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.

 

Deficiencies

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.

2. Failing to credit certain fees due to clients:

1. Pre-paid fees for terminated accounts.

2. Prorated fees for onboarding clients.

3. 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.

4. 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.

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