Investment Adviser Risk Alert on Wrap Fee by the SECCrelano@mahadvising.com
Investment Adviser Compliance Services on Wrap Fee by the SEC
The Division of Examinations of the SEC released a new investment adviser compliance services with regards to risk alert on July 21, 2021, that discussed the findings from its exams of more than 100 registered investment advisers involved in wrap fee programs. Wrap fee programs allow advisers to charge their clients a single comprehensive fee for investment advice and brokerage services rather than charging them separately for investment advice, administrative expenses, brokerage fees, and other charges. Division officials say they decided to confront this issue because wrap fee programs are over generating investor assets and because disclosure and conflict practices have been observed.
Under the “Wrap Fee Initiative” the SEC examined wrap fee sponsors and portfolio managers whose clients are involved in independent wrap fee programs. As a result, many examined investment advisers could improve their compliance programs, specifically regarding oversight, compliance, and disclosure.
Our article below provides information on the main areas of focus when performing examinations, common deficiencies cited, and specific examples when observing:
1. Adherence to fiduciary standards: Staff reviewed if wrap fee programs were designed in accordance with the interests of the client – initially and over time. They also analyzed the documentation of the assessments, and they checked whether there were periods where there were no transactions in accounts and no trading activity.
In some cases, examined advisers were unable to monitor trading activities in clients’ accounts in a proper or effective manner. As a result, advisers frequently continue to advise wrap fee programs, and clients are often unaware they are required to pay transaction fees on top of the wrap fees. Observations similarly concluded that wrap-fee advisers lacked a basis for recommending these programs. As part of these assessments, advisers recommended wrapping fee programs, however they did not carry out ongoing reviews to verify that the program continued to benefit their clients. On-going assessments performed by advisers also had inadequacies, according to the staff.
2. Adequacy of disclosures by the examined investment advisers: Division Staff looked for a full and fair disclosure of all material information, specifically regarding conflicts of interest, fees, expenses, and parties involved with the program.
Most examined advisers failed to disclose information adequately or inconsistently. Advisory agreements and Part 2A Appendix 1 of Form ADV in particular were inconsistent with sponsors’ regulatory documents and Part 2A Appendix 1 of Form ADV. A client agreed they would pay brokerage commission, but a brochure detailing the wrap fee program clearly states that the client does not have to pay brokerage commissions.
There were instances in which advisers failed to disclose conflicts of interest or described them inadequately. The wrap fee program is one example in which advisors provided investment recommendations resulting in the client paying higher fees, as the client never receives adequate disclosures regarding low trading volumes or high cash balances.
3. The effectiveness of the compliance programs of the investment advisers examined: Staff examined the effectiveness and implementation of processes to determine whether wrap fee accounts and programs were in the client’s best interest.
The omission of key risks in compliance programs and the lack of written compliance policies and procedures stood out as notable problems. Advisers’ wrap fee, for example, neglected to address risks associated with trading-away practices. Furthermore, annual reviews were found to be lacking in appropriate testing and inadequately documented because advisors failed to perform the reviews.
Additionally, in the investment adviser compliance services with regards to risk alert, Division staff provided best practices for compliance with wrap fee programs.
Fiduciary Duty & Clients’ Best Interest
- To assure the recommendations made by wrap fee programs are beneficial to the client, review the program initially and regularly. Utilize methods such as interviews, questionnaires, and discussions to gather client information.
- Clients should continually be reminded to let you know if their circumstances, financial standing, or needs have changed.
- Communicate types of account strategies and best interests to clients, if necessary, in person or over the phone.
- Clear disclosures are necessary regarding advisor conflicts of interest, as well as determining what expenses and services are excluded from the wrap fee.
- Regularly review documentation presented by supervised persons, and implement automation, internal controls, or compliance staff for monitoring compliance.
- Make sure advisers are monitoring and validating their best execution strategies.
- In the policies and procedures, advisers must specify how they will determine whether the wrap fee agreement still benefits their clients.
As a conclusion to the investment adviser compliance services with regards to risk alert, the Division emphasizes the importance of companies evaluating their supervision, compliance, and other risk management systems about wrap fee programs.