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Should AIFMs/Asset Managers engage Third-Party Distributors who say, “Our fund distribution model is Reverse Solicitation”?
Clients have asked us over the years, “We want to engage a third-party distributor to market and sell our fund cross-border. The third-party distributor (TPD) tells us their fund distribution business model is “Reverse Solicitation”. Should we engage them? Should we pay distribution fees to the TPD under such an operational model?”
For more than two decades, we have investigated numerous client queries with our legal counsel network in 70+ countries about the sales practice called “reverse solicitation”, aka “reverse enquiry” or “passive solicitation”.
In the fifth of a series of blogs on Reverse Solicitation, we share some insights into this sales practice.
Reverse Solicitation as a sales practice
Reverse Solicitation is a sales practice whereby the potential investor contacts the fund manager (AIFM/Asset Manager) and requests information on the fund manager’s fund (or financial services) on an unsolicited basis. This sales practice was intended by the regulators to be an example of a carve-out to local regulations on solicitation of financial products or services so long as the contact with the investor was genuinely unsolicited by the fund manager – or, in this case, by the fund manager’s appointed third party distributor. (Read our second blog post in the series: Reverse Solicitation: What is the "initiative test"?)
Engaging a third-party distributor
AIFMs and Asset Managers who wish to increase their fund distribution capability either in their own jurisdiction or cross-border in overseas jurisdictions may choose to contractually engage a third-party distributor to market and sell their fund to investors. The attraction of a third-party distributor is the TPD’s client relationships and potentially new client segments. The TPD can have jurisdictional reach that the AIFM/Asset Manager doesn’t have in-house.
The AIFM/Asset Manager wants the appointed third-party distributor to proactively market the AIFM/Asset Manager’s fund on its behalf, paying the TPD a distribution fee to do so. Proactive marketing of an AIFM/Asset Manager’s fund is the TPD’s service to its clients, it is their job and, more importantly, their whole reason for existence.
Proactive Marketing vs. Reverse Solicitation
As we have mentioned in several blogs, Reverse Solicitation is a sales practice based on the assumption that no party makes proactive outreach to the end investor, who contacts the fund manager at their own initiative, requesting information about the AIFM/Asset Manager’s fund and/or financial services.
Industry Myth: Reverse Solicitation is a distribution model
We have observed there is an increasingly prevalent industry myth perpetuated (in part) by some commercially driven, low-ethic law firms who provide what we term “throwaway legal advice” to “just rely on Reverse Solicitation”. This implies that the sales practice of Reverse Solicitation is a carve-out or exemption from local marketing regulations without in-depth analysis about the risks of reverse solicitation, what the “initiative test” means, procedures for documentary evidence (proof) and the regulator’s intent for this sales practice. Read our blog, Reverse Solicitation: Beware of throwaway legal advice.
As a result of this industry myth, there are some industry players who believe that Reverse Solicitation is a fund distribution model.
It’s a VERY strange phenomenon and one that’s potentially harmful to your business.
Third-Party Distributors and Reverse Solicitation: Fact vs. fiction
Under the Regulator’s intent for Reverse Solicitation, there is no proactive outreach by the fund manager or its distributors to the end investor. That is the “initiative test” applied by regulators.
FACT: If you hire a TPD to market and sell your fund, you are hiring them to proactively market your fund to investors. You are paying them a distributor fee for this service. You expect the TPD to make proactive outreach to investors. This is a FACT.
If your appointed TPD says, “We will fundraise in your fund via Reverse Solicitation”, then applying the initiative test, this means the TPD is not proactively marketing your fund or making any proactive outreach to fund investors.
Why would you pay a TPD a distribution fee to provide you the service of proactively marketing your fund, when under Reverse Solicitation, the TPD has to wait for the phone to ring (that is, wait for potential investors to contact them) to comply with the “initiative test”?
FICTION: Any Third-Party Distributor is making proactive outreach in substance to investors. That is their whole reason for existence. It is a fiction to think that a TPD can fundraise in third-party funds by not making outreach. It is a fiction to believe that a TPD operating under Reverse Solicitation is compliant with local laws on marketing regulations because they are paid by fund managers to proactively market their client’s products and services.
Making proactive outreach to investors in breach of the initiative test and calling it Reverse Solicitation really means the TPD is potentially breaching local marketing regulations. Effectively, you could be hiring a TPD to market your fund in breach of local marketing regulations because there is no such thing as “Reverse Solicitation as a distribution model”. This is a FICTION.
If a TPD says to you, “Our Fund Distribution Model is Reverse Solicitation”, then run (don’t walk) away fast.
And don’t pay their fees. Better yet, don’t engage them in the first place.
Distribution Risk: AIFMs & asset managers
Engaging a third party to market and sell your fund on the AIFM/Asset Manager’s behalf should be a well-considered business decision. We encourage our clients to choose any TPD wisely because they will represent your funds to investors. Choose a TPD that is fully compliant with local marketing regulations, whether you are hiring them to market your funds or financial services in your own jurisdiction or cross-border (overseas).
If a TPD breaches local marketing regulations, it is the AIFM/Asset Manager who is exposed to 5-Key Distribution Risks as well as the TPD (who conducts the marketing). So choosing a non-compliant TPD, especially one that claims “Our distribution model is Reverse Solicitation”, can potentially and significantly increase the AIFM/Asset Manager’s distribution risk. You have skin in the game too.
(See our blog about the 5-Key Distribution Risks for cross-border marketing.)
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