A state-registered investment adviser (IA) has decided to switch its fee structure from an hourly rate to a performance-based fee for certain qualified clients. Under the Uniform Securities Act (USA), which of the following is true regarding this change?
- APerformance-based fees are permissible only for federal covered investment advisers (FCIAs).
- BPerformance-based fees are generally prohibited for all state-registered IAs.
- CPerformance-based fees are permissible for state-registered IAs only if the client is an institutional investor.
- DPerformance-based fees are permissible for state-registered IAs if the client meets specific net worth or assets under management (AUM) requirements.
Show answer & explanationAnswer & explanation
Correct answer: D. Performance-based fees are permissible for state-registered IAs if the client meets specific net worth or assets under management (AUM) requirements.
While performance-based fees are generally prohibited for state-registered IAs due to potential conflicts of interest, the USA (and NASAA rules) provide an exception for 'qualified clients.' These clients typically meet specific high net worth or AUM thresholds, indicating they are sophisticated enough to understand and bear the risks associated with such fee arrangements.
Why the other options are wrong
- A. While FCIAs can use performance fees, state-registered IAs also have exceptions for qualified clients.
- B. This is generally true but misses the 'qualified client' exception.
- C. While institutional investors often meet the qualified client criteria, the exception is broader and refers to specific financial thresholds, not just institutional status.
Performance-Based Fees (USA)
Performance-based fees are generally prohibited for state-registered Investment Advisers (IAs) unless the client is a 'qualified client' meeting specific net worth or assets under management thresholds, or other limited exceptions apply.
- Generally prohibited for state IAs.
- Exception for 'qualified clients'.
- Qualified clients meet specific AUM or net worth criteria.
- Requires disclosure of risks.
Memory trick: Performance pay is a no-go, unless you're a qualified pro.