Client Contracts

Every investment adviser (IA) relationship starts with a contract, but the required contents depend on who regulates the adviser. The Investment Advisers Act of 1940 (IAA) sets a federal minimum for SEC-registered advisers. State-registered advisers face a broader set of requirements under the Uniform Securities Act (USA) and the NASAA Model Rule on advisory contracts.

What Are the Required Contract Elements?

Federal law and state law do not impose the same requirements, and the exam tests the difference directly:

• Federal law (the IAA's advisory-contract requirements) applies to SEC-registered advisers. It requires only three things, and it does not require the contract to be in writing: no performance-based fee except for qualified clients (covered below), no assignment without the client's consent, and (for a partnership adviser) notice of membership changes.
• State law (the Uniform Securities Act and the NASAA Model Rule on advisory contracts) applies to state-registered advisers. It requires the entire contract to be in writing and adds five more disclosure elements on top of the shared no-assignment-without-consent and partnership-notice requirements.

Think of it this way: A federal-covered adviser only has to hit the three IAA marks, and can even do it in an oral agreement. A state-registered adviser's written contract is the client's roadmap for the entire relationship: it tells them what they are getting, what it costs, who controls their money, and what happens if the firm changes hands. Every required element exists to protect the client from a specific type of harm.

What Counts as Assignment of the IA Contract?

An advisory contract must provide that no assignment shall be made by the investment adviser without the consent of the other party.

What counts as assignment:

• Any direct or indirect transfer of the contract
• A change in the majority ownership (controlling block of voting securities) of the adviser
• If an adviser is acquired or merges, this constitutes an assignment and client consent is required

The statute does not specify written consent; the contract itself defines whether consent must be affirmative or negative (failure to object).

How Does This Interact With the Partnership Notice Requirement?

Two separate rules can both apply to a partnership adviser:

• Any change in partnership membership triggers the partnership notice requirement above: the contract must require notifying the other party within a reasonable time, regardless of how large the change is
• A change in majority ownership (a controlling block of voting securities) is separately treated as an assignment, which additionally requires client consent, not just notice

A majority change therefore triggers both obligations at once: notice (because membership changed) and consent (because control changed).

Exam Tip: Gotchas

• "Assignment" does not just mean physically handing over the contract. A change in majority ownership of the advisory firm is ALSO an assignment. If Firm A buys Firm B (an advisory firm), all of Firm B's client contracts are deemed "assigned" and clients must consent. This is heavily tested.
• Notice and consent are not the same obligation. Every partnership membership change requires notice; only a majority (control) change additionally requires consent.

What Is the Performance-Based Fee Prohibition?

Advisers generally may not charge fees based on a share of capital gains or capital appreciation (the performance-fee restriction in the IAA).

Exception for qualified clients (Securities and Exchange Commission (SEC) qualified-client thresholds):

A client qualifies by meeting either one of these two tests, not both:

Also permitted for: qualified purchasers and knowledgeable employees of the adviser.

State-registered advisers must also comply with state performance-based compensation rules.

Exam Tip: Gotchas

• If a question asks whether a performance fee is allowed, check: Is the client a qualified client?
• A client with $900,000 in AUM and $3 million net worth (excluding primary residence) does qualify (meets the net worth test).

What Is the Prohibition on Waiver of Client Rights?

No advisory contract may require a client to waive any rights under:

• The Uniform Securities Act (USA)
• The Investment Advisers Act of 1940 (IAA)

Any waiver clause is void and unenforceable, regardless of whether the client agreed to it.

• Advisory contracts must not contain exculpatory clauses (also called hedge clauses) that waive fiduciary duties
• A client who signs a contract containing a waiver provision does not lose any legal protections
• The waiver clause itself is simply treated as if it does not exist

Exam Tip: Gotchas

• A signed waiver does not waive anything. Even if a client voluntarily agrees to waive their rights under the USA or IAA, that waiver is void. The client retains full legal protection regardless of what the contract says.

What Are Wrap Fee Programs?

Contracts for wrap fee programs must disclose additional information about bundled services and fees. A wrap fee bundles advisory services, trade execution, clearing, and custody into a single all-inclusive fee.

How it's billed: Like a standard asset-based advisory fee, a wrap fee is quoted as a percentage of assets under management (AUM) (e.g., 1.5% annually) and billed periodically against the account, typically quarterly.

There is no separate rule setting wrap-fee billing frequency; the exact schedule, and whether it is billed in advance or in arrears, is set by the adviser and must appear in the contract's fee schedule, the same required contract element that applies to any advisory fee.

How it compares to a normal (unbundled) advisory fee: A standard asset-based advisory fee pays only for advice. Trade execution, clearing, and custody are billed separately (commissions per trade, custodian fees, etc.). A wrap fee folds all of those costs into the single AUM-based rate, so the client writes one check instead of several.

Exam Tip: Gotchas

• Wrap fees are not always a good deal. Because the wrap rate is priced assuming a normal level of trading, a client who trades infrequently pays for bundled execution costs they barely use. That same client would often pay less under an unbundled advisory fee plus per-trade commissions.

What Should You Check on Exam Day?

• Federal law (the IAA) requires only three things, and does not require a written contract: no performance-based fee except for qualified clients, no-assignment-without-consent, and (for a partnership) notice of any membership change
• State-registered advisers must also put the entire contract in writing and add five more elements: services, term, fee schedule, prepaid fee refund, and discretionary authority
• A change in majority ownership (over 50%) of the adviser counts as an assignment requiring client consent, on top of the notice owed for any membership change
• The statute does not require written consent to an assignment; the contract defines whether consent must be affirmative or negative
• Performance-based fees are prohibited except for qualified clients: $1,400,000 or more in AUM with the adviser, OR net worth over $2,700,000 excluding primary residence (either test qualifies, not both)
• Qualified purchasers and knowledgeable employees of the adviser are also exempt from the performance-fee prohibition
• No advisory contract may require a client to waive rights under the USA or IAA; any such waiver clause is void and unenforceable, even if the client signed it
• Wrap fee programs bundle advisory, execution, clearing, and custody into a single AUM-based fee, and must disclose additional information about bundled services and fees