Published on Jul 28th, 2021 |

Division of Examinations Releases Risk Alert about Examining Investment Advisers that Manage Client Accounts Participating in Wrap Fee Programs | SEC Releases

On July 21st, the Division of Examinations (“DOE”) released a Risk Alert about Investment Advisers managing client accounts that participate in wrap fee programs.

The DOE has made it a priority to examine advisers that are associated with wrap fee programs. They highlighted the following potential conflicts for advisers and risks to investors:

  • Incentives for advisers trading less frequently than may be in the client’s best interest.
  • Engaging in transactions that reduce costs to the adviser but increase expenses borne by the client.
  • Mis-billing by failing to incorporate certain covered transactions costs into the wrap fee.

Due to the continued growth of investor assets participating in such programs, as well as conflicts and disclosure practices observed during previous examinations, the Division decided to focus on wrap fee programs.

There were over 100 examinations of advisers conducted from two perspectives, which were Advisers serving as portfolio managers of wrap fee programs, and Advisers that advised their clients’ accounts through one or more unaffiliated third-party wrap fee program.

Upon examination, the Division observed issues that related to adviser’s assessments and trading practices on their wrap fee programs, and on an on-going basis, in the best interest of their clients. The following points are what the staff observed:

  • Fiduciary Duty and Recommendations Not Made in Clients’ Best Interests
    • Advisers did not monitor the trading activity in clients’ accounts, or their monitoring activities were ineffective.
    • Advisers did not have a reasonable basis to believe that the wrap fee programs were in the clients’ best interest.
  • Potentially Misleading or Omitted Disclosures
    • Advisers had inconsistent disclosures regarding the same topic in various documents (i.e., firm brochures did not have full disclosures regarding fees that were not included in the wrap fee).
    • Advisers omitted disclosures or inadequately described conflicts of interest (i.e., financial incentives supervised persons and the examined advisers had to make certain recommendations).
  • Compliance Programs
    • Advisers omitted compliance policies and procedures.
    • Advisers had inadequate policies and procedures.
    • Advisers inconsistently implemented or enforced, or failed to implement, their policies and procedures.

Advisers did not perform required annual reviews or performed the reviews inadequately.

Based off the DOE’s examinations, there are valuable ways to assist advisers with compliance relating to deficiencies in policies and practices they observed. Below are key recommendations from the DOE to improve Compliance for each area they examined.

  • Fiduciary Duty and Recommendation Made in Clients’ Best Interest
    • Make sure reviews of wrap fee programs are conducted initially and periodically afterwards to determine whether the programs recommended to clients are in the best interests of clients, using information gathered directly from clients.
    • Periodically remind clients, after conducting initial best interest reviews associated with the recommendation to participate in wrap fee programs, to report any adjustments to their financial standing, or personal situations or needs, and investment objectives that might affect the investment allocations, clients’ risk tolerances, and/or recommend investments.
    • Communicate with clients (over the phone or in-person), to prepare and educate clients when recommending converting their accounts from non-wrap fee accounts to participating in wrap fee programs.
  • Disclosures
    • Provide clients with disclosures regarding the advisers’ conflicts of interest related to transactions executed within the wrap fee programs.
    • Provide clear disclosures, when recommending wrap fee programs to clients, about whether certain services or expenses are not included in the wrap fee.
  • Compliance Programs
    • Written compliance policies and procedures include factors to be used when assessing whether investment recommendations made to clients participating in wrap fee programs, including asset allocations and selection of managers, are in the clients’ best interests.
    • Compliance programs monitor and validate that the advisors sought best execution for clients’ transactions.
    • Compliance policies and procedures define what the advisers that recommend wrap fee programs to clients consider to be occasionally traded accounts and compliance programs review such accounts to determine whether the wrap fee programs remain in the clients’ best interests.

After reflecting on the DOE’s review of the following advisers, they wanted to advise advisers that recommend wrap fee programs to consider and adopt policies and procedures to address those challenges, risks, and conflicts discussed.

To learn more detail behind the following examinations and recommendations from the DOE click here to view the full release!


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