Whether it’s contracts with custodians, subadvisors, technology service providers, software vendors, compliance product vendors, consultants, accountants, insurance carriers, or landlords, registered investment advisors (RIAs) are flooded with contracts, many of which seem like they are written in a foreign language. While it is understandable to focus on the core service and economic terms between the parties, investment advisors can face severe consequences if they overlook other important provisions. The discussion below highlights three areas where the failure to review and negotiate critical terms can be costly to RIAs.
The first area relates to the allocation of responsibility among the parties if something should go wrong in the course of the relationship. While no one entering a contract wants to think about “worst case scenarios,” because of the potential for significant financial harm that can be suffered by an advisor in such circumstances, it is critical to clearly understand these provisions. Typically, these provisions will be found in sections with headings that include the words “Liability,” “Exculpation,” and/or “Indemnification”. “Liability” and “exculpation” provisions address who will pay for damages and losses if one of the parties suffers losses. “Indemnification” provisions address which party will pay for damages if a third party suffers losses as a result of the actions of one of the contracting parties. Unsurprisingly, service provider and vendor contracts will often require the RIA to assume significant liability under the contract while minimizing or eliminating the service provider’s own responsibility for losses altogether. As a result, to the extent possible, these provisions should be heavily negotiated. Among other things, the issues to be negotiated include (a) the scope of parties that can be held at fault, (b) which parties can claim damages, (c) the types of losses or damages that the responsible party can be required to pay for, and (d) under what circumstances will a party be held responsible for paying for such losses. Often, attorney’s fees are included in recoverable losses, and such fees and expenses could be significant if a lawsuit drags on for an extended period of time. As a result, it is critical for an RIA to carefully consider the bad outcomes that could occur and to heavily negotiate these provisions to minimize its responsibility for damages.
The second area of concern for RIAs is the provisions in a contract dealing with the parties’ confidentiality obligations given business and regulatory concerns over cybersecurity and data breaches. The SEC and other regulators expect, among other things, that RIAs will ensure that their contracts contain provisions requiring service providers and vendors to adequately protect the advisor’s and its clients’ data. As such, RIAs should ensure that provisions are in place to restrict the vendor or service provider’s use of the advisor’s (and its clients’) data and to proactively require the service provider or vendor to implement safeguards that are reasonably designed to protect such information. Not doing so may allow a vendor or service provider to share information in a fashion that is unexpected by the advisor. Similarly, advisors who receive confidential information from vendors and service providers should understand their obligations to protect the vendor’s confidential information if any is shared with the advisor. If an advisor believes that such provisions will not adequately allow the advisor to effectively conduct its business, the advisor should raise the issue with the vendor or service provider. There are numerous important issues to address when negotiating confidentiality provisions including, among other things: (a) what information falls within the scope of “confidential information,” (b) defining how confidential information may be used; (c) defining when confidential information may be shared and with whom; and (d) defining the actions that the affected party can take if its confidential information is improperly disclosed or used.
The third area of concern is clearly outlining the responsibilities of each party upon termination of the contract. Investment advisors have numerous goals that they should account for when contemplating termination of service provider or vendor contracts including facilitation of a smooth transition to a new service provider and addressing how books and records of the advisor will be handled upon termination of a contract. At the outset, investment advisors should understand the duration of the contract and what, if any, notice must be given to terminate the contract. The advisor will want to minimize the amount of notice it is required to provide before the contract can be terminated (for maximum flexibility to move to another vendor) while requiring the vendor or service provider to provide as much advance notice prior to terminating the contract, particularly where it may be challenging for the advisor to quickly find alternate arrangements (i.e., office leases, performance reporting software, etc.). Failure to adequately negotiate the termination notice provisions could leave the advisor in a lurch if the contract is suddenly terminated which could create significant headaches for its operations. Similarly, the advisor should understand what obligations the service provider or vendor has during the transition period, if any, after the notice of termination has been given and before the last day of the contract. Ideally, the advisor would enlist the vendor’s or service provider’s good faith cooperation in facilitating the migration of data or other assets to the replacement vendor or service provider if possible. The failure to negotiate for the service provider’s cooperation in advance of signing the contract could result in disputes and significant disruptions when the contract is finally terminated. Separately, advisors should remember that, if the service provider or vendor retains certain books and records that the advisor is required to keep pursuant to applicable laws and regulations, such as the Investment Advisers Act of 1940, the advisor must negotiate how such books and records will be made available to the advisor upon the termination of the contract. For instance, an advisor will need to determine how to transfer any emails that are archived with a email archiving vendor once the contract with the service provider terminates. If the service provider or vendor cannot make such books and records available to the advisor at the end of the contract term, the advisor may not be able to enter into the contract with the vendor or service provider. However, advisors must keep these books and records retention requirements in mind when negotiating the contract or they could face violations of applicable regulations if they are unable to obtain such books and records from the vendor when the contract is ultimately terminated.
In summary, while it’s easy to simply sign contracts presented by vendors without review or negotiation, such a move can be damaging to an RIA. Therefore, investment advisors should carefully review such contracts, and, if appropriate, bring in an attorney to review such contracts on their behalf.
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