Key Takeaways
- Advisory contracts must be in writing and contain specific required provisions.
- Assignment of contracts requires client consent; change in control is deemed assignment.
- Performance-based fees are restricted to 'qualified clients' meeting wealth thresholds.
- Qualified client thresholds: $1.1 million AUM OR $2.2 million net worth.
- Hedge clauses that waive fiduciary duty are prohibited.
- Prepaid fees must be refunded pro-rata upon termination.
- Clients must be able to terminate without penalty.
- Contract must disclose services, fees, term, and termination provisions.
Advisory Contracts
Investment advisory agreements must meet specific requirements under both federal and state law.
Required Contract Provisions
Essential Elements
| Provision | Requirement |
|---|---|
| Services | Detailed description of advisory services |
| Fees | Fee structure, calculation method, billing frequency |
| Term | Duration of the agreement |
| Termination | How either party can end the relationship |
| Assignment | Consent requirement for assignment |
| Authority | Discretionary vs. non-discretionary |
Additional Disclosures
Contracts should also address:
- Investment restrictions or guidelines
- Custody arrangements
- Proxy voting policies
- Conflict of interest disclosure
- Risk factors
Fee Arrangements
Common Fee Structures
| Type | Description | Typical Range |
|---|---|---|
| Assets Under Management (AUM) | Percentage of assets | 0.25% - 2.0% annually |
| Hourly | Billed for time spent | $150 - $500/hour |
| Fixed/Flat | Set fee for services | Varies by scope |
| Performance-Based | Based on investment returns | Subject to restrictions |
| Wrap Fee | All-inclusive fee | 1.5% - 3.0% annually |
AUM Fee Calculation
Example: 1% annual fee, billed quarterly
- Portfolio value: $1,000,000
- Annual fee: $10,000
- Quarterly fee: $2,500
Fee Billing Methods
| Method | Description |
|---|---|
| Advance billing | Charged at beginning of period |
| Arrears billing | Charged at end of period |
| Tiered fees | Lower percentage for higher assets |
| Breakpoints | Rate reduction at asset thresholds |
Performance-Based Fees
General Prohibition
Section 205(a)(1) of the Advisers Act prohibits performance fees for most clients.
Qualified Client Exception
Performance fees ARE permitted for "qualified clients" under Rule 205-3:
| Qualification Method | Threshold (2025) |
|---|---|
| Assets under management | $1,100,000 with the adviser |
| Net worth | $2,200,000 (excluding primary residence) |
| Qualified purchaser | As defined in Investment Company Act |
| Knowledgeable employee | Of the investment adviser |
Threshold Adjustments
- SEC adjusts thresholds every 5 years for inflation
- Clients who qualified under prior thresholds remain qualified
- New clients must meet current thresholds
Fulcrum Fee
One type of permitted performance fee:
- Fee increases if performance exceeds benchmark
- Fee decreases if performance falls below benchmark
- Changes must be symmetrical
Assignment of Contracts
What Constitutes Assignment?
| Action | Assignment? |
|---|---|
| Transfer of contract | Yes - direct assignment |
| Change in controlling interest | Yes - deemed assignment |
| Death of sole proprietor | Yes |
| Sale of substantially all assets | Yes |
| Change in non-controlling ownership | No |
Assignment Requirements
| Requirement | Details |
|---|---|
| Client consent | Must be obtained before assignment |
| Form of consent | Written preferred; "negative consent" may be acceptable |
| Notification | Notify client of the change |
| Right to terminate | Client can terminate without penalty |
Negative Consent
Some states allow "negative consent" where:
- Client is notified of assignment
- Client is given time to object (typically 30 days)
- Silence = deemed consent
Prohibited Contract Provisions
Hedge Clauses
Prohibited hedge clauses include provisions that:
- Waive adviser's compliance with securities laws
- Limit liability for violations of fiduciary duty
- Release adviser from negligence liability
Allowed Disclaimers
General disclaimers are acceptable if they:
- Do not negate fiduciary duty
- Are not misleading
- Don't purport to waive securities law compliance
Example of allowed language: "Investment involves risk and past performance does not guarantee future results."
Termination Provisions
Client Rights
| Right | Description |
|---|---|
| Terminate at will | Client can end relationship |
| No penalty | Cannot penalize early termination |
| Refund of prepaid fees | Pro-rata refund required |
Prepaid Fee Refund
Example: Client pays $4,000 quarterly in advance
- Terminates after 1 month
- Refund: $4,000 × (2/3) = $2,667
Adviser Termination Rights
Advisers may terminate with:
- Reasonable notice
- Return of client assets
- Orderly transition to new adviser
Wrap Fee Programs
Special contract requirements for wrap fee programs:
| Requirement | Description |
|---|---|
| Separate brochure | Schedule H wrap fee brochure |
| Disclosure of services | What's included in wrap fee |
| Conflicts | Trading incentives (less trading = more profit) |
| Cost comparison | When wrap may cost more than unbundled |
Exam Tip: Performance fees are for QUALIFIED CLIENTS only ($1.1M AUM or $2.2M net worth). Assignment requires CLIENT CONSENT. Hedge clauses that waive fiduciary duty are PROHIBITED. Prepaid fees must be refunded PRO-RATA.
Performance-based advisory fees may be charged to:
An investment adviser firm is being acquired. This acquisition:
Which contract provision is prohibited?
A client pays a $6,000 quarterly fee in advance and terminates after one month. The client is entitled to a refund of:
14.3 Cybersecurity and Privacy
Continue learning