INVESTMENT ADVISERS—Division of Examinations issues Risk Alert on investment advisers’ fee calculations - 15 November 2021

The Division has supplemented a previously issued Advisory Fees Risk Alert by providing greater detail on compliance issues observed during the recent Advisory Fees Initiative examinations.

The SEC's Division of Examinations has issued a Risk Alert supplementing a previously published Advisory Fees Risk Alert by providing greater detail on certain compliance issues observed during the recent Advisory Fees Initiative examinations, including additional details regarding the staff’s observations concerning fee-related deficiencies and fee-related compliance and disclosure issues. The Division encourages advisers to routinely review, refine, and improve their fee billing policies, procedures, and practices and address new risks as they are identified. In addition, advisers should review their disclosures regarding such practices to ensure that clients are provided with full and fair disclosure of all fees and expenses and related material conflicts of interest.

Advisory fee calculations. The staff observed that several examined advisers charged advisory fees inaccurately. These inaccurate calculations were due to a variety of errors, including that inaccurate percentages were used to calculate advisory fees, advisory fees were double-billed, breakpoint or tiered billing rates were not correctly calculated, householding of client accounts were not correctly calculated, and incorrect client account valuations were used. Several examined advisers either did not refund prepaid fees on terminated accounts or did not assess fees for new accounts on a pro-rata basis. The staff identified the following issues related to refunding prepaid fees: 1) inconsistently refunding unearned fees; and 2) requiring clients to provide written requests to refund unearned advisory fees.

False, misleading or omitted disclosures. Several of the examined advisers were identified as having a range of disclosure issues. The issues identified were related to incomplete or misleading Form ADV Part 2 brochures and other disclosures that: (1) did not reflect current fees charged or whether fees were negotiable; (2) did not accurately describe how fees would be calculated or billed; and (3) were inconsistent across advisory documents, such as stating the maximum fee in an advisory agreement that exceeded the fees disclosed in the adviser’s brochure. Examples of issues with fee-related disclosures that the staff observed, included cash flows and their effect on fees, timing of advisory fee billing, valuations for fee calculations, and minimum fees, extra fees, and discounts.

Missing or inadequate policies and procedures. The staff observed that many of the examined advisers did not maintain written policies and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both. Some examples of the staff’s observations included policies and procedures that specifically address fee calculations and policies and procedures to address material advisory fee components.

Inaccurate financial statements. The staff observed issues or inaccuracies with financial statements at several examined advisers with respect to advisory fees. These issues included examined advisers in potential financial distress and examined advisers not properly: (1) recording pre-paid advisory fees as liabilities; or (2) maintaining their financial statements. Some examples included not recording all advisory fee income, administrative fee revenue, and compensation expenses in general ledgers and on financial statements, as well as using a cash and modified cash basis of accounting but preparing financial statements on an accrual basis of accounting.

Staff observations regarding industry practices. During the examinations, the staff observed advisers implementing a range of policies and practices to address their legal and regulatory obligations related to compliance issues. The staff is providing the following examples of policies and practices to assist advisers with compliance: 1) adopt and implement written policies and procedures addressing advisory fee billing processes and validating fee calculations; 2) centralize the fee billing process and validate that the fees charged to clients are consistent with compliance procedures, advisory contracts, and disclosures; 3) ensure resources and tools established for reviewing fee calculations are utilized; and 4) properly record all advisory expenses and fees assessed to and received from clients, including those paid directly to advisory personnel.

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