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The purchase, sale or merger of an advisory practice involves a whirlwind of tightly-coordinated efforts by a myriad of different parties. In the shuffle of negotiating the deal terms, settling on a valuation methodology, coordinating with custodians and integrating technological systems, when does the client get a say, if any? In the time-honored tradition of attorneys everywhere, my answer is that it depends.
Section 205(a)(2) of the Investment Advisers Act of 1940 prohibits advisers from entering into an investment advisory contract with a client that “fails to provide, in substance, that no assignment of such contract shall be made by the investment adviser without the consent of the other party by the contract.” This is the baseline requirement that an advisory contract must, without exception, afford the client the opportunity to consent to his or her contract being assigned to another adviser.
That said, the SEC has never explicitly defined what constitutes client consent. Must a client affirmatively take some sort of action to provide consent to an assignment, or is the client’s failure to object to an assignment sufficient? It depends, in large part, in what exactly the signed investment advisory agreement states.
If the signed investment advisory contract requires the client’s written consent to an assignment, the assignment cannot occur until the client physically signs something granting his or her approval (i.e., positive consent). If the investment advisory contract does not require written consent, assignment may automatically occur if the client fails to object within the stated period of time (i.e., negative consent). If the investment advisory contract does not address the assignment consent issue, it does not meet the requirements of the Advisers Act.
The important takeaway for advisors, however, is that negative consent is generally permissible in the context of an assignment. The SEC affirmed this view through a series of no-action letters from the 1980s, which were later reaffirmed in further no-action letters from the 1990s.
A workable assignment clause in an investment advisory contract should afford the client a reasonable amount of time to object after receiving written notice of the assignment (typically 30-60 days). Language should make it clear to the client that a failure to object to an assignment within X number of days will be treated as de facto consent to the assignment.
Though it is beyond the scope of this article, an advisor should also carefully review what the SEC considers to be an “assignment.” At a very high level, an assignment occurs if there is a change in control at the adviser. There is an oft-cited rebuttable presumption that “control” constitutes a 25% or more ownership/voting interest in the advisor, but technically the rebuttable presumption exists in the Investment Company Act and not the Investment Advisers Act.
The point is that advisers should be conscious of positive v. negative consent issues even if their entire practice doesn’t change hands. Another word of caution: advisors to mutual funds are indirectly subject to a separate set of rules promulgated under the Investment Company Act, which states that an advisory contract with a fund automatically terminates in the event of an assignment.
Inserting appropriate negative consent assignment provisions into advisory contracts will help prepare an advisory practice for a smooth transition should an acquisition or merger opportunity present itself. Such provisions are also important to consider when creating a workable continuity or succession plan, as obtaining positive client consent is often easier said than done when the plan actually needs to be executed. As the adage goes, “It’s easier to ask forgiveness than it is to get permission.”