April 26, 2008
I represent several dozen investment advisers. Nearly all of them advise one or more hedge funds. Most also advise one or more separate accounts. Though most of my clients' compensation arrangements include both asset-based fees and performance-based compensation, those arrangements sometimes vary significantly among their different clients. For example, some performance compensation arrangements may include a "soft" hurdle, others a "hard" hurdle, still others no hurdle at all. The method by which "high water marks" are calculated may differ from client to client. Asset-based fee and/or performance-compensation percentage rates may vary among clients, and some performance-compensation arrangements may call for percentage tiers while others may not.
Each arrangement that applies to a specific investor of the adviser, whether an investor in a hedge fund or a separate account managed by the adviser, is disclosed clearly and in detail in the agreement signed by the investor and in the disclosure document delivered to the investor before he or she commits to invest. This being so, will it be useful, or more likely confusing, to investors to require that an adviser describe his or her compensation arrangements in the adviser's brochure? If an adviser uses various compensation arrangements with its advisory clients, for example, must the adviser describe each of them in its brochure, since the adviser obviously cannot know in advance which arrangement might apply to a particular reader who decides to retain the adviser? May such an advisor disclose merely (and, therefore, all but pointlessly) that it charges asset-based fees and/or performance-based fees, which vary among clients? In either case, if the advisor also discloses that it reserves the right to make different compensation arrangements with any client in the future, will the reader have come away with anything of value from this disclosure?
Would it not make more sense simply to require (as, frankly, is already required) that an adviser disclose to an advisory client, apart from the brochure but not in it, the specific compensation arrangements that will apply to that advisory client?