Investment Advisory Fees
The most basic rule about an investment adviser’s fee, but also the most unclear, is that an adviser’s fee must not be unreasonable; that is, it must be reasonable. This means that the fee should not too greatly exceed what other advisers charge for the same services; nor should it vary too greatly from what that adviser charges his other clients for the same services.
In addition to a fee being reasonable, there are also certain disclosures and requirements for financial professionals when working with their clients. First, all conflicts of interest arising from an investment adviser’s or IAR’s compensation structure as it relates to a client must be disclosed to the client in writing. This includes situations where a securities professional is:
- • Receiving fees, commissions, or compensation in addition to those previously communicated to the client
- • Charging a client an advisory fee in addition to a commission, or vice versa
Advisers are prohibited from charging performance-based fees, unless a client meets certain requirements (see the section later in this chapter on Suitability). A performance-based fee is when an adviser shares in the profits and losses of a client’s account. This includes being paid a proportion of gains over a specific benchmark (for example, the adviser receives 20% of the returns over the returns of a market index, such as the S&P 500). This prohibition exists because performance-based fees can encourage a professional to take greater risks in search of greater returns.
Investment advisers and IARs are usually compensated by charging a percentage of assets under management (AUM). For example, an investment adviser who is paid 1% of AUM for an account with $1,000,000 in it would be paid a total of $10,000. If the customer’s account grows from $1 million to $2 million over a year, an adviser who charges 1% of AUM will see his fees increase from $10,000 to $20,000. Simi