This month, Lexington Compliance focuses on RIA compliance issues when charging fixed, flat or retainer fees.
While the vast majority of registered investment adviser (RIA) firms still charge traditional advisory fees calculated as a percentage of assets under management*(e.g. 1% of AUM), a growing number of investment advisory firms are considering implementing an ongoing flat-fee structure (e.g. $200 per month). The concept of charging a fixed or subscription fee has been around for quite some time, but we have seen new variations on the fixed-fee model emerge. As such, we wanted to offer some general compliance thoughts and considerations for RIA firms looking to charge a fixed fee.
Categorizing the Types of Fixed Fees that RIA Firms May Charge
To set the stage, we first want to separate fixed fees into two categories:
- Fixed fee for traditional portfolio management services
Charging a recurring fixed fee for providing advisory services is a model many regulators are quite familiar with and often comfortable with. This is not an uncommon fee model for RIA firms serving the ultra-high net worth client segment. An example of this model would be charging an annual client advisory fee of $5,000 regardless of the client's level of assets under management. Often, this fixed fee is split into quarterly payments which would equate to $1,250 each in this example.
In general, charging a fixed fee for providing ongoing portfolio management services will not lead to compliance issues, so long as (i) no more than 6 months of fees are collected in advance in order to avoid potential custody issues* and (ii) the fixed fee is not considered to be "excessive" given the client's portfolio. Many states consider annual advisory fees to be excessive if they are greater than 2%-3% of the client's AUM. Thus, charging an annual $5,000 fixed fee for portfolio management services to a client with only $100,000 in managed assets would generally not be allowed.
- Fixed fee for other services such as financial planning
On the other hand, a new variation of the fixed-fee model entails RIA firms charging a monthly fee to clients that often do not have significant investment assets. In contrast to firms offering fixed portfolio management fees to ultra-high net worth clients, this arrangement is often utilized by firms looking to serve a younger or less affluent set of clients than those traditionally served by most advisory firms today. Developing a new business model to serve these less traditional clients is an exciting development for the industry, but there may be some firms contemplating this new fee model that do not fully understand the relevant regulatory considerations.
The Utah Division of Securities issued regulatory guidance back in February 2009 on retainer fees that does a very nice job of highlighting some of the potential issues with this new variant of fixed fees. In particular, the release from the Utah Division of Securities notes the following:
The Division finds a common mistake is for an adviser to use the terms “Fixed Fees” and “Retainer Fees” interchangeably.
To clarify, a Fixed Fee is a fee based on the set dollar amount for a given service or set of services. The set dollar amount is either predetermined by the adviser or negotiated between the adviser and the client. Moreover, Fixed Fees can be charged in advance or in arrears. From the Division’s review of investment advisers who purport to charge Retainer Fees, most are actually charging a Fixed Fee in advance and mislabeling that fee a “Retainer Fee.”
A Retainer Fee is generally an agreement between a professional (in this case, investment adviser) and a client in which the client agrees to pay a sum of money to the professional for the professional’s performance of or promise to be available to perform, at an agreed price, any services that are needed during a specified period.
Retainer Fees can take different forms, but the Division considers most Retainer Fees unreasonable advisory fees. However, one form of Retainer Fee may be charged to Utah clients if established correctly.
While the above release is specifically relevant to RIA firms registered in the state of Utah, it's important to note that many state and federal regulators share similar concerns in regard to firms charging a fixed monthly, quarterly, or annual fee with no specific ongoing services delivered to the client. In other words, charging a flat monthly fee in exchange for simply being available to answer a client's questions without any additional regular service or deliverable being provided by the advisor to the client could be deemed an "unethical business practice"* by regulators.
It's important to note that this is still an emerging compliance topic and therefore each regulatory jurisdiction may take slightly different stances on what constitutes "services being provided," but in general charging a fee to a client to just be available to answer questions is likely to create regulatory issues.
Free Basic Compliance Hotline provided by Lexington Compliance* for Scottrade® RIAs
To learn how Lexington Compliance can help you understand compliance issues, please visitriainabox.com.* Talk to your advisor service team at 877.726.8741 email@example.com about the free basic compliance hotline** provided to Scottrade®advisors by Lexington Compliance.
*By clicking on this link, you understand you will be redirected to riainabox.com, a third-party website operated and maintained by Lexington Compliance. Scottrade and Lexington Compliance are not affiliated. Lexington Compliance’s website contains information that may be of interest or use to the reader. Third-party websites, research and tools are from sources deemed reliable; however, Scottrade does not guarantee accuracy, completeness or timeliness of the information, is not responsible for statements, offers or products issued and makes no assurances with respect to the results to be obtained from their use. No information presented constitutes a recommendation by Scottrade or its affiliates to purchase any product or instrument discussed therein or engage in any specific strategy. Please research any product or service carefully.
**The scope of this service will include basic questions about the operation of a registered investment advisor and related compliance and registration areas. If an inquiry requires extensive research, significant review of materials or drafting of materials, then Lexington will offer its standard compliance consulting packages for a fee. If you choose to retain Lexington for compliance consulting services that are outside the scope of the hotline, you are responsible for making all required payments.