SEC Division of Investment Management Staff Letter: Charles Schwab & Co., Inc.

Effective November 4, 2022, This Letter is Withdrawn. Please consult the following web page for more information: https://www.sec.gov/divisions/investment/im-modified-withdrawn-staff-statements .

Investment Advisers Act of 1940 — Section 206(4) / Rule 206(4)-3 Charles Schwab & Co., Inc.

RESPONSE OF THE CHIEF COUNSEL'S OFFICE DIVISION OF INVESTMENT MANAGEMENT

We would not recommend enforcement action to the Securities and Exchange Commission ("Commission") under section 206(4) of the Investment Advisers Act of 1940 ("Advisers Act") and Rule 206(4)-3 thereunder if any investment adviser that is required to be registered pursuant to section 203 of the Advisers Act pays to Charles Schwab & Co., Inc. ("CS&Co."), or any of CS&Co.'s associated persons, as defined in section 202(a)(17) of the Advisers Act, a cash payment, directly or indirectly, for the solicitation of advisory clients i n accordance with Rule 206(4)-3, [1] notwithstanding a final judgment as to CS&Co., which has been entered by the United States District Court for the Northern District of California (the "Final Judgment"), that otherwise would preclude such an investment adviser from paying such a payment, directly or indirectly, to CS&Co . [2]

Our position is based on the facts and representations in your letter dated August 7, 2018, particularly the representations of CS&Co. that [3] :

It, directly or indirectly, will conduct any cash solicitation arrangement entered into with any investment adviser required to be registered under section 203 of the Advisers Act in compliance with the terms of Rule 206(4)-3 as if CS&Co. were not a disqualified person for purposes of Rule 206(4)-3 by virtue of the Final Judgment;

The Final Judgment does not bar, suspend, or limit CS&Co., or any person currently associated with CS&Co., from acting in any capacity un der the federal securities laws; [4]

It has complied, and will continue to comply, with the terms of the Final Judgment, including, but not limited to, the Injunction and the payment of the civil monetary penalty; and

Until ten (10) years from the date of the entry of the Final Judgment on July 9, 2018, CS&Co. and any person through whom CS&Co. directly or indirectly conducts its solicitation activities or any investment adviser with which it or any such person has a solicitation arrangement subject to Rule 206(4)-3 will disclose the Final Judgment in a written document that is delivered to each person whom CS&Co. or such persons solicit: (a) not less than 48 hours before the person enters into a written or oral investment advisory contract with the investment adviser; or (b) at the time the person enters into such a contract, if the person has the right to terminate such contract without penalty within five business days after entering into the contract.

This position applies only to the Final Judgment and not to any other basis for disqualification under Rule 206(4)-3 that may exist or arise with respect to CS&Co.

Thankam A. Varghese

Special Counsel

[1] Rule 206(4)-3 prohibits any investment adviser that is required to be registered under the Advisers Act from paying a cash fee, directly or indirectly, to any solicitor with respect to solicitation activities if, among other things, the solicitor is subject to an order, judgment or decree that is described in section 203(e)(4) of the Advisers Act.

[2]

Securities and Exchange Commission v. Charles Schwab & Co., Inc. , Case No. 4:18-cv-03942-KAW (N.D. Cal. July 9, 2018).

[3] This response confirms the no-action relief provided orally by the staff on July 9, 2018.

[4] Under section 9(a) of the Investment Company Act of 1940 (the "Investment Company Act"), as a result of the injunction ("Injunction") included in the Final Judgment, CS&Co. and its Fund Servicing Affiliates (as defined below) were prohibited from serving or acting as, among other things, an investment adviser or depositor to any registered investment company or as principal underwriter for any registered open-end investment company or registered unit investment trust. On July 10, 2018 and August 7, 2018, as applicable, the Commission issued orders temporarily and permanently exempting certain affiliated persons of CS&Co.:Charles Schwab Investment Management, Inc. ("CSIM", and collectively with CS&Co., the "Fund Servicing Affiliates") and any existing company of which CS&Co. was an affiliated person within the meaning of section 2(a)(3) of the Investment Company Act, and any other company of which CS&Co. may become an affiliated person in the future (together with the Fund Servicing Affiliates, the "Covered Persons"). In re Charles Schwab & Co. Inc. , et al. , SEC Rel. No. IC-33157 (July 10, 2018); SEC Rel. No. IC-33195 (August 7, 2018). Therefore, the Covered Persons are not currently barred or suspended from acting in any capacity specified in section 9(a) of the Investment Company Act as a result of the Injunction.

Incoming Letter

The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/investment/noaction/2018/charles-schwab-080718-206(4).htm

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SIDLEY AUSTIN LLP
60 STATE STREET SIDLEY 36TH FLOOR
BOSTON, MA 02109
+1 617 223 0300
+1 617 223 0301 FAX
EMARINO@SIDLEY.COM
+1 617 223 0362
AMERICA • ASIA PACIFIC • EUROPE
By E-Mail and Overnight Courier
Deputy Director and Chief Counsel
Division ofInvestment Management
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-0506
Re: Securities and Exchange Commission v. Charles Schwab & Co., Inc., Case No.
4:18-cv-03942-KAW (ND.Cal. July 9, 2018)
Dear Mr. Cellupica:
We are writing on behalf of Charles Schwab & Co., Inc. ("CS&Co." or the "Firm"), the defendant in the injunctive action captioned above brought by the Securities and Exchange Commission (the "Commission"). CS&Co. seeks the assurance ofthe staff ofthe Division of Investment Management ("Staff') that it would not recommend enforcement action to the Commission under Section 206(4) ofthe Investment Advisers Act of 1940 (the "Advisers Act"), or Rule 206( 4)-3 thereunder (the "Rule"), if an investment adviser registered or required to be registered pursuant to Section 203 ofthe Advisers Act pays CS&Co. or any of its associated persons, as defined in Section 202(a)(17) of the Advisers Act, a cash payment directly or indirectly for the solicitation of advisory clients, notwithstanding the entry offinal judgment as to CS&Co. by the U.S. District Court for the Northern District of California on July 9, 2018 (the "Final Judgment"), as described below. While the Final Judgment does not prohibit or suspend CS&Co. or any of its associated persons from being associated with or acting as an investment adviser (except as provided in Section 9(a) ofthe Investment Company Act of 1940 (the "Company Act")), 1 and does not relate to solicitation activities on behalf of any investment 1 Under Section 9(a) ofthe Company Act, CS&Co. and its affiliated persons will, as a result ofthe Final Judgment, be prohibited from serving or acting as, among other things, an investment advisor or depositor of any registered investment company or principal underwriter for any registered open-end investment company or registered unit investment trust. CS&Co. and affiliated persons of CS&Co. who act in the capacities set forth in Section 9(a) of the Company Act have filed an application under Section 9(c) ofthe Company Act (the "Section 9(c) Application") requesting the Commission to issue both temporary and permanent orders exempting them, and CS&Co.'s future affiliated persons should any of them serve or act in any ofthe capacities set forth in Section 9(a) in the future Sidley Austin (NY} LLP is a Delaware limited liability partnership doing business as Sidley Austin LLP and practicing in affiliation with other Sidley Austin partnerships. ACTIVE 232830964

SIDLEY adviser, the Final Judgment may affect the ability of CS&Co. and its associated persons to receive such payments. The Staff in many other instances has granted no-action relief under the Rule in similar circumstances. BACKGROUND CS&Co. is dually registered with the Commission as a broker-dealer and investment adviser. CS&Co. is a wholly owned indirect subsidiary ofThe Charles Schwab Corporation ("CS"). The Commission filed a complaint in federal district court relating to the above captioned proceeding (the "Complaint") alleging violations of Section 17(a) ofthe Securities Exchange Act of 1934 (the "Exchange Act") and Rule 17a-8 thereunder. As discussed below, CS&Co. consented to the entry ofthe Final Judgment, without admitting or denying the allegations made in the Complaint. According to the Complaint, CS&Co. failed to file Suspicious Activity Reports ("SARs") on suspicious transactions by independent, third party investment advisers ("Advisers") that CS&Co. terminated from its custodial platform in violation of Section 17(a) of the Exchange Act and Rule 17a-8 thereunder. Such Advisers were not affiliated or associated with CS&Co. CS&Co. terminated the Advisers for engaging in activity CS&Co. determined violated its internal policies and presented risk to CS&Co. or its customers. The Complaint alleges (1) that CS&Co.' s failure to file SARs during the 2012-2013 time period resulted from its inconsistent implementation of policies and procedures for identifying reportable transactions under the SAR Rule (31 C.F.R. § 1023.320(a)) when CS&Co. investigated and terminated Advisers from its custodial platform; (2) although CS&Co. took steps to investigate and terminate Advisers, CS&Co. did not have clear or consistent policies for the types of activities for which SARs (together, the "Covered Persons"), from the restrictions of Section 9(a). On the basis ofthe representations and conditions contained in the Application, the Commission issued a notice and temporary order exempting the Covered Persons from the prohibitions of Section 9(a) of the Company Act resulting from the Final Judgment. The Final Judgment also disqualifies CS&Co. and certain of its affiliates from acting in certain capacities under certain provisions of the Securities Act of 1933 and the rules and regulations thereunder, including Rule 506 of Regulation D. CS&Co. obtained a waiver of the disqualification from relying on Rule 506 of Regulation D that may arise with respect to CS&Co. or any other person as a result of the Final Judgment. ACTIVE 232830964

SIDLEY needed to be filed; and (3) in a number of cases in which Advisers were terminated and there was reason for CS&Co. to suspect fraudulent activity, CS&Co. applied an unreasonably high standard for determining whether to file a SAR on the suspicious transactions. CS&Co. submitted an executed Consent ofthe Defendant Charles Schwab & Co., Inc. to Entry of Final Judgment (the "Consent"), which was presented to the U.S. District Court for the Northern District of California when the Commission filed its Complaint. In the Consent, solely for the purpose ofproceedings brought by or on behalf ofthe Commission or in which the Commission is a party, CS&Co. consented to the entry ofthe Final Judgment without admitting or denying the allegations made in the above-captioned proceeding ( except as to personal and subject matter jurisdiction, which were admitted). The Final Judgment permanently restrains and enjoins CS&Co. from violating Section 17(a) ofthe Exchange Act and Rule 17a-8 thereunder and ordered CS&Co. to pay a civil penalty in the amount of $2,800,000. DISCUSSION Rule 206(4)-3 prohibits an investment adviser that is required to be registered under the Advisers Act from paying a cash fee, directly or indirectly, to any solicitor that has been permanently or temporarily enjoined by an order, judgment, or decree of a court of competent jurisdiction (among other disqualifying events) from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security. The Final Judgment causes CS&Co. to be disqualified under the Rule, and accordingly, absent no-action or other relief, CS&Co. and its associated persons are unable to receive cash payments for the solicitation of advisory clients. In addition, because the Final Judgment is not a Commission order, CS&Co. cannot rely on the Staffs no-action letters, dated March 26 and July 3, 2003, to Dougherty & Company, LLC. In the release adopting the Rule, the Commission stated that it "would entertain, and be prepared to grant in appropriate circumstances, requests for permission to engage as a solicitor a person subject to a statutory bar."2 We respectfully submit that the circumstances present in this case are precisely the sort that warrant a grant ofno-action relief. 2 See Requirements Governing Payments ofCash Referral Fees by Investment Advisers, Release No. IA-688 (July 12, 1979), 17 S.E.C. Docket (CCH) 1293, 1295, at note 10. ACTIVE 232830964

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The Rule's proposing and adopting releases explain the Commission's purpose in including the disqualification provisions in the Rule - namely, to prevent an investment adviser from hiring as a solicitor a person whom the adviser would not be permitted to hire as an employee, thus doing indirectly what the adviser could not do directly. In the proposing release, the Commission stated that:
[b]ecause it would be inappropriate for an investment adviser to be permitted to employ indirectly, as a solicitor, someone whom it might not be able to hire as an employee, the Rule prohibits payment of a referral fee to someone who ... has engaged in any of the conduct set forth in Section 203(e) ofthe [Advisers] Act ... and therefore could be the subject of a Commission order barring or suspending the right of such person to be associated with an investment adviser. 3 The Final Judgment does not bar, suspend, or limit CS&Co. or any person currently ~ssociated with CS&Co. from acting in any capacity under the federal securities laws ( except as provided in Section 9(a) of the Company Act).4 CS&Co. has not been sanctioned for conduct in connection with the solicitation of advisory clients for investment advisers nor was any such activity at issue. Accordingly, consistent with the Commission's rationale in proposing and adopting the Rule, there is no reason to prohibit any investment adviser from paying CS&Co. or its associated persons for engaging in solicitation activities under the Rule. In addition, the need for the no-action relief requested is neither theoretical nor speculative, but instead is concrete. CS&Co. is currently contractually entitled to receive cash compensation from certain investment advisers in connection with its solicitation of advisory clients for those advisers. The Staff previously has granted numerous requests for no-action relief from the disqualification provisions ofthe Rule to individuals and entities found by the Commission to have violated a wide range of federal securities laws and rules thereunder or permanently enjoined by courts of competent jurisdiction from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security. 5 3 See Requirements Governing Payments ofCash Referral Fees by Investment Advisers, Release No. IA-615 (Feb. 2, 1978), 14 S.E.C. Docket (CCH) 89, 91. 4 See supra note 1. 5 See, e.g., Macquarie Capital (USA) Inc., SEC No-Action Letter (Jun. 1, 2017); Stifel, Nicolaus & Company, Inc., SEC No-Action Letter (Dec. 6, 2016); F. Porter Stansberry and Stansberry & Associates Investment Research LLC, SEC No-Action Letter (Sept. 20, 2015); JPMorgan Chase & Co., SEC No-Action Letter (May 20, 2015); Royal ACTIVE 232830964

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UNDERTAKINGS
In connection with this request, CS&Co. undertakes that:

1. It, directly or indirectly, will conduct any cash solicitation arrangement entered into
   with any investment adviser registered or required to be registered under Section 203 ofthe Advisers Act in compliance with the terms ofRule 206(4)-3 as if CS&Co. were not a disqualified person for purposes of Rule 206(4)-3 by virtue of the Final Judgment;
2. The Final Judgment does not bar, suspend or limit CS&Co. or any person currently
   associated with CS&Co. from acting in any capacity under the federal securities laws (except as provided in Section 9(a) of the Company Act);
3. It has complied and will continue to comply with the terms ofthe Final Judgment,
   including, but not limited to, the Injunction and the payment of the civil monetary penalty;and
4. For ten (10) years from the date ofthe entry ofthe Final Judgment, CS&Co. and any
   person through whom CS&Co. directly or indirectly conducts its solicitation activities or any investment adviser with which it or any such person has a solicitation arrangement subject to Rule 206(4)-3 will disclose the Final Judgment in a written document that is delivered to each person whom CS&Co. or such persons solicit (a) not less than 48 hours before the person enters into a written or oral investment advisory contract with the investment adviser, or (b) at the time the person enters into such a contract, if the person has the right to terminate such contract without penalty within five business days after entering into the contract. Bank ofCanada, SEC No-Action Letter (Dec. 19, 2014); Bank ofAmerica, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, SEC No-Action Letter (Nov. 25, 2014). ACTIVE 232830964

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CONCLUSION
We respectfully request the Staff to advise us that it will not recommend enforcement action to the Commission if an investment adviser that is required to be registered with the Commission pays CS&Co. or its associated persons a cash payment for the solicitation of advisory clients, notwithstanding the Final Judgment. Elizabeth A. Marino ACTIVE 232830964