WASHINGTON - The Securities and Exchange Commission soon will change its rules to make it easier for investment advisers to charge performance-based advisory fees for institutional investors and high-net-worth individuals, said Robert E. Plaze, associate director of regulations in the agency's investment management division.
In letting money managers charge performance fees, the SEC intends to use exemptive authority granted by lawmakers last fall that lets the securities watchdog agency streamline or eliminate certain rules as long as investor protection isn't harmed.
Under the current rule, money managers can charge fees linked to the performance of their investment portfolios for affluent clients with at least $500,000 under management or a net worth of more than $1 million, but the rule imposes numerous restrictions.
"We are planning to eliminate those restrictions," Mr. Plaze said.
"If you meet the threshold, then the adviser is free to negotiate a contract, subject to the anti-fraud provisions," Mr. Plaze said. "There is a feeling that if you have sophistication, nothing other than anti-fraud" protection is needed.
As part of the review of the rule, the agency is considering increasing those thresholds for inflation. "Those are about 12 years old," he said.
Rule change suggested in '92
Easing the restriction on performance-based fees originally was recommended by the SEC's investment management division in a 1992 study.
The agency's move follows changes in the law last fall that opened the door for money managers to charge performance fees for foreign clients and "super rich," hedge fund investors.
That change also was recommended by the SEC's 1992 study that suggested lawmakers lift the ban on money managers charging performance fees for sophisticated investors that do not need protection, as well as for investors from other countries where such arrangements are common.
Under the law enacted last October, the super rich or "qualified" hedge fund investors are individuals with more than $5 million in investments, and institutions with at least $25 million in investments.
"Right now, there are no other exceptions that allow performance fees" without conditions, Mr. Plaze said.
To be sure, mutual fund money managers, and those with more than $1 million under management, already are permitted to charge fulcrum fees, where an adviser's compensation rises or falls in tandem with the portfolio's performance relative to an index or other benchmark over a specified period.
But other than those limited exceptions, money managers registered with the SEC have been banned from charging performance fees since the 1940 passage of the Investment Advisers Act. That provision was included in the act because the government feared that performance fees would prompt money managers to take inordinate risks in order to earn higher fees.
In 1970, lawmakers extended the ban to contracts between investment advisers and registered mutual funds, largely because many mutual funds had performance-based fee arrangements that rewarded money managers, beyond the customary fee, for good performance, without penalizing them for poor performance.
Component of sweeping review
The SEC's decision to lift the ban on performance-fees for money managers is part of a sweeping review of rules overseeing money managers, Mr. Plaze said.
"We are looking at the investment adviser statute in light of new developments over the years . . . changes we have been able to deal with in a piecemeal fashion, and now we are looking at everything in a comprehensive fashion," Mr. Plaze said.
As part of the review, the agency also is redoing the form ADV and working to develop a one-stop system so that money managers can file a single form with both the federal securities agency and state securities regulators. Such a revision has been expected for a long time.
The agency is developing a rule proposal and Mr. Plaze hopes the agency will be able to finalize its rule on the ADV revisions sometime next year. Money managers must annually update the form ADV, which provides details about their business.