SEC Risk Alert: Regarding Fee and Expense Issues

 

Most Frequent Advisory Fee and Expense Compliance Issues Identified in Examinations of Investment Advisers

The Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission’s National Exam Program issued a Risk Alert on April 12, 2018, that provides a list of compliance issues related to fees and expenses charged by SEC-registered advisers that were identified most often in deficiency letters from over 1,500 adviser examinations completed during the past two years. An adviser that fails to adhere to terms of a client’s advisory fees and expenses as detailed in a client agreement and described in the adviser’s Form ADV may violate the Investment Advisers Act of 1940 and the rules promulgated thereunder, including the antifraud provisions.

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Most Frequent Compliance Issues Related to Advisory Fees and Expenses

 

    • Fee-Billing Based on Incorrect Account Valuation.
      • Valued assets using a different metric than specified in the client agreement (i.e., using asset’s original cost to value an illiquid asset rather than using a value based on its fair market value).
      • Used a different process than specified in the client agreement (i.e., using market value at end of the billing cycle, instead of average daily balance over the entire billing cycle; including assets in the fee calculation that were excluded by the agreement, such as cash or cash equivalents, alternative investments or variable annuities).

 

    • Billing Fees in Advance or with Improper Frequency.
      • Billed fees monthly instead of quarterly as agreed upon in the client agreement or disclosed in Form ADV Part 2, or billed in advance despite the agreement stating client would be billed in arrears.
      • Billed in advance for entire billing cycle, instead of pro-rating charges when  services began mid-billing or not reimbursing a client a pro-rated portion of fees when client terminated services mid-billing, despite disclosing they would do so in Form ADV Part 2.

 

    • Applying Incorrect Fee Rate.

      • Applied higher rate than agreed upon, or double billed.
      • Charged a non-qualified client performance based fees.

 

    • Omitting Rebates and Applying Discounts Incorrectly.
      • Client account values for member of the same household not aggregated for fee-billing purposes in accordance with adviser’s Form ADV or client agreement.
      • Fee not reduced when client’s account reached a prearranged breakpoint level according to the client agreement or the adviser’s Form ADV.
      • Charged additional fees, such as brokerage fees, when client was in the adviser’s wrap fee program.

 

    • Disclosure Issues Involving Advisory Fees.
      • Included a disclosure in Form ADV that was inconsistent with actual practices (i.e., maximum advisory fee rate, but had agreement with certain client to charge a fee exceeding the disclosed maximum rate).
      • Did not include disclosures about certain additional fees or markups in addition to advisory fees (i.e., collected expenses from a client for third-party execution and clearing services that exceeded the actual fee charged for those services by the outside clearing broker; earned additional compensation on certain asset purchases for client accounts or that they had fee sharing arrangements with affiliates).

 

    • Adviser Expense Misallocations.
      • Advisers to private and registered funds misallocation of expenses to funds (i.e., allocation of distribution and marketing expenses, regulatory filing fees, and travel expenses to clients instead of the adviser, in contravention of the applicable advisory agreements, operating agreements or other disclosures).

     

    OCIE encourages advisers to assess their advisory fee and expense practices and related disclosures to ensure they are complying with the Advisers Act, the relevant rules, and their fiduciary duty, and to review the adequacy and effectiveness of their compliance programs.

     

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