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To maximize client reach around the globe, some AIFM/Asset Managers choose to fundraise by engaging third party distributors to market and sell their fund under a fund distribution agreement. Do you know the facts about third-party fund distribution?
Clients have asked us over the years: “Why do we need to conduct compliance due diligence on our appointed third-party distributors? Can’t we just sign the fund distribution agreement that has provisions stating the distributor will comply with all laws in foreign jurisdictions for the marketing of our fund? Isn’t that enough protection for us?"
There is a bit of an industry myth (an assumption) that generally third-party distributors or referral agents are compliant with fund marketing regulations and that they have a valid license to conduct fund marketing. AIFM/Asset Managers think, “If third party distributors were not fully compliant with fund marketing regulations or didn’t have a license, how could they be in business?”
It’s a legitimate question. We clarify this industry myth below.
Third-party distributor options
If you are an AIFM/Asset Manager, you have a range of options to appoint a third-party distributor to fundraise in your funds:
- Global financial institution (via the institutional marketing team, private wealth management channels, etc.)
- Boutique fund distributor specialized in a certain asset class (private equity, hedge funds, etc.)
- Individual referral agents/distributors
When you appoint a third party to distribute your fund cross-border, you lose a bit of compliance control over their marketing activities, because you have outsourced the marketing function to a third party.
Our message to AIFM/Asset Managers is: Regardless of the type of third-party distributor you appoint to market your fund cross-border — whether it is a global FI or a one-person shop — you must do the third-party distributor compliance due diligence to confirm 3-track compliance.
The 3-track compliance questions you need to be asking:
- How does the TPD comply with country fund marketing regulations?
- What are the TPD’s sales practices to source investors for your fund?
- Does the TPD have a valid license to market and sell my fund in all jurisdictions where marketing is conducted? (Be sure to obtain a copy of their license for your files.)
Commercial drivers for third-party fund distribution
Throughout this process, it’s important to bear in mind the commercial drivers of third-party distributors: They want you (the AIFM/asset manager) to sign the distribution agreement (contract) and hire them to fundraise in your funds. That is how they earn their distribution fees/trailers.
In our decades-long experience, we’ve observed some third-party distributors in our industry represent to AIFM/asset managers that they are fully compliant with fund marketing regulations and have a valid license to conduct fund marketing in any jurisdiction … but when you delve into their marketing and sales practices and/or their license, there can be potential compliance problems.
Here are some examples we’ve seen over the years:
- The TPD represented to the AIFM/Asset Manager that they have a fund marketing license in certain Asian and Middle East jurisdictions yet they did not have any such license. In addition, their fund marketing approach was in breach of the countrys’ fund marketing regulations.
- A TPD represented to the client, “Our fund distribution model is reverse solicitation” — a sales practice that is problematic and exposes AIFM/Asset Managers as well as distributors to potential compliance risks. Learn more about the specifics in our Blog post: Beware of third-party distributors and reverse solicitation.
Who is responsible for checking local fund marketing regulations?
It’s the Age-Old Debate: Who is responsible for investigating the local country’s fund marketing regulations? Is it the AIFM/Asset Manager or their appointed third-party distributor? Technically both parties are responsible for compliance with local fund marketing regulations.
In practice, the third-party distributor typically takes responsibility for their licensing compliance, but the AIFM/Asset Manager has the task of investigating country fund marketing rules. Learn more in our Blog post: The Age-Old Debate: Who Investigates country marketing restrictions?
Who holds the 5-Key Distribution Risk “Hot Potato”?
“Marketing” or soliciting funds in any country constitutes a regulated activity and is subject to the local country’s fund marketing regulations as well as licensing rules. Bone up on the essential tenets in our Blog post about Cross-Border Marketing Compliance: What you Need to Know.
Does it matter if my appointed third-party distributor breaches local fund marketing rules?
It might be reasonable as an AIFM/Asset Manager to ask: Even if my TPD breaks the rules and even if they are sanctioned, what does it matter to me? I can simply switch to another TPD, right?
Here is a risk scenario in practice: Under a third-party fund distribution agreement, the appointed third-party distributor is actually “out there in the field”, conducting the regulated activity (soliciting the fund) with potential investors. If the TPD breaches local fund marketing laws and/or does not have a valid license to conduct fund solicitation in the local jurisdiction, the TPD could potentially get sanctioned by the local Regulator (sanctions risk).
Here's why it matters to you: If your fund was marketed in breach of local fund marketing laws, investors in your fund could sue both the marketer (the TPD) and the AIFM/Asset Manager to get their money back — a litigation risk and investor rescission rights risk. All of these risks could potentially lead to business franchise risk and reputation risk, which could have far-reaching implications. Read our Blog post 5-Key Distribution risks for cross-border marketing.
So the answer is, both the AIFM/Asset Manager and the appointed TPD hold the 5-Key Distribution Risk “Hot Potato”: You both have skin in the game (risk exposure).
Importance of compliance due diligence on your appointed TPD
We are not implying that all TPDs are non-compliant with fund marketing regulations and/or don’t have a license. In fact, the TPD industry has come a long way in the last decade to meet AIFM/Asset Manager’s cross-border fund marketing compliance requirements. From a marketing compliance perspective, we have seen industry improvement.
Our message to AIFM/Asset Managers is that the safest compliance approach is to conduct in-depth compliance due diligence on all distributors, regardless of the TPD’s size, industry reputation, and/or fully explore the compliance representations they make in fund distribution agreements. Do your own independent 3-track compliance due diligence (as outlined above) before you sign the fund distribution agreement on the dotted line.
Third-party fund distribution: Trust but VERIFY, VERIFY, VERIFY
Summary: Engaging a third-party distributor to market your fund cross-border makes a lot of commercial sense to some AIFM/Asset Managers.
The importance of compliance due diligence cannot be overstated because both the distributor and the AIFM/Asset Manager share the 5-Key Distribution risks if things go wrong.
Marketing compliance due diligence on all distributors with records to the compliance file is the winning ticket. It’s a win-win for all parties.
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