In this latest risk alert, SEC OCIE staff notes, "The terms of a client’s advisory fees and expenses are typically detailed in an advisory agreement and described in an adviser’s Form ADV and other materials provided to the client. An adviser that fails to adhere to the terms of these agreements and disclosures, or otherwise engages in inappropriate fee billing and expense practices, may violate the Investment Advisers Act of 1940 (“Advisers Act”), and the rules promulgated thereunder, including the antifraud provisions. Moreover, advisers must adopt and implement written policies and procedures reasonably designed to prevent such violations."
SEC OCIE staff observed a wide range of advisory fees and expenses compliance issues. Some of the highlighted issues related to advisory fees and expenses lead to the following questions for the firm's Chief Compliance Officer ("CCO") to consider when evaluating and testing the firm's compliance program related to client fee billing:
- Fee-Billing Based on Incorrect Account Valuations
- Does the fee percentage being applied match the metric which is specified in the client's advisory agreement?
- Is the fee properly being applied using an average daily balance or other point in time as specified in the client's advisory agreement?
- Is the advisory fee being applied to assets that are supposed to be excluded such as cash or cash equivalents?
- What testing is being done to ensure fees are being properly applied and no clients are being overbilled?
- Billing Fees in Advance or with Improper Frequency
- Are advisory fees being billed on a monthly rather than quarterly basis as specified in the client's advisory agreement or in the Form ADV Part 2?
- Are advisory fees being billed in advance rather than in arrears as specified in the client's advisory agreement or in the Form ADV Part 2?
- Are new and terminated clients being properly billed or reimbursed the proper pro-rated portion of advisory fees?
- Applying Incorrect Fee Rate
- Is the advisory fee being applied higher than the amount specified in the client's advisory agreement?
- Is a non-qualified client being charged performance fees?
- Omitting Rebates and Applying Discounts Incorrectly
- Are all client household accounts being properly aggregated to qualify for discounted advisory fees as stated in the firm's Form ADV or advisory agreement?
- Is the client's fee rate being properly reduced when the account value reaches a prearranged breakpoint level?
- Are additional fees being charged to a client, such as brokerage fees, when the client was placed into the adviser's wrap fee program?
- Disclosures Involving Advisory Fees
- Is a client being charged more than the maximum advisory fee as stated in the firm's Form ADV?
- Are additional expenses being collected for third-party execution and clearing services or fee sharing arrangements without full and proper disclosure?
- Adviser Expense Misallocations
- When advising a private fund, are expenses being misallocated the fund in conflict with the applicable advisory agreements, operating agreement, other disclosure documents?
We highly recommend that the CCO and all advisory firm principals carefully review this latest SEC RIA compliance risk alert. Fee billing issues can present serious compliance issues and also continue to be one of the most frequently discovered compliance deficiencies during state-registered RIA examinations. In addition, firms should take this opportunity to do the following:
- Review the firm's Form ADV to ensure that full and accurate disclosures related to fees and expenses are being made that match the firm's current billing practices
- Review all client advisory agreements to ensure that actual fees being charged match what is specified in relevant client advisory agreements
- Review the firm's billing system to ensure that all fee rates are being properly calculated and applied to the proper asset types as specified in relevant client advisory agreements
- Ensure that all new and terminated clients being properly billed or reimbursed the proper pro-rated portion of advisory fees
- Ensure that fees are being properly billed in advance or in arrears as specified in the Form ADV and client advisory agreements
Be sure to check back soon as we continue to provide updates on relevant RIA regulatory compliance focus areas.
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.