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What is more important for the “initiative test”: form or substance?
Since 2006, Global Sales Compliance (GSC) has worked closely with AIFM/Asset Manager marketing teams to ensure compliance with cross-border marketing rules.
Many clients have asked us, “What is the ‘initiative test’ for reverse solicitation and how should this test apply to our cross-border marketing business model? Should we focus on initiative test form or substance (or both)?”
AIFMs/Asset Managers want to understand that if they do accept a subscription from an investor in their fund that came about through an inbound enquiry via “reverse solicitation”, how does the “initiative test” apply to the transaction? Are the AIFM/Asset Manager’s 5-Key Distribution Risks mitigated?
During nearly two decades of GSC’s bespoke marketing compliance advisory, we have investigated with our legal counsel network in 70+ countries hundreds of client queries about the sales practice called reverse solicitation, aka “reverse enquiry” or “passive solicitation”.
What is reverse solicitation?
Reverse solicitation is a sales practice whereby the potential investor contacts the fund manager (the AIFM/Asset Manager) and requests information on the fund manager’s fund or financial services on an unsolicited basis.
In the third blog of our popular Reverse Solicitation series, we share insights into this sales practice.
What is the initiative test?
To confirm if a case of reverse solicitation is genuine (or not), regulators generally apply the initiative test. Simply put, Who contacted whom first?
Did the investor conduct their own independent research to find the fund manager and contacted the fund manager (first) to request information on the manager’s fund/service without any prior contact by the fund manager or by any third party? Or did the fund manager make outreach first to the investor (taking the first initiative) by using any means of communication (phone calls, emails, video calls, in-person meetings, etc.)?
What is initiative test form vs. substance?
We have all heard the phrase “form over substance” and “substance over form”, but what do these terms really mean for the reverse solicitation initiative test?
Form. Focusing on “form” in reverse solicitation means the AIFM/Asset Manager breaches the initiative test, makes proactive outreach to investors first and cares only about the paper trail to the file, obtaining reverse solicitation letters, emails or other written correspondence from the investor. This process is repetitive and ongoing -- not one-off instances.
Substance. Focusing on “substance” in reverse solicitation means the AIFM/Asset Manager only responds to truly unsolicited inbound enquiries about its funds or services from investors, doing so on a one-off, limited basis. The AIFM/Asset Manager does not make proactive reach first to the client (in compliance with the initiative test) and documents such evidence of reverse solicitation to their compliance files.
Aren’t we safe having reverse enquiry confirmation by the client on file, regardless of who makes initial contact?
AIFM/Asset Manager clients say to us, “We have all the signed reverse solicitation letters and emails in our compliance files sent by investors after we asked them to sign/send the confirmation back to us. Isn’t that enough to document our evidence of reverse enquiry, meeting the reverse solicitation initiative test?”
Our response is, AIFMs/Asset Managers who focus only on the documentation to the file (numerous reverse solicitation forms, letters, emails signed by investors) while proactively contacting investors first (breaching the initiative test) about their funds, services or capability, expecting to operate under a waiver of local marketing regulations as a safe harbour is a high-risk approach and not the intent of the regulator.
Does substance really matter?
Yes. Substance matters to the regulator.
If an investor reaches out to an AIFM/Asset Manager without any prior contact by the fund manager or any other third party to request information about the AIFM/Asset Manager’s fund, then this scenario could qualify in substance as meeting the initiative test of reverse solicitation emphasized by the regulators.
Furthermore, as part of the substance case, the investor should ask the fund manager for information on a specific fund and not general requests, “please send us information on all the AIFM/Asset Manager’s (type of asset class) management capability and available funds”. The AIFM/Asset Manager should document all legitimately unsolicited reverse enquiries from investors about their fund/financial services in case the AIFM/Asset Manager needs to prove their case of operation under a potential regulatory waiver if challenged by the regulator and/or the investor in court.
Volumes of reverse solicitation documentation to the file (letters, emails, etc.) could very likely indicate that the AIFM/Asset Manager is in breach of the initiative test and is proactively marketing its funds or services to investors in breach of local marketing regulations in substance.
Substance backed up by form
AIFMs/Asset Managers who ignore the substance of the reverse solicitation initiative test, make proactive and repeated contact with potential investors about their funds, financial services or investment capability, yet prioritize “form over substance” by getting investors to sign reverse solicitation letters or any other written evidence to the file and use this approach repeatedly across jurisdictions in our view operate at potentially high levels of 5-Key Distribution Risk. See our blog, 5-Key Distribution Risks for cross-border marketing
Regulators in all circumstances favour substance backed up by form to document evidence of reverse solicitation.
However, AIFMs/Asset Managers should always remember that reverse solicitation as a sales practice is not a safe harbour.
See our blog Is reverse solicitation a safe harbour?
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