Section 205 of the Investment Advisers Act of 1940 outlines requirements for Investment Advisory Contracts. My recent experience with an investment adviser reminded me to not only look at the rule itself but also to look at other’s work and my own experience having reviewed and audited IMAs for applicability and impact. Here is a short list to look out for:
- Advisory fee – Rule 205 (a)(1) specifically prohibits investment advisory contracts that contain performance fees as well as contingent fee arrangements.
- Assignment of advisory contracts – There should be a provision to require client consent before the assignment/transfer of an advisory contract. This includes when there is a change of control if the adviser is a corporation or a change in partnership.
- Hedge and arbitration clauses – Adviser can not include any statement waiving their compliance obligations to the Advisers Act. In addition, there is a new claused added from the Dodd-Frank Act that essentially discourages an arbitration clause.
- Termination penalties – Client should not be penalized if they want to terminate the relationship. The adviser can only charge for services already performed.
- Rescission rights – The client has the right to sue for rescission of the contract if the contract was found in violation of the Advisers Act.
There are many outlines on the requirements, but I found this outline (published and updated for many years), by Robert Plaze, former Deputy Director of the Division of Investment Management at the SEC particularly easy to understand as well as providing a wealth of cases.
https://s3.amazonaws.com/assets.production.proskauer/uploads/f09a98d6a3772c83e8ddef323215f446.pdf
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