This article is written by Tanisha Kohli who is pursuing an Advanced Diploma in Contract Drafting and Negotiation from Lawsikho.
Several factors can serve as a push factor for a person or group of persons to hire an Investment Advisor, such as lack of time and/or the necessary knowledge to manage one’s money, increased complexity of finances, having a substantial amount of wealth which one wishes to invest, and so on. Choosing an Investment Advisor that is able to adequately meet one’s needs is an important task, and the terms of the contract that determine the services the Investor provides, and fee structure, the responsibility of the parties towards one another, and so on are of critical importance.
An investment advisory contract is entered into between any person who is engaged in the business of providing investment advice for a consideration (referred to as ‘the Investment Advisor’), and the person or group of persons to whom such investment advice is given (referred to as ‘the Client’).
Investment advisory contracts are entered into with regards to investment advice which relates to:
- Purchasing, Selling or otherwise dealing in securities or investment products
- Investment Portfolio containing securities or investment products
- Financial Planning
The advice may be oral, written, or through any other means of communication for the benefit of the Client.
The relevant law
To understand the regulations governing Investment Advisors, one must look at the SEBI (Investment Advisers) Regulations, 2013. Investment Advisors are regulated by and registered under these Regulations. The Regulations lay out the provisions regarding registration of Investment Advisor, general obligations and responsibilities of the Investment Advisor, the disclosure an Investment Advisor has to make to the Client, records to be maintained by the Investment Advisor, redressal of Client grievances, and so on.
Securities and Exchange Board of India (‘SEBI’) has recently amended the said Regulations, which will come into effect from 1st October, 2020. Some important aspects of the Amendment which should be taken into account while drafting an Investment Advisory Contract are:
- The same client cannot receive both advisory and distribution services from the Investment Advisor or from group entities of the Investment Advisor.
- If the client receives advisory services from the Investment Advisor, the contract must ensure that the Investment Advisor or its group entities do not receive any distributor consideration from the Client.
- If the client receives distribution services from the Investment Advisor, the contract must ensure that the Investment Advisor or its group entities do not receive any advisory fee from the Client.
- Investment Advisors can provide implementation services to the Advisory Clients in the securities market, but they cannot charge implementation fees from the Client. Neither can Investment Advisors either directly or indirectly receive any consideration including referral fees or commission for implementation fees.
- No person, while dealing in distribution of securities, should be referred to as “Independent Financial Adviser or IFA or Wealth Adviser or any other similar name” unless he/she has been registered with SEBI as an Investment Adviser.
The essential clauses of an Investment Advisory Contract
Appointment of the Investment Advisor – This clause contains two main points. Firstly, that the Client appoints the Investment Advisor to perform the services set out in the Agreement as per agreed-upon terms. Secondly, that the Investment Advisor accepts the said appointment.
Authority of the Investment Advisor – This clause should clearly specify the extent of the authority of the Investment Advisor. For example, whether the Investment Advisor has the authority to negotiate agreements on behalf of the Client, which the Investment Advisor deems necessary for performance of his services under the Agreement. The conditions under which prior consent of the Client is necessary, as well as the conditions under which the Investment Advisor does not need prior consent of the Client may be clearly enlisted.
Services to be provided by the Investment Advisor – This clause should contain the exact scope of the services. For example, the Client may wish to authorise the Investment Advisor to trade in all securities, instruments, or forms of investment, other than underlying Loans. The services may be classified into categories such as Advisory, Compliance, Execution of Transactions etc.
Representations and Warranties by the Investment Advisor – This clause should contain the following representations and warranties:
- That the Investment Advisor is registered with SEBI pursuant to Securities and Exchange Board of India (Investment Advisers) Regulations, 2013
- That the Investment Advisor is duly authorised to execute, perform, and deliver the Investment Advisory Agreement.
Representations and Warranties by the Client – This clause should contain the following representations and warranties:
- That the Client/the person executing the Agreement on behalf of the Client is duly authorised to enter into and perform the Agreement
- That the information the Client provides to the Investment Advisor is complete and correct, and any material change in the said information shall be notified to the Investment Advisor forthwith.
- That in relation to any investment activity carried on by the Investment Advisor under this Agreement, the Client shall be responsible for payment of all taxes and making all relevant claims and provide the necessary information to the tax authorities.
- That the Client understands the risks involved in the Investment business and that no assurance has been given to the Client by the Investment Advisor to ensure profits or avoid loss for the Client
Conflict of Interests – This clause should specify whether the Client has been made aware of any existing conflicts of interests and whether the Client agrees to waive the said conflict and hold the Investment Advisor harmless from any claims arising from such conflict. It should also specify that the Investment Advisor undertakes the responsibility to disclose any actual or potential conflict of interest that arises to the Client, as and when such conflict arises. The objective of this clause is to ensure that the objectivity or independence of the Investment Advisor in performing its services is not compromised and that the Client is fairly treated.
Limitation of liability of the Investment Advisor – This clause protects the Investment Advisor, acting in good faith and exercising due care and judgement, from any liability arising out of any act, omission, investment recommendation, loss suffered, or any other financial consequences, due to services provided under the Agreement. It should clearly specify the instances under which the Investor Advisor will be held liable – such as gross negligence, bad faith, etc.
Indemnity – Through this clause, the Client indemnifies the Investment Advisor and all its directors, employees, representatives from and against all and any liabilities, losses, damages, penalties, obligations, suits, judgements, costs of any kind, arising from the performance of this Agreement. The clause should also specify the conditions under which the client will not indemnify the Investment Advisor – such as gross negligence, bad faith etc.
Compensation to be paid to the Investment Advisor – This clause should include the consideration which is to be paid to the Investment Advisor for its services under the Agreement. It is standard practice that the consideration is computed on a percentage basis. This clause should also include whether the compensation is to be paid monthly or quarterly or annually etc. It should also specify the expenses which are to be borne by the Investment Advisor and the Client.
Confidentiality – This clause should protect the confidential information of both the Client and the Investment Advisor. It should clearly specify under what conditions information may be disclosed to a third party. For example – with prior written consent, necessary to be disclosed under the law etc.
Termination – This clause should include the mode of termination, grounds of termination, sufficient notice of termination, the effect of termination on any pending payments.
Governing Law – This clause specifies that the laws of which country shall govern the agreement.
Dispute Resolution – The parties may specify that disputes arising out of the Agreement will be settled by arbitration and all other necessary details such as the appointing authority, place of arbitration etc.
Common mistakes to be mindful of
- Failing to update the Investment Advisory Agreement – It is advised to ensure that the Agreement complies with any amendments in the law and necessary regulatory compliances.
- Ambiguity in the authority of Investment Advisor – The scope of the authority of the Investment Advisor should be clearly defined in the agreement, especially with regards to any assets of the client in the accounts managed by the Investment Advisor i.e whether the Investment Advisor has trading authorization, the discretionary authority of the Advisor etc.
While drafting an Investment Advisory Agreement, the above mentioned clauses must be incorporated. Importantly, one needs to be on the lookout for a separate circular to be issued by SEBI which is currently awaited, relating to a mandatory agreement to be entered into between the Client and IA. It is expected that it will have the underlying intent of ensuring greater transparency, fees to be charged by the IA, and compliance processes for client segregation into advisory client and distribution services client.
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