the
individual's associated firm or employer? \403\ Should we specify that
in such instances, an adviser must enter into a written agreement with
a firm (as opposed to any individual solicitor at the firm)? Why or why
not?
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    \403\ An individual associated with a registered broker-dealer
who enters into a solicitation agreement in her individual capacity
may, under some circumstances, be an investment adviser or a broker
or dealer within the meaning of section 202(a)(11) of the Act or
section 3(a)(4)(A) or 3(a)(5) of the Exchange Act, respectively, and
may be subject to statutory or regulatory requirements under Federal
law, including the requirement to register as an investment adviser
or as a broker-dealer pursuant to section 15(a) of the Exchange Act,
and/or state law and certain FINRA rules.
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6. Adviser Oversight and Compliance; Elimination of Additional
Provisions
    Our proposal would require that the investment adviser must have a
reasonable basis for believing that the solicitor has complied with the
agreement.\404\ In addition, the proposed rule would eliminate the
current rule's requirement for the adviser to obtain a signed and dated
acknowledgment from the client that the client has received the
solicitor's disclosure.\405\ Our proposal would also eliminate the
current rule's explicit reminders of

advisers' requirements under the Act's special rule for solicitation of
government entity clients and their fiduciary and other legal
obligations, which we believe are covered by other provisions of the
Act and the rules thereunder.
---------------------------------------------------------------------------

    \404\ Proposed rule 206(4)-3(a)(2).
    \405\ See rule 206(4)-3(a)(2)(iii)(B).
---------------------------------------------------------------------------

a. Adviser Oversight and Compliance
    Our proposed requirement that the investment adviser must have a
reasonable basis for believing that the solicitor has complied with the
rule's written agreement would replace the current requirement that
``the investment adviser makes a bona fide effort to ascertain whether
the solicitor has complied with the agreement, and has a reasonable
basis for believing that the solicitor has so complied.'' \406\ We
believe that this provision would protect investors' interests by
requiring advisers to monitor their compensated solicitors for
compliance with the rule's written agreement requirements. The question
of what would constitute a reasonable basis would depend upon the
circumstances. However, we believe that a reasonable basis generally
should involve periodically making inquiries of a sample of investors
referred by the solicitor in order to ascertain whether the solicitor
has made improper representations or has otherwise violated the
agreement with the investment adviser.\407\ For example, depending on
the facts and circumstances, an adviser could satisfy the proposed
rule's compliance requirement by making the inquiries described above
and being copied on any emails the solicitor sends to investors with
the solicitor disclosure.
---------------------------------------------------------------------------

    \406\ Rule 206(4)-3(a)(2)(iii)(C).
    \407\ 1979 Adopting Release, supra footnote 27, at text
accompanying nn.14 and 15.
---------------------------------------------------------------------------

    Under our proposal, the rule's compliance requirement would replace
the current rule's requirement that an adviser obtain a signed and
dated acknowledgment from the client that the client has received the
solicitor's disclosure.\408\ The proposed rule would allow advisers to
tailor their compliance with the solicitation rule as appropriate for
each adviser and the risks and operations in their particular
solicitation relationships. We believe that advisers are better
situated than most solicitors to determine appropriate policies and
procedures to ensure that their solicitors comply with their written
agreement (including, if applicable, the agreement that the solicitor
deliver the solicitor disclosure to investors at the time of
solicitation or as soon as reasonably practical thereafter). Some
advisers may find that written acknowledgements from all solicited
investors are most appropriate, but others may rely on other methods to
satisfy themselves of the solicitor's compliance, such as making
inquiries of investors referred by the solicitor in order to ascertain
whether the solicitor disclosure has been delivered or whether the
solicitor has made improper representations or has otherwise violated
the agreement with the investment adviser.
---------------------------------------------------------------------------

    \408\ See rule 206(4)-3(a)(iii)(B) (the investment adviser must
receive from the client, prior to, or at the time of, entering into
any written or oral investment advisory contract with such client, a
signed and dated acknowledgment of receipt of the investment
adviser's written disclosure statement and the solicitor's written
disclosure document). Under the current rule, certain solicitors
(e.g., in-house solicitors, certain affiliates of the adviser, and
solicitors for impersonal investment advice) are exempt from such
requirement.
---------------------------------------------------------------------------

    Our principles-based proposal relating to compliance is consistent
with the Act's compliance rule, adopted in 2003,\409\ which contains
requirements for advisers to adopt compliance policies and
procedures.\410\ When an adviser utilizes a solicitor as part of its
business, the adviser must have in place compliance policies and
procedures that address this relationship and are reasonably designed
to ensure that the adviser is in compliance with rule 206(4)-3. Our
proposed approach is also similar to recently adopted rules under the
Investment Company Act.\411\
---------------------------------------------------------------------------

    \409\ Rule 206(4)-7. See Compliance Program Adopting Release,
supra footnote 33.
    \410\ Under the compliance rule, each adviser that is registered
or required to be registered under the Act is required to adopt and
implement written policies and procedures reasonably designed to
prevent the adviser and its personnel from violating the Advisers
Act. Id.
    \411\ For example, rule 2a-7 under the Investment Company Act
leverages rule 38a-1, the compliance rule under that statute, rather
than prescribing requirements for how a retail money market fund
determines that its beneficial owners are natural persons. See SEC
Money Market Fund Reform Release, supra footnote 232 at text
accompanying nn.715-716; see also Compliance Rule Adopting Release,
supra footnote 33, at nn.24-28 and accompanying text. The Investment
Company Act compliance rule also requires that the fund's procedures
provide for the oversight of compliance by specified service
providers.
---------------------------------------------------------------------------

b. Elimination of Additional Provisions
    We are also proposing to eliminate the current rule's explicit
reminders of advisers' requirements under the Act's special rule for
solicitation of government entity clients and their fiduciary and other
legal obligations.\412\ We believe these cross references to advisers'
other obligations are not necessary under the solicitation rule because
they are addressed by other provisions under the Act.
---------------------------------------------------------------------------

    \412\ Rule 206(4)-3(c) and (e).
---------------------------------------------------------------------------

    The current rule's paragraph (e) states that ``[s]olicitation
activities involving a government entity, as defined in [the pay-to-
play rule], shall be subject to the additional limitations set forth in
that section.'' \413\ The Commission added this provision when it
adopted the pay-to-play rule in 2010, and explained that the provision
``alerts advisers and others that special prohibitions apply to
solicitation activities involving government entity clients under rule
206(4)-5.'' \414\ We believe that this provision is no longer necessary
in light of the fact that advisers should now be well aware of their
obligations under the pay-to-play rule.
---------------------------------------------------------------------------

    \413\ Rule 206(4)-3(e).
    \414\ See Political Contributions by Certain Investment
Advisers, Release No. IA-3043 (July 1, 2010) [75 FR 41018 (July 14,
2010)], at nn.429 and 430 and accompanying text.
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    We are also proposing to remove the current rule's provision that
``[n]othing in this section relieves any person of any fiduciary or
other legal obligation.'' \415\ When we adopted the solicitation rule,
we included this provision as a reminder to investment advisers and
solicitors.\416\ We noted that it was not intended to suggest the scope
and nature of any obligations an adviser or solicitor might have under
the securities laws or under other laws.\417\
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    \415\ Rule 206(4)-3(c).
    \416\ See 1979 Adopting Release, supra footnote 27, at n.16 and
accompanying text. With respect to the possible relevance of other
laws, the Commission noted that, ``where the solicited client is a
pension plan or other employee benefit plan, payment of a fee to the
solicitor might, depending upon the circumstances, result in a
prohibited transaction under the Employee Retirement Income Security
Act of 1974 (ERISA) and the Internal Revenue Code of 1954 (Code).
The rule being adopted of course provides no relief from ERISA or
the Code.'' Id.
    \417\ Id. (``The rule is not intended to suggest the scope and
nature of any obligations an adviser or solicitor might have under
the securities laws or under other laws. For this reason, and in
response to a comment, the rule as adopted omits the proposed rule's
reference to a solicitor's obligation to recommend an adviser `best
suited' to a client.''). It would continue to be the case that an
adviser that is subject to the solicitation rule would be subject to
any other applicable provisions in the Federal securities laws.
---------------------------------------------------------------------------

    We request comment on our proposed adviser oversight and compliance
provisions. We also request comment on the proposed elimination of the
current rule's provisions that cross-reference other provisions under
the Act.
     Do commenters believe that advisers should be required to
have a reasonable basis for believing that the solicitor has complied
with the written agreement required by the proposed rule? Why or why
not? Should we maintain the current requirement that an adviser make a
bona fide effort to ascertain whether the solicitor is in compliance
with the terms of the

agreement and has a reasonable basis for believing that the solicitor
is in compliance? Why or why not?
     Should the rule include a specific method or methods of
demonstrating a solicitor's compliance with the rule's written
agreement requirements, such as the current rule's requirement for an
adviser to obtain a signed and dated acknowledgment of the solicitor
disclosure statement? Why or why not? If not, what methods should
advisers use to satisfy their compliance and oversight provision to
form a reasonable basis for believing that the solicitor is in
compliance? Would methods such as inquiring with some or all of its
solicited investors reasonably ensure that an adviser's solicitor is in
compliance with the rule's written agreement requirements? Are there
other methods that would be more effective at assessing whether a
solicitor is in compliance with its obligations under the required
written agreement?
     Should the rule include a requirement for advisers to
adopt and implement policies and procedures governing their use of
solicitors, even though advisers are also required to do so under the
Act's separate compliance rule? Why or why not?
     Should the rule continue to include a provision reminding
advisers that solicitation activities involving a government entity, as
defined in rule 206(4)-5 are subject to additional limitations in that
rule? Why or why not?
     Should the rule continue to include a provision reminding
advisers and solicitors that nothing in the rule is to be deemed to
relieve any investment adviser or solicitor of any fiduciary or other
obligation which he may have under any law? Why or why not?
7. Exemptions
a. Impersonal Investment Advice
    The proposed rule would partially exempt from the rule solicitors
that refer investors for the provision of impersonal investment
advice.\418\ This exemption would cover solicitation activities for
investment advisory services that do not purport to meet the objectives
or needs of specific individuals or accounts.\419\ We propose to
incorporate into the rule the Form ADV definition of ``impersonal
investment advice,'' which would replace the current rule's definition
of ``impersonal advisory services,'' to achieve consistency with Form
ADV.\420\ We do not believe, however, that modifying the definition for
consistency would change the types of persons to whom the exemption
would apply. For example, the proposed exemption would generally
continue to apply to solicitations of subscribers to publishers of
market newsletters and subscription services containing investment
advice, when the adviser's services do not purport to meet the
objectives or needs of specific individuals or accounts. The proposed
exemption would be inapplicable to automated advisers (often
colloquially referred to as ``robo-advisers''), which are registered
investment advisers that use technologies to provide discretionary
asset management services to their clients through online algorithmic-
based programs.\421\ This is because robo-advisers generate client
portfolios for clients based on personal information and other data
that clients enter into interactive platforms.\422\ internet advisers--
another type of automated adviser--would also fall outside of the
exemption for impersonal investment advice. Internet advisers provide
investment advice to their clients through interactive websites based
on personal information that clients enter into the website.\423\
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    \418\ Proposed rule 206(4)-3(b)(1).
    \419\ Id. The proposed rule incorporates the Form ADV definition
of ``impersonal investment advice,'' which reads: ``investment
advisory services that do not purport to meet the objectives or
needs of specific individuals or accounts.'' Form ADV: Glossary of
Terms.
    \420\ The Form ADV definition of ``impersonal investment
advice'' would replace the current rule's definition of ``impersonal
advisory services,'' which is ``investment advisory services
provided solely by means of (i) written materials or oral statements
which do not purport to meet the objectives or needs of the specific
client, (ii) statistical information containing no expressions of
opinions as to the investment merits of particular securities, or
(iii) any combination of the foregoing services.'' Rule 206(4)-
(3)(d)(3).
    \421\ See generally Division of Investment Management, SEC,
Staff Guidance on Robo-Advisers (February 2017), available at
https://www.sec.gov/investment/im-guidance-2017-02.pdf.
    \422\ See id. (``A client that wishes to utilize a robo-adviser
enters personal information and other data into an interactive,
digital platform (e.g., a website and/or mobile application). Based
on such information, the robo-adviser generates a portfolio for the
client and subsequently manages the client's account.'')
    \423\ See Exemption for Certain Investment Advisers Operating
Through the internet, Release No. IA-2091 (December 12, 2002) [67 FR
77619 (Dec. 18, 2002)]. In order to be eligible for registration
with the Commission pursuant to rule 203A-2, an internet adviser
must provide investment advice to its clients through an interactive
website, which the rule defines as ``a website in which computer
software-based models or applications provide investment advice to
clients based on personal information each client supplies through
the website.'' Id. Unlike typical robo-advisers, internet advisers
do not manage the assets of their internet clients. See id.
---------------------------------------------------------------------------

    When we adopted the cash solicitation rule, we added a partial
exemption from the rule with respect to solicitation activities for the
provision of impersonal advisory services only, because we understood
that ``prospective clients normally would be aware that a person
selling such services was a salesman who was paid to do so.'' \424\ We
continue to hold this belief. However, even though we are proposing to
continue the partial exemption for such solicitors, advisers could not,
under the proposed rule, compensate a solicitor for the solicitation of
impersonal investment advice if the solicitor is disqualified under the
rule.
---------------------------------------------------------------------------

    \424\ See 1979 Adopting Release, supra footnote 27, at text
accompanying nn.12-13.
---------------------------------------------------------------------------

    Under the current rule, advisers making cash payments for
solicitation for impersonal advisory services must have a written
agreement with the solicitor and comply with the rule's
disqualification provision.\425\ However, they are exempt from the
rule's disclosure requirements, the specific requirements of the
written agreement, and the supervision provisions.\426\ The proposed
rule would maintain the current rule's partial exemption for
compensated solicitors of impersonal investment advice, with one
modification: Such solicitors would not be required to enter into a
written agreement with the investment adviser.\427\ We believe that
applying the written agreement provision to such solicitors could
result in an expense without a sufficient corresponding benefit. This
is because the exemption would exempt the solicitor and the adviser
from the substantive requirements of the written agreement, and the
agreement itself without the requirements would not add any meaningful
investor protections.
---------------------------------------------------------------------------

    \425\ Rule 206(4)-3(a)(2)(i) and (iii).
    \426\ Id.
    \427\ Proposed rule 206(4)-3(b)(1). Under the current rule, an
adviser and a solicitor of impersonal investment advice are required
to enter into a written agreement, although the rule does not
specify any required provisions.
---------------------------------------------------------------------------

    The partial exemption would continue to be available only to
solicitation that is solely for impersonal investment advice.\428\ A
registered investment adviser that offers a full line of advisory
services, including personal and impersonal investment advice, may only
rely on the partial exemption when the solicitation activities relate
exclusively to the investment adviser's impersonal investment advice.
It would not be permitted to rely on the partial exemption under the
proposed rule when an investor is solicited for both impersonal and
personal investment

advice, even if that investor receives only impersonal investment
advice.
---------------------------------------------------------------------------

    \428\ Id.
---------------------------------------------------------------------------

    We request comment on our proposal to revise the rule's partial
exemption for solicitors for the provision of impersonal investment
advice.
     Should solicitors of investors for the provision of
impersonal investment advice be subject to any or all of the
requirements of the rule? If so, which requirements, and why? For
example, should we continue to require that these solicitors enter into
written agreements with the advisers? As another example, should we
exempt these solicitors from the solicitor disqualification provisions?
Why or why not?
     Should the rule include additional requirements
specifically for such solicitors? If so, what should these requirements
be?
     Should we replace the current definition of ``impersonal
advisory services'' with the Form ADV definition of ``impersonal
investment advice,'' as proposed? Would this definitional change have
any practical effects in terms of the applicability of proposed rule
206(4)-3? If so, what would they be?
     Can commenters provide examples of investment advisory
services that are offered today that would be ``impersonal investment
advice'' (i.e., the activities do not purport to meet the objectives or
needs of specific individuals or accounts), other than, or in addition
to, market newsletters or other periodicals and recommended lists? Do
advisers that offer such impersonal investment advice typically provide
it directly to investors? Do they typically provide it in addition to
personalized investment advice? If so, do they provide impersonal
investment advice as an add-on service to investors to whom they
provide personalized investment advice, or do they provide it to a
different set of investors, or do some (but not all) investors receive
both types of investment advice?
     Do commenters agree that robo-advisers and internet
advisers should not be eligible for the exemption for impersonal
investment advice, because they typically provide personalized
investment advice?
b. Advisers' In-House Solicitors and Other Affiliated Solicitors
    The current rule provides a partial exemption for an adviser's
solicitation relationship with any person that is an adviser's partner,
officer, director and employee (sometimes referred to as in-house
solicitors), and any partner, officer, director, or employee of a
person which controls, is controlled by, or is under common control
with the adviser (sometimes referred to as affiliated solicitors),
provided that the affiliation is disclosed to the client at the time of
the solicitation or referral.\429\ Under the current rule, an adviser
is exempt from the following requirements with respect to such
solicitors: (i) The detailed provisions of the written agreement
requirement (e.g., to provide the solicitor disclosure and perform
solicitation activities in accordance with the adviser's instructions
and the Act), and (ii) the rule's other compliance and oversight
provisions (e.g., the client acknowledgement requirement and the
adviser's supervisory requirement).\430\ However, under the current
rule, an adviser is subject to the following requirements with respect
to such solicitors: (i) The rule's statutory disqualification
provision; and (ii) the rule's requirement to enter into a written
agreement with the adviser (although not the written agreement's
detailed requirements).\431\ Under the current rule, in order to rely
on the partial exemption, any affiliation between the investment
adviser and such other person must be disclosed to the client at the
time of the solicitation or referral.\432\
---------------------------------------------------------------------------

    \429\ Rule 206(4)-3(a)(2)(ii).
    \430\ See id.; Rule 206(4)-3(a)(2)(iii). Our proposed rule would
cover ``[a] solicitor [that] is a person which controls, is
controlled by, or is under common control with the investment
adviser, or is a partner, officer, director or employee of such a
person . . .'' subject to the provisions therein. Proposed rule
206(4)-3(b)(2). The current rule's exemption only covers solicitors
who are principals or employees of certain related firms, but our
staff has previously stated it would not recommend enforcement if, a
solicitor which is a person (rather than an officer, director or
employee of such person) which controls, is controlled by, or is
under common control with, the investment adviser that is paying a
cash referral fee to the solicitor pursuant to the cash solicitation
rule comes within, and is subject to, the terms of clause (ii) of
paragraph (a)(2) of such rule. See, e.g., Allen Isaacson, SEC Staff
No-Action Letter (pub. avail. Dec. 17, 1979); Stein, Roe and Farnham
Inc., SEC Staff No-Action Letter (pub. avail. May 26, 1987).
    \431\ Id. The current rule requires solicitation payments to in-
house and affiliated solicitors to be paid pursuant to a written
agreement (although the rule does not specify the terms of that
agreement).
    \432\ Rule 206(4)-3(a)(2)(ii).
---------------------------------------------------------------------------

    We propose to generally maintain the central elements of the
current rule's partial exemption for affiliated solicitors: That the
solicitor disclosure, adviser oversight and the detailed provisions of
the written agreement are not required with respect to affiliated
solicitors under certain conditions. We would generally continue the
partial exemption, with some modifications, provided that the status of
such solicitor as in-house or affiliated is disclosed to the investor
at the time of the solicitation unless such relationship is readily
apparent, and the adviser documents such solicitor's status at the time
of entering into the solicitation arrangement.\433\
---------------------------------------------------------------------------

    \433\ Proposed rule 206(4)-3(b)(2).
---------------------------------------------------------------------------

    We believe that when an investor is aware that a solicitor is an
adviser's in-house solicitor or its affiliate, the solicitor disclosure
is not necessary to inform the investor of the solicitor's bias in
recommending such adviser. In these instances with respect to in-house
solicitors, an investor is on notice that the solicitor has a stake in
soliciting the investor for its own firm. Similarly, investors
solicited by persons they know to be affiliated with the adviser would
also be likely to be aware that the solicitor has a business interest
in seeing its affiliate gain additional investors, and that the
recommendation is not coming from a neutral party. We are proposing to
modify the current rule's requirement, however, to permit an adviser to
rely on the rule's partial exemption for in-house and affiliated
solicitors not only when the status of such solicitor as in-house or an
affiliate is disclosed to the investor at the time of the solicitation
or referral, but also when such relationship is readily apparent to the
investor at the time of solicitation. In some cases, the relationship
between the in-house or affiliated solicitor and the adviser may be
readily apparent to the investor, such as when the in-house solicitor
shares the same name as the advisory firm, or clearly identifies itself
as related to the adviser in its communications with the investor. For
example, in the latter case, even if the solicitor does not share the
same name as the adviser, its affiliation would be readily apparent if
a business card distributed to investors at the time of the
solicitation clearly and prominently states that the solicitor is a
representative of the adviser. In these cases, we believe that an
additional requirement under the proposed rule to disclose the
solicitor's status as an in-house or affiliated solicitor would not
result in a benefit to the investor, and would create additional
compliance burdens for the adviser and solicitor.
    In other situations, the relationship with an in-house solicitor is
not readily apparent, such as when the solicitor is a representative of
the adviser but operates its solicitation activities through its own
DBA name or brand, and the legal name of the adviser is omitted or less
prominent.\434\ In these cases when the relationship is not readily
apparent the adviser or solicitor

would be required under the proposed rule to disclose the solicitor's
status with respect to such investment adviser as its in-house
solicitor or affiliated solicitor in order to avail itself of the
rule's partial exemption. Similarly, for affiliated solicitors, when
the affiliation is not disclosed or otherwise readily apparent to the
investor, the adviser would not be permitted to rely on the proposed
partial exemption. This could be the case, for example, when the
soliciting affiliate does not share a company name with the adviser,
and neither the adviser nor the solicitor discloses such affiliation at
the time of solicitation. It could also be the case when the
affiliation between two different company names is not commonly known,
and neither the adviser nor the solicitor discloses such affiliation at
the time of solicitation.
---------------------------------------------------------------------------

    \434\ Such solicitors could be employees, but are likely to more
often be independent contractors. We request comment below on
whether the rule should specifically address independent
contractors.
---------------------------------------------------------------------------

    Another modification we are proposing to the current rule is to
expand the partial exemption to cover any solicitor which is a person
which controls, is controlled by, or is under common control with, the
investment adviser that is compensating the solicitor pursuant to the
solicitation rule.\435\ This is because we believe that a person that
controls, is controlled by, or is under common control with, the
investment adviser, should be treated similarly under the proposed rule
to any officers, directors or employees of such affiliated person. We
are not proposing to continue the current rule's requirement that
advisers and their in-house and affiliated solicitors enter into a
written agreement.\436\ Unlike the current rule's detailed requirements
for the written agreement with unaffiliated solicitors (i.e., that the
solicitor perform its activities in a manner consistent with the
adviser's instructions and the provisions of the Act and the rules
thereunder), the current rule does not specify what a written agreement
between an adviser and in-house solicitor must include.\437\ We
continue to believe that the detailed provisions of the written
agreement are not necessary for in-house solicitors because this kind
of oversight and authority over the solicitor already applies in the
context of in-house solicitors and is addressed by the adviser's power
to oversee its own personnel. Likewise, we do not believe we should
continue to require advisers to enter into written agreements with
their own affiliates in order to avail themselves of the proposed
rule's partial exemption. Advisers and their affiliated solicitors may
wish to enter into agreements, or they may find it more convenient and
effective to delineate their responsibilities to one another in other
ways. Such methods might include, for example, policies and procedures
regarding such affiliated personnel. We are also proposing that the
rule no longer require any written agreement between an adviser and its
in-house personnel under the solicitation rule because we believe this
requirement creates additional compliance obligations for the adviser
and its in-house and affiliated solicitor that are not justified by any
corresponding benefit.
---------------------------------------------------------------------------

    \435\ See supra footnote 430 (describing the specific proposed
change in the rule text).
    \436\ Under the current rule, advisers and their in-house and
affiliated solicitors are required to enter into written agreements,
but they are not required to comply with the current rule's detailed
requirements for the written agreements. From time to time, advisers
have asked whether they can forego the written agreement requirement
for employees of the adviser to refer business to the adviser for
cash compensation. See, e.g., Merchants Capital Management,
Incorporated, SEC Staff No-Action Letter (Oct. 4, 1991) (stating
that the staff cannot assure the requestor that it would not
recommend any enforcement action to the Commission under rule
206(4)-3 if the requestor proceeds as described in the letter).
    \437\ See supra footnotes 393-395 and accompanying text
regarding the written agreement requirement under the proposed rule.
---------------------------------------------------------------------------

    We are proposing to continue to apply, with respect to in-house and
affiliated solicitors, the exemption from the rule's separate
compliance requirement, which would require that investment adviser
have a reasonable basis for believing that the solicitor has complied
with the agreement. As with the written agreement requirement, we
believe that this kind of oversight over the solicitor already applies
in the context of in-house solicitors, and is addressed by the
adviser's power to oversee and supervise its own personnel. We also
believe advisers and their affiliates are well positioned to determine
how best to achieve an affiliated solicitor's compliance with the Act,
and do not need the protections of the rule's compliance and oversight
provision.
    Finally, we are proposing to continue the application of the rule's
disqualification provisions to in-house and affiliated solicitors. Some
in-house solicitors with disciplinary events under the proposed rule
would be disqualified from association with an investment adviser
independent of the solicitation rule, if the Commission has barred or
suspended that person from association with an investment adviser under
section 203(f) of the Act. Other in-house or affiliated solicitors with
such disciplinary events may not be subject to such Commission action
and, absent the application of the rule's disqualification provision,
would be permitted to solicit for the adviser in-house, notwithstanding
their disqualifying event. Without the disqualification provision
applicable to such solicitors, the adviser would risk that the
Commission may bar or suspend that person from association with an
investment adviser after the solicitation activities have commenced. We
continue to believe that investors should be protected from
solicitation by persons with certain disciplinary events, regardless of
whether the solicitation is conducted in-house, by an affiliate or by a
person unaffiliated with the adviser.
    We are proposing a new requirement that in order to avail itself of
the proposed partial exemption, each adviser must document such
person's status as an in-house or affiliated solicitor
contemporaneously with the solicitation arrangement.\438\ We are
proposing to add this requirement to the rule so that advisers do not
make after-the-fact determinations as to whether or not a solicitor
qualifies for the partial exemption.
---------------------------------------------------------------------------

    \438\ Proposed rule 206(4)-3(b)(2)(ii).
---------------------------------------------------------------------------

    We request comment on our proposal to revise the rule's
requirements governing solicitation arrangements by in-house and
affiliated solicitors.
     Should the proposed rule partially exempt the adviser's
partners, officers, directors, and employees who are engaged in
solicitation activities, or any solicitor that controls, is controlled
by or that is under common control with the adviser or is a partner,
officer, director, or employee of such person, from certain of the
provisions of the solicitation rule? Why or why not? If so, which
provisions of the rule should we exempt such solicitors from, and why?
For example, should the proposed rule continue to exempt advisers and
their in-house and affiliated solicitors from the detailed requirements
of the written agreement (but not the requirement to enter into a
written agreement) and the rule's oversight and compliance
requirements? Alternatively, should we fully exempt such solicitations
from the rule (including, for example, the rule's disqualification
provisions)? Why or why not?
     Should the proposed rule exempt in-house and affiliated
solicitors from the rule's solicitor disqualification provision, as
discussed in detail below? \439\ Without the application of the
disciplinary provision, would investors be made aware in all cases of
an in-house or affiliated solicitor's

disqualifying events? \440\ If we were to exempt affiliated solicitors
from the rule's disqualification provision, should we nevertheless
require some affiliated solicitors (such as affiliated solicitors that
solicit investors in private funds) to be subject to the rule's
disqualification provision (because private fund investors may not
otherwise be aware of in-house solicitors' disciplinary events since
advisers are not required to deliver Form ADV to them)? Do in-house and
affiliated solicitors with disciplinary histories present less risk of
misleading investors or otherwise conducting solicitations in a
fraudulent manner than solicitors without disciplinary histories?
---------------------------------------------------------------------------

    \439\ See infra section II.B.7.c.
    \440\ An adviser is required to disclose to clients in its Form
ADV brochure disciplinary information about the firm and its
management persons, which likely do not include a solicitor that
controls, is controlled by or that is under common control with the
adviser or is a partner, officer, director, or employee of such
person. See Form ADV Part 2A, Item 9 and Form ADV General
Instructions. Some advisers are also required to deliver to clients
brochure supplements containing disciplinary information about
certain of their supervised persons. See Form ADV Part 2B. However,
solicitors likely would not be considered to be providing advice
that would trigger delivery at the time of solicitation. An adviser
to a private fund, however, is not required to deliver the Form ADV
brochure or brochure supplement to investors in the fund.
---------------------------------------------------------------------------

     Do commenters agree with the types of persons that would
be covered by the partial exemption (i.e., the adviser's partners,
officers, directors, and employees, and any solicitor that controls, is
controlled by or that is under common control with the adviser or is a
partner, officer, director, or employee of such person)? If not, how
should we adjust the rule's description of affiliated solicitors?
     Should the proposed rule's partial exemption for in-house
and affiliated solicitors be conditioned on any factors or requirements
(e.g., as proposed, that the relationship is disclosed to the investor
at the time of solicitation or is readily apparent to the investor at
the time of solicitation)? What other conditions or factors, if any,
should apply?
     Would advisers and solicitors have difficulty in
interpreting or applying the ``readily apparent'' standard? Should we
instead require in house solicitors to disclose to investors, as
applicable, their relationship at the time of the solicitation or as
soon as reasonably practicable thereafter in all cases?
     Do commenters agree that the proposed rule should apply
the written agreement and compliance requirements to every in-house and
affiliated solicitor relationship, where the conditions of the proposed
rule are not met? If so, why? If not, which of these in-house and
affiliated solicitor relationships should be exempt from the proposed
rule's written agreement and compliance requirements, and why?
     Should advisers' relationships with certain affiliated
solicitors be subject to different provisions under the proposed rule
from its solicitation relationships with other affiliated solicitors?
For example, should an adviser, with respect to an affiliated solicitor
that is itself a Commission-registered investment adviser, be exempt
from some or all of the rule's provisions for such solicitor?
Conversely, for advisers that do not use SEC-registered affiliated
solicitors, should we require an oversight provision, such as, for
example, that the registered adviser take reasonable steps to ensure
that its affiliated solicitor complies with provisions of the Act and
the rules thereunder with respect to its solicitation activities? Is
appropriate oversight otherwise achieved by an adviser's relationship
with its affiliate?
     If the rule, as proposed, does not require in-house and
affiliated solicitors that meet the rule's conditions to deliver to
investors the solicitor disclosure, should we require in-house or
affiliated solicitors (or the adviser) to deliver to investors another
form of disclosure? For example, should we require a Form ADV brochure
supplement for in-house and affiliated solicitors, even if the firm is
not otherwise required to deliver one for such person? If so, why, and
what additional information, if any, should we require the brochure
supplement to include? Should we require the adviser to give investors,
at the time of solicitation or as soon as reasonably practicable
thereafter, its Form ADV disclosure, pursuant to which advisers are
required to disclose any compensation to in-house and affiliated
solicitors and any fee differential and the conflict of interest? If
so, what disclosure should we require advisers to provide to investors
(given that the relevant Form ADV provision does not require specific
information about compensation by advisers to private funds)?
     Should we include a definition of ``employee'' for the
purpose of the proposed partial exemption? If so, how should we define
the term? Should we define it to include an adviser's independent
contractors that are subject to the adviser's supervision and control?
Why or why not? We believe that the Form ADV definition of ``employee''
would not work for the solicitation rule because many soliciting
employees and independent contractors do not provide investment
advisory services.\441\ Do commenters agree? Do advisers use
independent contractors to solicit investors on their behalf? If so,
are those independent contractors subject to the adviser's supervision
and control, or are those contractors subject to the supervision and
control of another regulated entity such as a registered broker-dealer
or a commercial bank? Should we provide that the partial exemption for
in-house personnel does or does not apply to an adviser's independent
contractors? Why or why not? Should we use another term instead of
``employee,'' such as ``supervised person''?
---------------------------------------------------------------------------

    \441\ C.f. Form ADV Glossary (defining ``employee,'' to include
an adviser's independent contractors who perform advisory functions
on the adviser's behalf).
---------------------------------------------------------------------------

     Do commenters agree with the proposed requirement for an
adviser to document the status of its solicitors as partners, officers,
directors, or employees, or affiliated solicitors, as applicable? Do
commenters agree that such documentation should be made at the time the
adviser enters into the solicitation arrangement, to ensure that
advisers do not make a determination as to the solicitor's status
after-the-fact? Will such timing be feasible for advisers? Why or why
not? Do commenters recommend another point in time, and if so, when,
and why?
     Do commenters agree that in-house solicitors should be
subject to the proposed rule's disqualification provisions? Why or why
not?
c. De Minimis Compensation
    The proposed rule contains an exemption for de minimis
compensation. Specifically, the rule would not apply if the solicitor
has performed solicitation activities for the investment adviser during
the preceding twelve months and the investment adviser's compensation
payable to the solicitor for those solicitation activities is $100 or
less (or the equivalent value in non-cash compensation).\442\ An
adviser must come into compliance with the solicitation rule if it
makes any compensation to a solicitor that, together with all
compensation provided to that solicitor in the preceding 12 month
period, exceeds the de minimis amount. Accordingly, if an adviser
expects to make payments to a solicitor in excess of the de minimis
amount, even though it has not yet done so, an adviser may wish to
carefully consider whether it wishes to avail itself of the exemption.
Although, as discussed above, we believe heightened safeguards would
generally be

appropriate for an investor solicitation because a solicitor's
incentives to defraud an investor likely would be greater than a
promoter's, the solicitor's incentives are significantly reduced when
receiving de minimis compensation. We believe the need for heightened
safeguards is likewise reduced.
---------------------------------------------------------------------------

    \442\ See proposed rule 206(4)-3(b)(3).
---------------------------------------------------------------------------

    There is no de minimis exemption in current rule 206(4)-3; payment
of de minimis cash referral fees to a solicitor is subject to the
provisions of the current rule. We are proposing a de minimis exemption
because we believe it could be overly burdensome for advisers and
solicitors that engage in solicitation for de minimis compensation to
comply with the rule, in light of the benefits. We have observed that
changes in technology, such as the advent of social media, since the
current rule was adopted have resulted in an increasing trend toward
the use of solicitation and referral programs that involve de minimis
compensation, such as refer-a-friend programs. Our proposed solicitor
disclosure and written agreement requirements are designed to be
adaptable to a variety of solicitation arrangements, including refer-a-
friend programs and other solicitation arrangements that may involve
small amounts of compensation; however, we acknowledge that the
proposed solicitor disqualification provisions might present greater
compliance challenges for advisers that compensate multiple solicitors
for de minimis compensation than for other advisers. These advisers may
be smaller advisers without the resources to make the necessary inquiry
into each person's disciplinary history, as required by the proposed
rule.\443\ Accordingly, we believe a de minimis exemption is now
appropriate to ease the burden for these solicitation arrangements.
Moreover, to the extent a solicitation is also a testimonial or
endorsement of the proposed advertising rule, one of the primary policy
goals of the proposed solicitation rule--disclosure of the compensation
to the solicitor--would be satisfied by applying the testimonials and
endorsements provision of the proposed advertising rule.
---------------------------------------------------------------------------

    \443\ See infra section II.B.8 (discussing current and proposed
solicitor disqualification provisions).
---------------------------------------------------------------------------

    Drawing from other rules applicable to certain dual registrants and
broker-dealers, we chose a $100 threshold (or the equivalent value in
non-cash compensation) payable to the solicitor for its solicitation
activities for the investment adviser during the preceding twelve
months.\444\ We believe that proposing an aggregate de minimis amount
over a trailing year period is more consistent with our goal of
providing an exception for small or nominal payments than an exception
of a certain amount per referral. A very engaged solicitor who is paid
even a small amount per referral could potentially receive a
significant amount of compensation from an adviser over time, and in
such a case we believe that investors should be informed of the
conflict of interest and gain the benefit of the other provisions of
the rule. The proposed advertising rule's requirements for testimonials
and endorsements would often apply even when an adviser provides de
minimis compensation to a person for solicitation activity.\445\
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    \444\ FINRA's ``gifts rule'' prohibits any member or person
associated with a member, directly or indirectly, from giving
anything of value in excess of $100 per year to any person where
such payment is in relation to the business of the recipient's
employer. FINRA Rule 3220 (Influencing or Rewarding Employees of
Others) (``FINRA's Gifts Rule''). FINRA's Gifts Rule also requires
members to keep separate records regarding gifts and gratuities. Id.
    \445\ See supra section II.A.4.
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    We request comment on our proposed treatment of de minimis
compensation under the solicitation rule.
     Is our belief correct that the fact of compensation would
still be disclosed when a solicitor receives $100 or less because such
referrals would often be testimonials or endorsements? Are there
situations that might qualify for the proposed exemption that would not
be subject to the proposed testimonials and endorsements provision of
the proposed advertising rule? For example, because an oral statement
by a person would not be an advertisement under the rule, would
investors who are solicited through oral conversations not be informed
of the payment made by the adviser for the referral? Should a de
minimis exception be available only to the extent the referral is
subject to the proposed advertising rule's provisions regarding
testimonials and endorsements (notably, disclosure of the fact of
compensation)? Should we require the fact of compensation to be
disclosed by an adviser availing itself of the de minimis exception?
     Should the proposed rule include an exemption for de
minimis compensation for solicitation? If so, what should the de
minimis amount be, and how should it be calculated (e.g., per referral,
or per aggregated referrals over a certain time period)? Should it be
higher or lower than $100? For example should it be $20, $50, $200, or
$500? How should a de minimis exemption be applied to non-cash
compensation?
     Should some of the rule's provisions continue to apply to
a solicitation arrangement that qualifies for the de minimis exemption?
If so, which ones?
     When a promotional communication triggers the application
of both the proposed advertising and solicitation rules, as discussed
above,\446\ should a de minimis exemption apply? For example, if an
adviser provides $50 per successful referral to its investors for
writing a positive review about the adviser on the adviser's social
media page, should the advertising rule, but not the solicitation rule,
apply? Would an exemption in such a case meaningfully reduce an
adviser's compliance burden? Would it reduce a solicitor's burden?
Would potential investor harm weigh in favor of applying the additional
safeguards under the proposed solicitation rule? What kinds of investor
harm would that be?
---------------------------------------------------------------------------

    \446\ See supra text accompanying footnotes 351-353.
---------------------------------------------------------------------------

     Basing the exemption on a specified dollar value means
that over time inflation may cause such a value to become outdated or
lose its utility. Should we consider a more principles-based de minimis
exception rather than one based on a dollar value? For example, an
exemption could alternatively or additionally be made for promotional
items of nominal value and commemorative items,\447\ or for an
occasional meal, a ticket to a sporting event or the theater or
comparable entertainment which is neither so frequent nor so extensive
as to raise any question of propriety.\448\ Should we

incorporate such an exemption? If so, should we provide guidance on
when such items raise a question of propriety? If so, should we include
a recordkeeping requirement in the rule to highlight that advisers must
track their use of de minimis compensation?
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    \447\ See Notice to Members, Guidance: Gifts and Gratuities:
NASD Issues Additional Guidance on Rule 3060 (Influencing or
Rewarding Employees of Others), December 2006, available at http://www.finra.org/sites/default/files/NoticeDocument/p018024.pdf
(providing staff guidance that gifts of de minimis value (e.g.,
pens, notepads or modest desk ornaments) or promotional items of
nominal value that display the firm's logo (e.g., umbrellas, tote
bags or shirts) would not be subject to the restrictions of the
Gifts Rule or its recordkeeping requirements). In 2008, the
Commission approved the transfer of NASD Rule 3060 into the
Consolidated FINRA Rulebook without material change and renumbered
the rule as FINRA Rule 3220 (i.e., FINRA's Gifts Rule). FINRA staff
did not specify in its 2006 staff guidance at what value it would
consider a gift to be of de minimis value. Id. See FINRA's Gifts
Rule, which also requires members to keep separate records regarding
gifts and gratuities.
    \448\ See letter from R. Clark Hooper, Executive Vice President,
NASD, to Henry H. Hopkins, Director, and Sarah McCafferty, Vice
President, T. Rowe Price Investment Services, Inc., dated June 10,
1999 (NASD staff interpretive letter taking this approach).
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d. Nonprofit Programs
    Under our proposed rule, certain types of nonprofit programs would
be exempt from the substantive requirements of the rule because we
believe the potential for the solicitor to demonstrate bias towards one
adviser or another is sufficiently minimal to make the protections of
the rule unnecessary. Specifically, the rule would not apply to an
adviser's participation in a program,
    (i) when the adviser has a reasonable basis for believing that
    (A) the solicitor is a nonprofit program,
    (B) participating advisers compensate the solicitor only for the
costs reasonably incurred in operating the program; and
    (C) the solicitor provides clients a list of at least two advisers
the inclusion of which is based on non-qualitative criteria such as,
but not limited to, type of advisory services provided, geographic
proximity, and lack of disciplinary history; and
    (ii) the solicitor or the investment adviser prominently discloses
to the client at the time of any solicitation activities:
    (A) The criteria for inclusion on the list of investment advisers,
and
    (B) that investment advisers reimburse the solicitor for the costs
reasonably incurred in operating the program.\449\
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    \449\ Proposed rule 206(4)-3(b)(4). Some solicitors have, from
time to time, requested no action relief from the cash solicitation
rule from the Commission staff for referral programs with some, or
all, of these features. See National Football League Players
Association, SEC Staff No-Action Letter (Jan. 25, 2002) (``NFLPA
Letter''); Excellence in Advertising, Limited, SEC Staff No-Action
Letter (Nov. 13, 1986; pub. avail. Dec. 15, 1985) (``EIA Letter'');
International Association for Financial Planning, SEC Staff No-
Action Letter (Jun. 1, 1998) (``IAFP Letter''). As discussed in
section II.D., staff in the Division of Investment Management is
reviewing staff no-action and interpretative letters to determine
whether any such letters should be withdrawn in connection with any
adoption of this proposal.
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    The first and second elements of the proposed exemption, taken
together, are intended to mitigate the conflict of interest associated
with the nonprofit solicitor's receipt of compensation. We believe that
the absence of compensation that is related to the program's generation
of referrals lessens the need for the protections of the rule. This is
because a solicitor would be unlikely to demonstrate bias in referring
one adviser over another when neither adviser compensates the solicitor
based on the number of referrals made or any other indicator of the
potential to earn the adviser profit. The third element of the proposed
exemption (requiring the solicitor to provide a list of at least two
advisers based on non-qualitative criteria) is intended to mitigate the
risk that clients would view the nonprofit program as referring any one
adviser. Requiring that the list be based on non-qualitative criteria
would also reduce the likelihood of the solicitor appearing to favor or
endorse the advisers in the program over other advisers that are not in
its program, or any particular advisers in the program over other
advisers in the program. Examples of non-qualitative criteria are the
type of advisory services provided, geographic proximity, and lack of
disciplinary history. Another example that would likely be a non-
qualitative criterion is the presence of certain certifications for the
firm or its personnel. If the list were to be sorted based on a
qualitative assessment, such as adhering to a particular investment
philosophy, that would not fall within the scope of the proposed
exemption. Once the solicitor has selected a pool of advisers based on
non-qualitative criteria, the program could permit a client to then
screen for specific types of advisers within the pool based on the
client's own selection criteria. Similar to other proposed solicitation
rule requirements, we are proposing to require that, in order to rely
on the nonprofit exemption, the adviser must have a reasonable belief
that the program meets these requirements.
    Finally, we are proposing to require, as a condition of the
nonprofit exemption, disclosures to be made by the solicitor to the
client at the time of any solicitation activities: The criteria for
inclusion on the list of investment advisers, and that investment
advisers reimburse the solicitor for the costs reasonably incurred in
operating the program. We believe that these disclosures would inform
clients of the basis for advisers' participation in the program.
Depending on the context and content of the required disclosures,
however, there could be circumstances where a solicitor's disclosures
do not effectively convey to clients the scope and limitations of the
program with respect to the selection of advisers in the program. For
example, if it is not clear from the disclosures that the program does
not assess the quality of any adviser or its appropriateness for any
client, and that that the program does not present a client with all of
the investment advisers that may be available to the client, an adviser
should consider making such disclosures or requiring them of the
solicitor.
    We request comment on this aspect of the proposal.
     Should we provide the proposed nonprofit exemption? Should
we define what types of programs qualify as ``nonprofit,'' perhaps
through reference to IRS guidance? If so what entities should we
include and why? Would such a list become outdated? Should there be any
limit on the kind of compensation paid to the solicitor to ensure that
the nonprofit status of the program does not serve merely as a conduit
for circumventing the solicitation rule?
     Should some of the rule's provisions apply to a
solicitation arrangement that qualifies for the proposed nonprofit
exemption? If so, which ones?
     Should we limit the use of the fees paid to covering
``costs reasonably incurred in operating the program,'' as proposed? If
not, what other types of costs should we permit, any why? How would an
adviser seeking to rely on the exemption demonstrate that the fees paid
to the solicitor only cover such costs? Should we include a
recordkeeping requirement that the adviser maintain records of the fees
paid to the solicitor, as we do in our proposed corresponding
amendments to the books and records rule?
     Should we provide further guidance on what we mean by
``non-qualitative'' criteria? For example, should we provide a list of
such criteria that a person could use in accepting advisers for the
nonprofit program and/or sorting the list? What should that list
include?
     Should we require the adviser or the solicitor to disclose
to the client, at the time of any solicitation activities or as soon as
reasonably practicable thereafter, the criteria for inclusion on the
list of investment advisers, and that the advisers reimburse the
program for the costs reasonably incurred in operating the program? Why
or why not? Should we require disclosure of the amount of
reimbursement? Should we also require that the program state that it
does not assess or opine on the quality of any adviser or its
appropriateness for any client, and/or that the program does not
include all investment advisers that may be available to clients? Why
or why not?
     As proposed, should we require that a list that includes
more than a single adviser be provided clients to qualify for the
exemption? Should a solicitor be allowed to provide the name

of only a single adviser if such an adviser is the only participating
adviser that meets the non-qualitative criteria established?
     Our staff has previously stated that it would not
recommend enforcement action against certain persons that operate
programs similar to what we are proposing today under the non-profit
exemption.\450\ Would such existing programs be able to meet the
proposed exemption? If not, should we consider making any other changes
to the proposed exemption to allow existing similar programs to
continue to operate? What changes and why?
---------------------------------------------------------------------------

    \450\ See, e.g., NFLPA Letter; EIA Letter; IAFP Letter, id.
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8. Disqualification for Persons Who Have Engaged in Misconduct
    We are proposing to revise the current rule's disqualification
provision, which prohibits persons who have engaged in certain
misconduct from acting as solicitors.\451\ The current rule generally
disqualifies a person from acting as a solicitor if: (i) The person is
subject to a Commission order issued under section 203(f) of the Act
(i.e., the Commission has barred or suspended that person from
association with an investment adviser, or has censured or placed
limitations on the activities of a person associated with an investment
adviser, under section 203(f) of the Advisers Act); \452\ or (ii) the
Commission or a court has found that person to have engaged in
enumerated misconduct that could subject them to sanctions under
section 203(f), or that could subject the firm with which they are
associated to disciplinary action by the Commission under section
203(e) of the Act.\453\ These provisions reflect the Commission's
concern that persons with a history of misconduct that might affect
their prospects for direct employment with an adviser not seek to avoid
our scrutiny by working as solicitors instead.\454\ Drawing from
statutory changes and Commission rules regarding limitations on
activities since the rule was promulgated, including the Dodd-Frank Act
and the rules disqualifying felons and other ``bad actors'' from
certain securities offerings, our proposal would add to the types of
disciplinary events that would disqualify a person from acting as a
solicitor, including by adding certain disciplinary actions by other
regulators and self-regulatory organizations. It would also provide a
conditional carve-out for certain types of Commission actions.
---------------------------------------------------------------------------

    \451\ See rule 206(4)-3(a)(1)(ii).
    \452\ Section 203(f) of the Act authorizes the Commission to bar
persons from association with an investment adviser, or to suspend
them from association with an investment adviser. Under section
203(f), we may issue a bar or suspension order if the Commission, a
court, or another regulatory authority has found the person to have
engaged in categories of misconduct specified in section 203(e) of
the Act, discussed below. Section 203(f) also authorizes us to
censure or place limitations on the activities of a person
associated with an investment adviser instead of barring or
suspending them.
    \453\ Section 203(e) of the Act [15 U.S.C. 80b-3(e)] authorizes
the Commission to, by order, censure, place limitations on the
activities, functions, or operations of, suspend for a period not
exceeding twelve months, or revoke the registration of any
investment adviser, under certain circumstances described therein.
Under section 203(e), we may take these disciplinary actions in
connection with our finding that a firm, or a person associated with
the firm, has engaged in categories of misconduct specified in
section 203(e), such as violating the Federal securities laws or
willfully filing a false registration form. Section 203(e) also
authorizes us to commence disciplinary action if a court or certain
other regulatory authority find an adviser or an associated person
has engaged in categories of misconduct specified in section 203(e),
such as committing a crime in connection with the conduct of a
securities business or a violating a foreign regulation regarding
transactions in securities.
    \454\ See 1978 Proposing Release, supra footnote 27, at n.1 and
accompanying text.
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a. Disqualification
    Under our proposal, an investment adviser could not compensate,
directly or indirectly, a person for any solicitation activities that
it knows, or that it, in the exercise of reasonable care, should have
known, is an ineligible solicitor.\455\ An ``ineligible solicitor''
would be defined to mean a person who, at the time of the solicitation,
is either subject to a disqualifying Commission action or is subject to
any disqualifying event.\456\ The proposal's inclusion of a reasonable
care standard would be a change from the current rule, which contains
an absolute bar on paying cash for solicitation activities to a person
with any disciplinary history enumerated in the rule.
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    \455\ Proposed rule 206(4)-3(a)(3)(i). The proposed rule would,
however, provide exemptions for referrals for the provision of de
minimis compensation and for certain nonprofit programs. See supra
section II.B.7.c.
    \456\ Proposed rule 206(4)-3(a)(3)(ii). See proposed rule
206(4)-3(a)(3)(iii) for the defined terms ``disqualifying Commission
action'' and ``disqualifying event.''
---------------------------------------------------------------------------

    We believe that adding a proposed reasonable care standard would
preserve the rule's benefits while reducing the risk that advisers
would violate the rule as a result of disqualifying event or actions
that they should not have known, in the exercise of reasonable care,
existed.\457\ Such a standard necessarily includes inquiry by the
adviser into the relevant facts; however, we are not proposing to
specify what method or level of due diligence or other inquiry would be
sufficient to exercise reasonable care. We are also not proposing to
prescribe the frequency of such inquiry, but whether the adviser
satisfied the reasonable care standard would be determined in light of
the circumstances of the solicitor and the solicitation arrangement.
For example, as we have stated in other contexts implementing rules for
the treatment of ``bad actors'', where we have included a reasonable
care standard and have not prescribed or delineated what steps an
issuer would be required to take to show reasonable care \458\: The
steps an issuer should take to exercise reasonable care will vary
according to the particular facts and circumstances. For example, we
anticipate that issuers will have an in-depth knowledge of their own
executive officers and other officers participating in securities
offerings gained through the hiring process and in the course of the
employment relationship, and in such circumstances, further steps may
not be required in connection with a particular offering. Factual
inquiry by means of questionnaires or certifications, perhaps
accompanied by contractual representations, covenants and undertakings,
may be sufficient in some circumstances, particularly if there is no
information or other indicators suggesting bad actor involvement.\459\
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    \457\ Cf., Disqualification of Felons and Other ``Bad Actors''
from Rule 506 Offerings, Release No. 33-9414 (Jul. 10, 2013) [78 FR
44729 (Jul. 24, 2013)] (``Bad Actor Disqualification Adopting
Release''). As with the ``bad actor'' disqualification provisions
adopted therein, our proposed reasonable care standard would address
the potential difficulty for advisers in establishing whether any
solicitors are the subject of disqualifying events, particularly
given that there is no central repository that aggregates
information from all the Federal and state courts and regulatory
authorities that would be relevant in determining whether solicitors
have a disqualifying event in their past. Id., at text accompanying
nn.190-191.
    \458\ Id. See Rule 506(d)(2)(iii) and instruction thereto
(providing an exception to the rule's disqualification provision:
``If the issuer establishes that it did not know and, in the
exercise of reasonable care, could not have known that a
disqualification existed under paragraph (d)(1) of this section'').
    \459\ Bad Actor Disqualification Adopting Release, supra
footnote 457, at nn. 201-202 and accompanying text.
---------------------------------------------------------------------------

    The frequency of inquiry could vary depending upon, for example,
the risk of using an ineligible solicitor, the impact of other
screening and compliance mechanisms already in place, and the cost and
burden of the inquiry.\460\ For example, if the adviser has an ongoing
relationship with a solicitor that solicits investors over

time, the adviser should consider inquiring into the solicitor's status
on a periodic basis during the relationship as appropriate based on the
applicable facts and circumstances. In this circumstance, an annual
inquiry could be sufficient if there is no information or other
indicators suggesting changes in circumstance that would be
disqualifying under the rule. Conversely, if an adviser compensates a
solicitor on a one-time basis at the time of solicitation, an inquiry
into the solicitor only once no later than the time of solicitation
generally should be sufficient.
---------------------------------------------------------------------------

    \460\ Advisers should address such methods in their policies and
procedures under the compliance rule. See rule 206(4)-7.
---------------------------------------------------------------------------

    Additionally, our proposal would prohibit adviser compensation of a
solicitor if the solicitor is subject to a disqualifying Commission
action or is subject to any disqualifying event at the time of the
solicitation.\461\ We believe the time of solicitation--rather than the
time the adviser compensates, or engages, the solicitor for
solicitation--is the appropriate point in time to tie the disqualifying
event or action to the solicitor's status as an ineligible
solicitor.\462\ The time of solicitation is when investors are most
vulnerable to fraud or deceit regarding the solicitation. However, even
though our proposed provision is tied to the time of solicitation, as a
practical matter advisers generally should conduct due inquiry into the
solicitor's eligibility at the time of engagement, because an adviser
that engages a solicitor that is ineligible at the time of engagement
runs the risk that the solicitor will remain ineligible and conduct
solicitations before the adviser becomes aware of such status. Under
our proposed rule, if a solicitor was eligible at the time of
solicitation but subsequently became ineligible, an adviser would be
permitted to compensate the solicitor for the solicitation activity
that occurred prior to the ineligibility.
---------------------------------------------------------------------------

    \461\ The proposed disqualification provision would apply to an
``ineligible solicitor'', which would mean a person who at the time
of the solicitation is either subject to a disqualifying Commission
action or has any disqualifying event. Proposed rule 206(4)-
3(a)(3)(ii) (emphasis added).
    \462\ The time of solicitation (or, in the case of mass
communications, as soon as reasonably practicable thereafter) is
also when the solicitor or the adviser, as applicable, is required
under the required written agreement to deliver the solicitor
disclosure. Proposed rule 206(4)-3(a)(1)(iii).
---------------------------------------------------------------------------

    Our proposed rule would also apply the rule's definition of
ineligible solicitor to certain persons associated with a firm that is
an ineligible solicitor.\463\ For each ineligible solicitor, the
following persons would also be ineligible solicitors: (i) Any
employee, officer or director of an ineligible solicitor and any other
individuals with similar status or functions; (ii) if the ineligible
solicitor is a partnership, all general partners; (iii) if the
ineligible solicitor is a limited liability company managed by elected
managers, all elected managers; (iv) any person directly or indirectly
controlling or controlled by the ineligible solicitor as well as any
person listed in (i)-(iii) with respect to such person.\464\ These
persons would therefore be ineligible solicitors even if they do not
themselves have any of the rule's disqualifying events. However, under
our proposal, a firm would not necessarily be an ineligible solicitor
if one or more of such listed persons are ineligible solicitors under
the proposed rule, provided that such persons do not conduct
solicitation activities. Because a solicitor that is a firm engages in
solicitation activities through its associated individuals, we believe
that an individual's conduct should be subject to the rule's
disqualification when the firm is disqualified. A firm sets the
compliance tone for its personnel, and many types of regulated entities
are responsible under their regulatory regimes for the supervision and
control of their personnel.
---------------------------------------------------------------------------

    \463\ Proposed rule 206(4)-3(a)(3)(ii).
    \464\ Id.
---------------------------------------------------------------------------

    We request comment on the proposed disqualification provision;
particularly the ``reasonable care'' standard, the point of time
referenced in the ineligible solicitor definition, and the application
of the rule's ineligible solicitor definition to certain individuals
associated with a firm that is disqualified.
     Should the rule per se prohibit advisers from compensating
for solicitation activities persons that have certain disqualifying
events that meet the rule's definition of ineligible solicitor? Or,
should the rule include the reasonable care standard we have proposed?
Should we further specify in the rule or in guidance what would
constitute reasonable care for knowing that the solicitor is an
ineligible solicitor? For example, should we specify a method or level
of due diligence that would be sufficient to establish reasonable care?
Should we prescribe the frequency of such inquiry? Why or why not?
Should we specifically require that the adviser conduct due inquiry as
part of exercising reasonable care? Why or why not?
     Should the definition of ineligible solicitor refer to a
person's disqualifying events or orders at the time of solicitation, as
proposed? Or, should it refer to a different point in time, such as the
adviser's engagement of the solicitor or when the adviser compensates
the solicitor? Why or why not? For example, under our proposed rule, if
a solicitor was eligible at the time of solicitation but subsequently
became ineligible, an adviser would be permitted to compensate such
person for the solicitation activity that occurred prior to the
solicitor becoming ineligible. Do commenters agree with this result?
Why or why not?
     Should we apply the rule's definition of ineligible
solicitor to any individual associated with a firm that is an
ineligible solicitor, even if the individual would not otherwise be an
ineligible solicitor absent the particular association with the
ineligible solicitor firm? Do commenters agree with the categories of
persons as proposed? Why or why not? Should we list in the rule
different categories of persons we would presume to be associated with
a firm? For example, should the proposed rule specify whether or not an
independent contractor would be included as ``any employee, officer or
director of such ineligible solicitor and any other individuals with
similar status or functions''? The Form ADV definition of ``employee''
includes an adviser's independent contractors who perform advisory
functions on the adviser's behalf. Should these persons be included in
the rule as associated with a firm? Why or why not?
     Should we specify in the rule that a firm would be an
Ineligible Solicitor if an individual who is an ineligible solicitor
controls the firm, even if the firm is not otherwise an ineligible
solicitor and the individual who is an ineligible solicitor does not
engage in solicitation activities on behalf of the adviser? Why or why
not? If so, should we define the term ``control'', and if so, how? For
example, should we use the Act's definition of ``control,'' which means
``the power to exercise a controlling influence over the management or
policies of a company, unless such power is solely the result of an
official position with such company''? Should we use the definition of
``control'' in Form ADV, which includes, but is not limited to, each of
the firm's officers, partners, or directors exercising executive
responsibility (or persons having similar status or functions)? Should
we use another definition, and if so, what should that definition be,
and why?
     If the rule permits an adviser to compensate for
solicitation a firm that employs one or more individuals who are
ineligible solicitors, should we specify the level of diligence an
adviser should conduct in order to establish that

none of the firm's ineligible solicitors conducts solicitation
activities on the adviser's behalf?
b. Disqualifying Commission Action
    Under our proposal, a person who at the time of solicitation is
subject to a disqualifying Commission action would be an ineligible
solicitor.\465\ A disqualifying Commission action would be a Commission
opinion or order barring, suspending, or prohibiting a person from
acting in any capacity under the Federal securities laws, or ordering
the person to cease and desist from committing or causing a violation
or future violation of (1) any scienter-based antifraud provision of
the Federal securities laws, including a non-exhaustive list of such
laws and the rules and regulations thereunder; or (2) Section 5 of the
Securities Act of 1933.\466\ Under our proposal, if the Commission
prohibits an individual from acting in a specific capacity under the
Federal securities laws (e.g., supervisor, compliance officer), the
individual would be disqualified as a solicitor under the proposed
rule, even if the Commission has not barred or suspended the individual
from association with an investment adviser, broker-dealer or other
registrant. In addition, if the Commission has ordered a person to
cease and desist from committing or causing a violation or future
violation of a scienter-based antifraud provision of the Federal
securities laws, but has not barred or suspended that person, that
person would be disqualified under the proposed rule.\467\ We believe
that this provision would cover a wide scope of Commission orders
concerning misconduct that could call into question the person's
trustworthiness or ability to act as a solicitor. We believe that the
Commission's cease and desist orders we propose to include as a
disqualifying Commission action would call into question that person's
trustworthiness or ability to act as a solicitor even if the Commission
did not bar, suspend, or prohibit that person from acting in any
capacity under the Federal securities laws.
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    \465\ In addition, as discussed below, a person who at the time
of solicitation has any disqualifying event is also an ineligible
solicitor. See infra footnote 468 and accompanying text.
    \466\ Proposed rule 206(4)-3(iii)(A). The imposition of a bar,
suspension, or prohibition may appear in an opinion of the
Commission or in an administrative law judge initial decision that
has become final pursuant to a Commission order. In both cases, such
a bar, suspension, or prohibition would be a disqualifying
Commission action. These would include, for example, officer and
director bars imposed in Commission cease and desist orders,
limitations on activities imposed under section 203(e) or 203(f) of
the Advisers Act that prevent persons from acting in certain
capacities, penny stock bars imposed under section 15(b) of the
Exchange Act, and investment company prohibitions imposed under
section 9(b) of the Investment Company Act.
    \467\ The reference to a scienter-based anti-fraud provision of
the Federal securities laws is based on the bad actor
disqualification provisions under Rule 506 of Regulation D. See Rule
506(d)(1)(v) (including, in a non-exhaustive list of scienter-based
anti-fraud provisions of the Federal securities laws, section
17(a)(1) of the Securities Act, section 10(b) of the Exchange Act
and rule 10b-5, section 15(c)(1) of the Exchange Act, section 206(1)
of the Advisers Act).
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c. Disqualifying Event
    Under our proposal, a person that at the time of the solicitation
is subject to any disqualifying event would also be an ineligible
solicitor.\468\ A disqualifying event would generally include a
finding, order or conviction by a United States court or certain
regulatory agencies (other than the Commission) that a person has
engaged in any act or omission referenced in one or more of the
provision's four prongs, as discussed below. Any such finding, order or
conviction would generally be a disqualifying event if it occurred
within the previous ten years or if the bar or injunction is in effect
at the time of solicitation.
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    \468\ Proposed rule 206(4)-3(a)(3)(iii)(B).
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    We are proposing a ten-year time limit (or ``look-back period'') on
certain of the disqualifying events, as described below, because this
look-back period is used in section 203(e), which is a basis for
Commission action to censure, place limitations on the activities, or
revoke the registration of any investment adviser or its associated
persons.\469\ It is also used for certain disciplinary events in the
rules disqualifying felons and other ``bad actors'' from certain
securities offerings.\470\ For regulatory and court-ordered bars and
injunctions, we are proposing that such bar or injunction be in effect
at the time of solicitation in order to be disqualifying. This is
consistent with the current rule as well as the bad actor
disqualification requirements under rule 506.\471\
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    \469\ Section 203(e)(2) and (3) (containing a ten-year look-back
period for convictions for certain felonies and misdemeanors). See
supra footnotes 453 and 452 (describing sections 203(e) and 203(f),
respectively).
    \470\ See, e.g., paragraph (d)(1)(iii)(B) of Rule 506 of
Regulation D (disqualifying a covered person subject to a final
order of the U.S. Commodity Futures Trading Commission or another
regulatory entity described therein, based on a violation of any law
or regulation that prohibits fraudulent, manipulative, or deceptive
conduct entered within ten years before the sale described in the
rule).
    \471\ See rule 206(4)-3(a)(1)(ii)(D) (applying the
disqualification provision to a solicitor that ``is subject to an
order, judgment or decree described in section 203(e)(4) of the
Act); see also paragraphs (d)(1)(ii), (d)(1)(iii)(A) and (d)(1)(iv)
of rule 506 of Regulation D (requiring that the applicable order,
judgment or decree be in effect at the time of the sale, and also in
some cases that the order, judgment or decree have been entered
within a look-back period of five or ten years).
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    Under our proposal, certain solicitors that are not currently
disqualified under the rule would be disqualified under the amended
rule as ``ineligible solicitors'' solely as a result of the proposed
changes to the rule's disqualification provisions. To the extent that
the proposed amendments would expand disqualifying events under the
proposed rule (i.e., any disqualifying Commission action or
disqualifying event) beyond the scope of disqualifying events listed in
the current rule's disqualification provision, the proposed
disqualification provision would apply only to any disqualifying
Commission action or disqualifying event occurring after the effective
date (or the compliance date, as applicable) of the proposed rule
amendments. Any disqualifying Commission action or disqualifying event
that occurs prior to the effectiveness of the proposed rule (or the
compliance date, as applicable) would be subject to the current rule's
disqualification provision. We recognize that some advisers and
solicitors rely on letters issued by the Commission staff stating that
the staff would not recommend enforcement action to the Commission
under section 206(4) and rule 206(4)-3 if an investment adviser paid
cash solicitation fees to a solicitor that was subject to particular
disciplinary events that fall within the current rule's
disqualification provision.\472\ We request comment, below, on whether
we should ``grandfather'' such persons into compliance with the
proposed rule by permitting advisers to continue to compensate such
solicitors after the effective date of the proposed rule, if the
solicitors continue to comply with the conditions specified in the
letters and, except for the disciplinary events described in the
applicable letter, would not otherwise be ineligible solicitors under
the proposed rule.
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    \472\ See, e.g., the ``bad actor'' letters listed below in
Section II.D. While these staff letters generally only apply to the
solicitor or adviser to which the letter is addressed, the staff has
issued one letter which it stated would apply with respect to any
cash solicitation arrangement under which an investment adviser
proposes to pay cash solicitation fees to a solicitor subject to a
specific type of disqualification event under the circumstances
described in the letter. See Dougherty & Co., LLC, SEC Staff No-
Action Letter (Jul. 3, 2003) (``Dougherty Letter''), discussed infra
footnote 495.
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    The first prong of the proposed disqualifying event definition
describes a conviction by a court of competent jurisdiction within the
United States, within the previous ten years, of any

felony or misdemeanor involving conduct described in paragraphs (2)(A)
through (D) of section 203(e) of the Act.\473\ This prong generally
follows the provision of the current rule that disqualifies persons
convicted within the previous ten years of any felony or misdemeanor
involving conduct described in section 203(e)(2)(A) through (D) of the
Act, which are bases for Commission action to censure, place
limitations on the activities, or revoke the registration of any
investment adviser or its associated persons.\474\ We are proposing,
however, not to include as a disqualifying event a conviction by a
foreign court of competent jurisdiction with respect to the misconduct
described in section 203(e)(2)(A) through (D) of the Act because we do
not believe advisers should be required to incur the cost and burden,
with respect to their solicitors,\475\ of inquiry into foreign
proceedings or to make a determination of what is a ``substantially
equivalent crime'' to a felony or misdemeanor, as is part of the
conditions of section 203(e)(2).\476\ A person subject to any such
foreign conviction might still be an ineligible solicitor, however, to
the extent that the Commission uses its authority to bar, suspend or
place limits on that person's association with an investment adviser,
or otherwise issues a disqualifying Commission action based on such
conduct.\477\
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    \473\ Proposed rule 206(4)-3(a)(3)(iii)(B)(1). Paragraphs (2)(A)
through (D) of section 203(e) of the Act include, for example,
felonies or misdemeanors involving dishonesty or misappropriation of
funds or securities, and any felony or misdemeanor arising out of
the conduct of the business of certain types of entities such as a
broker, dealer, investment adviser, bank, and insurance company.
Section 203(e)(A)-(D).
    \474\ Rule 206(4)-3(a)(1)(ii)(B).
    \475\ Compare Item 11 of Part 1A of Form ADV (requiring advisers
to report certain foreign court actions about themselves and their
affiliates). We believe that requiring an adviser to gather such
information about foreign court actions affecting the solicitors
they use (who may or may not be affiliated) may be significantly
more difficult than gathering and reporting such data about the
adviser itself or its affiliates as required under Form ADV.
    \476\ Section 203(e)(2)(A)-(D). Cf section 9(b) of the
Investment Company Act, pursuant to which foreign court convictions
are not automatically disqualifying.
    \477\ See section 203(f). Any Commission order issued under this
section would be a disqualifying Commission action under the
proposed rule.
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    The second prong of the proposed disqualifying event definition
describes a conviction by a court of competent jurisdiction within the
United States, within the previous ten years, of engaging in any of the
conduct specified in paragraphs (1), (5), or (6) of section 203(e) of
the Act.\478\ This prong is derived from the third prong of the current
rule's disqualification provision, which describes persons the
Commission finds to have engaged, or that have been convicted of
engaging, in any of the conduct specified in paragraphs (1), (5) or (6)
of section 203(e) of the Act.\479\ We believe that these felony and
misdemeanor convictions should continue to be disqualifying under the
rule, subject to the rule's carve-out as described below. In many
cases, conduct underlying a felony or misdemeanor would be picked up by
our proposed rule as a disqualifying Commission action (i.e., to the
extent the Commission has issued an opinion or order barring,
suspending, or prohibiting the person from acting in any capacity under
the Federal securities laws or issued certain types of cease and desist
orders described in the proposed rule).
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    \478\ Proposed rule 206(4)-3(a)(3)(iii)(B)(2). Paragraphs (1),
(5), or (6) of section 203(e) of the Act generally include, but are
not limited to, a person who: (i) Has willfully made or caused to be
made certain false reports with the Commission; (ii) has willfully
violated any provision of the Act or other Federal securities laws;
and (iii) has willfully aided, abetted, counseled, commanded,
induced, or procured the violation by any other person of any
provision of the of the Act or other Federal securities laws.
    \479\ Rule 206(4)-3(a)(1)(ii)(C).
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    We are not proposing to add to the provision's second prong any
references to conduct specified in paragraphs (3) and (8) of section
203(e) of the Act (e.g., certain felony convictions not described in
paragraph (2) of section 203(e) and certain findings by foreign
financial regulatory authorities).\480\ Similar to our rationale for
not proposing to include in the first prong any ``substantially
equivalent crime by a foreign court of competent jurisdiction,'' we do
not believe advisers should be required to incur the cost and burden of
inquiry into findings by foreign financial regulatory authorities, as
is required in section 203(e)(8).\481\ In addition, we are not
convinced that the rule should prohibit the compensation of solicitors
subject to certain felony convictions not described in paragraph
203(e)(2) or substantially equivalent crimes by a foreign court of
competent jurisdiction. We believe that including such felony
convictions could overly broaden the scope of the disqualifying
provision because such types of convictions are less likely to call
into question the credibility of such solicitor's referral. However, a
person subject to such felony convictions might still be an ineligible
solicitor under our proposed rule, if the Commission has used its
authority to bar, suspend or place limits on that person's association
with an investment adviser, or otherwise issue a disqualifying
Commission action based on such conduct.
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    \480\ Since 1979, section 203 has been amended to expand the
types of misconduct for which the Commission has the authority to
bar or suspend a person from being associated with an adviser,
including by the addition of paragraphs (3) and (8) of section
203(e) of the Act. See Securities and Exchange Commission
Authorization Act of 1987, Public Law 100-181 (amending section
203(e) and 203(f) of the Act); Securities Act Amendments of 1990,
Public Law 101-550 (amending section 203(e) and 203(f) of the Act);
National Securities Markets Improvement Act of 1996, Public Law 104-
290 (amending section 203(e) and 203(f) of the Act); Securities
Litigation Uniform Standards Act of 1998, Public Law 105-353
(amending section 203(e) of the Act); and Sarbanes-Oxley Act of
2002, Public Law 107-204 (amending section 203(e) of the Act).
    \481\ Section 203(e)(8).
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    The third prong of the proposed disqualifying event definition
generally describes the entry of a bar or final order based broadly on
the person's fraudulent conduct, by certain regulators and self-
regulatory organizations. In particular, this section refers to: The
Commodity Futures Trading Commission (``CFTC''), any self-regulatory
organization, a State securities commission (or any agency or officer
performing like functions), a State authority that supervises or
examines banks, savings associations, or credit unions, a State
insurance commission (or any agency or office performing like
functions), an appropriate Federal banking agency (as defined in
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(q))), or
the National Credit Union Administration. The proposed provision refers
to any final order of any such body that (i) bars a person from
association with an entity regulated by such body, or from engaging in
the business of securities, insurance, banking, savings association
activities, or credit union activities; or (ii) constitutes a final
order, entered within the previous ten years, based on violations of
any laws, regulations, or rules that prohibit fraudulent, manipulative,
or deceptive conduct.\482\
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    \482\ Proposed rule 206(4)-3(a)(3)(iii)(B)(3).
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    This proposed third prong is not part of the current rule's
statutory disqualification provision.\483\ It is derived from section
203(e)(9) of the Act, which is a basis for Commission action to
censure, place limitations on the activities, or revoke the
registration of any investment adviser or its associated persons.\484\
However, our

proposal would add self-regulatory organizations and the CFTC to the
list of regulators incorporated from section 203(e)(9). Adding these
entities would be consistent with the rules disqualifying felons and