Client Communication and Compensation - Investment Advisory Contracts

Contracts between IAs and Clients
While state laws require that contracts between state-registered IAs and clients be in writing, the Investment Advisers Act of 1940 does not.
However, most IAs take the initiative to put their contracts in writing to avoid misunderstandings.

SEC Rules on WrittenIA Contracts
SEC rules impose the following conditions on a written investment advisory contract:

  • Performance-based fees are generally prohibited (we'll discuss further in the next section).
  • Contract language must not lead clients to believe they have waived rights to take legal action against the adviser.
  • There must be no provisions that force the client to waive compliance with any of the rights or rules within the Investment Advisers Act of 1940.
  • The contract must prohibit the IA from assigning the contract without the client's consent.


Exam Tips and Tricks
Although the NASAA Model Rule on Unethical Business Practices states that written contracts are required, the questions on the exam reference oral contracts.


Uniform Securities Act Rules on Contracts
Under the Uniform Securities Act, IA contracts must do the following:

  • Disclose all material information regarding the services to be provided and the fees to be charged
  • Disclose conditions under which the contract may be assigned to another party
  • Require client consent prior to the IA assigning the contract
  • Require the IA (if a partnership) to notify the client of any change in the membership of the partnership
  • Prohibit the IA from being compensated on the basis of sharing in capital gains or capital appreciation of the client's accounts (however, fees based on the total value of the account, such as an assets under management fee, are allowed)

Performance Guarantees
Performance guarantees are generally considered a conflict of interest. The hallmark of an investment adviser is objectivity, so there must be no personal interest in the outcome of any specific investment recommendation. Also, guaranteeing a client's account against loss is specified as an unethical business practice under the Uniform Securities Act.


Look Out!
Remember that guaranteeing a client\'s account against loss is a type of performance guarantee. The Series 65 exam is not likely to test you on any distinction between these two concepts.

Advertising


Related Articles
  1. Professionals

    Investment Advisor Contracts

    FINRA/NASAA Series 66 - Investment Advisor Contracts. In this section Investment Advisor contract requirements and performance guarantees.
  2. Professionals

    Other Prohibited Behaviors

    FINRA/NASAA Series 65 - Other Prohibited Behaviors. In this section unethical actions, conflicts of interest, agency cross transactions and insider trading.
  3. Professionals

    Prudent Investor Standards

    FINRA/NASAA Series 65 - Prudent Investor Standards. In this section the prudent person rule and sample question.
  4. Professionals

    Prudent Investor Standards

    FINRA/NASAA Series 66 - Prudent Investor Standards. This section explains the prudent investor standards.
  5. Professionals

    Other Prohibited Behaviors

    FINRA/NASAA Series 66 - Other Prohibited Behaviors. This section describes other prohibited behaviour such as misrepresentations, third-party research, improper facts, misleading statements and ...
  6. Professionals

    Introduction

    FINRA/NASAA Series 66 - Client Communication and Compensation Issues. This section explains the need and use of brochure rule.
  7. Professionals

    Conflicts of Interest

    FINRA/NASAA Series 65 - Conflicts of Interest. In this section curning, client loans and exceptions to client loans.
  8. Professionals

    The Brochure Rule

    FINRA/NASAA Series 65 - The Brochure Rule. This section outlines the document requirements of brochure rule.
  9. Professionals

    Solicitation

    FINRA/NASAA Series 65 - Solicitation. This section otlines the rules under which solicitation is permitted.
  10. Professionals

    Solicitation

    FINRA/NASAA Series 66 - Solicitation. In this section rules for solicitation and sample question.
RELATED TERMS
  1. International Accounting Standards ...

    An older set of standards stating how particular types of transactions ...
  2. Onerous Contract

    A type of contract where the costs involved with fulfilling the ...
  3. Assignable Contract

    A futures contract with a provision permitting the contract holder ...
  4. Performance Bond

    A bond issued to one party of a contract as a guarantee against ...
  5. Form 6781: Gains And Losses From ...

    A tax form distributed by the Internal Revenue Service (IRS) ...
  6. Continuous Contract

    A reinsurance contract that does not have a fixed contract end ...
RELATED FAQS
  1. Under what circumstances can an IA choose to sell a security for a client without ...

    A. When the transaction is less than $5,000B. When the IA decides only how many shares to sellC. When the client tells the ... Read Answer >>
  2. Type Of Return

    A client asks an IA to calculate what rate of return must be earned to grow $10,000 to $25,000 in five years. The rate of ... Read Answer >>
  3. What is the difference between forward and futures contracts?

    Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell ... Read Answer >>
  4. All of the following are unethical behaviors prohibited under the Uniform Securities ...

    The correct answer is b. All registrants must follow the client’s instructions, including executing a trade that the registrant ... Read Answer >>
  5. Under the Uniform Securities Act, client information may not be disclosed to a third ...

    The correct answer is c. No authorization is needed from the client’s wife since it is a joint account. Also none is needed ... Read Answer >>
  6. How do the investment risks differ between options and futures?

    Learn what differences exist between futures and options contracts and how each can be used to hedge against investment risk ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center