The Securities and Exchange Commission issued a risk alert for registered investment advisers with regards to economic conflicts of interest and improper billing, according to AdvisorHub.
After reviewing adviser activities, the SEC’s Division of Examinations found economic conflicts of interest that were undisclosed, or the disclosures were incomplete or misleading. The Division also observed adviser practices and fees that were inconsistent with advisory agreements and disclosures. Finally, the staff observed compliance programs that did not fully address economic conflicts of interest and risks. The alert is intended to assist advisers in developing effective compliance programs and disclosures.
One potential conflict was in the area of cash management recommendations. The Division observed advisers who recommended programs where clients’ uninvested cash was automatically moved into interest bearing accounts, some of which were held at affiliated parties. Advisers that received revenue in exchange for these recommendations created an economic conflict of interest.
“As fiduciaries the economic conflict of interest should have been fully and fairly disclosed to clients in order for clients to provide informed consent,” the SEC said. “However, the staff encountered the examples below where (1) the fees were inconsistent with advisory agreements and/or disclosures, (2) compliance programs did not fully address economic conflicts of interest, and/or (3) the disclosures were misleading or omitted material information.”
Among the examples cited were advisers omitting material information or provided misleading disclosures regarding revenue sharing arrangements they had with clearing broker-dealers or clients’ custodians, including not disclosing:
-Revenue the advisers received from certain custodians based on the cash balances their clients held with those custodians.
-Incentives to recommend cash sweep vehicles that resulted in the greatest possible compensation to the adviser.
Some advisers failed to adequately explain revenue they received from sweep programs or interest-bearing accounts at affiliated institutions. Others used vague language that they “may” receive compensation even when those payments were already occurring, the alert said.
The SEC also observed that advisers continue to select mutual fund share classes paying 12b-1 fees or other compensation to the adviser, an affiliate, or an individual adviser representative where lower-cost share classes of the same fund were available. The risk alert noted instances where advisers failed to disclose economic benefits related to custodial credits, margin loans and credits, and transaction markup fees.
The Division of Examinations also observed various fee billing issues, with advisers assessing client advisory fees that were inconsistent with the advisers’ agreements, disclosures, or both. These included overcharging and charging for services that were not provided. Issues included double billing, charging fees on inactive accounts and failure to provide refunds for pre-billed services on terminated contracts.
Examples of fee calculation inconsistencies included:
-Prorating advisory fees when clients made deposits or withdrawals in their accounts during the billing period, but advisory agreements and disclosures to clients did not address prorating fees in such situations (e.g., adviser disclosed that asset-based fee
calculations used clients’ account balances at the beginning of the month, but the adviser prorated its fee for a large deposit received mid-month).
-Charging asset-based advisory fees on holdings specifically excluded from the fee billing calculations per advisory agreements (e.g., initial cash inflows and fixed income assets).
-Assessing incorrect fee rates to clients and not applying reduced asset-based fee rates for cash and fixed income assets by, among other things, not householding accounts for fee rate breakpoints. Similarly, not identifying fixed income mutual funds as fixed income assets, which were subject to a lower asset-based fee rate than the assessed rates.
-Not rebating certain transaction fees, even though advisory agreements specifically state that clients would not incur any fees for such transactions.
The SEC found that many RIAs “did not appear to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder consistent with the nature of the adviser’s operations.” This includes monitoring all billing and fees charged for accuracy, adopting policies that address all types of available billing arrangements and ensuring that client agreements align with firm policies and procedures.
According to the alert, the division’s findings “often” result in clients receiving the money they are owed.
“In addition, advisers have improved the clarity of their disclosures, the accuracy and consistency of their billing practices, and the effectiveness of their compliance programs in response to examinations,” the alert stated, admonishing others to proactively address billing, conflicts and disclosures.
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