A Registered Investment Advisor typically wishes to avoid customer disputes if at all possible. Compared to RIAs, brokers, and other providers of financial services, individual customers often receive considerable sympathy from courts and governing bodies during legal disputes. The International Centre for Settlement of Investment Disputes states that customers receive favorable decisions in 56 percent of all claims. This is consistent with the “underdog effect,” a phenomenon explored by various researchers over the years––including those at the American Journal of Political Science. One of the most efficient strategies for avoiding these disputes is to create effective client-facing RIA agreements. RIA regulatory defense attorneys can offer guidance and assistance throughout the contract drafting process to limit needless disputes. Contact the Altitude Securities Law Office at (405) 534-4914 to learn more. 

What Is an RIA Client-Facing Agreement?

In basic terms, a client-facing agreement is any contract between a customer and a business that outlines the delivery of services or goods. An RIA client-facing agreement outlines how the RIA will provide investment advisory services to its customers. Many RIAs also refer to these contracts as “advisory agreements.” 

A client-facing agreement may also help to ensure regulatory compliance with the Securities and Exchange Commission (SEC). If an RIA is registered with the SEC, it must carefully draft its client-facing agreement in accordance with SEC guidelines. 

SEC Guidelines for RIA Client-Facing Agreements

The SEC outlines several requirements for client-facing agreements under Section 205 of the Investment Advisers Act. These requirements impose regulatory restrictions on fee structures as well as mandating when and how any changes must be communicated to clients.

Performance-Based Fees Are Banned for Many RIAs

When a customer pays performance-based fees, they provide compensation based on the total upside associated with their investments. If these investments perform well over a specified period, they will pay higher fees. If the investments lose money, they may not have to pay any fees whatsoever. 

Under SEC guidelines, performance-based fees are banned for most RIAs, and client-facing agreements should only mention them under very specific circumstances. Exceptions may apply to performance-based fees for “qualified customers” with a certain level of Assets Under Management (AUM). A 1998 amendment to Section 205 states that these fees may also be acceptable for clients who are “financially sophisticated.” Before offering a performance-based fee structure, consider speaking with a qualified regulatory defense attorney at the Altitude Securities Law Office. 

Customers Must Consent to Certain Changes

Under SEC guidelines, certain changes to advisory agreements require customers’ consent. If a customer becomes accustomed to working with a particular adviser, the RIA cannot assign that client to a different adviser on a whim. Even if the RIA changes ownership or merges with another firm, the account cannot be transferred without the client’s explicit consent to having their assets managed by new professionals. 

RIAs Must Notify Customers of Certain Partnership Changes

For RIAs with a partnership structure, any advisory agreement must include clauses that ensure prompt notification, to clients, of certain membership changes. If partners at the RIA change, SEC guidelines require that all customers must be informed within a reasonable amount of time. 

What Should an RIA Client-Facing Agreement Include?

Aside from required additions under SEC guidelines, effective client-facing agreements for RIAs often encompass a number of additional elements. Some examples include:

A Description of the Fee Structure

The client-facing agreement should describe the fee structure in detailed, clear terms. Include not only the amounts, but also due dates and prorating calculations. Consider describing calculation processes for AUM, including averages. Include any third-party fees that may be passed on to customers. Remember that performance-based fees are not allowed for many clients. If the customer meets the SEC requirements under Section 205, however, and the RIA wishes to pursue a performance-based fee structure, the agreement should include a description of performance-based fees, including multi-tiered schedules, breakpoints, and profit calculation methods. 

Describe the Dispute Resolution Process

While effective client-facing contracts can prevent potential disagreements, they also streamline inevitable disputes. An RIA client-facing agreement should clearly explain the dispute resolution process. The document might also specify limitations on liability in certain situations. However, liability limitation is an area that is subject to complex SEC regulations, and dispute resolution may be further complicated by state-specific regulations. RIAs may wish to consult with a regulatory defense attorney to ensure compliance in this particular section of the agreement. 

Client’s Signature on Certain Acknowledgments 

The client should acknowledge in writing that they have provided certain documents and disclosures in good faith. They should also provide their consent to provide these forms in electronic format. In addition, the agreement should require the client to review their responsibilities, such as accurate and timely communication with the advisor. Perhaps most importantly, the client should acknowledge in writing that investing comes with inherent risk, and returns are not guaranteed. 

Basic Information

Finally, each RIA client-facing agreement should include basic information. This includes the specific identity of the client. Accuracy is important in this area, and each client-facing advisory agreement must specify whether the agreement is with an individual, a business entity, or a retirement plan. Specificity is also important when it comes to dates. Ensure that the agreement clearly outlines exactly when the client-RIA relationship will begin, and for how long (and under what circumstances) it will continue.

Should I Mention the Custodian in an RIA Agreement?

In addition to the client and the RIA, there may be an important third party to consider in this overall relationship: the custodian. The client signs a separate agreement directly with the custodian. This agreement will describe the role of the custodian in this relationship, including how they will follow trading instructions, when they will deduct fees, and so on. 

The custodian should not be mentioned in the RIA client-facing agreement because they play no role in the relationship between the RIA and the client. Although the RIA, the custodian, and the client have a triangular relationship with many overlapping connections, the client-facing agreement is a two-party contract. Not only does the custodian play no part in this agreement, but in their own, separate agreements with RIAs they often specifically instruct the RIAs with whom they contract not to mention them in these documents. 

Contact an RIA Regulatory Defense Lawyer

Although online research provides a general outline of effective RIA client-facing agreements, regulatory defense lawyers can offer further guidance. The most effective client-facing agreements are highly personalized based on the specific needs of each RIA, its clients, and other varying factors. To discuss the most appropriate approach to the contract drafting process, consider contacting the Altitude Securities Law Office. Call (405) 534-4914 today to get started.