Smart RIA

Smart RIA

On April 12, 2018, the Office of Compliance Inspections and Examinations (“OCIE”) issued a National Exam Program risk alert in which it outlined the most frequent advisory fee and expense compliance issues identified in deficiency letters sent to SEC-registered investment advisers. To read the full risk alert, click here. The six most frequent areas of concern noted were:

  • Fee-Billing Based on Incorrect Account Valuations – for example, using a different metric or process than was specified in the client agreement or including assets in the fee calculation that were named as “excluded” assets for billing purposes in the client agreement and/or other disclosure documents.
  • Billing Fees with Improper Frequency – for example, billing in advance instead of arrears, billing monthly instead of quarterly, or billing on the market value as of the end of the billing cycle rather than on the average daily balance as described in the client agreement and/or other disclosure documents.
  • Applying Incorrect Fee Rate – for example, applying an incorrect fee rate or charging performance based fees to non-qualified clients.
  • Omitting Rebates and Applying Discounts Incorrectly – for example, not aggregating account values for members of the same household and/or not applying proper breakpoints as specified in the agreement and/or disclosure documents, or wrap fee participants paying brokerage or other transaction based fees disclosed as being included in the bundled fee.
  • Disclosure Issues Involving Advisory Fees – for example, ADV disclosures or agreement terms that were inconsistent with advisory practices, such as exceeding stated maximum fees and/or not disclosing additional fees or markups in additions to advisory fees, such as fee sharing arrangements with affiliates or third-parties in connection with certain asset purchases.
  • Adviser Expense Misallocations – for example, with regard to advisers to private or registered funds that misallocated expenses, such as distribution and marketing expenses, regulatory filing fees, and travel expenses, inconsistent with applicable advisory or operating agreements, or other disclosures.

Failing to adhere to the terms of advisory agreements and disclosures, engaging in incorrect billing and expense practices, and failing to adopt and implement written policies and procedures reasonably designed to prevent violations of securities laws can rise to the level of enforcement. In such cases, advisers have been charged with violations of the Investment Advisers Act of 1940 and the rules promulgated thereunder, which could include, in some cases, violations of certain anti fraud provisions.

RIA Compliance Group encourages advisers to review their current billing practices, to review their fee and expense disclosures made to clients in Form ADV or other disclosure documents and advisory contracts, and to test and enhance related internal policies and procedures to ensure that any billing or expense issues are immediately corrected. Corrective measures should include proactively reimbursing any incorrectly charged fees or expenses and strengthening written policies and procedures and the internal controls in place to detect and prevent such errors going forward.

Recently the SEC also penalized advisers for charging fees on so-called “orphaned” accounts after the assigned IAR left the firm and for disclosure failures related to compensation received from third parties for investing clients’ assets in certain mutual funds. Moreover, some advisers were charged with breaches of fiduciary obligations and their duties to seek best execution where they invested client assets in funds charging 12b-1 fees when cheaper share classes in the same funds were available. As a reminder, the SEC has indicated it is willing to recommend more favorable settlement terms for advisers self-reporting this type of misconduct on or before June 12, 2018.

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Ara Jabrayan is the Managing Member of RIA Compliance Group, LLC, and on the Advisory Board for SmartRIA. His specialties include SEC and state RIA registrations, ongoing compliance assistance, mock exams, and the development of compliance programs. Follow him on LinkedInFacebook, or check out his Blog.

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