Performance Guarantees Prohibition

What Is the Blanket Prohibition?

State rules prohibit guaranteeing a client that a specific result will be achieved (gain or no loss) with advice that will be rendered. The Investment Advisers Act of 1940 (IAA) antifraud authority and fiduciary duty also treat performance guarantees as fraudulent conduct.

This prohibition applies to all investment advisers, investment adviser representatives (IARs), and federal covered advisers.

What is prohibited:

• Guaranteeing any specific rate of return ("I guarantee 10% annually")
• Guaranteeing that a client will not lose money ("You won't lose a dime")
• Promising that an investment strategy will achieve a particular outcome
• Guaranteeing performance results of any kind

This prohibition applies:

• Regardless of how the guarantee is worded
• Regardless of whether the client requests or demands it

There is no "client requested it" exception. Even if a client says, "Just promise me I won't lose money," a securities professional must refuse.

Think of it this way: No one can predict the future. Markets carry inherent risk, and any promise that removes that risk from a client's mind is misleading. A guarantee shifts the risk onto the professional, which distorts the client's decision-making and violates securities law.

Exam Tip: Gotchas

• A guarantee to break even is still a performance guarantee. It promises a specific minimum outcome (zero loss). This is frequently tested.
• "The client asked me to guarantee it" is never a valid defense. The prohibition is absolute.

What Is Permitted?

Not everything related to performance is off-limits:

• Discussing historical performance (subject to advertising rules)
• Providing reasonable projections or illustrations with appropriate disclaimers
• Explaining how an investment has performed in the past, with disclosure that past performance does not guarantee future results
• Offering a money-back guarantee on advisory fees: this is not a guarantee of investment performance

The prohibition is on guaranteeing investment results, not on guaranteeing service quality. An adviser may offer to refund advisory fees if the client is dissatisfied, but may never guarantee that an investment will produce a gain or avoid a loss.

Exam Tip: Gotchas

• Even a statement like "you can't lose with this strategy" violates the rule.
• A fee refund guarantee is permitted because it relates to service quality, not investment outcomes.

What About Hedge Clauses?

A hedge clause is contract language that tries to limit the adviser's liability to the client. The industry also calls it an exculpatory clause, and the exam may use either name.

• A hedge clause that disclaims liability for negligence is suspect, because an adviser cannot contract away a fiduciary duty
• Broad language such as "the adviser is not responsible for any losses" can mislead a client about the rights the client actually keeps
• The SEC treats an overly broad hedge clause as potentially misleading for that reason
• A hedge clause is the mirror image of a guarantee. A guarantee promises the client too much. A hedge clause takes away too much.

Any clause that requires the client to waive rights under the Uniform Securities Act or the Investment Advisers Act of 1940 is void, whatever it is called. See Client Contracts for that rule.

Exam Tip: Gotchas

• "Hedge clause" and "exculpatory clause" name the same thing. A question may use either term, and neither one refers to hedging a portfolio with options or futures.
• A hedge clause does not have to say "waiver" to be a problem. Language that merely discourages a client from enforcing their rights can be misleading on its own.

What Should You Check on Exam Day?

• The prohibition applies to all investment advisers, IARs, and federal covered advisers
• A guarantee to break even is still a prohibited performance guarantee, since it promises a specific minimum outcome
• There is no "client requested it" exception; a professional must refuse even if the client demands a guarantee
• Discussing historical performance and offering reasonable projections with appropriate disclaimers remain permitted
• A money-back guarantee on advisory fees is allowed because it guarantees service quality, not investment results
• The prohibition applies regardless of how the guarantee is worded
• A hedge clause, also called an exculpatory clause, limits the adviser's liability, and one that disclaims liability for negligence is suspect because an adviser cannot contract away a fiduciary duty