Episode 13: Take-Aways from the OCIE Risk Alert on Advisory Fee Expense Issues

Michelle Jacko discusses key takeaways from the OCIE’s recent Risk Alert on Advisory Fee Expense Issues.



Over the course of the last two years, the SEC identified various deficiencies from over 1500 adviser examinations. The purpose of the risk alert is to notify SEC registered investment advisers of what they should be thinking about when they are reviewing their practice’s policies and procedures so that they could fully comply with the Investment Advisers Act of 1940 requirements.

Importantly, as part of this, the SEC provided a summary of the most frequent compliance issues related to advisory fees and expenses. One might think that the most common deficiency has to do with the calculation of fees and that is correct. Oftentimes such fee calculations are based on incorrect account valuations. Because most investment advisers charge their advisory fees based on a percentage of assets under management, if assets are incorrectly valued, that means that the fee assessed for those assets would obviously be incorrect and lead to incorrect billing practices.

The SEC notably found that in some cases, assets were valued in a client’s account using different matrix than what was specified in the client’s advisory agreement. And in other cases, the advisers used a process that differed from the process specified in the client’s adviser agreement.

So, for example, if an investment adviser specified that cash and equivalence would not be included in the calculation of an advisory fee during some of the examinations, the staff found that some of the assets actually were included in the fee calculation and thus, the adviser overcharged the client.

Another common deficiency area involved billing fees, and whether or not they were billed either in advance or with improper frequency. In some cases, the staff found that the contracts stated that advisory fees would be billed on a quarterly basis, but in practice saw that the advisers were billing on monthly basis instead of quarterly.

In other cases, the staff observed that the advisers billed advisory fees in advance despite their agreement specifying that clients would be billed in arrears. In other cases, the staff found that when clients actually terminated their account with the investment adviser, if that adviser had been charging for fees in advance, that adviser failed to reimburse the client a prorated amount of the advisory fees based upon the timing of when the client terminated the advisory services even though the disclosure in Form ADV part 2A stated that the adviser would do so.

Another area of focus involves the incorrect fee rate. In some cases, the staff found that a higher rate was applied than what was originally agreed upon in the advisory agreement. Or in some cases, a client may have been double billed. The staff also found that advisers failed to apply discounts correctly.

So, for example, some investment advisers may aggregate accounts into certain households and for fee billing purposes develop certain breakpoints and apply discounted fees for members of the same household. Even though the From ADV or advisory contract indicated that such households would receive discounted fees, in practice, that did not occur.

Similarly, in some cases advisers stated that as a client’s assets under management increased, the client would receive a breakpoint which would allow the that client to be assessed a lower fee rate according to the adviser’s Form ADV or advisory contract. However, in practice that did not necessarily occur.

In addition, the staff found that disclosure in Form ADV was inconsistent with the advisors actual practice. For example, in some cases the ADV may state what a maximum advisory fee would be assessed, however, in practice the advisor actually assessed a much higher rate than that which was disclosed in Form ADV. In other cases, the staff found that advisors failed to disclose certain additional fees or markups received in addition to advisory fees. For example, if the advisor earned additional compensation on certain asset purchases for client accounts or had fee sharing arrangements, that was not properly disclosed within Form ADV.

A final area that the staff found was that the advisor may have misallocated expenses, particularly in the case of private and registered funds. For example, marketing or travel expenses were allocated to the fund and its investors rather than the investment advisor, which contradicted with operating agreements and other disclosures provided.

Notably, the risk alert concludes by stating that adviswrs are encouraged to look at their practices to enhance policies and procedures particularly as it relates to the advisory fee practices and to reimburse clients that may have been overbilled amounts of advisory fees and expenses as a result of these as a result of these findings.

It’s important to remember that as investment adviswrs you have a fiduciary duty to act in the best interest of the client, and that means taking proactive steps to ensure that internal testing of billing practices are consistently provided so that we can ensure clients are billed appropriately.

For more information and considerations on how you can evaluate your practices and enhance your policies and procedures in this regard, we encourage you to please contact Core Compliance and Legal Services at (619) 278-0020 or at info@corecls.com


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