Client Communication and Compensation Issues - Introduction

Disclosure - The Brochure Rule
Investment advisors must disclose the nature of the relationship between the client and the IA. IAs cannot participate in, nor be compensated by, any percentage gains of a client's portfolio. These terms must be included within the investment advisor's contract.

The most important rule regarding disclosure is the brochure rule, which requires an IA to provide a written disclosure document to each investment advisory client or potential client. The IA can simply provide a copy of the Form ADV Part II, or create a brochure with substantially the same content. The document must include all of the following information:

  • Background information of the IA and any IARs

  • Services available and the fees for those services

  • Disclosure of any compensation received from third parties (such as commissions or referral fees)

  • Whether the IA exercises discretion over client funds

  • Types of clients for whom advisory services are provided, including any minimum dollar amount for assets to be managed

  • Disclosure of any affiliation with a broker-dealer

  • Any material legal or disciplinary action that occurred within the last 10 years

  • Any financial condition of the IA (such as bankruptcy) that might impair its ability to meet client commitments must also be disclosed if the IA:
    • has discretion over client accounts.
    • has custody of client monies or securities.
    • requires prepayment of more than $500 in fees, more than six months in advance.

The brochure must be provided at least 48 hours before entering into an advisory contract, or at the time of entering into a contract, if the client has the right to terminate the contract without penalty within five business days. Each year, the IA must deliver (or offer to deliver) its disclosure document to existing clients. Failure to meet disclosure requirements is considered fraudulent behavior.


Look Out!
It is crucial for you to know when the brochure must be given; the timing of this disclosure is frequently tested on the exam. Remember, it is not true that a brochure must be provided prior to entering into the contract; however, the contract must then explicitly offer the right to terminate without penalty within five business days. If this offer is not part of the contract, the brochure may not be provided at the time of signing the contract. Watch for answers such as "...if the IA states he/she has a right to terminate within five business days..." - this is incorrect, since a verbal statement is not sufficient.


Under the USA, an additional disclosure is required if the IA acts as principal for its own account or as broker for both an advisory client and another person on any securities transaction. In these instances, the IA must disclose (prior to completion of the transaction) in what capacity it is acting, and it must receive the client's written consent.

Wrap fee (or wrap account) programs require a special disclosure form instead of the Form ADV Part II. For these purposes, the SEC definition of wrap accounts does not include:

  • Managed account programs - Traditional portfolio management services offered by money managers

  • Mutual fund asset allocation programs - Bundled programs that charge a percentage of assets fee to manage a portfolio of no-load (or load-waived) mutual funds

The wrap fee disclosure must include the following information (where applicable):

  • The amount of the wrap fee, the services that are included, and whether the fees are negotiable
  • Any additional fees that might be required
  • What methods are used to select portfolio managers
  • What compensation is paid to the person who recommended the program


    Look Out!
    It is crucial for you to know when the brochure must be given; the timing of this disclosure is frequently tested on the exam. Remember, it is not true that a brochure must be provided prior to entering into the contract; however, the contract must then explicitly offer the right to terminate without penalty within five business days. If this offer is not part of the contract, the brochure may not be provided at the time of signing the contract. Watch for answers such as "...if the IA states he/she has a right to terminate within five business days..." - this is incorrect, since a verbal statement is not sufficient.

  1. The brochure rule applies to:
    1. only discretionary advisory contracts.
    2. only written advisory contracts.
    3. only oral advisory contracts.
    4. both oral and written advisory contracts.

The correct answer is "d". The brochure rule applies to all investment advisory contracts.

  1. Under the brochure rule, the IA clients (or potential clients) must receive a copy of the brochure:
    1. at least 48 hours prior to entering into an advisory contract.
    2. within 24 hours of entering into an advisory contract.
    3. at the time of entering into an advisory contract, as long as the client can terminate the contract without penalty within three days.
    4. within five days of entering into an advisory contract.

The correct answer is "a". "c" is wrong because this provision only applies if the client can terminate within five days.

Investment Advisor Contracts
Related Articles
  1. FA

    The Basics of The Series 79 Exam

    Passing the Series 79 exam is usually necessary for anyone who wants to work in investment banking.
  2. Term

    What is the Series 66?

    The Series 66 exam is one of two tests required to register as both a securities agent and an investment advisor.
  3. Professionals

    Breaking Down Financial Securities Licenses

    Find out which exam you need to begin your career as an investment professional.
  4. Professionals

    Career Advice: Financial Analyst Vs. Investment Banker

    Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
  5. Professionals

    Who Needs to Take the Series 65?

    Most states require individuals to pass the Series 65 exam in order to act as investment advisors.
  6. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  7. Professionals

    Understanding Series 6

    Upon successful completion of the Series 6, an individual will have the qualifications needed to sell open end mutual funds and variable annuities
  8. Professionals

    Top Strategies on How to Become a Stock Broker

    Gunning to be a stock broker and want an edge? Here's some veteran advice.
  9. Trading Systems & Software

    Steps to Starting Up an Independent Broker Dealer

    Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
  10. Professionals

    Understanding Series 63

    Series 63 is a securities license that entitles the holder to sell securities in a particular state.
RELATED TERMS
  1. Series 6

    A securities license entitling the holder to register as a limited ...
  2. Series 79

    A examination to ensure a candidate is qualified to become a ...
  3. Research Analyst

    A person who prepares investigative reports on equity securities. ...
  4. Series 34

    An exam required for individuals seeking to engage in off-exchange ...
  5. Financial Advisor

    One who provides financial advice or guidance to customers for ...
  6. Series 23

    An exam offered by the Financial Industry Regulatory Authority ...
RELATED FAQS
  1. Is a financial advisor required to have a degree?

    Financial advisors are not required to have university degrees. However, they are required to pass certain exams administered ... Read Full Answer >>
  2. If I have only a limited amount of time to study for the Series 6, what should I ...

    The Series 6 Investment Company and Variable Contracts Products Representative Qualification Examination is administered ... Read Full Answer >>
  3. What role does the 'chip cycle' play in the electronics sector?

    There are several highly acclaimed private Series 6 Exam courses in the United States. Many can be completed online. Popular ... Read Full Answer >>
  4. What does passing the Series 6 enable me to do?

    The Series 6, or the Investment Company Products/Variable Contracts Limited Representative, exam is administered by the Financial ... Read Full Answer >>
  5. What are the differences between the Series 6 exam and the Series 7 exam?

    The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
  6. Do I have to successfully complete the Series 7 exam before I can register for the ...

    There are no prerequisites to register for the Series 63 exam. However, once you have registered for the exam, you must schedule ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center