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Top 12 Regulatory Deficiencies for RIAs — #3 Advisory Agreements

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What You Need to Know

According to the North American Securities Administrators Association (NASAA), 44% of regulatory exams conducted in 2013 resulted in deficiencies related to the firm’s contracts or advisory agreements.

The most common contract deficiency was not in the content of the contracts, but instead the faulty execution of them. In cases where the actual content of the contracts were deficient, the most common issues were:

  • Fees and fee calculation methods not being correctly identified
  • Inaccurate or out-dated terms within the agreement
  • Use of “hedge clauses” that inappropriately limited the advisor’s role or responsibilities
     

Why You Should Care

Apart from regulatory issues, inaccurate advisory agreements have the potential to negatively impact your firm or your relationship with your clients by increasing business risk, creating the potential for personal liability and creating confusion among clients.

Improperly executed contracts create both regulatory and legal risk, and in some cases financial risk. Documenting and adhering to the fee terms and calculation methods in your advisory agreements will ensure that you are getting paid the correct amount by your clients. Performing a review of your existing agreements gives you a chance to find discrepancies before a regulator does.

Maintaining an updated version of all contract templates (both current and prior versions) serves as an effective control so that your firm is always using the most recent version with new clients.

Our Recommendations

To ensure that your firm is keeping up with regulatory requirements and industry best practices in this area:

  • Don’t “borrow” language from another firm’s advisory agreement. Your agreements must be both internally consistent and in alignment with the language and declarations in your ADV (including the fee calculation methods used).
  • Avoid hedge language that conflicts with or absolves you from your duties as a fiduciary
  • Use a separate agreement for ongoing advisory services (both discretionary and nondiscretionary) as well as “project-based” services, like financial planning. Your duties differ with each and this should be clear in your agreements.
  • Maintain one set of agreements as “production versions” to ensure that the most up-to-date contracts include the current terms.
  • Store retired versions in your books and records files and take steps to ensure that IARs are pulling from the production version.
  • Ensure that you track the delivery and receipt of advisory agreements and maintain a signed agreement for each client. Test the completeness of these files periodically.
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