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SEC RIA Regulatory Enforcement Focus: Improper Client Fee Billing

Posted by RIA in a Box

Nov 28, 2018 10:49:18 AM

RIA enforcement actions client fee billingOn November 19, 2018, the Securities and Exchange Commission ("SEC") Division of Enforcement announced that it settled claims with a registered investment adviser ("RIA") firm "that it charged more than 290 client accounts higher advisory fees than those in its fee schedule. According to the SEC release, like many advisory firms in the industry, this RIA firm charged clients advisory fees calculated based on a percentage of the assets under management ("AUM"). The firm's fee schedule included a series of “breakpoints” that reduced advisory fees charged to a client as the total amount of that client's AUM increased. The fee schedule was incorporated and disclosed in the firm's client advisory agreements, distributed as a separate document by client request, and disclosed on the firm's Form ADV Part 2A. The SEC order found that from early 2010 to early 2018, the advisory firm inconsistently applied the advisory fee "breakpoint" discounts. As a result of this issue, the firm "overcharged more than 290 client accounts during that period by assessing approximately $304,000 in excess advisory fees."

This particular enforcement case is relevant to RIA firms of all sizes that charge client advisory fees based on the client's AUM with "breakpoints" that reduce the total advisory fee when the client's AUM increases. 

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Proper client fee billing has been a consistent RIA regulatory focus area for a number of years. According to the North American Securities Administrators Association ("NASAA") 2017 Investment Adviser Coordinated Examinations Report, over 27% of state-registered investment advisory firms had regulatory compliance deficiencies related to client fee billing. As this most recent SEC enforcement case shows, client fee billing issues are not limited to state-registered RIA firms, but can also impact larger, SEC-registered firms as well.

On April 12, 2018, the SEC Office of Compliance Inspections and Examinations ("OCIE") released a National Exam Program Risk Alert listing the most commonly found registered investment adviser ("RIA") advisory fee and expense compliance issues in recent regulatory examination deficiency letters. In the risk alert, SEC OCIE staff notes, "advisers should review their practices, policies, and procedures to ensure compliance with their advisory agreements and representations to clients in light of the fee and expense issues noted in this Risk Alert." 

In particular, this case highlights three common client fee billing compliance issues:

  1. Fee charged doesn't match the firm's Form ADV or client advisory contract
  2. Miscalculated fees leading to overcharging clients
  3. Inconsistent fee billing practices leading to certain clients being treated more favorably 

In particular, the SEC enforcement staff cited the following compliance program implementation issues which led to violations of Rules 206(2), 206(4)-7, and 207:

  1. Failed to adopt and implement policies and procedures reasonably designed to prevent advisory fees to be overcharged.
  2. Failed to conform fee billing policy matched the Form ADV and other disclosure documents.
  3. Policies and procedures were not designed to prevent favoring certain clients. Only some clients had their accounts aggregated for fee discounting purposes.
  4. Did not properly document the firm's client household aggregation fee billing policy for all clients in the firm's policies and procedures manual.

As a result of this latest SEC investment adviser regulatory enforcement action and recent regulatory risk alert, we encourage the Chief Compliance Officer ("CCO") of all RIA firms to consider the following steps when evaluating and testing the firm's compliance program related to client fee billing:

  • Fee Disclosure Documents
    • Does the advisory fee being charged to the client match the fee schedule as outlined in the investment advisory contract?
    • Does the advisory fee being charged to the client match the fee schedule as outlined in the firm's Form ADV Part 2A?
    • Are fee "breakpoint" discounts clearly and consistently disclosed to all clients?
    • If all accounts from a client household are being aggregated for fee billing purposes, is this clearly and consistently disclosed to all clients?
    • Is the client receiving all proper disclosure documents before engaging with the firm?
  • Fee Calculations and Billing
    • Is the firm utilizing automated fee calculation and billing software to ensure proper calculations?
    • Are the proper fee schedules being assigned and applied to each client?
    • Are all fee "breakpoints" being properly applied to each client?
    • Are all client accounts being properly aggregated for fee billing purposes for each client?
    • Are all client accounts being billed at the proper frequency (monthly, quarterly, etc.)?
    • Are all client accounts being billed properly in arrears or in advance?
  • Compliance Policies and Procedures
    • Have all client fee billing policies and procedures been recently reviewed to ensure they match current fee billing practices?
    • Have proper procedures been implemented to test and ensure that all clients are being charged the proper fees?
    • Are all fee "breakpoint" and aggregation policies properly documented to ensure consistency across all clients?
    • Are policies being properly implemented to ensure that all clients are receiving proper and consistent fee disclosures?

Given that the above list is not an exhaustive list of all client fee billing best practices, we also highly recommend that the CCO and all advisory firm principals carefully review this latest SEC RIA enforcement action. As demonstrated in this most recent instance, failure to address client billing issues can lead to serious compliance issues. Be sure to check back soon as we continue to provide updates on relevant RIA regulatory enforcement actions and compliance focus areas.

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RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

Topics: RIA Compliance, RIA Operations

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