Advisory agreements for Registered Investment Advisers (RIAs) contain many sections that are important both for the purposes of complying with SEC and state securities regulations, and for constituting a valid agreement between the RIA and the client.

In his latest article for the Nerd’s Eye View blog, Chris Stanley, investment management attorney and Founding Principal of Beach Street Legal, laid out the statutory requirements for RIA advisory agreements and what to include in the agreement when describing the RIA’s services and fees. In this follow-up guest post, Chris expands upon the best practices for drafting advisory agreements and covers numerous other essential elements for advisory agreements to contain, including identifying the client and effective date of the agreement, disclosure responsibilities for the RIA and client, the language around both parties’ rights and responsibilities in the event of a dispute, and how the agreement can be modified or terminated.

To start, the agreement should contain basic information about the adviser-client relationship, including who the client is (e.g., a single person, a couple, a business, or a retirement plan) and the date on which the agreement will become effective.

The agreement should also lay out some acknowledgments for the client to review. These include the acknowledgment that the adviser has provided required disclosure documents like Forms ADV Part 2A/B and Form CRS (and, importantly, has obtained consent to have those documents delivered electronically), acknowledgment of the client’s responsibilities to provide complete and accurate information needed by the adviser in a timely manner and to communicate any changes relevant that might affect the advice given by the adviser, and an acknowledgment that investment and financial planning recommendations involve risk and that there is no guarantee of future performance.

Another important section of the agreement concerns the resolution of disputes between the adviser and the client. While many IRAs include a clause in their advisory agreements limiting their liability in giving financial advice in good faith, the SEC and state regulators have recently been scrutinizing such ‘hedge clauses’ to the extent that they may be found impermissible going forward. At a minimum, the agreement should describe in detail how and where such disputes should be resolved (including which state’s laws the proceedings would be pursuant to).

Finally, the advisory agreement should include provisions for how it may be amended, modified, or terminated, as well as standard legal ‘boilerplate’ language and, of course, a space for the adviser and client to sign the agreement (either physically or electronically).

The key point is that, while the specific requirements for advisory agreements required by the Advisers Act may be fairly narrow in scope, in reality, there are many contractual best practices that advisers can follow to fully comply with Federal and state securities regulations. And even though many advisory agreement provisions can be standardized, agreements should still accurately reflect the advisory relationship with each client (meaning they shouldn’t be so broadly worded as to not reflect the specific services provided and fees charged by the adviser). And while it may not be necessary to have an attorney review every individual agreement signed by a client, it may be wise to obtain some legal advice to aid in the drafting of template agreements (especially given the many state-specific nuances in securities regulation that may diverge from the broad provisions of the Advisers Act).

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Registered Investment Advisers (RIAs) are generally required to enter into an advisory agreement with their clients prior to being hired for advisory services. And while there is no standard ‘template’ language applicable to all advisory agreements, there are a number of best practices that RIAs can follow in drafting and reviewing their agreements to ensure they can pass legal and regulatory muster.

In this guest post, Chris Stanley, investment management attorney and Founding Principal of Beach Street Legal, lays out the statutory requirements for RIA advisory agreements and some of the essential elements for advisory agreements to include when describing the RIA’s services and fees.

Advisory agreements for SEC-registered RIAs are governed by Section 205 of the Investment Advisers Act of 1940. In terms of specific advisory agreement language, the Advisers Act focuses essentially on three items:

• First, the law restricts RIAs from charging performance-based fees unless the client is a “qualified client” (in most cases, a client with at least $1.1 million under the management of the adviser, or with a total net worth of at least $2.2 million);
• Second, advisory agreements are required to give clients the opportunity to consent to their advisory agreement being ‘assigned’ to another adviser (including when an RIA changes ownership by merging with or being acquired by another firm); and
• Third, advisory agreements of RIAs organized as partnerships are simply required to contain a clause informing the client of any change in the membership of that partnership “within a reasonable time after such change”.

But even though the specific requirements of the Advisers Act are relatively narrow in scope, a well-crafted advisory agreement will contain additional elements, including descriptions of the RIA’s services and fees.

When describing the RIA’s services, advisory agreements should lay out the specific services – such as discretionary or nondiscretionary asset management, and the scope and duration of any financial planning services – to be included in the arrangement.

When it comes to fees charged to clients, advisory agreements should include – at minimum – the exact amount of the fee (either as a dollar amount or percentage of assets under management), when the fee will be charged, how the fee will be prorated at the beginning and end of the agreement, how the client can pay the fee, and which of the client’s accounts may be billed. For AUM-based fees, agreements should also include breakpoints for multi-tiered fee schedules (and whether breakpoints are applied on a ‘cliff’ or ‘blended’ basis) and how AUM is calculated (and whether it is based on assets at a single point in time or averaged over a specific period, and if it includes cash and/or margin balances). Any fees for third-party advisers or subadvisers should also be described in the agreement. While these constitute only two core elements of advisory agreements, there are numerous other essential components for RIAs to include (so many, in fact, that covering them all will require another separate article!).

The key point, however, is that a good advisory agreement requires a solid grasp of the Federal and state statutory requirements, and clearly lays out the RIA’s services and fees. For established firms, understanding these points more deeply will allow RIA owners to review their existing agreements – to ensure not only that they comply with existing regulations, but that they also include the elements constituting a valid agreement between RIA and client!

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