A properly drafted Advisory Agreement will help limit your professional liability by making a record of the mutual understanding of you and your client as to services, client responsibilities, fees, and timing of billing.
By clarifying the exact nature and extent of the services rendered you can hopefully prevent unfounded expectations that the client may have. Properly drafted advisory agreements can enhance your professional image. Agreements can help you comply with required disclosures and record keeping requirements of the Investment Advisers Act of 1940. Finally, written agreements serve as a basis to enforce claims against clients for unpaid fees.
A problem advisors encounter is what to put in the Agreement. Advisors will borrow language of Agreements from colleagues, and try to blend multiple samples into one. But this often results in inconsistent language throughout the Agreement, let alone from the advisor’s own Form ADV. This article will provide guidance on how to compose an Advisory Agreement.
I often see Advisory Agreements simply list “SERVICES” as “Advisor has the discretionary authority to trade the account.” What does this really mean? That is more of a “Trading Authorization” than a description of the Services. Perhaps a better Services clause may read, “Advisor shall provide Money Management. Investments will be implemented in no-load mutual funds. The portfolio is reviewed quarterly for rebalancing. Client receives a quarterly performance report.”
Of course if you provide “supervisory” (on-going) monitoring of the account, your language will vary. Your Form ADV will describe your service(s) in more detail, but you do need to have a brief synopsis of what you are doing for the client in your Agreement.
TRADING AUTHORIZATION will describe the authority to buy/sell securities and/or the authority to select a broker/dealer. Many advisors only “recommend” a broker/dealer, but may not actually have the discretionary authority to select a broker/dealer. Is your authority only to rebalance portfolios back to an agreed upon asset allocation model? Be specific as to what your authority includes and does not include.
PROXY VOTING is an issue that advisors with discretion must address. You either must explicitly disclaim proxy voting authority, or include language about your authority to vote.
FEE PAYMENT AUTHORIZATION is an important clause that should have its own heading. Do not bury it in your Compensation language. The ability to deduct your advisory fees from your client account does constitute custody, and there is some specific language you should include.
A requirement for advisors with custody is to disclose the name and address of the custodian.
The TERMINATION clause for managed accounts generally reflect “on-going services until either party terminates on X days written notice.” But an on-going agreement is not appropriate for financial planning services. A Plan is a snapshot in time and the service should terminate upon delivery of the Plan to protect your professional liability. Financial planning updates should be done under the term of a new Agreement each year. Yes, it is [just a minor] pain for you, but have the client sign a new Agreement. The client probably does not mind as much as you do. But the legal protection it affords you is well worth the minutes it takes to get a new signature.
Your COMPENSATION clause needs to include your fee schedule, hourly rate schedule, or fill in the blank. What is the timing of the payment? (Quarterly in advance or arrears? How is the first partial [pro-rata] payment handled and how about subsequent payments?)
A common mistake advisors make is to include indemnification clauses. The SEC considers these to be illegal “hedge clauses.” What you can include is “BASIS OF ADVICE” language stating that you do not guarantee the results.
You are not required to arbitrate disputes, however, if you want arbitration, make sure to include a valid ARBITRATION clause. Make sure you include language that says, “Arbitration is final and binding on the parties.” Also do not mistakenly copy arbitration clauses from broker/dealer new account forms, because regulations for broker/dealers require different language than what is necessary for investment advisors. Despite what you might see elsewhere, investment advisors need to state, “Client understands that this Agreement to arbitrate does not constitute a waiver of the right to see a judicial forum where such waiver would be void under the federal securities laws.” Also watch for law updates that may ban the practice of mandatory pre-dispute arbitration clauses.
You must include a clause providing for “written consent of the client for any assignment” of the contract.
Client is to acknowledge receipt of your Form ADV Part 2 (formerly ADV Part II). Best place for this is in bold immediately above the client signature. The regulators may cite the advisor for a deficiency if this receipt language is not prominent.
This article covered the important regulatory components of your Advisory Agreement. There are other provisions that your legal counsel or compliance consultant would recommend for inclusion in your Agreement.
Note from the editor: You don’t need to start from scratch in drafting your Agreement, and you don’t need to have an outside party draft a custom Agreement for you. The Consortium provides an Advisory Agreement template. It is delivered to you in WORD for your easy customization. There is no one-size fits all Agreement. The template prompts you to make decisions that match your operations. For more details go to: http://www.liftburden.com/prod-advisory-agree.html