Although business development companies and private investment companies are excluded from these performance fee disclosure requirements, hedge funds are not exempt. It should be noted, however, that state regulations vary widely in this regard. Therefore, state-registered advisors should carefully review the specific regulations of the specific states where they are registered.
Your Chair-Standard Structural Provisions
It's vital that your client agreements build a strong relationship foundation that will allow you to appropriately serve your client. Structural provisions you'll want to articulate include whether you will have discretionary power over your client's assets, any relevant investment guidelines or restrictions pertaining to the client's investment policy statement, and ideally your approach to determining investment suitability.
Agreements should detail your brokerage practices, including disclosure of any soft-dollar arrangements, any compensation derived from anyone other than the client, and your policies and procedures on principal transactions and ensuring the best execution. Your firm's proxy voting policies need to be detailed, along with your procedures for transmitting notices and communications. And if your firm either recommends or hires and fires subadvisors, that too must be disclosed.
Conversely, many advisors run into problems of "over-disclosing" when it comes to privacy and confidentiality. While SEC-registered advisors must comply with Regulation S-P and state-registered advisors need to abide by FTC regulations and applicable state laws, there's a tendency on the part of many advisors to try and provide such tight confidentiality assurances that they often include language that, if strictly adhered to, would prohibit them from effectively carrying out their duties.
Keep in mind that the sharing of client information with third parties such as custodians and portfolio management and reporting firms is an essential part of your business. Don't make the mistake of too tightly restricting your ability to share client information with these partners.
Your Bed-Ensuring Peace Of Mind For You And Your Client
In an effort to stave off potential litigation, the temptation among advisors and attorneys alike is to litter their client agreements with a litany of hedge clauses such as "the advisor shall not be liable for losses resulting from any actions taken in good faith." The SEC has taken a strong stance that hedge clauses likely to lead a client to believe they've waived any right of action against their advisor can be considered a fraudulent and deceptive practice. So it's best to be judicious when using them. Make sure you include language to the effect that "nothing in this contract should be construed as a waiver or limitation of any rights that you may have under applicable state or federal law."
Arbitration
When it comes to the inclusion of arbitration provisions, the difficult question is, "Who do you listen to?" The SEC has traditionally expressed concern about advisors including mandatory arbitration clauses in agreements. In addition, Congress recently asked the SEC under Dodd-Frank to consider whether mandatory arbitration clauses should be allowed. The U.S. Supreme Court, however, has held that pre-dispute arbitration agreements are both valid and enforceable.
In light of the uncertainty, it may be best to refrain from including any arbitration provision to your client agreements. If you do choose to add one, however, the inclusion of some language that provides "this agreement to arbitrate does not constitute a waiver of your right to seek a judicial forum where such waiver would be void under federal or applicable state securities laws" will help you avoid the wrath of the SEC.
Assignment
The SEC also requires that your advisory contracts include language stating that the contract may not be assigned without the client's consent. Depending on the specific circumstances of the assignment, that consent may be obtained either expressly or implied after sufficient notice. Keep in mind, however, that for state-registered advisors, some states mandate written consent before agreements can be assigned.
Termination
The SEC has stated that a client has the right to terminate an advisory relationship at any time, so this right must be clearly articulated. If a client does terminate an advisory contract, you must make a pro rata refund of any prepaid advisory fees. The SEC does, however, allow for reasonable start-up or termination expenses to be charged, assuming those expenses are disclosed in your client agreements.
Non-Exclusivity
Your client agreements should also include non-exclusivity representations that not only elucidate the fact that your services are not exclusive to that client, but also that you may manage assets in a different manner for other clients. This will afford you some protection from future claims that might arise when Client A learns of Client B's significantly better portfolio performance and feels mistreated.