RIA Compliance and Practice Management Blog

SEC Releases Investment Adviser Risk Alert on Wrap Fee Programs

Posted by RIA in a Box

Jul 22, 2021 2:50:05 PM

www.riainabox.comhubfsSEC Risk Alert-1-Dec-14-2020-09-53-33-74-PM

On July 21, 2021, the Securities and Exchange Commission (“SEC”) Division of Examinations issued a new risk alert discussing the findings from recent examinations of more than 100 investment advisers registered with the SEC associated with wrap fee programs. Wrap fee programs allow investment advisers to offer a bundled comprehensive fee to their clients versus multiple charges for investment advice, brokerage services, administrative expenses, and other fees. The Division stated their decision to focus on this issue is due to the persistent growth of investor assets in wrap fee programs and the observed conflicts and disclosure practices.

The SEC’s “Wrap Fee Initiative” examined portfolio managers or sponsors of wrap fee programs and advisers with client accounts in one or more unaffiliated third-party wrap fee programs. The outcome shows that many examined advisers’ compliance programs could be improved, specifically in the areas of compliance and oversight as well as disclosures.

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Below we discuss the key focus areas of examinations, common cited deficiencies and specific examples from the observation findings:

  1. Consistency with fiduciary obligations: The staff looked to determine if the wrap fee programs were recommended in the best interest of the client – initially and regularly. They also focused on how the assessments were documented, as well as whether there were instances of undisclosed transaction charges and no trading activity in accounts for extended periods.

    The staff noted instances of examined advisers’ failure to monitor the trading activity properly or effectively in clients’ accounts. The issue often occurred when advisers continued to recommend wrap fee programs, and clients were unknowingly incurring transaction costs in addition to paying the bundled wrap fees. Observations also concluded advisers did not have a reasonable basis to recommend the wrap fee programs. Specifically, advisers showed they conducted initial assessments to recommend the wrap fee programs, yet they did not conduct on-going reviews to ensure the program was still in their clients’ best interest. The staff also described occurrences of inadequate on-going assessments by advisers.

  2. The adequacy of the examined advisers’ disclosures: Division Staff examined for full and fair disclosures of all material facts to clients, specifically regarding conflicts, fees, expenses, and entities involved in the programs.

    Many of the examined advisers were found to have inadequate or inconsistent disclosures. In particular, the advisers Part 2A and Form ADV were inconsistent with sponsors’ Part 2A Appendix 1 of Form ADV, advisory agreements, and other related documents. In one specific example, the advisory agreement indicated the clients would pay brokerage commissions, but the wrap fee program brochure clearly stated the clients will not pay such fees.

    The staff discovered instances where advisers omitted or inadequately described conflicts of interest in their disclosures. An example includes occasions of advisers providing investment recommendations which resulted in the client paying higher fees in the wrap fee program, whereas the clients did not receive proper disclosures to describe the fees associated with low trading volume or high cash balances.

  3. The effectiveness of the examined advisers’ compliance programs: The staff focused on discovery of the implementation and effectiveness of processes for determining whether wrap fee programs and accounts were in the best interests of clients.

    Notable issues with compliance programs included both omitting key risk areas and failure to implement written compliance policies and procedures. For example, wrap fee advisers did not address key risks related to trading-away practices. Advisers were also discovered to fail in performing annual reviews or the reviews were labeled inadequate due to limited testing or minimal documentation.

In this risk alert, the Division staff also revealed compliance best practices for wrap fee programs.

Fiduciary Duty & Clients' Best Interest

  • Conduct reviews of wrap fee programs initially and regularly to properly assess the recommendations are in the client’s best interest. Use strategies to gain client information, including interviews, discussions, or questionnaires.
  • Continually remind clients to report any changes to their personal situation, financial standing or needs, and investment objectives.
  • Communicate the differences in account strategies and account best interest in-person or over the phone with clients, as appropriate.

Disclosures

  • Provide clients with clear disclosures regarding the advisers’ conflicts of interest and whether certain services or expenses are not included in the wrap fee.

Compliance Programs

  • Conduct regular reviews of supervised persons’ documentation and use compliance staff, automated systems, or internal controls to uphold compliance.
  • Monitor and validate how advisers address best execution for client transactions.
  • The policies and procedures must outline how advisers will identify the wrap fee arrangement is no longer in their clients’ best interests.

Matching your RIA Firm's Form ADV Parts 1, 2, and 3

The Division concludes the risk alert by emphasizing on the importance for firms to properly assess their supervisory, compliance, and other management risk systems related to wrap fee programs. 

Topics: RIA Operations, RIA Compliance, RIA Technology

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.

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