Show Me the Money
How are you getting paid? That is the question that the SEC is focused on in recent regulatory examinations of investment advisers. In two recent document request letters, the focus on advisory fees and account reconciliation has never been more prominent. But that should not be a surprise to advisers since the SEC includes this topic in their 2021 examination priorities.
Within the Exam Priorities, the SEC stated, “The Division will continue to focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed, compensation arrangements. Recent market volatility and industry pressures have impacted fees and other revenues collected by firms. These conditions may cause increased financial stress on firms and their personnel, which may, in turn, lead to increased instances of fraudulent conduct.” So frankly, the SEC wants to ensure advisers are not inflating fees to cover losses from 2020!
So, what exactly is the SEC interested in? Based on our review of recent document request letters, it appears they are zeroing in on calculation of fees, reconciliation of quarter-end balances, householding of accounts for fee-billing purposes, just for starters.
In the SEC Exam Priorities Letter, they said focus would be paid to, “… concerns may arise when an RIA does not aggregate certain accounts for purposes of calculating fee discounts in accordance with its disclosures. In reviewing fees and expenses, the staff will review for: (1) advisory fee calculation errors, including, but not limited to, failure to exclude certain holdings from management fee calculations; (2) inaccurate calculations of tiered fees, including failure to provide breakpoints and aggregate household accounts; and (3) failures to refund prepaid fees for terminated accounts.”
Here is just a sample of the questions investment advisers are being asked to substantiate:
- Indicate if fees are subject to householding and how households are determined.
- Provide all compliance and operational policies and procedures, including desktop procedures related to fee billing.
- Any written interim or annual compliance reviews, internal control analyses, and forensic or transactional tests performed in relation to client fee billing. Include any significant findings, both positive and negative, and any information about corrective or remedial actions taken regarding these findings.
- Adviser’s general ledger, subsidiary ledgers, and journals related to client fee billing for the Examination Period, including fee offsets and refund of prepaid fees.
Now is the time to focus your compliance testing on the topic of advisory fee billing; especially for retail clients. Ask yourself these questions to get started:
- Do you have a policy on the billing of cash?
- Does the firm have a policy on billing on clients’ legacy or unpriced assets?
- Who handles billing and what supervisory review is performed by an independent party?
- If you bill in advance, how are you handling the cash flows throughout the quarter? Is your billing system set up to adjust fees based on significant cash flows into and out of the accounts throughout the quarter or do you have to manually adjustment? If manual, how are you ensuring the accuracy of the calculations are accurate.
If you do not perform quarterly or periodic testing of your fee bill calculations, now would be a great time. Forensic testing can include sampling client accounts to determine if their fees are aligned with the stated fee schedule detailed in the advisory agreement, breakpoints, and householding policies. Review the language within your Form ADV Part 2A and Investment Management Agreements to ensure there is consistency between them. Document all your results, especially if you determine there were discrepancies in your practices. Finally, determine whether your compliance policies accurately reflect your firm’s practices and are reasonably designed to mitigate errors.
Our next “For CCOs, By CCOs” webinar series will cover regulatory exams on September 16. For more information or to speak with a regulatory expert, please email info@cssregtech.com.