IA Compliance:
Clear and Reasonable Disclosure of Fees
The following information reflects the views of NASAA’s Investment Adviser Section Resources and Publications Project Group. It does not necessarily represent the views of NASAA, and it is not intended as legal advice. Any questions should be directed to the appropriate state regulators.
Are your firm’s advisory fees reasonable and adequately disclosed? This article will highlight some factors that state regulators may consider when determining whether a fee is reasonable and how a firm can clearly disclose its fees.
Reasonableness of Fees
A firm should consider some of the following when determining whether its advisory fees are reasonable:
- The services provided to clients.
- The total fee percentage when compared to the clients’ total investable assets (many states consider more than two or three percent to be unreasonable).
- Total compensation received, including commissions earned through outside product sales.
- Comparable fees paid by similar clients of the firm and those charged by other firms in the area that provide similar services.
For additional details on the reasonableness of fees see NASAA Investment Adviser Section, Regulatory Policy and Review Project Group Fee Guidance.
Disclosure of Fees
Equally important to the reasonableness of a firm’s fees is the clear communication of those fees in a firm’s disclosure documents. The three main disclosure documents, all of which serve different purposes, are the Form ADV Part 1, Part 2 (“brochure”), and the advisory contract. In examinations regulators will review whether a firm clearly, accurately, and consistently discloses its fees in each of these documents and whether the firm’s actual billing practices are in line with the same.
Form ADV Part 1
All fees and advisory services must be disclosed under Item 5 of the Form ADV Part 1A which describes to regulators the types of fees that a firm plans to collect from clients. If a firm charges a type of fee that does not match any of the available listed options, it can be disclosed by checking the “other” box and providing a detailed description of that fee. The services disclosed are an important factor in determining whether a firm’s fees are reasonable. The value of the service should correlate to the fee charged. For example, a client with a passively managed portfolio would be charged a different fee than a client with an actively managed account.
For additional guidance see the Form ADV Part 1A instructions.
Form ADV Part 2: Brochure
Building off the foundation of Part 1A, the brochure gives clients a detailed description of the services that a firm provides and how fees are charged for each service. Investment advisers should be sure to disclose any compensation arrangement that might present a conflict of interest or any arrangement that might create an incentive for an adviser to recommend products based on the compensation received, rather than a client’s needs. Some considerations when describing a firm’s fees in the brochure include, but are not limited to, the following:
- How and when clients will pay advisory fees.
- How fees are calculated, including a clear formula that clients can use to verify fees.
- The range of fees charged to clients, and whether the fees are negotiable.
- Additional compensation earned for the sale of securities or other investment products outside of the firm, such as commissions or other fees.
- Any other types of fees or expenses clients may pay in connection with the advisory services, such as custodian fees or mutual fund expenses.
- How a client can obtain a refund and how the firm will determine the amount of the refund.
See the General Instructions for Part 2 of Form ADV for more information.
Advisory Contract
Most states require advisers to enter into a written contract with their clients. The contract defines the legal relationship with the client. It sets out exactly what fees it will charge to the client for the services provided. Clients should be able to independently verify that the fees they are billed are accurate. Contracts should clearly disclose and describe the following:
- The services the adviser will provide, the exact negotiated fee rates associated with those services, and the billing frequency.
- The formula for computing the fee, including whether fees are charged in arrears or advance.
- The amount of any prepaid fees to be refunded in the event the relationship is terminated or the adviser fails to perform.
For additional information on the requirements of client contracts contact your state securities regulator.
Ongoing Concerns
Firms should be prepared to justify to a regulator that the fees charged to any client are reasonable. A client’s file, including notes or memos covering contacts and meetings with a client, can be used to help explain why a firm’s fees are reasonable for the services being rendered.
At least annually, a firm should review its business practices and file an annual amendment to its Form ADV Part 1 and 2. Changes to a firm’s business practices outside of that annual review may trigger the requirement for the firm to file an other-than-annual amendment to one or more of the disclosure documents discussed above. These amendments are to ensure that the firm’s disclosures accurately reflect current business practices. An amendment to one disclosure document likely necessitates amending the others.
For more information about how to make the appropriate disclosures on the Form ADV Part 1 and 2 or contracts, contact you state securities regulator, or review NASAA’s Industry Resources.
