WHEREAS, Ala. Code § 8-6-17(d)(1) prohibits an investment adviser from entering into, extending or renewing a contract which does not expressively prohibit compensation based on a share of the capital gains or appreciation of the funds or a portion of the funds of the client otherwise known as “performance fees,” and

WHEREAS, Ala. Code §  8-6-17(g) provides that the Alabama Securities Commission (the “Commission”) many by Order adopt an exemption from the prohibition against the charging of performance fees contained at Ala. Code § 8-6-17(d)(1), provided such exemption is consistent with the purposes fairly intended by the policies and provisions of the Alabama Securities Act (the “Act”) and consistent with the interests of the investing public, and

WHEREAS, the Commission staff has researched this issue and based on current industry standards has determined that performance fees may be allowed as such contracts are applied to “Qualified Investors”, that term being defined by United States Securities Exchange Commission (the “SEC”) Rule 205-3(d)(1) and subject to the restrictive provisions herein stated.

Historical Context

In adopting the Investment Advisors Act of 1940, the UNITED States Congress generally prohibited performance fee compensation arrangements believing that such arrangements could encourage advisers to take undue risks with client funds to increase advisory fees. (Section 205(a)(1)). Congress provided the SEC rule making authority to conditionally exempt these prohibitions for persons who did not need the protections based on factors such as financial sophistication, net worth, knowledge of and experience in financial matters, amount of assets under management, relationship with a registered adviser, and such other factors as the SEC determines are consistent with (Section 205). As such, in 1985 the SEC used their rule making authority to implement rule 205-3 allowing the payment of performance fees under specific conditions and to persons who meet the definition of a “qualified investor”.

The Alabama Securities Act was implemented and adopted based primarily on the Uniform Securities Act of 1956, which correlated to provisions prohibiting the charging of performance fees, as well as the power of the Commission to grant broad exemptive relief from such prohibitions.

In 1996, Congress passed the National Securities Markets Improvement Act, in which, among other issues, Congress bifurcated the regulation of investment advisers between the SEC for large advisors (those with assets under management [“AUM”] of $25,000,000 or more) and the states (those with less than $25,000,000 of AUM). Pursuant to the Dodd-Frank Act of 2010 the division of regulatory responsibility for investment advisers was reallocated between the Federal Government and States with all investment advisers having AUM of less than $100,000,000 reverting to state regulation and the SEC retaining regulation of those investment advisers with AUM of $100,000,000 or more. With this change, many advisers previously subject to the SEC rules relating to performance fees are now subject to regulation under the Alabama Securities Act.  Due to the restrictions relating to the type of client who may participate in such fee arrangements, very few investment advisors charging performance fees were regulated by the states prior to the reallocation of regulatory responsibilities under Dodd-Frank.  

Historically, prior to the reallocation of regulatory responsibilities under Dodd-Frank, the SEC has found little abuse relating to these fees as charged to Qualified Investors, that such arrangements can be beneficial to the client under the right circumstances and that the imposition of such fees is consistent with current industry practice. In fact, the failure to allow such fees as it related to investment advisers transitioning from SEC to state regulation may prejudice the investor by effectively denying access to advisers with whom the investor has maintained long term relationships.

See original statement of policy HERE.