Common Mistakes in Client Agreements That Can Cost

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The investment advisory agreements entered into between an advisor and their clients are the principal documents governing the advisory relationship. Yet we too often see advisors using templates provided by third parties that do not properly reflect their desired terms for their relationship with their clients.

At the very least, these mistakes can create confusion for advisors and clients. At the very worst, they expose the advisor to liability and can create unexpected legal or regulatory liability for the advisor that can cost a significant amount financially and lead to reputational harm.

In this article, I summarize some of the most common mistakes I come across when reviewing client agreements and how such mistakes can cost an advisor.

Choosing the wrong client agreement for the engagement

In some circumstances, we find that the client agreement entered into by the advisor and the client is an inappropriate type of agreement for the relationship. This occurs, for example, when advisors entering into advisory relationships with special types of clients (such as retirement plan sponsors) for specialized retirement plan services utilize the investment management agreement (IMA) they use for clients for whom they manage assets through separately managed accounts (SMAs).

Such IMAs do not properly reflect the relationship between the advisor and the retirement plan sponsor (including services to be provided), do not address the regulatory issues typically applicable to such relationships (such as prohibited transaction and other issues under ERISA), and can cause an advisor to incur unexpected fiduciary liability under ERISA. For instance, retirement plan agreements typically delineate whether the advisor is acting purely as an investment consultant (i.e., rendering services as a 3(21) fiduciary) or if the advisor is providing discretionary investment management services to the plan (i.e., rendering services as a 3(38) fiduciary). These retirement plan agreements also typically protect an advisor by delineating what services the advisor will render as an ERISA fiduciary versus which services are being rendered without the advisor acting as an ERISA fiduciary.