September 3, 2019

CCO Series: Wrap Fee Program

The question of whether or not to place client assets in a wrap fee program is a challenging decision for many advisors. Ultimately, the decision of whether or not a wrap fee program is in the best interest of a client can only be made on a case by case basis, depending on the client’s specific needs. If a wrap fee program is utilized, it is crucial that all costs and trading practices be fully disclosed in your Form ADV Part 2A and Wrap Fee Program Disclosure Brochure.

Wrap Fee Program In a Nutshell

Wrap fee programs are generally where clients pay a single bundled fee based on a percentage of the client’s assets under management, which covers the cost of all services provided within the program, including investment advice, transaction fees, custodial fees, and administrative fees. This differs from traditional asset management programs, where clients pay for investment advice, and are then charged separately for brokerage and administrative costs.

Advisor’s have found wrap fee programs to be a convenient way to include all costs associated with an advisory relationship into a single fee, where clients costs do not vary based on the number of transactions in a particular period. Although there are perceived benefits of such an arrangement, regulators have expressed their concerns with regards to Advisor’s abusing this level of service, due to the incentives of modifying trading practices in order to maintain a larger margin of the paid advisory fees.

Through the Regulator's Eyes

Regulators have two primary concerns with wrap fee programs, (1) cost to the client (2) disclosures.

  1. Costs: Among the SEC’s concerns is that because wrap fee programs charge a single bundled fee regardless of the number of trades executed, they can be more expensive they can be more expensive than traditional investment advice for low volume traders, as standard fees tend to be higher to cover trading costs.
    1. Wrap fee programs present a conflict of interest as the advisor is incentivized to keep their internal costs down by trading less frequently. However, these savings are not passed on to the clients, who continue to pay the same fee, regardless of the accounts actual trading level.
    2. A advisors brokerage practices, especially if they utilize step out trades, can result in additional charges to a client. Step-out trades, also called trading away, occurs when a wrap fee manager directs trades to a broker whose fees are not covered by the wrap program. While there are many valid reasons to do this, include best executions, it may result in the client paying additional brokerage fees
  2. Disclosures - The SEC has brought several enforcement actions against wrap fee managers and sponsors over inadequate disclosure. At the core of these cases, the SEC looks to determine whether or not clients were fully informed of the costs of a wrap fee program as compared to the cost of a traditional investment advisory fee. In the view of a regulator, the wrap fee brochure provided to clients must contain all material facts about the advisors conflicts of interest, as well as wrap fees total costs, including the managers step out trading practices (if applicable), and whether there will be any additional expenses, such as mutual fund fees.

Any time an advisor recommends a client invest in a wrap fee program, regulators expect that the advisor is acting in the clients best interest. You should closely review the costs, and services provided in the wrap program, as compared to other investment platforms, and be able to evidence your rationale for recommending a wrap fee program to your clients.

CCO Best Practices

  • Review client investment objectives, financial situation and risk tolerance
  • Run a trade blotter report for selected clients in a wrap fee program
    • Assess the trading activity and determine whether there are any instances of reverse churning If certain accounts are in a wrap, conduct a comparison to trading in similar accounts that are not in a wrap fee program
    • Conduct an analysis of what fees would have been in a wrap vs non wrap. Items to take into consideration include, but are not limited to :
      • trading activity
      • types of investments
      • cash balances
      • investment objectives
    • Determine whether the client paid more than they would have paid in a traditional program and assess whether the wrap fee program continues to serve the client’s best interest in light of the anticipated activity in the account.

The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.


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