Advisory Contracts – Transition for Newly Registered Advisers

The SEC’s Division of Investment Management supplemented its Investment Management Staff Issues of Interest posting on the SEC website to include no-action relief for a newly registering adviser under Section 205(a)(2) and (3). Those include requirements that (1) an investment advisory contract not be assigned without consent and (2) that if the advisor is a partnership, the advisor will notify the client of any change in the membership of such partnership within a reasonable time after such change

The SEC has previously sought to minimize the disruption to the contracts of newly registering advisers when such contracts were permissible at the time they were entered into. For example, the SEC allowed performance fees for newly registered funds in Investment Advisers Act Release No. 2333 (Dec. 2, 2004)  More recently, the SEC permitted performance fees to formerly qualified clients after the SEC increased the threshold to be so qualified in  Investment Advisers Act Release No. 3372 (Feb. 15, 2011.

The advisor will need to meet three standards:

 (i) the advisory contract was entered into or last amended prior to the submission of the adviser’s application for registration;

(ii) any future amendment of the advisory contract will include the provisions required under Sections 205(a)(2) and (3);

(iii) the adviser undertakes to operate and perform under the advisory contract as if it contained the provisions specified in sections 205(a)(2) and (3)

 

Here is the text of the SEC language:

Advisory Contracts – Transition for Newly Registered and Registering Advisers

Sections 205(a)(2) and (3) of the Advisers Act generally prohibit registered advisers, and advisers required to be registered, from entering into, extending, renewing, or performing under an advisory contract that fails to include the provisions specified by those sections. In general, this means that an advisory contract must provide that (i) the contract may not be assigned by a registered adviser without the consent of the client and (ii) the registered adviser, if a partnership, will notify its clients of any change in membership within a reasonable time after such change.

As a result of the Dodd-Frank Act changes to the Advisers Act, previously exempt advisers are now required to register with the Commission. Nevertheless, newly registering advisers may be operating under existing advisory contracts that were entered into when such advisers were neither registered nor required to be registered with the Commission. As a result, these advisory contracts may fail to include the specified provisions of sections 205(a)(2) and (3). Advisers may need to seek the consent of their clients to amend the advisory contracts to include these provisions. Obtaining the consent of clients in a timely fashion to amend all existing advisory contracts, however, may be impracticable for some advisers.

The Commission has previously sought to minimize the disruption to the contracts of newly registering advisers when such contracts were permissible at the time they were entered into. See e.g., Investment Advisers Act Release No. 2333 (Dec. 2, 2004) (the Commission adopted rules to grandfather pre-existing contractual arrangements providing for performance-based compensation that were entered into when the adviser was exempt from registration) and Investment Advisers Act Release No. 3372 (Feb. 15, 2011) (the Commission adopted rules to grandfather pre- existing performance fee contractual arrangements that satisfied the requirements of the rule at the time that the contract was entered into ).

Accordingly, the staff would not recommend enforcement action to the Commission under sections 205(a)(2) and (3) of the Advisers Act if an adviser that has applied for registration but was not registered, nor required to be registered, when it entered into its advisory contracts, did not amend an advisory contract to include the provisions required by sections 205(a)(2) and (3), provided that: (i) the adviser undertakes to operate and perform under the advisory contract as if it contained the provisions specified in sections 205(a)(2) and (3), (ii) the adviser discloses such undertaking to the client and, in the case of a private fund client, each investor (or independent representative of the investors) in such client, (iii) the advisory contract was entered into or last amended prior to the submission of the adviser’s application for registration; and (iv) any future amendment of the advisory contract would include the statutory provisions set forth in sections 205(a)(2) and (3). [March 30, 2012]

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