Regulatory Focus on the Accuracy and Adequacy of Advisory Fee Billing and Disclosures

On November 10, 2021 the SEC Division of Examinations (“Division”) issued a Risk Alert outlining deficiencies the Division found during their national exam initiative on advisory fees. The focus of this Risk Alert was supplementary to the Risk Alert on advisory fees issued by the Division in April 2018 and covered the following areas:

Regulatory Focus on the Accuracy and Adequacy of Advisory Fee Billing and Disclosures

 

  • The accuracy of the fees charged by the examined advisers,
  • The accuracy and adequacy of the examined advisers’ disclosures, and
  • The effectiveness of the examined advisers’ compliance programs and accuracy of their books and records.

During the initiative, the Division’s Staff observed that a typical adviser from the 130 advisers examined had the following characteristics: 

  1.  A standard fee schedule with tiered fee levels based upon assets under management;
  2. Assessed fees quarterly;
  3. Deducted fees directly from client accounts;
  4. Calculated fees based on the account value at the beginning or ending date of the billing period;
  5. Used software or third-party service providers to calculate fees;
  6. Documented fees with clients through written advisory agreements or contracts; and
  7. Combined family account values when such actions resulted in lowers fees (i.e., householding of accounts).

 In this Risk Management Update, we discuss the deficiencies found by the Division and provide suggestions for compliance testing to help you ensure compliance with requirements. 

Advisory Fee Calculations

Deficiencies found included:

  • Implementing a new or updated fee schedule without converting all clients to the same;
  • Double billing due to a change in billing practices;
  • Breakpoint/householding or tiered billing rates  not correctly applied resulting in inaccurate calculations; and
  • Inaccurate pro-rating at account opening and/or failure to refund prepaid fees on terminated accounts.

Compliance Testing Suggestions: Perform a sampling review each billing cycle comparing the fee percentage/rate used to calculate the fee, with the fee percentage/rate outlined in the client agreement.   Also, for tiered fees perform sampling review to confirm that all applicable related account values are included in the calculation.   

False, Misleading, or Omitted Disclosures

Deficiencies found included:

  • Insufficient or lack of disclosures for cash flows and their effect on advisory fees such as how a client will be billed for large deposits and mid-billing cycle;
  • Inaccurate disclosures or ambiguity regarding the timing of  fee billing;
  • Inaccurate disclosures or ambiguity regarding the values used to calculate advisory fees; and
  • Lack of disclosures regarding minimum fees, extra fees, and discounts with an emphasis on (1) platform administration fees (and how they could be avoided, when applicable), (2) the negotiability of fees or falsely disclosed that fees were not negotiable when they, in fact, could be negotiated, (3) householding eligibility and its implementation, and (4) fees related to participating in wrap fee accounts and non-wrap accounts.  

Compliance Testing Considerations: Compare current billing processes with disclosures in Form ADV and client agreements to ensure accuracy. 

Missing or Inadequate Policies and Procedures 

Deficiencies found included:

  • Vague or generic policies and procedures that did not address specifics related to a firm’s processes for computing, billing, and testing advisory fees; and
  • Failure to disclose material advisory fee components such as: 

(1) valuation of illiquid assets included in the assets for the calculation of advisory fees, (2) fee offsets, such as those offered for 12b-1 fees, 

(3) fee reimbursements for terminated accounts, where the client prepaid fees, 

(4) prorating fees for additions or subtractions of assets in accounts, and 

(5) family account aggregation or householding for fee calculations.

Compliance Testing Considerations: Review policies and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both to ensure that they have been formalized as current and in practice. 

Inaccurate Financial Statements 

Deficiencies found included:

  • Issues or inaccuracies with financial statements for examined advisers in potential financial distress.
  • Not recording all advisory fee income (such as bartering), administrative fee revenue, and compensation expenses in general ledgers and on financial statements; and
  • Using a cash and modified cash basis of accounting but preparing financial statements on an accrual basis of accounting.

Compliance Testing Considerations: Advisers in potential financial distress need to re-examine their financial statements for potential violations of the anti-fraud provisions of the Advisers Act.  For example, refunding prepaid advisory fees only to certain clients.

Industry Best Practices Observed by the Division Staff 

Examples provided by the Division of policies and practices to assist advisers with compliance in the above referenced areas included the following:

  • Adopting and implementing written policies and procedures addressing advisory fee billing processes and validating fee calculations.
  • Centralizing the firm’s fee billing process to validate charged fees as consistent with compliance procedures, advisory contracts, and disclosures.
  • Consistently utilizing checklists and other resources for reconciling client fee calculations with client agreements.
  • Properly recording all advisory expenses and fees assessed to and received from clients, including those paid directly to advisory personnel.

Conclusion

Lastly it should be noted that an adviser that engages in inappropriate fee billing and other fee-related deficient practices may have regulatory implications beyond the focus of the Risk Alert as described above. Advisers must review routinely, refine, and improve, as appropriate, their fee billing policies, procedures, and practices and address new risks as they are identified to include assurances that clients are provided with full and fair disclosure of all fees and expenses and related material conflicts of interest. The Core Compliance & Legal Services, Inc. consulting team are well versed in this area and can assist with the assessment of your advisory fees. Contact us at 619-278-0020 or visit us at www.corecls.com for more information.

Author:  Maggie Tavares, Sr. Compliance Consultant; Editor: Tina Mitchell, Managing Director, Consultation Services, Core Compliance & Legal Services (“Core Compliance”). Core Compliance works extensively with investment advisers, broker-dealers, investment companies, hedge funds, private equity firms and banks on regulatory compliance issues. 

This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer and/or tax professional.

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