The written terms every advisory agreement needs under state and federal rules, the clauses it must never contain and the special rules for mutual fund contracts

Under the NASAA model rules adopted by most states, an investment advisory contract must be in writing and must set out the services to be provided, the term of the contract, the advisory fee and how it is calculated, how any prepaid fee will be refunded if the contract ends early, and whether the adviser has discretionary authority. It must also state that the contract cannot be assigned without the client’s consent.

Federal law adds its own requirements for SEC-registered advisers. Under Section 205 of the Investment Advisers Act of 1940, every advisory contract must prohibit assignment without client consent, must generally avoid performance-based fees, and, where the adviser is a partnership, must require it to notify clients of changes in its partners.

This guide covers each required term, the federal and state rules side by side, what an advisory contract must never contain, the special rules for contracts with mutual funds, worked examples, the exam traps and five practice questions. It is written for Series 65 and Series 66 candidates, and for anyone who wants to understand the agreement they sign with an investment adviser.

Why Advisory Contracts Are Regulated

An advisory contract sets the terms of a relationship in which the client trusts the adviser with decisions about their money. Because the adviser usually knows far more than the client, the law does not leave the terms entirely to negotiation.

The rules aim to make sure the client knows exactly what they are paying for, how the fee works and what authority they are handing over. They also stop the client being moved to a different adviser without agreement, and ban terms that would encourage the adviser to take excessive risks.

These protections sit alongside the adviser’s fiduciary duty. The contract sets out the terms, but the fiduciary duty applies whatever the contract says.

Where This Topic Appears on the Exams

Advisory contracts are tested in the laws and regulations section of the Series 65, and they also appear on the Series 66. Questions typically list several contract terms and ask which one is required, which is prohibited, or what happens when an adviser is sold or a partner leaves.

FRC’s Series 65 Exam Preparation course covers advisory contracts alongside the other adviser rules, chapter by chapter, and the Series 65 needs no sponsoring firm. The SIE Examination Preparation course introduces the difference between brokers and advisers that sits behind this topic.

Every FRC course can be spread across interest-free monthly payments, so cost is no reason to delay. Contract questions follow a short checklist, so once that list is memorised they become dependable marks.

The Contract Must Be in Writing

Under the NASAA model rule on unethical business practices, it is unethical for a state-registered adviser to enter into, extend or renew an advisory contract unless it is in writing. An oral agreement, however clear, does not meet this standard.

The federal Advisers Act does not itself require every contract to be written. In practice, however, SEC-registered advisers use written contracts because the required terms, the brochure delivery rules and their recordkeeping obligations all point that way.

For exam purposes, the safe answer is that an advisory contract must be in writing. Questions on the state rules almost always test this point.

The Required Terms Under the State Rules

The NASAA model rule lists the disclosures a written advisory contract must contain. The first is the services to be provided, so the client knows whether they are getting ongoing portfolio management, a one-off financial plan, or something else.

The second is the term of the contract, meaning how long it lasts and how it can be ended. The third is the advisory fee, together with the formula for calculating it, so the client can work out exactly what they will pay.

The fourth is the amount of any prepaid fee that will be returned if the contract is ended or not performed, and how that refund will be calculated. The fifth is whether the contract grants the adviser discretionary authority, and the sixth is a statement that the contract cannot be assigned without the client’s consent.

The Checklist in Brief

The table covers the six items most exam questions draw on. The sections that follow explain the terms that cause the most confusion.

Fees and the Formula Behind Them

The contract must state the fee, but it must also show how the fee is calculated. A typical formula is a percentage of assets under management, such as one percent a year, charged quarterly on the account value at the end of each quarter.

Other common structures include flat annual fees, hourly rates for financial planning and fixed fees for a written plan. Whatever the method, the client should be able to read the contract and calculate the fee without relying on the adviser.

The fee must also be reasonable. Charging an unreasonable advisory fee is listed among the unethical practices in the NASAA model rule, and FRC’s guide to what conflicts of interest an investment adviser must disclose explains how fee arrangements create conflicts that must be disclosed.

Prepaid Fees and Refunds

Some advisers charge fees in advance, for example quarterly or annually at the start of the period. If the client ends the contract partway through, they are entitled to a refund of the unearned portion.

The contract must say how that refund is calculated, usually on a pro rata basis for the days remaining. Advisers that require large prepayments face additional disclosure requirements in Form ADV.

FRC’s guide to what Form ADV is explains those disclosures. Prepayment of large fees well in advance also brings a requirement to include a balance sheet in the brochure.

Discretionary Authority in the Contract

Discretionary authority allows the adviser to decide which securities to buy or sell, and in what amounts, without asking the client before each trade. The contract must state whether the adviser has this authority.

Under the NASAA model rules, a state-registered adviser may exercise discretion based on oral authority from the client for the first ten business days after the first discretionary transaction, but must obtain written authority within that period. A discretionary account without written authority after that point is a violation.

Discretion does not cover decisions about timing and price alone. If the client chooses the security and the amount, and the adviser only decides when to execute and at what price, that is not discretion and does not need written authority.

No Assignment Without Consent

The contract must state that it cannot be assigned without the client’s consent. Assignment means transferring the contract to another adviser, so that someone other than the adviser the client chose would manage the account.

Under the Advisers Act, assignment includes any direct or indirect transfer of the contract, and also a transfer of a controlling block of the adviser’s voting securities. If an advisory firm is sold, the change of control counts as an assignment, so clients must consent before their contracts move to the new owner.

The rationale is simple: clients choose an adviser based on trust in particular people and a particular firm. They should not find themselves with a different manager because of a business deal they had no say in.

Partnerships and Changes in Membership

If the adviser is a partnership, federal law requires the contract to provide that the adviser will notify clients of any change in the membership of the partnership. The notice must be given within a reasonable time after the change.

A change of a minority partner is not treated as an assignment, so client consent is not needed. Clients must simply be told.

A change in the partners who hold control is different. If the change amounts to a transfer of control, it is an assignment and client consent is required.

Performance-Based Fees

Section 205 of the Advisers Act generally prohibits contracts that pay the adviser a share of the capital gains or capital appreciation in the client’s account. These fees are seen as encouraging an adviser to take excessive risks to earn a larger reward.

There are exceptions. The most important allows performance fees for qualified clients, who meet minimum thresholds for assets under management with the adviser or net worth, and there are further exceptions for registered investment companies and certain other sophisticated clients.

Fees based on the average value of assets over a period are not performance fees, because they rise and fall with the account value rather than sharing in gains. Most states follow the federal approach, and the next guide in this series covers performance fees in full.

What a Contract Must Never Contain

An advisory contract must not contain a hedge clause or any other term that attempts to waive the client’s rights under the securities laws. A clause saying the adviser is not liable for losses caused by its own negligence, or that the client gives up the right to sue, is misleading and unenforceable.

Under Section 215 of the Advisers Act, any contract term that purports to waive compliance with the Act is void. The NASAA model rules likewise treat such provisions as unethical.

Contracts also must not misrepresent the adviser’s qualifications, services or fees. Anything stated in the contract must match the adviser’s brochure and the way the adviser actually operates.

The Brochure and the Right to Cancel

Before or at the time the contract is signed, the adviser must deliver its brochure, Part 2 of Form ADV. Under the NASAA approach adopted by many states, if the brochure is not delivered at least 48 hours before the contract is signed, the client has five business days to cancel without penalty.

The brochure and the contract work together. The brochure explains the adviser’s business, fees, conflicts and disciplinary history, while the contract sets the terms of this particular relationship.

FRC’s guide to the brochure rule explains the delivery requirements and the exceptions. Both documents are usually provided together at the start of the relationship.

Contracts With Mutual Funds

Contracts between an adviser and a registered investment company, such as a mutual fund, are governed by Section 15 of the Investment Company Act of 1940. These contracts must be in writing and must describe all the compensation the adviser will receive.

The initial contract must be approved by the fund’s board of directors and its shareholders. After the first two years, it must be renewed at least annually by the board, including a majority of the independent directors, or by the shareholders.

The contract must allow the fund to end it at any time without penalty on no more than 60 days’ written notice, and it must end automatically if it is assigned. These terms give fund investors stronger protection than a typical individual advisory contract.

Advisory Contracts and Investment Adviser Representatives

The advisory contract is between the client and the advisory firm, not the individual adviser representative. The representative acts on the firm’s behalf and is supervised by it.

If a representative leaves the firm, the client’s contract remains with the firm. The client can choose to stay or to follow the representative to a new firm, but moving requires a new contract with the new firm.

FRC’s guide to what a registered investment adviser is explains the difference between the firm and the individuals who work for it.

Recordkeeping for Advisory Contracts

Advisers must keep copies of their written agreements with clients as part of their books and records. Under the SEC’s books and records rule, these are generally kept for five years, with the first two years in an easily accessible place.

State rules impose similar requirements. Regulators examining an adviser will usually ask for a sample of client contracts and compare them with the fees actually charged.

Mismatches between the contract and the fees billed are among the most common examination findings. An adviser that charges more than its contract allows may have to refund the difference to clients.

Worked Example: The Missing Discretion Term

A state-registered adviser begins managing a new client’s account and makes several trades without consulting the client first. The written contract covers services, term and fees, but says nothing about discretionary authority.

The adviser is exercising discretion without written authority. It may rely on oral authority only for the first ten business days after the first discretionary trade, and must obtain written authority within that window.

The contract should have stated whether discretion was granted. The adviser needs to obtain written discretionary authority straight away and correct its contract template.

Worked Example: The Firm Is Sold

A small advisory firm agrees to sell a majority of its shares to a larger competitor. After the sale, the larger firm plans to manage all of the small firm’s clients.

The transfer of a controlling block of shares is an assignment of every advisory contract. The firm must obtain each client’s consent before the contracts can be treated as transferred.

Clients who do not consent are free to leave. In practice, firms in this position contact every client, explain the change and ask for consent in writing.

Worked Example: The Hedge Clause

An adviser’s contract includes a sentence stating that the adviser “shall not be liable for any loss, including losses resulting from the adviser’s negligence.” A client suffers losses after the adviser ignores the client’s stated investment restrictions.

The clause is an attempt to waive the client’s legal rights. Under both federal and state rules, it is unenforceable, and including it is itself a violation.

The client keeps every right they would have had without the clause. The adviser also faces regulatory action for using misleading contract terms.

The Exam Traps

The first trap is assuming the contract does not need to be in writing. Under the state rules tested on the exam, it must be.

The second trap is treating any change in partners as an assignment. A change of a minority partner requires only notice to clients, while a transfer of control is an assignment requiring consent.

The third trap is forgetting that a sale of a controlling interest in the adviser is an assignment. Client consent is needed even though the clients themselves have done nothing.

The fourth trap is thinking a hedge clause is acceptable if it is clearly disclosed. Any clause that tries to waive a client’s rights under the securities laws is prohibited, however it is presented.

FRC’s guide to Series 65 ethics and laws questions and exam traps covers more traps in this area. For the full list, see FRC’s guide to Series 65 exam traps and common mistakes.

A Memory Aid

Remember “STaFF RAD”: Services, Term, Fee and Formula, Refund of prepaid fees, Assignment needs consent and Discretion. That covers the six terms the state rules require.

For the prohibitions, remember “no hedge, no share.” No hedge clauses waiving client rights, and no share of the client’s gains except for qualified clients.

Practice Questions

Question one: must a state-registered adviser’s advisory contract be in writing? Yes, entering into an unwritten advisory contract is an unethical practice under the NASAA model rules.

Question two: an advisory firm that is a partnership replaces a minority partner. Must it obtain client consent? No, it must notify clients within a reasonable time, but a change of a minority partner is not an assignment.

Question three: an adviser sells a controlling interest in the firm. Is this an assignment of its advisory contracts? Yes, a transfer of a controlling block of voting securities is an assignment and requires client consent.

Question four: may an advisory contract include a clause waiving the adviser’s liability for its own negligence? No, any provision that waives a client’s rights under the securities laws is void and prohibited.

Question five: how often must a mutual fund’s advisory contract be renewed after its first two years? At least annually, by the board, including a majority of independent directors, or by shareholders.

Related Questions

Advisory contracts are one part of the wider set of obligations an adviser takes on. FRC’s guide to what custody is for an investment adviser covers the rules that apply when a contract allows the adviser to deduct fees directly from client accounts.

Get Exam-Ready

Advisory contract questions reward candidates who can run through the required terms and spot the prohibited ones quickly. Once “STaFF RAD” and “no hedge, no share” are fixed, these become some of the most reliable marks on the exam.

The FRC dictionary is more than a dictionary. It is a library of explainer videos, written explanations and on-page quizzes covering the FINRA and SEC rules you are tested on, so you can open any term and go deeper whenever a question catches you out.

Study With FRC

FRC’s programs and memberships are open to everyone. Whether you are preparing for the Series 65, the Series 7, the SIE or a combination, structured exam preparation turns topics like advisory contracts into marks you can rely on.

FRC’s Professional Membership adds verified progress and a Digital Profile, so when you apply to advisory firms, hiring managers can see your exam progress and the knowledge you are building, not just read about it on a resume.

Your Next Step

An investment advisory contract must be in writing and must set out the services, the term, the fee and its formula, how prepaid fees are refunded, whether the adviser has discretion, and that the contract cannot be assigned without client consent. It must not contain a hedge clause or, except for qualified clients, a share of the client’s gains.

Remember “STaFF RAD” and “no hedge, no share,” and you will be ready for every version of this question the exam can ask.