My investment advisory firm recently had a state examination. One of the items mentioned in the state's findings was our practice of occasionally discounting or waiving our quarterly fee for certain clients. We did this in the past for long-time clients whose accounts had little or no activity in the quarter. Why would the state have a problem if we charge clients less than what we could charge them?
— B.H., via e-mail
The state likely has a problem with you tying your fee in some respects to the client's activity level. I believe such a practice runs counter to the whole idea of fee-based advisory services. If the fee is tied to the activity in the account, then (theoretically) the advisor has a financial incentive to increase the activity, or maintain it at a certain level to keep the advisory fee as agreed, as opposed to executing transactions solely in a client's best interest. An advisor's management fee typically covers not only active management, but also monitoring of the account regardless of the number of transactions.
Also, how would you determine what level of activity warranted a particular discount? Would one trade during the quarter cause you to charge the full fee? What about 10 trades? Unless you had a specific written procedure, the decision to discount your fee would be too subjective, which could in turn disadvantage certain clients depending on who made the determination to discount or waive the fee.
Another reason the state might be concerned with the practice is that it could look like you're reimbursing clients for losses in an account or compensating them for a referral (assuming your state requires solicitors to be registered). In short, there's any number of reasons why the state might take issue with the practice, and I'd suggest you stick with your fee schedule. If you think you're charging clients too much, revise your fee schedule.
My RIA provides advisory services to several small banks, trust companies and insurance companies in California, although our home state is Oregon. I've been told that, since we have more than five clients in the state, we have to register there. I've also been told that, since our clients are not individuals, we don't have to register. A third person, however, has told us that since we rent conference room space in an executive office suite to meet with clients, we have to register regardless of the number of clients we have. Can you shed some light on this?
— N.P., Oregon
The California Corporations Code, Section 25202, states that you do not have to register if you do not have a place of business in this state and during the preceding 12-month period if you had fewer than six resident clients. Section 25202 specifically excludes banks, trust companies and insurance companies (among others) from the definition of "client." So while it's true that you wouldn't have to register because of the type of clients you have, the fact that you meet with clients at an executive office space in the state would probably be seen as a "place of business" and require registration.
While I could not find a definition of "place of business" in the state law, Rule 222-1 of the Investment Advisers Act of 1940 defines "place of business" of an investment advisor as an office at which the investment advisor regularly provides investment advisory services, solicits, meets with or otherwise communicates with clients. It is also defined as any other location that is held out to the general public as a place where the investment advisor does the same.
Alan J. Foxman is an attorney with the law offices
of Rita G. Dew, P.A., and a senior consultant with
National Compliance Services in Delray Beach, Fla.
Contact him at this email address.