On August 19, 2014, the staff (the “Staff”) of the SEC’s Division of Investment Management provided no-action relief under Section 205(a)(1) of the Investment Advisers Act of 1940 (the “Advisers Act”) permitting a registered investment adviser to offer clients an advisory fee rebate for periods of negative performance. As described in the no-action letter, Amerivest Investment Management, LLC (“Amerivest”) provides discretionary advisory services to certain clients by implementing model portfolios based on recommendations provided to Amerivest by Morningstar Associates, LLC (“Morningstar”). Under a proposed change to the fee arrangement for Amerivest’s clients, Amerivest would continue to charge a quarterly asset-based advisory fee in advance, but would rebate advisory fees for eligible clients who are invested pursuant to a model portfolio that experiences two consecutive discrete calendar quarters of negative performance (before advisory fees) during a twelve-month period.
Section 205(a)(1) of the Advisers Act generally prohibits registered investment advisers from entering into, extending or renewing any investment advisory contract that provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation in a client’s account or any portion thereof. Section 205(a)(1) was designed, in part, to prevent fee arrangements in which an adviser participates in profits and does not participate in the losses. Although Section 205(a)(1) does not, on its face, extend to fee waivers or rebates that are contingent on negative performance, the Staff has previously expressed the view that the concerns underlying the performance fee ban “are as apposite to advisory fees which are contingent upon an advisory account obtaining a certain level of performance as they are to fees which vary directly with capital gains or appreciation.”1 In requesting no-action relief, Amerivest had emphasized that the conflicts of interest typically associated with performance-based fees (and targeted by the Section 205(a)(1) prohibition) were not present or were substantially mitigated under Amerivest’s proposed fee arrangement.
In granting no-action relief, the Staff noted a number of conditions that contributed to alleviating the concerns about performance-based fees underlying Section 205(a)(1), including, but not limited to, the following:
- Amerivest would fully and clearly disclose the terms of the proposed fee arrangement to participating clients, including advance disclosure of any changes to the fee arrangement;
- The proposed fee arrangement would not contain any “catch up” or other provision that would allow Amerivest to recapture foregone fees through future appreciation;
- Amerivest would not deviate from or seek to influence Morningstar’s investment recommendations to avoid payment of any fee rebate pursuant to the fee arrangement;
- Amerivest could deviate from Morningstar’s investment recommendations solely for non-investment related reasons such as tax considerations or reasonable client restrictions or to the extent required to fulfill its fiduciary duty to clients; and
- There would be no contract or other understanding between Amerivest and Morningstar, such that Morningstar’s compensation or continued engagement would be affected by the payment or non-payment of any fee rebate pursuant to the proposed fee arrangement.