Under Section 205 of the Investment Advisers Act of 1940 (“Investment Advisers Act”), an investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”) shall not “enter into, extend, or renew any investment advisory contract, or in any way to perform any investment advisory contract entered into, extended, or renewed…” unless the investment advisory contract meets certain requirements specified under Section 205. Section 205(d) of the Investment Advisers Act defines an investment advisory contract as “any contract or agreement whereby a person agrees to act as an investment adviser to or to manage an investment or trading account of another person….”
Although the Investment Advisers Act does not expressly require that agreements or advisory contracts be in writing, it is generally considered best practice to have a written agreement between the investment adviser and the client and certain provisions of the Investment Advisers Act, such as Section 205, and SEC Rule 204-2, the books and records rule, is based on the existence of written agreements or advisory contracts. For example, Rule 204-2(a)(9) under the Investment Advisers Act requires SEC registered investment advisers to maintain, “[a]ll powers of attorney and other evidence of the granting of any discretionary authority by any client to the investment adviser, or copies thereof.” Similarly, Rule 204-2(a)(10) requires SEC registered investment advisers to maintain, “[a]ll written agreements (or copies thereof) entered into by the investment adviser with any client or otherwise relating to the business of such investment adviser as such.” If a dispute or a regulatory inquiry or investigation occurs, a written investment advisory agreement will serve to provide evidence of the registered investment adviser’s authority to act on the client’s behalf as well as the level of authority the investment adviser has been given by the client.
When entering into an investment advisory contract with a client, an SEC registered investment adviser must make sure that at a minimum the investment advisory contract meets the following requirements.
- No assignments without client consent – Section 205(a)(2): The investment advisory contract must provide that the investment adviser cannot assign the contract without the client’s consent; therefore, the investment advisory contract must convey that the investment advisory services provided by the SEC registered investment advisory may not be assigned by the investment adviser to any other person(s) without prior consent from the client.
- Disclosures of general partnership changes – Section 205(a)(3): If the registered investment adviser is a partnership, the investment advisory contract must provide that the investment adviser will notify the client to changes in membership of the partnership within a reasonable time period after any change.
- Restrictions on Performance Fees – Section 205(a)(1): Investment advisory contracts generally shall not provide for compensation to the registered investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds of a client (“performance fees”). However, Section 205(b) of the Investment Advisers Act provides certain circumstances when Section 205(a)(1) will not apply and Rule 205-3 under the Investment Advisers Act provides certain exemptions from the compensation prohibition under Section 205(a)(1) and allows investment advisers to receive performance fees in certain limited circumstances.
- Prohibition of Waiver of Compliance – Section 215 (a) & (b): Section 215(a) states that “Any condition, stipulation, or provision binding any person to waive compliance with any provision of this title or with any rule, regulation, or order thereunder shall be void.” The SEC believes that any clauses or provisions that are likely to lead clients to believe that they have waived their rights of legal action under federal securities laws or common law may violate the anti-fraud provisions of the Investment Advisers Act. Therefore, hedge clause provisions generally may not be included in investment advisory contracts.
The securities laws of many states actually require written investment advisory agreements and require the investment advisory contracts to meet at a minimum the same requirements previously stated. Additionally, many state securities regulators require certain basic terms and disclosures such as, services to be provided, the term of the contract, the advisory fee or formula for computing the fee, and the manner for pro-rating pre-paid fees at termination.
For more information on investment advisory contracts, attorney, Bryan Hill, will share his insights about key provisions and disclosures that should be included in an investment advisory agreement during a webinar sponsored by RIA Compliance Consultants on June 6, 2013, at 12:00 CDT, titled: “Key Elements that Should be Included in an Investment Advisory Client Contract – Presented by Bryan Hill Law.” During this webinar Mr. Hill will review state and federal regulatory requirements, common mistakes and best practices for an investment adviser to consider when preparing its client agreement. (Please note RIA Compliance Consultants is not a law firm.) For more information and to register for this event, please click here.
Posted by Bryan Hill
Labels: Books Records, Client Contracts, Compliance Program, Investment Advisory Client Contracts, Webinar