RIA Compliance Blog
On April 12, 2018, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations published a Risk Alert “providing a list of compliance issues relating to fees and expenses charged by SEC-registered investment advisers… that were the most frequently identified in deficiency letters sent to advisers.” According to OCIE, investment advisers often explain the terms of a client’s fees and expenses in their Form ADV and their advisory agreements. If an investment adviser does not follow these terms and participates in improper fee billing, that investment adviser may be violating the Investment Advisers Act of 1940. The Risk Alert is designed to compel investment advisers to evaluate their practices, as well as their policies and procedures, to help ensure compliance with the Advisers Act.
According to OCIE, one common compliance issue involving fees and expenses is investment advisers overbilling clients because they did not value the clients’ accounts correctly. These incorrect valuations typically resulted from the investment advisers’ valuing a client’s account utilizing a metric other than the one selected in the client’s advisory agreement or valuing a client’s account utilizing a process other than the one selected in the client’s advisory agreement. For example, investment advisers, in the process of valuing an account, would take into account assets that the advisory agreement forbade from being included in the advisory fee calculation. Another common deficiency involved the timing of investment advisers’ fees, such as billing clients on a monthly basis rather than the agreed upon quarterly basis or billing a new client for a whole billing cycle rather than prorating that client’s fee.
Use of incorrect fee rates was another frequent compliance issue that OCIE found. This may involve an investment adviser using a larger fee rate than the fee rate agreed upon or billing a non-qualified client performance-based fees. Another common compliance deficiency that OCIE found involved investment advisers failing to “apply certain discounts or rebates to their clients’ advisory fees, as specified in the advisory agreements, causing the clients to be overcharged.” For example, investment advisers who have a wrap fee program often charge participants a “bundled fee,” which includes brokerage fees. OCIE found that certain investment advisers charged wrap fee participants a brokerage fee when the brokerage fee was already part of the bundled fee.
OCIE also found that there were frequent issues with investment advisers’ disclosure obligations in regard to advisory fees. According to OCIE, there were instances where an investment adviser made representations in their Form ADV that contradicted their practices involving fees. OCIE also noted that some investment advisers did not bother to inform clients about fees or markups that they could be charged in addition to advisory fees. Finally, OCIE found that compliance deficiencies involving allocations of adviser expenses were common. OCIE noted that certain investment advisers to private and registered funds would allocate expenses, such as marketing expenses and regulatory filing fees, to clients rather than to the investment adviser.
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