November 13, 2021

SEC Issues Risk Alert on Robo-Advisors


SEC Issues Risk Alert on Robo-Advisors

On November 9, 2021, the U.S. Securities and Exchange Commission (“SEC”) developed a risk alert in relation to compliance failures observed when providing electronic investment advice to clients. The risk alert was a result of concluding a national initiative where the Division of Examinations (the “Division”) conducted audits of SEC-registered investment advisers who provide electronic investment advice (“Robo-Advisors”). Robo-Advisors can offer impactful benefits including accessible and lower-cost services for investors. However, when Robo-Advisors fail to comply with regulatory obligations, the investors may be at risk. 

The Division conducted a series of examinations to assess the practices of advisors providing Robo-Advisory services, focusing on their compliance programs, formulation of investment advice, marketing, and advertising practices, data protection practices, and registration information. Nearly all advisors examined received deficiency letters. Common deficiencies included: 

  • Compliance Programs - Most advisors had inadequate compliance programs, lacked written policies and procedures, or had unimplemented or untested programs. 

  • Portfolio Management - Many advisors were found to not be testing the investment advice generated by their platforms, jeopardizing their fiduciary obligation to the duty of care. Advisors were also found to have inaccurate or incomplete disclosures in many Form ADV filings. 

  • Performance Advertising and Marketing - More than half the advisors examined had misleading or prohibited statements on their websites, materially misleading performance advertisements, and inadequate disclosures about “human” services in their advertising and marketing material. 

  • Cybersecurity and Protection of Client Information - Few advisors were found to have policies/procedures that addressed protecting the firm’s systems. In addition to lacking written policies and procedures, few advisors were found to have tested the system's emergency responses as well.  

  • Registration matters - Many advisors were found to be relying on the Internet adviser exemption but were ineligible to do so. SEC rule 203A-2(e) of the Investment Advisers Act of 1940 creates an eligibility to operate as a registered investment advisor under the Internet Advisor Exemption, provided the elements of that rule are met.  The elements of that rule include the following:

  • Provides investment advice to advisory clients through an interactive website. An interactive website means a site in which computer software-based models or applications provide investment advice based on personal information each client submits through the website.

  • Provides advice to all of its clients exclusively through the interactive website;

  • Maintains documentation demonstrating that it provides investment advice to clients exclusively through an interactive website.

Best Practices

The Staff recommended the following to improve compliance:

  • Adopt, implement, and follow written policies and procedures that are tailored to the advisor’s practice. Paying special attention to portfolio management, custody, and books and records. 

  • Test algorithms periodically to ensure they are operating correctly. 

  • Safeguard algorithms. Employing safeguards to prevent unauthorized algorithm changes. 

All in all, the Division recommends that advisors providing electronic investment advice review their portfolio management practices and related disclosures, performance advertising, and marketing materials, written policies and procedures. Advisors relying on the Internet advisor exemption should also review their registration eligibility regularly.

Click here to read the full risk alert.

SEC Issues Risk Alert on Advisory Fee Calculations


SEC Issues Risk Alert on Advisory Fee Calculations

On November 10, 2021, the U.S. Securities and Exchange Commission (“SEC”) developed a risk alert in relation to advisory fee calculations. The risk alert was a result of concluding a national initiative where the Division of Examinations (the “Division”) conducted approximately 130 audits of SEC-registered investment advisers with a focus on advisory fees. During the exam, the SEC prioritized evaluating whether advisers’ fees are accurate and fair. They also took a closer look at whether an advisor is appropriately disclosing their fees to clients in a way that is clear and easy to understand.

All examined advisers had a broad range of assets under management, firm organization size, and business operations. However, they all provided investment advice to retail clients. Examiners focused on reviewing policies and procedures related to advisory fees, the accuracy of fees charged, the accuracy and adequacy of advisers’ disclosures, the effectiveness of compliance programs, and finally the accuracy of books and records.


Throughout this examination initiative, the Division noted that advisors have a variety of different fee arrangements and calculation methods. However, the most common billing characteristics observed were as follows:


  • Standard fee schedules with tiered fee levels based on assets under management.

  • Assessed advisory fees on a quarterly basis.

  • Advisory fees deducted directly from clients’ accounts.

  • Fees calculated based on the account value at the beginning or ending date of the billing period.

  • Calculated fees by using a software or third-party service provider.

  • Fees were documented with clients through a written advisory agreement or contract.

  • Combined family account values to result in lower fees.



During the examinations, the Division identified several deficiencies. Many of these deficiencies resulted in financial detriment to clients. The reported deficiencies are as followed:


  1. Advisory fee calculation errors:

    1. Over-billing.

    2. Inaccurate calculations of tiered or breakpoint fees.

    3. Inaccurate calculations due to incorrect householding of accounts.

    4. The use of incorrect client account valuations.

  1. Failing to credit certain fees due to clients:

    1. Pre-paid fees for terminated accounts.

    2. Prorated fees for onboarding clients.

  1. Fee-related compliance and disclosure issues:

    1. ADV Part 2 brochures did not disclose up to date fees or whether fees were negotiable.

    2. ADV Part 2 brochures did not align with a client’s agreement resulting in inconsistent fee disclosures.

    3. Policies and procedures were not maintained to address advisory fees or the monitoring of fee calculations and billing.

  1. Inaccurate financial statements:

    1. Failing to record all advisory fee income, administrative revenue, and compensation expenses in general ledgers and on financial statements.

    2. Preparing financial statements on an accrual basis of accounting while a cash and modified cash basis of accounting was actually used.


Best Practices

Concluding the examinations, the staff observed that there is no “one-size fits all” approach when it comes to advisors adopting appropriate policies and procedures. To assist with compliance in the focused areas, it is suggested to (i) adopt and implement written policies and procedures that address the advisory fee billing process and validating fee calculations, (ii) implement a centralized fee billing process and validate that the fees charged to clients are consistent with compliance procedures, advisory contracts, and disclosures, (iii) review fee calculations by utilizing resources and tools, such as a checklist for reconciling fee calculations with advisory agreements, and (iv) ensure all advisory expenses and fees assigned to and received from clients are properly recorded, including those paid directly to advisory personnel.


Advisory fees and billing calculations continue to be an area of focus when it comes to investment advisor examinations. Advisors are encouraged to review their current disclosures, agreements, and policies and procedures to ensure that not only are they accurate, but that clients are being provided with full and fair disclosures that are in their best interest.


Click here to read the full risk alert.

August 29, 2021

SEC Issues Risk Alert on Principal and Agency Cross Trading


SEC Issues Risk Alert on Principal and Agency Cross Trading

The Securities and Exchange Commission (SEC) recently published an alert detailing the most common compliance failures advisors commit in regards to principal trades and agency cross trades. Principal and agency transactions are two cases in which the advisory firm has an interest in the circumstances or outcome of the client trades. This incentive then becomes a conflict of interest in the discretion or recommendation of that transaction.

Principal Trade:
A “principal trade” occurs when an investment adviser, acting as a principal for its own account, purposefully (i) sells any security to a client or (ii) purchases any security from a client. Section 206(3) prohibits advisers from making principal trades unless the adviser discloses all material information about the proposed trade to and obtains the consent of the client before the completion of the transaction. Notably, disclosure and consent are required for each transaction.

Agency Cross Transaction:
An “agency cross transaction” occurs when an investment adviser, acting as a broker for a person other than the advisory client (themselves included), knowingly makes a sale or purchase of any security for the account of that client. Section 206(3) prohibits investment advisers from making agency cross trades unless the investment adviser discloses material information about the trade to the client prior to the execution of the trade and obtains the consent of the client to the transaction. Under Rule 206(3)-2, it may not be required to effect transaction-by-transaction disclosure and consent for certain agency cross transactions if the advisor takes additional precautions.

In short, advisors must disclose both principal and agency trades in Form ADV Parts 1 and 2A and maintain appropriate documentation to support these transactions. The SEC advised that Section 206(3), Sections 206(1), and (2) be considered together so that the advisor further discloses any potential conflicts of interest revolving around a trade.

Common Deficiencies: 
  • Failure to recognize the nature of trade 
  • Improper disclosure 
  • Non-adherence to policies and procedures
There are many ways for advisers to ensure that they follow the principal and agency cross trading requirements described above, included, but not limited to, the following:
  • Maintaining an updated list of principal accounts and requiring pre-approval by the advisor’s Chief Compliance Officer of any proposed trades between an advisory client and an account on that list;
  • Utilizing trading or compliance software to flag any trades with principal accounts prior to trade execution;
  • Maintaining a comprehensive checklist to be used when executing transactions that raise conflicts of interest (including principal and agency cross trades) to raise awareness of compliance concerns;
  • Establishing independent representatives to approve principal and agency cross trades on behalf of private fund and managed account clients to satisfy disclosure and consent requirements; and
  • Maintaining books and records of all steps taken to approve transactions that present conflicts of interest (including the disclosure and consent requirements of principal and cross trades);
  • Engaging in continuous education regarding principal trades, cross trading, and all other potential conflicts of interest. 
This SEC alert is consistent with the Commission’s focus on conflicts of interest and fiduciary duty in practice. Advisors have a duty to their clients to ensure they follow all regulator rules as well as their own policies and procedures.

August 5, 2021

SEC Issues Risk Alert on Wrap Fee Programs

SEC Issues Risk Alert on Wrap Fee Programs

On July 21, 2021, the SEC published a risk alert concerning various findings and subsequent deficiencies as it relates to advisors that participate in wrap fee programs, either as a sponsor or as a portfolio manager. The release was a clear signal from the SEC that it will continue to scrutinize wrap fee programs as part of the exam process moving forward.

The alert highlighted the most common deficiencies that the SEC staff identified over the course of their examinations, serving as a surrogate warning for SEC-registered advisors to be mindful of what their current practices are and to address any potential issues within their compliance programs related to their findings. The SEC identified three specific areas where advisors were short of meeting their fiduciary duty or their compliance programs were inadequate. 

A common deficiency the SEC noted pertains to suitability. The SEC cited numerous firms failing to conduct requisite ongoing due diligence of their wrap fee programs, specifically for failing to ensure ongoing client suitability. Such instances include advisors failing to monitor trading activity in client accounts. Limited trading in client accounts presents a conflict of interest between the client in a wrap fee program and the advisor, as the advisor stands to earn more compensation in that scenario if trading activity and the costs associated with trading are substantially less than what the client pays for services. This may present a breach of an advisor’s fiduciary duty of care for not reviewing and determining the ongoing suitability of clients in a wrap fee program by not having a reasonable basis to believe that the wrap fee programs were in the client’s best interests.

The SEC also noted misleading or omitted disclosures as another common deficiency. Specifically, the SEC found that advisors' disclosure documents were, in many cases, inconsistent with one another. Examples such as advisory agreements stating that clients will pay brokerage commissions while the wrap fee program brochure expressly stated that they would not pay these fees were noted as common deficiencies. Additionally, instances where fees that were not included as covered in the wrap fee programs but were to be paid by clients were not disclosed adequately or at all.

The link between the above examples of deficiency is tied directly to the last common deficiency that was noted, the advisor’s compliance program. The SEC noted the weak and ineffective compliance policies and procedures in these cases as a key finding. In some cases, advisors omitted policies and procedures entirely for key business risks associated with recommending a wrap fee program. In other cases, advisors had written policies and procedures in place to address these risks, however, adherence to these policies was on a case-by-case basis, willfully ignored, or never reviewed.

While offering a wrap fee program to clients presents an efficient means of billing and allows for a degree of client certainty, the business risk that an advisor opens itself up to is significant. As fiduciaries, advisors are required to, at all times, act in the best interest of the client. In order to meet that expectation, it is imperative that advisors that wish to implement a wrap fee program not only understand the mechanics of doing so, but understand the degree of due diligence required to fulfill their duty as a fiduciary. Regular reviews of the wrap program offering itself, ongoing client best interest reviews, and clear, thorough disclosures related to the various conflicts of interest that present themselves in these cases are critical components of maintaining a compliant wrap fee program.

July 12, 2021

Amendments to "Qualified Client" Dollar Thresholds

Amendments to "Qualified Client" Dollar Thresholds

Every five years, as provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act amended section 205(e) of the Investment Advisers Act of 1940 (“Advisers Act”), the U.S. Securities and Exchange Commissions (“SEC”) adjusts the dollar amount thresholds for a Qualified Client to account for inflation, to the nearest multiple of $100,000. This five-year redefinition will increase the standards for a qualified client as of August 16, 2021. 

Rule 205-3 of the Advisers Act permits investment advisers to receive performance-based compensation only when the client is a qualified client. As of August 16, 2021, a qualified client will be a client that:

  1. Has at least $1.1 million in assets under management with the investment adviser immediately after entering into the advisory contract; or

  1. Has a net worth (together, in the case of a client that is a natural person, with assets held jointly with a spouse) that the investment adviser reasonably believes to be in excess of $2.2 million immediately prior to entering into the advisory contract”

A qualified client also includes a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 (“Company Act”), as amended, and an investment adviser’s “knowledgeable employees.”

The increased thresholds will affect individually managed accounts and private funds that rely on the exception to the definition of an investment company provided in section 3(c)(1) of the Company Act, which is required to “look through” to each investor of such a fund to determine such investor’s qualified client status. 

Clients that enter into advisory elements in reliance on the net worth test prior to the effective date will be grandfathered in under the prior net worth threshold. However, private fund advisers to 3(c)(1) funds should update their current offering documents to conform to the new qualified client threshold. The updated net worth threshold should be reflected in prospective investor net worth representations in subscription agreements for any section 3(c)(1) funds with closings on or after the effective date and representations in any documents used in effectuating secondary transfers of ownership interests in existing section 3(c)(1) funds following the effective date.

Click here for additional information regarding the order approving adjustment for inflation of the dollar amount tests in Rule 205-3 under the Advisers Act.

July 2, 2021

Rollover Recommendations: Improving Investment Advice for Workers and Retirees


Rollover Recommendations
Improving Investment Advice for Workers and Retirees

On December 18, 2020, The Department of Labor (“DOL”) adopted Prohibited Transaction Exemption 2020-02 (“PTE 2020-02”). PTE 2020-02, called Improving Investment Advice for Workers and Retirees, expands the definition of advice covered under ERISA law to include recommendations about retirement plan rollovers and Individual Retirement Accounts (“IRAs”). PTE 2020-02 went into effect on February 16, 2021, and included a non-enforcement policy until December 20, 2021.

The result of expanding the DOL definition of investment advice to include recommendations to rollover a client's assets from an ERISA sponsored retirement plan to an IRA is significant, as ERISA fiduciaries are prohibited from engaging in transactions where they receive increased compensation as a result of the advice provided, otherwise categorized as “conflicting advice”. There is a myriad of disclosures and policies and procedures that require implementation in order to receive compensation for rollover recommendations.

The DOL has established a Five-Part Test in order to assist advisors in determining whether a recommendation to roll over retirement plan assets into an IRA falls under ERISA. The regulation states that a person provides “investment advice” if he or she: (1) renders advice to a plan or participant as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property; (2) on a regular basis; (3) pursuant to a mutual agreement or understanding; (4) that such advice will be a primary basis for investment decisions; and that (5) the advice will be individualized to the plan or participant.

How does this impact Registered Investment Advisors? Many that once did not offer retirement plan advisory services will now find themselves subject to the ERISA fiduciary standard when providing recommendations to roll over a participant’s retirement plan assets into an IRA. Certain of these requirements and standards were already required under the Investment Advisers Act of 1940 (“Advisers Act”), so the DOL requirements below shouldn’t come as a major surprise. Under the DOL there are requirements to adhere to the following:
  1. acknowledgment from the advisor of their fiduciary status under Title I of ERISA and the Internal Revenue Code;
  2. due diligence and written documentation of the specific reasons that any recommendation to roll over assets (whether from an ERISA plan to an IRA, from one IRA to another IRA, or from one type of account to another (e.g. commission-based account to fee-based account) is in the best interest of the client.
  3. written disclosure to clients that include (i) the scope of the relationship, (ii) all material conflicts of interest, and (iii) the reasons the rollover recommendation is in their best interest;
  4. compliance with the Impartial Conduct Standards which includes (i) provide prudent investment advice, (ii) charge only reasonable compensation, and (iii) avoid misleading statements; and
  5. an annual compliance review with the results in a written report to a Senior Executive Officer of the advisor.
The written fiduciary acknowledgment is designed to ensure that the fiduciary nature of the relationship under Title I of ERISA and/or the Code is clear to the advisor, as well as the client, at the time of the recommended investment transaction. This requirement reflects the DOL’s view that parties wishing to take advantage of the broad prohibited transaction relief in the new exemption should make a conscious up-front determination that they are acting as fiduciaries; tell their client’s that they are rendering advice as fiduciaries; and, based on their decision to act as fiduciaries, implement and follow the exemption’s conditions.

There are a number of specific considerations to be reviewed and compared before executing any action. Considerations include the following:
  • The range of investment options between the existing plan and proposed rollover account, and which is in the client's best interest.
  • A comparison of the fees and expenses associated with the existing plan and the proposed rollover account.
  • What, if any, tax implications exist for the individual client should they choose to accept rolling over their ERISA plan assets into an IRA?
  • Are there services that the client would receive from the existing plan that would benefit them that they would not receive in a new account?
  • Is the client's age a factor? Are they planning to retire early or do they plan to work past the age where Required Minimum Distributions (RMD’s) will come into play?
  • ERISA plans typically have unlimited protection from creditors, whereas IRA assets are only protected in bankruptcy proceedings. Is this a concern for the client?
Advisors are expected to make diligent and prudent efforts to obtain information about the existing employee benefit plan and the participant’s interest in it. The focus should not be solely based on the client’s current holdings, but instead should consider the overall options available in the plan. Consideration of factors like the long-term impact of any increased costs, why the rollover is appropriate (notwithstanding any additional costs), and the impact of any economic investment features that exist are critical components in determining suitability with each individual client. In the event that a client won’t provide the information, even after an explanation of its significance, and the information is not otherwise readily available, the institution and professional should make a reasonable estimation of expenses, asset values, risk, and returns based on publicly available information. Documentation should be maintained whenever assumptions are being used and their limitations.

Prior to engaging in a transaction under the exemption, the Advisor must provide its clients a written description of the Advisor’s material conflicts of interest arising out of the services it provides and any recommended investment transaction. These conflicts must include those associated with proprietary products, payment from third parties, and compensation arrangements for both the advisor and its investment advisor representatives. Disclosures with material omissions will be considered inaccurate and will not satisfy the exemption. It should be further noted that the disclosure cannot be a “check-the-box” activity. As it pertains to the written disclosure of the recommendation, advisors should consider, discuss, and document the alternatives to executing a rollover. Those alternatives include leaving the money in the existing plan, rolling the money into a new employer-sponsored plan, or withdrawing money from the ERISA plan completely.

Disclosures with material omissions will be considered inaccurate and will not satisfy the exemption. It should be further noted that the disclosure cannot be a “check-the-box” activity. As it pertains to the written disclosure of the recommendation, advisors should consider, discuss, and document the alternatives to executing a rollover. Those alternatives include leaving the money in the existing plan, rolling the money into a new employer-sponsored plan, or withdrawing money from the ERISA plan completely.

The cornerstone of the exemption is the requirement that advisors adopt and adhere to the Impartial Conduct Standards. The essence of these standards should come as no surprise, as they speak directly to the duty of care and loyalty that should be paid to all clients and transactions at all times as an advisor. Those standards are outlined below:
  • Investment advice must be in the best interest of the client and must not place any other interests ahead of that interest.
  • Compensation paid for such advice must be reasonable.
  • Statements made with respect to the transaction must not be materially misleading.
The Advisor’s annual review should be designed to assist the firm in detecting and preventing violations of, and archiving compliance with, the impartial conduct standards and their policies and procedures. The results of the review must be reduced to a written report that is submitted to one of the institution's senior executive officers. The officer must make certain certifications related to their review of the report. The report, certification, and supporting data must be retained for six years and provided to the DOL within 10 business days of a request.

How will the DOL Oversee Compliance with PTE 2020-02?

To the extent that advisors experience violations of the exemption, PTE 2020-02 contains a self-correction procedure for violations of the conditions under the exemption. To self-correct, an advisor must:
  1. Determine that the violation did not result in investment loss, or it must make the client whole for any such loss;
  2. Correct the violation and notify the DOL within thirty (30) days of correction;
  3. Complete the correction no later than ninety days after the advisor learned of (or reasonably should have learned of) the violation; and
  4. Notify the person(s) responsible for conducting the retrospective review during the applicable review cycle so the correction can be included in the report.

NEXT STEPS: We are currently building various tools embedded within AdvisorCloud360® to assist with these requirements. In the meantime, we strongly encourage advisors to adopt policies and procedures to help with their due diligence and documentation efforts, as well as ongoing disclosure requirements.

If you’d like to receive more information on the new DOL rule, please reach out to AdvisorAssist at