For most financial advisers, staying compliant means applying extreme diligence across a variety of areas as you keep tabs on a host of regulatory requirements.
From advertising compliance to creating audit and record trails to ensuring fees are accurately charged, compliance professionals must be constantly vigilant regarding the actions and decision-making processes of their firms.
Recently, performance fees have been a hot topic of frustration for many compliance professionals in the financial advisor/investment professional arena.
What Are Performance Fees?
Performance fees are fees paid to investment professionals for generating positive returns. These fees are different from asset management fees, which are calculated as a percentage of your overall fees under management.
Performance fees, on the other hand, are charged based on the investment options an adviser chooses for their client and how those investments perform. Calculations for performance fees can vary depending on the agreement made between the financial adviser and the client.
Who Can Be Charged a Performance Fee?
Federal regulations prohibit charging performance fees to anyone other than “qualified clients.”
According to the Investment Advisers Act of 1940, a qualified client is one who has more than $2.1 million net worth or at least $1 million in assets with the advisor charging the performance fee.
What Consequences Might You Face for Wrongfully Charging a Performance Fee?
Many financial advisers consider performance fees a fair way to be compensated for their efforts on behalf of their clients. When performance fees are applied, advisers are incentivized to find better opportunities for clients and grow their wealth more aggressively.
However, the flip side of the performance fee coin is that clients may suffer if their adviser falls behind on anticipated earnings and takes bigger risks in order to compensate for potential losses.
Charging performance fees when they’re not warranted can also result in large fines levied against advisers. In a recent judgment by the Texas State Securities Board, a financial adviser was fined $10,000 for wrongfully charging performance fees to a client whose net worth didn’t meet the qualified client threshold.
What Steps Should I Take To Ensure My Firm Is Properly Managing Performance Fees?
If your firm is considering charging performance fees, it’s crucial to ensure the clients you’re working with are qualified clients. This requirement applies to both state-registered and SEC-registered advisers.
For advisers registered with the SEC, the fee, services for the fee, and conflicts caused by charging performance-based fees must all be disclosed in Form CRS filings.
Regulators take violations of performance fee guidelines very seriously. If you’re concerned about implementing or managing performance fees, talk with a compliance consultant about the best way to manage this process for your firm.
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About Red Oak Compliance Solutions
Red Oak Compliance Solutions is a leading provider of intelligent compliance software, offering a range of AI-powered solutions designed to help firms of all sizes successfully navigate the increasingly complex regulatory landscape. Our suite of 17(a)-4/WORM compliant features offer risk minimization, cost reduction, and process optimization capabilities with features that are designed to evolve with our client’s needs. Our flagship advertising review software enables firms to deliver compliant content to the market with confidence, faster. Our Disclosure Management and Intelligence solution simplifies the management of disclosures, while our Registration Management solution automates and streamlines the licensing and registration process, further enhancing your internal processes.