There has been a lot of debate this year about the fairness of advisory fees. Who am I kidding? This is a debate that has been going on for years now. In this post, I address what the law says about advisory fees (but not performance-based fees). In my next post I plan to share some ideas that I have on the fairness and value of advisory fees.
Congress and the SEC have deferred to market forces in considering whether an advisory fee is appropriate. The SEC Staff has historically taken the position that “an investment adviser that charges a fee ‘larger than that normally charged by other advisers’ (based on factors such as size of the account, location, and nature of the business of the advisory firms being compared) has a duty under Section 206 of the Advisers Act to disclose to clients that the same or similar services may be available elsewhere at a lower fee.” The SEC Staff previously opined that this disclosure was necessary for engagements at 3%. More recently, the Staff has suggested that this disclosure would be required if an investment adviser’s fee is 2%. See, Investment Advisers: Law & Compliance § 8.03 (2020). Notably, the recent Commission Interpretation Regarding Standard of Conduct for Investment Advisers was silent on the issue of fees charged directly by investment advisers.
The SEC’s position makes sense. In the absence of specific laws, we lawyers often look to other bodies of law for precedent. One common body is the law governing agency and principal relationships–which fits quite nicely in discussing investment adviser’s relationships with their clients. The Restatement of Agency, which is a treatise summarizing the law suggests, “An agreement between a principal and an agent may also set the agent’s right to compensation at an amount or rate that is standard or customary in a particular industry.” See, Section 8.13. This follows the position of Congress and the SEC (or perhaps Congress and the SEC follow this position).
These are the reasons why we haven’t seen any real change in the industry attacking asset-based fees or the 1% fee in general. As long as a 1% fee can be considered standard or customary, it won’t be going anywhere.
Obviously, a fiduciary has an obligation to act prudently in carrying out its duties, deal fairly with clients, and make full disclosure of all material facts regarding its fees. However, this is satisfied by selecting investments that are appropriate (which may or may not be low-cost investments), accurately disclosing fees in a contract between an adviser and its client, and charging fees only according to that contract. There isn’t any obligation for an investment adviser to disclose its fees on its website so that competitors can undercut prices. There isn’t any obligation to offer the lowest rate in town or in a niche. There isn’t any legal obligation to charge an hourly rate. There isn’t even any obligation to prove your value. As it relates to the value proposition, the law simply requires that you disclose to the client: (i) your services, (ii) your fees, and (iii) that you perform the agreed upon services. The law allows clients who believe they aren’t receiving value to seek recourse or walk away from the relationship.
Investment advisers also need to comply with their obligations under Form ADV and Form CRS, but that is a slightly different topic.
* I would also note that certain state securities authorities have their own views on what fees are appropriate and what is required of investment advisers to earn fees. For example, certain states seem to prohibit subscription-based fees, because they somehow believe that advisers aren’t capable of proving they provide value in each month. If only they knew the same could be said about any other fee arrangement.