Wrap Fee Program Compliance Risks: The SEC’s Latest Guidance
WHAT HAPPENED?
The SEC recently released a Risk Alert outlining common compliance concerns among advisers’ wrap fee programs. This type of compensation arrangement carries unique risk because the flat fee structure may incentivize advisers to trade wrap accounts less frequently. However, wrap fee programs are popular among investors because of the predictable cost structure.
The Risk Alert covers issues impacting advisers sponsoring wrap fee programs and firms participating as advisers in third-party wrap fee programs. The Commission’s guidance focuses on advisers’ fiduciary obligations, disclosure, and policies and procedures. See below for key takeaways from the SEC’s Risk Alert:
KEY TAKEAWAYS
Common areas of deficiency among firms utilizing a wrap fee program included:
- Advisers did not uphold their fiduciary obligations and recommendations were not made in clients’ best interests. Examples of this activity included low trading activity and other actions that caused clients to pay higher fees than they would have outside of a wrap fee program. Advisers also recommended wrap fee programs to clients while knowing these products may be outside the client’s best interest, or they neglected to assess the suitability of wrap fees before making a recommendation.
- Disclosures were misleading or not included in required materials. Some of the deficient advisers’ disclosures on the same topic varied across different documents like firm brochures and advisory agreements. In other cases, disclosures were not made at all, or conflicts of interest were not appropriately communicated.
- Compliance program policies and procedures for wrap fee programs were incomplete or inadequate. Common deficiencies included failure to adopt and implement written policies and procedures, poorly written or inaccurate compliance manuals, inconsistently enforced policies and procedures, and not conducting annual compliance reviews.
The SEC’s guidance for maintaining a well-documented wrap fee program:
- Take measures to ensure wrap fee program recommendations are in clients’ best interest. If your firm sponsors a wrap fee program, it is important that there is a review in place upon initial implementation and at least annually thereafter for each client. During these reviews, clients can be reminded to report any changes to their personal financial standing to confirm the wrap fee program remains a good fit and actively communicate when converting accounts to a wrap fee structure.
- Provide appropriate conflicts of interest disclosures to clients. For example, disclose information regarding:
- Adviser compensation arrangements.
- Financial incentives related to migrating to infrequently traded wrap accounts.
- Incentives not to trade client accounts due to ticket charges.
- The possibility of wrap accounts incurring more fees than other types of accounts.
- Changes related to mutual fund share class selection, like 12b-1 fees.
- Write, adopt, and implement compliance policies and procedures to address your handling of wrap program clients. Advisers sponsoring a wrap program, should include processes for determining whether a wrap fee program is in a client’s best interest and identifying infrequently traded accounts. Any adviser managing wrap program clients should be monitoring and validating best execution for client transactions.
WHAT DOES THIS MEAN FOR ME?
Make sure to integrate the SEC’s guidance and check for any compliance gaps if your firm sponsors or participates as an adviser within a wrap fee structure for any of its clients. Proactively adjust your wrap fee account operations to continually meet fiduciary obligations, provide clients with full and fair disclosure, and implement appropriate policies and procedures.
If your firm requires assistance with meeting wrap fee program compliance expectations, Fairview can help. We support registered investment advisers by creating and implementing comprehensive, sustainable compliance programs with the help of our in-house regulatory experts. Contact us today for more information about our services.
