IA Compliance:
Best Practices for Investment Advisory Contract Terms
The following information reflects the views of NASAA’s Investment Adviser Section Resources and Publications Project Group. It does not necessarily represent the views of NASAA, and it is not intended as legal advice. Any questions should be directed to the appropriate state regulators.
Every investment adviser (“adviser”) is required to execute an investment advisory contract (“contract”) with each client, outlining the services provided and the fees to be charged for such services. Often, advisers utilize a contract template; however, it is important to review the template for accuracy, applicability to the adviser’s business, and to ensure the disclosures meet and comply with state and federal securities laws. This article outlines potential issues in contract templates and offers best practices advisers can consider to avoid common deficiencies.
Problematic Language
Use of negative consent
Negative consent is when a change in the terms automatically goes into effect unless the client explicitly rejects, often in writing, the change within a certain time period. Essentially, inaction by the client is consent to the change. Many jurisdictions prohibit negative consent language and require all parties to affirmatively consent in writing to any contract amendments or assignment. This usually requires the formal execution of a new contract or an addendum. Below are two common examples of where negative consent language may appear:
Fees
If the fee is amended or changed for any reason, the client understands and agrees that the fee shall continue until 30 days after the adviser informs the client in writing of any change in the fee amount applicable to the account(s). At such time, the new fee will become effective unless the client notifies the adviser in writing that the terms of the amendment are not accepted or the account(s) is to be closed.
Assignment
Should there be a change of control of the adviser, the successor firm will notify the client in writing within a reasonable time after the change and continue to provide the services previously provided to the client by the adviser. If the client continues to accept the services provided by the successor without written objection during the thirty (30) days after receipt of the written notice from the successor, the successor may assume that the client has consented to the assignment, and the successor will become the adviser to the client under the terms and conditions of this contract.
Use of mandatory arbitration and indemnification clauses
Some contracts may include clauses which improperly limit or restrict their clients’ legal rights. A mandatory arbitration clause requires disputes between the adviser and client to be resolved through arbitration, in lieu of other means otherwise available to the client. Some jurisdictions prohibit mandatory arbitration clauses altogether. Additionally, an indemnification clause, also known as a “hedge” clause, typically limits the adviser’s liability to only acts of gross negligence or willful misconduct.
Many jurisdictions require a “non-waiver disclosure” indicating that nothing in the contract, including arbitration and indemnification clauses, should be construed as a waiver of any rights the client has under federal or state securities laws. This disclosure should be prominent.
Advisers should consider how these types of clauses may conflict with their fiduciary duties to their clients.
Contract Terms to Consider
Death and disability clause
It is important for advisers to contemplate how their relationship with their client will change in the event of the client’s death or disability. Some contracts include a death or disability clause that grants the adviser authority even after a client’s death or incapacitation. The use of such language should generally be followed by a subclause stating that the client’s emergency contact or executor can terminate the agreement through notice. Other contracts may terminate immediately upon a client’s death, though this may make administering their assets difficult. Advisers should use terms that best align with their capabilities and the client’s desires.
Electronic Signatures & delivery of documents
Many businesses are moving to electronic signature and delivery for contracts and other documents. Contracts should clearly state how the adviser will execute contracts with and provide documents to clients. If the adviser chooses to deliver documents electronically, they must use proper encryption to protect the client’s personal identifiable information. They should also ensure that they maintain documentation to evidence that the client signed and received a copy of the contract or other documents. This may involve a third-party service provider, which the adviser should conduct due diligence on before using the service.
Best Practices
Advisers should consider the following best practices when drafting and reviewing their contracts:
- Ensure that all required disclosures are included in the contract, pursuant to their jurisdiction’s rules and regulations;
- Use plain English, and do not rely on boilerplate templates that may be filled with legalese and jargon that neither party understands. The examples cited above do not utilize plain English and are difficult to read and comprehend; and
- Review contract terms and disclosures for consistency with firm practices and the firm brochure. Advisers should particularly review the following areas for accuracy and consistency:
- Terms and services;
- Types of authority (e.g. discretion, custody, proxy voting, etc.); and
- Fees, method(s) of payments, and the refund policy in the event of termination.
Conclusion
Advisers should review the terms and disclosures in contracts to ensure they are fair, honest, complete, aligned with firm practices, and consistent across all documents. Contract requirements may vary by jurisdiction. Please contact the applicable jurisdiction’s securities regulator with any questions.
