RIA Compliance Blog
The Division of Examinations of the Securities and Exchange Commission (SEC) recently released a Risk Alert relating to the Advisory Fee Initiative titled “Division of Examinations Observations: Investment Advisers’ Fee Calculations.” Under this Initiative, the SEC conducted approximately 130 examinations of SEC-registered investment advisers focusing on how advisory fees are disclosed and charged, particularly to retail clients.
Since 2018, the SEC has included the disclosure of the costs of investing in its list of yearly exam priorities. The Division of Examinations has focused on whether advisers have adopted policies and procedures reasonably designed to produce fair and accurate fee assessments, and whether those fees are disclosed to clients in a manner such that clients understand the costs of the advisory services provided.
During the Initiative, the Division’s review included: (1) the accuracy of the fees charged by the examined advisers; (2) the accuracy and adequacy of the examined advisers’ disclosures; and (3) the effectiveness of the examined advisers’ compliance programs.
The Division’s observations continue to illustrate that an adviser is expected to detail how advisory fees are assessed in contracts, agreements, and disclosure documents, and regularly monitor the accuracy of those advisory fees charged to clients. Detailing the assessment of advisory fees and monitoring the accuracy of charged fees is important to avoid the mistakes noted by the Division, including: (1) using the wrong percentage to calculated advisory fees, (2) double-billing of advisory fees, (3) misapplying tiered billing and householding fee breaks, and (4) using incorrect account valuations when charging fees.
The SEC’s observations included a separate section to discuss issues relating to the beginning and termination of the client relationship. These issues included failing to pro-rate advisory fees at the start of the client relationship and failing to properly refund unearned advisory fees when the relationship is terminated. This latter issue, failing to properly refund unearned advisory fees, has already been the subject of prior SEC enforcement actions. In the current Risk Alert, the SEC cautioned advisers whose policies and procedures require written notice from clients to refund prepaid advisory fees. The SEC noted that advisers in these situations failed to refund unearned advisory fees where the client terminated the relationship through the custodian or did not specifically request the fee refund in writing.
Going hand-in-hand with the accuracy of advisory fees charged, the SEC’s Risk Alert noted issues observed relating to false, misleading, or omitted disclosures. These observed issues included the typical situations where fee disclosures were not consistent across the multiple disclosure documents or were missing altogether. To highlight the issue of inadequate disclosures, the SEC noted several situations observed, such as: (1) insufficiently addressing the impact of deposits or withdrawals on advisory fees, (2) inaccurately detailing the timing of fee billing, (3) falsely detailing the negotiability of fees, and (4) inadequately explaining additional fees charged such as platform fees, sub-adviser fees, and wrap fees.
Finally, the SEC emphasized the importance of robust policies and procedures to assist advisers and compliance staff administer the overall advisory fee program. The SEC expects more than generic guidance that broadly explains advisory fees. Instead, advisers should specifically address the process for calculating, billing, and testing advisory fees.
Due to the high likelihood that an inadequate advisory fee process will cause issues resulting in client harm, advisers are encouraged to develop and maintain routine compliance actions focusing on advisory fees. If properly established, the compliance program helps to minimize the potential for advisory fee issues, with the disclosure documents and policies and procedures serving as a roadmap for administering the compliance program. A robust compliance program should create a process for assessing, monitoring, and testing the accuracy of advisory fees, as well as establish a procedure for amending the process and disclosures as changes are made that impact advisory fees, such as updating the fee schedule or changing custodians.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.