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.

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